FOMC20080130meeting--3 1,MR. POOLE.," Thanks, Mr. Chairman. I came here 10 years ago with a boom. I'm going out with a pause. [Laughter] " fcic_final_report_full--96 The Boom and Bust  6 FOMC20060510meeting--100 98,MR. POOLE.," Okay. Anyway, he said that their construction costs—for a store, I guess—have come in 27 percent above expectations. Their construction costs are even higher in the Gulf Coast area. He also said that Wal-Mart is in the process of raising starting wages in about 700 stores. This is the first time in eight years of talking with him that I’ve heard any comment like that. He said that some of the raises are part of the Wal-Mart, I’ll call it “social/political,” agenda because of all the controversy about Wal-Mart. But he said about 125 of these were market driven, that they have plenty of labor in rural areas and in urban areas, but they are developing a labor supply problem for their stores in suburban areas. Suburban areas are strong. I have received some unsolicited e-mail messages—well, I guess to be fair they’re sort of solicited. [Laughter] These are from two directors: “Heavy construction industry is really hot. In the past month, I have received reports of a second round of capital cost increases of 25 to 40 percent in the refining industry, and the same for construction of large power plants. These estimates follow similar increases last summer.” Another message discussed pressures on the cost of construction materials. I won’t read the whole thing. It says, “We believe we are now on the front side of a real surge in prices that will mainly affect highly volatile commodity building products—steel, copper, aluminum, and zinc. However, if it is sustained, it will ripple across a broad range of more-manufactured products.” Now, very briefly, I’ve made a list of what I think are classic inflation warning signs, and I’ll just rattle these off very quickly. Inflation expectations—we’ve talked about that. Dollar depreciation. Commodity prices are really breaking out of a trading range that has prevailed for about fifteen years— if you look at the chart in the Greenbook Part 2, you’ll see that. The surge in construction costs—I think there is a building boom indicating business confidence, and, of course, a direct source of aggregate demand. Relatively low risk spreads, making it easy for firms to raise capital. Strong stock market. Strong corporate profits. From our anecdotal information, some increase in pricing power. And a worldwide boom. There is growth in almost every region of the world, and, of course, that translates to some extent into price pressures everywhere, including goods that we import and goods that we export, at least eventually. I’ll stop there. Thank you." CHRG-111shrg57319--595 Mr. Killinger," I believe we were talking about back in the housing boom period? Senator Levin. Yes. And you were talking about your high-risk products? " CHRG-111hhrg54868--85 Mr. Scott," I know my time is running out. It is about to run out, too. But I did want to get to, why are so many banks closing, especially in the State of Georgia? What is there? Is there something we can point to that is going on in Georgia to explain why so many of these banks are closing? Ms. Bair. There are a lot of banks in Georgia. It was a boom area. Now, many of the boom areas are bust areas. There is residential mortgage distress and a lot of commercial real estate distress as well. In Georgia, like other parts of the country, it is broader economic problems that are feeding losses on bank balance sheets, which is driving closures as well. One of the best things you can do for the banking system, especially community banks, is to get the economy going again quickly, keep the unemployment rate down, get those retailers back in business, and get those hotels full again. Those are the kinds of things that will help banks as well. In Georgia, bank closures were a symptom of a lot of banks existing in the State, plus it was a great boom area. And as in other areas, like Florida, southern California, and Nevada, Georgia is having a severe bust now. " FOMC20050809meeting--109 107,MR. WILCOX., I can point to two main factors. One is simply the aging of the population. The baby boom cohorts are moving into an age of lower participation rates. CHRG-111shrg57319--452 Mr. Killinger," Yes, that is right. I just wanted to be sure that we understood the primary cause was that the refinancing boom from 2002 and 2003 subsided in the other period. Senator Levin. Now, you also changed your strategy. What year was that? " CHRG-109hhrg22160--215 Mr. Greenspan," I did not use it yesterday in the Senate. I consider the problem a very serious one, one that has to be addressed, in my judgment, quite soon, and certainly to be in place well before the 2008 leading edge of the baby boom generation retiring. " FOMC20060131meeting--54 52,CHAIRMAN GREENSPAN.," In other words, whether that bill passes or not, the pressures to fund these liabilities are going to increase, especially after the baby-boom generation starts to retire and fund managers look at the size of it." CHRG-111hhrg55809--40 Mr. Bernanke," There are tough questions there. I guess I would--it is not just a question of specialization. Unfortunately, financial crises, booms and busts are a long-standing problem of capitalism; and they have, I think, a special role in the broader-- " FOMC20080130meeting--148 146,MR. PLOSSER.," So are these ""extra channels""-- if you want to call them that--typically part of the forecast change and how you evaluate? That is to say, in the fall, when the stock market booms 10 percent, are we going to get another kicker upward in r* due to these same factors? " CHRG-111hhrg55809--58 Mr. Royce," Let me ask you another question. Some economists are arguing that the Fed not only lost control, but its policy actions have unintentionally become procyclical--encouraging financial excesses instead of countering the extremes. And this gets to the point that has been argued by many economists. In fact, Friedrich Hayek won the Nobel Prize in 1974 for arguing that artificially low interest rates lead to the misallocation of capital and the bubbles which then lead to bursts. Looking back, do you agree that the negative real interest rate set by central banks from 2002 to 2006 had a dramatic impact on the boom and the subsequent bust, especially when you take into consideration what was already an inflating housing bubble with the drastic steps taken by the Federal Government to encourage less creditworthy borrowers to get into loans they could not afford? Do you think those combinations could have had an impact on that boom-bust? " CHRG-109hhrg28024--240 Mr. Pearce," Looking 10 years into the future, when we're in the depth of the baby boom retirement and the number of skilled workers available, and again setting aside skilled versus unskilled on immigration, do you see enough reason that we'd need workers to come into the country, or do you think we can solve our internal problems with the people who are available in the next generations? " CHRG-111hhrg55814--158 Secretary Geithner," Congressman, there is one part of that quote you omitted, which is, I said, monetary policy around the world was too loose, too long. But I think it's very, you're right to say that this crisis was not just about the judgment of individuals to borrow too much or banks to lend too much. It wasn't just about failures in regulation supervision. It was partly because you had a set of policies pursued around the world that created a large credit boom, asset price boom. And I think you're right to emphasis that getting those judgments better in the future is an important part of the solution. Dr. Paul. Okay. On the issue that it's worldwide and we don't have the full responsibility, there's a big issue when you are running and managing the reserve currency in the world and other countries are willing to take those dollars and use those as their asset and expand and monetize their own debt, so it's all, we're not locked in a narrow economy, it's a worldwide economy and it's our dollar policy and our spending habits and our debt that really generated this worldwide crisis. That's why it's not a national crisis; it's a worldwide crisis. " CHRG-109hhrg31539--55 Mr. Bernanke," Our concern, Congresswoman, is to achieve a sustainable growth path. We don't want to get into a situation where we get into a boom and bust. We don't want to get into inflation, because inflation also detracts from the buying power of workers and the consumers. So we are looking to try and achieve a sustainable growth path. We are aware of the risks to that, and we are going to do our utmost to achieve that. " CHRG-109hhrg28024--90 Chairman Oxley," The gentleman yields back. The gentlelady from Indiana, Ms. Carson. Ms. Carson. Thank you very much, Mr. Chairman, and thank you, Mr. Chairman, for being here today. I have a quick question concerning the housing market. At one point it was just skyrocketing and booming, and now it seems to be on the decline. Could you anticipate what kind of effect, impact that's going to have on the domestic economic growth? " CHRG-111hhrg54867--161 Mr. Lucas," Because, after all, Secretary, in my region, we went through both an agricultural and energy property boom, bust, and bubble in the 1980's. We were slaughtered economically. We did not receive capital injections. Our industries were not propped up. It took us, 10, 15 years in some segments to recover from it. We do not wish that on anyone else, but by the same token, let us not make the matter worse because the feud back home is, it was the big boys that damn near killed us all, not the little players. " CHRG-111shrg54533--33 Secretary Geithner," Our plan does not address a range of other causes of this crisis, including policies pursued around the world that helped produce a long period of very low interest rates and a very, very substantial boom in asset prices, housing prices, not just in this country but in countries around the world. And I think you are right to underscore the basic fact that a lot of things contributed to this crisis. It was not just failures in supervision and regulation. And as part of what the world does, major countries around the world, in trying to reduce the risk we have a crisis like this in the future, it will require thinking better through how to avoid the risk that monetary macroeconomic policies contribute to future booms and asset prices and credit bubbles of this magnitude. Senator Bunning. Your plan puts a lot of faith in the Federal Reserve's ability to spot risk and exercise its power to prevent the next crisis. However, if the Fed and other regulators have been doing their jobs and paying attention to what the banks and other firms were doing earlier this decade, they almost certainly could have prevented the mess. And the Fed has proven it is unwilling to use its power it has. Let me give you an example. Just look how slow it addressed the credit card abuses, and it took 14 years for the Fed to write one regulation on mortgages after we gave them the power to do that. So giving them the power and making them act are two different things. What makes you think that the Fed will do better this time around? " CHRG-111shrg55739--116 Mr. Coffee," I think that what some of us are saying is that you could certainly have alternatives that did not involve the use of an NRSRO agency. But to the extent that there already is this reputational capital out there in the public's mind and they are going to want you to have an NRSRO rating, some of us want to make that real and not illusory by insisting on due diligence. And that due diligence, to answer your earlier question, would probably be paid for by the underwriters. If the underwriters could get this market jump-started again, they would be happy to pay the cost of due diligence. Senator Corker. Thank you all. I appreciate it. Senator Reed. Thank you, Senator Corker. Senator Bunning. Senator Bunning. Thank you. Five minutes turns into 10 in a big hurry up here, and that is the only reason--since some of us have another meeting to go to. This is for anyone who would like to answer it. During the housing boom--the boom--rating agencies rated mortgage-backed securities without verifying any of the information about the mortgages. If they had, maybe they would have detected some of the fraud and bad lending practices. Do you think rating agencies should be required to verify the information provided to them by the issuer? And I am going to give you a caveat. The first mortgage that I ever took, I had to take three of my Federal tax returns in with me to verify that I had the income that I wrote on my application. You do not have to do any of those things right now, and I am asking if you think we ought to have a little more verification of what is on the list that the person who is looking for the mortgage at the time--and that is how we got into all this mischief with mortgage-backed securities being sold into the market without any verification, even though they were AAA rated. " CHRG-111hhrg51698--50 Mr. Gooch," Yes. I think that there is a danger in doing something drastic with a marketplace that exists now that is very liquid, and has actually functioned very well throughout the credit crisis. I would just like to point out that the taxpayer, in any case, in the United States of America, 50 percent of the country doesn't even pay taxes under Obama's tax plans; and so they are not picking up the tab. During the boom, when things were going very well and profits were being made, the government was taking a 35 percent corporate tax, the government was taking 38 percent, 35 percent taxes on incomes, and 15 percent capital gains. So, during the boom times, the government was taking more than 50 percent of the upside. And when you go through a cycle, which this one happens to be extremely severe, the government needs to then become involved in stepping in and paying their fair share in stabilizing the marketplace. But to step in now and kill the credit derivative market at this point in time where we are very delicately trying to get banks to lend, and they won't lend until they get these bad assets off their balance sheets. All this money that is sitting on the sidelines is willing to sell credit derivatives, which reduces cost of borrowing; and they won't be willing to sell them if they can't buy them naked. You will kill the credit derivative market and, in my opinion, extend the recession, possibly even creating a deeper recession for a very, very long period of time. " CHRG-109hhrg28024--247 Mr. Bernanke," The share of GDP that took the form of revenues in 2000 was about 21 percent, which was the post-war high, and certainly in retrospect, we can say that a good bit of that was due to the unsustainably high level of the stock market, in particular, capital gains, bonuses, and stock options, and the fact that firms did not have to contribute so much to their pension plans because their valuations were rising with the stock market and, therefore, they reported higher profits. So a significant portion of the tax collection clearly was related to the stock market boom of that period. " FOMC20070321meeting--58 56,MR. POOLE.," Dave, I have a question related to housing. I gather that a good part of the projection that the drag from housing will work off by the end of this year comes from the belief that sales will gradually clean out the inventory of unsold homes and, once that happens, construction can return to the rate of sales. That’s the unsold inventory of recently built new homes that I guess have never been occupied. If you take the housing boom over, say, the three years ending in the middle of last year, was there an accumulation of houses that ran beyond the underlying demographics and income—and the financing costs, too? I’m interested in those longer-run determinants of the equilibrium stock of housing. Did we end up with a stock of housing that outran the underlying long-run determinants and has to be worked off—in the sense that the underlying determinants have to catch up to the stock that has already been constructed?" FOMC20080625meeting--82 80,MR. BULLARD.," Thank you, Mr. Chairman. The District economy continues to be sluggish. Severe weather, combined with a very wet spring, is hampering agriculture in some areas. Major flooding has caused significant damage already, and the situation continues to develop. Many business contacts in the District emphasize energy costs along with some other high commodity prices as an overriding concern. Most of the descriptions I have encountered concern businesses and consumers scrambling to adjust to new pricing realities. Many contacts are reporting skittishness over the inflation outlook, fueled by dramatic increases in key commodity prices. Many contacts with deep experience in the commodities markets remain convinced that market manipulation or speculation is behind the run-up in commodity prices across the board over the past several years. This belief is widespread and deeply held. Many predict a crash in market prices of these commodities once the bubble bursts. My assessment is that this very strong belief may, by itself, have important macroeconomic implications. Businesses and households may be reacting very differently to price increases that they see as temporary, as opposed to their reaction if they view price increases as permanent and unlikely to reverse. Reports on the level of economic activity are decidedly mixed. The housing sector remains in a deep slump and subject to a widespread shakeup. Business in the energy sector continues to boom. High energy prices are affecting the logistics business, which has to try to be profitable at higher prices with reduced demand. Still, a very large retailer reports brisk activity, and a large technology firm is essentially unaffected by the macroeconomic slowdown. Recent data on the U.S. economy have been stronger than forecast, keeping economic performance weak but avoiding a particularly sharp contraction. The worst outcomes stemming from financial market turmoil have failed to materialize thus far. There is, to be sure, still some potential for additional upheaval, depending in part on the managerial agility among key financial firms. However, the U.S. economy is now much better positioned to handle financial market turmoil than it was six months ago. This is due to the lending facilities now in place and to the environment of low interest rates that has been created. Renewed financial market turmoil, should it occur during the summer or fall, would not now be as worrisome from a systemic risk perspective. In addition to this lessened risk from financial markets, I see the drag from housing dissipating during the second half of the year. Most likely we will also see a moderation in energy price increases. Output growth is, therefore, likely to be moderately stronger going forward. Policy was very aggressive during January and March of this year. This was, in part, a preemptive action, insurance against a particularly severe downturn brought on by financial contagion. This was a very real possibility, but it did not materialize. This has created a situation with more stimulus in train than would have been intended had we known the outcome in advance. This is putting upward pressure on inflation and inflation expectations in the second half of this year. Policy has to turn now to face this situation. On the long-term projections, I think it is a good idea to put down long-term projections. I am happy with any of the options. I have a slight preference for option 3. I think a trial run would be good. If the objective is to name these numbers, such as an inflation target or the potential growth of the economy, another way to do it would just be to name those numbers and not have it tied to any projection or any particular year. We could just say, ""This is what I think the inflation objectives should be. This is how fast I think the economy could grow in the absence of shocks. And this is what I think the unemployment rate would be if output were growing at potential and inflation were at target."" You could just name those numbers. You wouldn't have to say five years away or ten years away, which kind of brings in new long-run factors that you might not want to get into. Thank you. " CHRG-111hhrg55809--59 Mr. Bernanke," We are actually looking very carefully at this question because it is very important for policy going forward, and I think we need to keep an open mind. Having said that, I think that the very strong way you stated it is probably an overstatement. I think there are a lot of reasons to think that there were other factors involved in the housing boom and bust besides monetary policy. And I would say secondly that a strong, well-regulated financial system should not have been crashed by an increase and decrease in house prices. I think the failures of regulation, supervision and oversight allowed this to become as big a deal as it was. So I think that is a very high priority right now. " CHRG-111hhrg53245--133 Mr. Watt," Thank you, Mr. Chairman. Ms. Rivlin, I confess I am having a little trouble understanding what you would do. You talk about a ``macro system stabilizer'' and then you talk about a ``systemically important'' or somebody who is over--I thought that what you were proposing was akin to what the Obama Administration has proposed, that the Fed be put in charge of the kinds of things that you indicate a ``macro system stabilizer'' would do, but you seem to have some concerns about that. Can you clarify what it is you are proposing? Ms. Rivlin. Yes. I am proposing the exact opposite of what the Obama Administration is proposing. We both recognize that there are two kinds of tasks here. One is spotting problems in the system that might lead to excessive boom or a crash. " CHRG-111shrg57319--481 Mr. Killinger," Again, that product or that feature has been around for many years. I think what we are all dealing with is the housing crisis, or the housing boom grew and as competition grew, the use of limited documentation and no documentation kind of loans certainly expanded. And as we were commenting earlier, as we became more concerned that the housing market had increased in risk, I think that is one of the elements we all started to take a look at. So in our case, we started to cut back on our originations. We eliminated some of the product offerings. We tightened underwriting. As I heard from David Schneider earlier this morning, at one point, we also decided that limited documentation loans were not appropriate. Senator Kaufman. And what size mortgages were stated income loans used for at WaMu? " CHRG-110shrg50369--69 Mr. Bernanke," Well, and from a fiscal perspective in the longer term--and by longer term, I means only a few years from now because we are coming very close to the point where the baby-boom generation is going to begin to retire in large number. By far, the biggest issue is entitlements, particularly the Medicare part, but Social Security as well. Senator Allard. Yes, I appreciate those comments. The other thing, you talk about, you know, inflation being pushed by energy and food costs. What is offsetting that? There must be some--to come out with an average of 2 percent, a little over 2 percent, there must be somewhere over here where we are getting a lesser amount that is offsetting those increases. Where do you see that happening? " FOMC20081216meeting--153 151,MR. AARONSON.," Housing and construction always go down, so we take that out, and then we say, okay, so now there are these atypical movements that are greater than we usually see. That is what we would consider the sectoral reallocation. That is what is left over. You can see, as I mentioned in the briefing, that actually during recessions there is a lot of sectoral reallocation, even once you take out the usual declines in employment that differ across industries. That is because each recession has different causes. Different industries have grown a lot during the boom--like finance recently or, say, communications during the late 1990s--and those sectors are going to shrink more than usual during the recessions and get back to more of an equilibrium state. That is what is going on here. " CHRG-110hhrg44901--202 Mr. Perlmutter," First, Mr. Chairman, just thank you for the time that you have given to us. Thank you for rolling up your sleeves, working with the Secretary of the Treasury, and working with our chairman to try to deal with a lot of tough problems you have out there. There is no minimizing what those problems are. Like I said, I found a wealth of information in your report, some of it pretty disturbing. I don't know if you have it in front of you, but on page 25 of the report, there are several graphs there, and I just ask you about on the commercial paper it looks like everything is going along hunky-dory, and then boom, there is an earthquake in the summer of 2007. That same thing applies in the graph below it. What happened in the summer of 2007 that just has caused this tremendous upheaval right now? " fcic_final_report_full--117 The origination and securitization of these mortgages also relied on short-term fi- nancing from the shadow banking system. Unlike banks and thrifts with access to de- posits, investment banks relied more on money market funds and other investors for cash; commercial paper and repo loans were the main sources. With house prices al- ready up  from  to , this flood of money and the securitization appara- tus helped boost home prices another  from the beginning of  until the peak in April —even as homeownership was falling. The biggest gains over this pe- riod were in the “sand states”: places like the Los Angeles suburbs (), Las Vegas (), and Orlando (). FOREIGN INVESTORS: “AN IRRESISTIBLE PROFIT OPPORTUNITY ” From June  through June , the Federal Reserve kept the federal funds rate low at  to stimulate the economy following the  recession. Over the next two years, as deflation fears waned, the Fed gradually raised rates to . in  quarter- point increases. In the view of some, the Fed simply kept rates too low too long. John Taylor, a Stanford economist and former under secretary of treasury for international affairs, blamed the crisis primarily on this action. If the Fed had followed its usual pattern, he told the FCIC, short-term interest rates would have been much higher, discourag- ing excessive investment in mortgages. “The boom in housing construction starts would have been much more mild, might not even call it a boom, and the bust as well would have been mild,” Taylor said.  Others were more blunt: “Greenspan bailed out the world’s largest equity bubble with the world’s largest real estate bubble,” wrote William A. Fleckenstein, the president of a Seattle-based money management firm.  Ben Bernanke and Alan Greenspan disagree. Both the current and former Fed chairman argue that deciding to purchase a home depends on long-term interest rates on mortgages, not the short-term rates controlled by the Fed, and that short- term and long-term rates had become de-linked. “Between  and , the fed funds rate and the mortgage rate moved in lock-step,” Greenspan said.  When the Fed started to raise rates in , officials expected mortgage rates to rise, too, slow- ing growth. Instead, mortgage rates continued to fall for another year. The construc- tion industry continued to build houses, peaking at an annualized rate of . million starts in January —more than a -year high. As Greenspan told Congress in , this was a “conundrum.”  One theory pointed to foreign money. Developing countries were booming and—vulnerable to financial problems in the past—encouraged strong saving. Investors in these coun- tries placed their savings in apparently safe and high-yield securities in the United States. Fed Chairman Bernanke called it a “global savings glut.”  CHRG-111hhrg56776--58 Mr. Bernanke," Congressman, interest rates are very low right now, and I do not think building too many houses is really a problem. Dr. Paul. That makes a very important point. In the boom part of the cycle, the low interest rates cause people to do things that might not be proper and best for the economy, and then when the bust comes, we resort to the same policy of keeping interest rates extremely low for too long. What are the chances--do you think there is any chance in a year or two or three from now we will look back and say well, not only were they too low for too long in the early part of the decade, they were too low for too long in the latter part of the decade? When the prices start to go up, it is sort of a little bit too late, and then you have the job of reigning that all in. " CHRG-111hhrg48873--268 Mr. Lucas," Thank you, Mr. Chairman. Let us continue to look at the process of cleaning up behind this parade. In Oklahoma, in the 1980's, we went through a twin agriculture and energy resource boom and bust. And it was fascinating after the FDIC got done stomping through the arena how 5 and 10 and 15 years later, amazingly there were some millionaires made of dealing and disposing of these assets. Could we talk for a moment about the public-private investment fund? And if you could, just let me give you a real world--from a perspective of the real world. For a typical investor who might participate in this kind of a thing, this effort to clean up the legacy assets, the toxic assets, for $100, it could be $100 million, it could be $100 billion, but for $100, how many dollars' worth of assets, Secretary, do you envision that controlling or being worth? " CHRG-111hhrg67816--79 Mr. Rush," The chair thanks the chairman. The chair recognizes himself for 5 minutes for the purposes of questioning our witness. Chairman Leibowitz, during the housing boom the FTC had clear jurisdiction over many of the worse predatory lenders with the most objectionable practices, but the Commission arguably didn't do much to address any of these activities. As a matter of fact, it was the states that successfully brought actions against lenders such as Countrywide and AmeriQuest when there are abusive lending practices in the sub-prime mortgage market. In the second panel Attorney Jim Tierney will talk about these and other issues a little more. But to begin with, I want to ask a simple question to you. What happened at the FTC? Why did the FTC not take aggressive action against mortgage lenders in the earlier part of this decade? " CHRG-110shrg46629--107 Chairman Bernanke," We, of course, had many areas of rapid innovation in the past and it is just one of the long-standing economic irregularities that the share of capital and labor tends to stabilize over time. We saw in the 1990s, for example, that capital went ahead of labor for a while during the productivity boom and then labor began to catch up again. So, I do think that we will see a more normal---- Senator Bayh. I do not want to use all my time on this question and I apologize for interrupting. We are not for redistributing wealth overtly. But to judge at least by the first part of your answer, if the economy is rewarding more highly skilled parts of the labor force better, then perhaps a focus on education, access to college, and those kind of things might empower the middle class to enjoy a larger share of the wealth. " CHRG-111hhrg48873--293 Mr. Bernanke," Congressman, I certainly do not reject capitalism. I don't think this was a failure of capitalism per se. And I also think the free market should be the primary mechanism for allocating capital. Markets have shown over many decades that they can allocate money to new enterprises, to new technologies, very effectively. And so we want to maintain that free capital market structure. It is nevertheless the case that we have seen over the decades and the centuries that financial systems can be prone to panics, runs, booms, and busts. And for better or worse, we have developed mechanisms like deposit insurance and lender of last resort to try to avert those things. Those protections, in turn, require some oversight to avoid the buildup of risk. Dr. Paul. May I interrupt, please? " FOMC20080130meeting--180 178,MR. HOENIG.," Thank you, Mr. Chairman. Let me talk a bit about the region. The Tenth District is generally moving forward at a fairly steady pace, but there are some mixed data. The obvious wide variances are in real estate. Housing is weak--not as weak as some parts of the country but still weak. Also, it is interesting that commercial real estate in each of our major cities right now continues to do well. I recently talked with several developers. They are all doing well but are very concerned, and they are beginning to cut back on their plans and move away from them. So you can see the worry carrying forward in terms of what actions they are taking. In the agricultural area and in the energy area, real estate is a different story. It is booming. Land values have gone up in the ag part--non-irrigated land, something like 20 percent over the past year. If you are near an ethanol plant, it has gone up 25 to 30 percent. It is also interesting that the ag credit system is helping to fund that. Their increase in lending was about 12 percent this past year. That is up from about 9 percent the year before, so they are providing that. They are also now involved in lending to these ethanol plants in a very significant way, helping to carry that boom forward. That gives me some pause in terms of what is going on in some of the rural areas. Related to that, the energy and lease values are also accelerating at a fairly high rate. I found it reminiscent and somewhat disturbing in talking to a couple of individuals when they noted that the land values have about doubled over the past two or three years in some areas, and they said that I should relax because on current ag prices they should have tripled. [Laughter] Where have I seen that before? On the other side, actually, manufacturing in our region has held steady. We have a lot of aircraft manufacturing, which is really strong, and some other smaller manufacturers providing support in both ag and energy, and they seem to be doing well. Technology is also doing well in the region, especially in the mountain areas--the Colorado and Denver areas. Engineering firms are still very strong--the strong demand for engineers and the unfilled positions continue. They are supplying that service across the globe and see continued demand there. So it is mixed, but overall probably our region is doing better than average relative to the rest of the nation. On the national level, my projections suggest that we are going to grow below our potential growth rate. I am not as pessimistic as the Greenbook. I also have inflation coming down, but that is on the assumption that we are able to reverse our monetary policy at a fairly quick pace as we move through this year and into 2009. I will leave it there. Thank you. " CHRG-110shrg46629--47 Chairman Bernanke," It is not our expertise to directly say that this deal is a good deal and that deal is a bad deal. What we try to do is make sure that the banks and the investment banks themselves have good controls, have good models, have good approaches, have good risk management so that they can make what we believe to be, in general, appropriate decisions about these instruments. Senator Reed. Let me shift gears again, Mr. Chairman, to try to cover a lot of ground. We have witnessed all a booming housing market until very recently. As your predecessor, Chairman Greenspan, opined in many homes their increasing equity valuation was an ATM that they could go to without leaving the house. Current estimates are that equity withdrawals are down precipitously, 70 percent from 2005. What is your view of the macroeconomic effect as people can no longer essentially use their equity as a quick source of cash? " FOMC20080130meeting--330 328,MS. YELLEN.," I wanted to support President Poole's comment. I remember very well back at Jackson Hole in 2005 that Raghuram Rajan presented a paper in which he emphasized the misalignment of incentives between investors and managers and the fact that almost everyone down the line right up to the investors themselves should have had incentives here. I don't know what they were thinking, but everybody was rewarded for the quantity and not the quality of originations. He warned us before any of this happened that this could come to no good, and I think he did have some suggestions about compensation practices. These were not popular suggestions. So I think this is worth some thought. I don't know what the answer is in terms of changing these practices. Maybe the market will attend to them, but it seems to me that we have had an awful lot of booms and busts in which this type of incentive played a role. Your presentation and the paper started from the fact that you note the deterioration in underwriting, but we should go one step backward. I suppose another issue here is what we saw in our supervision and whether we acted appropriately given what we saw. That raises a number of issues that I won't go into at the moment but that I think we need to be sensitive to. " CHRG-111hhrg49968--18 Mr. Bernanke," Mr. Ryan, I certainly am concerned about that. I think we face a double challenge. One is that we have to restore ourselves to a more balanced fiscal path after addressing the financial and economic crises that we currently are facing. But, in addition, that is complicated by the fact that with the retirement of the baby boom and the increase in medical costs that we are facing rising entitlement costs, which--this is no longer a long-term consideration. This is something that has got to happen in the next 5 or 10 years. So that is extraordinarily challenging. My rough rule of thumb to the Congress would be, given that we have seen this increase in the debt-to-GDP ratio, that we should hope to try to at least stabilize it at the higher level and over time to try to reduce it. But certainly we cannot allow ourselves to be in a situation where the debt continues to rise, that means more and more interest payments, which then swell the deficit, which leads to an unsustainable situation. So it is very, very important that we---- " fcic_final_report_full--173 As one recent study argues, many economists were “agnostics” on housing, un- willing to risk their reputations or spook markets by alleging a bubble without find- ing support in economic theory.  Fed Vice Chairman Donald Kohn was one. “Identification [of a bubble] is a tricky proposition because not all the fundamental factors driving asset prices are directly observable,” Kohn said in a  speech, cit- ing research by the European Central Bank. “For this reason, any judgment by a cen- tral bank that stocks or homes are overpriced is inherently highly uncertain.”  But not all economists hesitated to sound a louder alarm. “The situation is begin- ning to look like a credit-induced boom in housing that could very well result in a systemic bust if credit conditions or economic conditions should deteriorate,” Federal Deposit Insurance Corporation Chief Economist Richard Brown wrote in a March  report. “During the past five years, the average U.S. home has risen in value by , while homes in the fastest-growing markets have approximately doubled in value.” While this increase might have been explained by strong market fundamen- tals, “the dramatic broadening of the housing boom in  strongly suggests the in- fluence of systemic factors, including the low cost and wide availability of mortgage credit.”  A couple of months later, Fed economists in an internal memo acknowledged the possibility that housing prices were overvalued, but downplayed the potential im- pacts of a downturn. Even in the face of a large price decline, they argued, defaults would not be widespread, given the large equity that many borrowers still had in their homes. Structural changes in the mortgage market made a crisis less likely, and the financial system seemed well capitalized. “Even historically large declines in house prices would be small relative to the recent decline in household wealth owing to the stock market,” the economists concluded. “From a wealth-effects perspective, this seems unlikely to create substantial macroeconomic problems.”  fcic_final_report_full--170 ALL IN CONTENTS The bubble: “A credit-induced boom” ................................................................  Mortgage fraud: “Crime-facilitative environments” ..........................................  Disclosure and due diligence: “A quality control issue in the factory” ................  Regulators: “Markets will always self-correct” ...................................................  Leveraged loans and commercial real estate: “You’ve got to get up and dance” ...................................................................  Lehman: From “moving” to “storage” ................................................................  Fannie Mae and Freddie Mac: “Two stark choices” ...........................................  In , the Bakersfield, California, homebuilder Warren Peterson was paying as lit- tle as , for a ,-square-foot lot, about the size of three tennis courts. The next year the cost more than tripled to ,, as real estate boomed. Over the pre- vious quarter century, Peterson had built between  and  custom and semi-custom homes a year. For a while, he was building as many as . And then came the crash. “I have built exactly one new home since late ,” he told the FCIC five years later.  In , the average price was , for a new house in Bakersfield, at the southern end of California’s agricultural center, the San Joaquin Valley. That jumped to almost , by June .  “By , money seemed to be coming in very fast and from everywhere,” said Lloyd Plank, a Bakersfield real estate broker. “They would purchase a house in Bakersfield, keep it for a short period and resell it. Some- times they would flip the house while it was still in escrow, and would still make  to .”  Nationally, housing prices jumped  between  and their peak in ,  more than in any decade since at least .  It would be catastrophically downhill from there—yet the mortgage machine kept churning well into , apparently in- different to the fact that housing prices were starting to fall and lending standards to deteriorate. Newspaper stories highlighted the weakness in the housing market— even suggesting this was a bubble that could burst anytime. Checks were in place, but  they were failing. Loan purchasers and securitizers ignored their own due diligence on what they were buying. The Federal Reserve and the other regulators increasingly recognized the impending troubles in housing but thought their impact would be contained. Increased securitization, lower underwriting standards, and easier access to credit were common in other markets, too. For example, credit was flowing into commercial real estate and corporate loans. How to react to what increasingly ap- peared to be a credit bubble? Many enterprises, such as Lehman Brothers and Fannie Mae, pushed deeper. CHRG-111hhrg54867--240 Mr. Royce," I just look at the way in which--when we look at the GSEs, Fannie Mae and Freddie Mac, I just look at the way in which that bifurcation between the mission over at HUD and then OFHEO, with safety and soundness, I just look at the goals that were stressed at one end obviously in conflict with safety and soundness, and all of the overleveraging that went on and the, sort of, the mandates for the portfolio that half of it had to be subprime in the portfolio or Alt-A loans. I look at that and I see why the regulators are nervous. And that, also, is a chapter that we have experience with. But let me ask you another question, because I was going to ask if you believe the perceived government safety net under our financial system distorted market incentives and contributed to the financial collapse, especially in the housing boom and bust. Can the moral hazard from the perceived safety net itself, in other words, have something to do with the ballooning of the housing market? I am thinking of Fannie and Freddie there. That could be a contributor. " fcic_final_report_full--88 Residential Mortgage-Backed Securities Financial institutions packaged subprime, Alt-A and other mortgages into securities. As long as the housing market continued to boom, these securities would perform. But when the economy faltered and the mortgages defaulted, lower-rated tranches were left worthless. 1 Originate Lenders extend mortgages, including subprime and Alt-A loans. Pool of RMBS TRANCHES Low risk, low yield 2 Pool Securities firms Mortgages AAA SENIOR TRANCHES purchase these loans and pool them. First claim to cash flow from principal & interest payments… 3 Tranche Residential mortgage-backed securities are sold to investors, giving them the right to the principal and interest from the mortgages. These securities are sold in tranches, or slices. The flow of cash determines the rating of the securities, with AAA tranches getting the first cut of principal and interest payments, then AA, then A, and so on. next claim… next… etc. A AA MEZZANINE TRANCHES These tranches were often purchased by CDOs. See page 128 for an explanation. BBB BB EQUITY TRANCHES High risk, high yield Collateralized Debt Obligation Figure . CHRG-111shrg57319--557 Mr. Killinger," And, Senator, the one point I want to be crystal clear on is that 2002 and 2003 were very unusual years for fixed-rate products because the country was going through a massive refinancing boom, and that is where so much of the origination was. If I went back to a more normalized time, like 2 years before that, you would have seen a balance that was more reflective of 2004 and 2005 and 2006 than it was of 2003. It is the only point I wanted to make there. Senator Levin. June 12, 2006, I am going to read this again: ``Finally, our Home Loans group should complete its repositioning within the next 12 months''--that is your strategy, June 2006--``and will be in a position to profitably grow its market share of ''--you are trying to grow your market share of high risk in June 2006. That is your plan. Option ARM, home equity, subprime, Alt A loans, that is your plan, right, in June 2006. I know that it changed after that, but that was still your strategy. I am just reading your words. " CHRG-111shrg61651--119 Mr. Johnson," Senator, we also have to remember that the ``too big to fail'' is a form of implicit subsidy from the taxpayer, which lowers the cost of funding for these derivative transactions. So one reason the massive banks were able to dominate this market is because they are viewed by the credit markets themselves as too big to fail. That gives them an unfair advantage that enables them to scale up and create even more risk for the taxpayer. The Bank of England financial stability people are calling this entire structure a ``doom loop'' because it is a repeated cycle of boom, bust, bailout, and we are just running through this again. Senator Reed. We have talked about interrelatedness, and I think that is a theme that everyone agrees to. But, Mr. Johnson, in terms of derivative trading, to what extent is that a key factor in this interrelatedness? I know there is no magic one thing, but it strikes me, given the notional size of derivative trading, given the fact that it inherently is staking your future to somebody else's future, would be one of the key drivers in some of these interrelated issues we have. " CHRG-111shrg49488--106 Mr. Green," A mixture. There is also no interest deductibility in the United Kingdom, though that has not stopped a boom in house prices. There has been no regulation of the terms of lending, and one of the issues that has arisen in the review that the FSA has undertaken of what went wrong and what might need to change--which I commend to you, it is a very detailed review covering many of the issues we have talked about today--is whether there should be some kind of mandatory loan-to-value ratios or loan-to-income ratios. So they were not in place, but that is seriously being considered. What has now been agreed at the European level is that there will be skin in the game and that the originator in securitization will have to maintain 5 percent. And I think I am right in saying that has now been legislated across the European Union because of a rather widespread perception that this was a problem that needed fixing. You may say 5 percent is only symbolic, but, of course, it will concentrate the minds of the management to all the issues that Dr. Clark has mentioned. Senator Collins. Thank you. Thank you, Mr. Chairman. " fcic_final_report_full--63 Nonetheless, just weeks later, in October , Congress passed the requested moratorium. Greenspan continued to champion derivatives and advocate deregulation of the OTC market and the exchange-traded market. “By far the most significant event in finance during the past decade has been the extraordinary development and expan- sion of financial derivatives,” Greenspan said at a Futures Industry Association con- ference in March . “The fact that the OTC markets function quite effectively without the benefits of [CFTC regulation] provides a strong argument for develop- ment of a less burdensome regime for exchange-traded financial derivatives.”  The following year—after Born’s resignation—the President’s Working Group on Financial Markets, a committee of the heads of the Treasury, Federal Reserve, SEC, and Commodity Futures Trading Commission charged with tracking the financial system and chaired by then Treasury Secretary Larry Summers, essentially adopted Greenspan’s view. The group issued a report urging Congress to deregulate OTC deriv- atives broadly and to reduce CFTC regulation of exchange-traded derivatives as well.  In December , in response, Congress passed and President Clinton signed the Commodity Futures Modernization Act of  (CFMA), which in essence deregulated the OTC derivatives market and eliminated oversight by both the CFTC and the SEC. The law also preempted application of state laws on gaming and on bucket shops (illegal brokerage operations) that otherwise could have made OTC de- rivatives transactions illegal. The SEC did retain antifraud authority over securities- based OTC derivatives such as stock options. In addition, the regulatory powers of the CFTC relating to exchange-traded derivatives were weakened but not eliminated. The CFMA effectively shielded OTC derivatives from virtually all regulation or oversight. Subsequently, other laws enabled the expansion of the market. For exam- ple, under a  amendment to the bankruptcy laws, derivatives counterparties were given the advantage over other creditors of being able to immediately terminate their contracts and seize collateral at the time of bankruptcy. The OTC derivatives market boomed. At year-end , when the CFMA was passed, the notional amount of OTC derivatives outstanding globally was . tril- lion, and the gross market value was . trillion.  In the seven and a half years from then until June , when the market peaked, outstanding OTC derivatives in- creased more than sevenfold to a notional amount of . trillion; their gross mar- ket value was . trillion.  Greenspan testified to the FCIC that credit default swaps—a small part of the market when Congress discussed regulating derivatives in the s—“did create problems” during the financial crisis.  Rubin testified that when the CFMA passed he was “not opposed to the regulation of derivatives” and had personally agreed with Born’s views, but that “very strongly held views in the financial services industry in opposition to regulation” were insurmountable.  Summers told the FCIC that while risks could not necessarily have been foreseen years ago, “by  our regulatory framework with respect to derivatives was manifestly inadequate,” and that “the de- rivatives that proved to be by far the most serious, those associated with credit default swaps, increased  fold between  and .”  CHRG-110shrg50369--104 Chairman Dodd," Fine. Senator Tester. Thank you, Senator Schumer, and thank you, Mr. Chairman, and thank you, Chairman Bernanke. I appreciate your forthrightness today and always. I want to talk about commodities for a little bit. I am a farmer. I am happy when commodities go up. But as was earlier pointed out today, oftentimes this can end up potentially like it was in the 1970s when we saw a big commodity raise; we saw the inputs that went into agriculture go through the roof; we saw food prices on the shelf go up because commodity prices were higher; and then commodity prices fell back. Those inputs that went into production agriculture stayed up, and the food on the shelf stayed up, too, because they said there was not enough wheat in a loaf of bread to make a difference after they raised the prices because commodities went up. My question to you is: Do you see that playing out the same way? I mean, we are going to see food prices go up probably, it would be my guess. We already have. And we have already seen inputs go up on the farm for production agriculture. I anticipate this commodity price will not stay where it is at forever. They usually do adjust, and they usually adjust down. And food prices will stay up, inputs will stay up. Do you see that same thing happening again? And is there anything we can do if it is that way? " CHRG-110shrg50409--55 Mr. Bernanke," Well, a part of what has been happening--and this goes back to Senator Menendez's question about the role of the subprime crisis and so on--is that there was, if you will, a credit boom or a credit bubble where there was an overextension of credit in a lot of areas. There has been a big reversal of attitudes. Banks and other financial institutions are scaling back on their credit risk. They are deleveraging. They are raising capital. And that adjustment process is part of what is happening now that is creating the drag on economic growth. So it is harder to get a mortgage, it is harder to get a business loan. And until we come to a more stable situation where banks are comfortable with their credit standards and their balance sheets, the leveraging process is going to continue and is part of what we are seeing here. Senator Tester. And very quickly, because my time is over, do you--I mean, we have heard figures of 150 banks potentially going down because, I assume, of this adjustment that you just talked about. Do you guys have any projections on what kind of impact banking institutions going down, how many there potentially could be in the next year or do you not want to comment on that? " CHRG-111hhrg56778--5 Mr. Posey," Thank you very much, Mr. Chairman. To help protect our citizens in the future, I think we probably need to glance at least a little bit on some of our previous failures. And I understand the Office of Thrift Supervision is responsible for supervising 35 holding companies that include both thrifts and insurance operating entities. And it has come to my attention through a news clip actually, just this morning, some revelations I had not previously been aware of and we might possibly clarify in some of our testimony this morning. This was ``Dateline Washington.'' It says, ``Banks weren't the only ones giving big bonuses in the boom years before the worst financial crisis in generations. The government was also handing out millions of dollars to bank regulators rewarding `superior' work, even as an avalanche of risky mortgages helped create the meltdown. The payments detailed in the payroll data released to the Associated Press under the Freedom of Information Act are the latest evidence of the government's false sense of security during the go-go days of the financial boom. Just as the bank executives got bonuses, despite taking on dangerous amounts of risk, regulators got taxpayer funded bonuses despite missing or ignoring signs that the system was on the verge of a meltdown. ``The bonuses were part of a program, little known outside the government. Some government regulators got tens of thousands of dollars in perks, boosting their salaries by almost 25 percent. Often, though, rewards amounted to just a few hundred dollars for employees who came up with good ideas. During the 2000 306 boom, the three agencies that supervised most U.S. banks, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the Office of the Comptroller of the Currency, gave out at least $19 million in bonuses, records show. ``Nearly all that money was spent recognizing superior performance. The largest share, more than $8.4 million, went to financial examiners, those examiners and managers who scrutinize internal bank documents and sound first alarms. Analysts, auditors, economists, and criminal investigators also got rewards. After the meltdown, the government's internal investigators surveyed the wreckage of nearly 200 failed banks and repeatedly found that those regulators had not done enough. ```OTS did not react in a timely or forceful manner to certain repeated indications of problems,' the Treasury Department's Inspector General said of the Thrift Supervision Office following the $2.5 billion collapse of Net Bank, the first major bank failure of the economic crisis. `OCC did not issue a formal enforcement action in a timely manner and was not aggressive enough in the supervision of A&B in light of the bank's rapid growth,' the Inspector General said of the currency comptroller after the $2.1 billion failure of A&B Financial National Association. ```In retrospect, a stronger supervisory response at earlier examinations may have been prudent,' FDIC's inspector general concluded following the $1.8 billion collapse of the New Frontier Bank. `OTS examiners did not identify or sufficiently address the core weaknesses that ultimately caused a thrift to fail until it was too late,' Treasury's Inspector General said regarding IndyMac, which in 2008 became one of the largest bank failures in history. And they believed their supervision was adequate. We disagree. ```OCC's supervision of Omni National Bank was inadequate,' Treasury investigators concluded following Omni's $956 million failure. Most of the bank inspection records are not public and the government blacked-out many of the employee names before releasing the bonus data. It is impossible to determine how many auditors got bonuses, despite working on major banks that failed. Regulators say it's unfair to use those missteps seeing it's a benefit of hindsight to suggest any bonus isn't proper.'' Thank you, Mr. Chairman. I yield back. " CHRG-111hhrg51698--253 Mr. Slocum," Well, the difference in commodities markets is, if I have information about the movement or storage levels of a commodity---- " CHRG-111hhrg51698--436 Mr. Masters," Sure. In the bill, in terms of defining what position limits should be, there is a sort of principle that was really developed by Franklin Roosevelt in the first Commodity Exchange Act, and that was there is something called ``excessive speculation.'' There is not just manipulation, there is excessive speculation. And that only applies to commodities futures markets, it doesn't apply to other markets. The reason it applies to commodities futures markets is because these markets used to be dominated by physical hedgers, and they are there for them to price risk. That is why we have commodity futures markets. We have a different regulator. We have a different way of looking at the markets, because these are commodities. They are not interest rates. Nobody goes home and eats a bowl of interest rates. " CHRG-111shrg50814--20 Mr. Bernanke," Well, we have seen a very broad-based weakness. Housing is very central. At this point, the housing market has reversed the boom that we saw earlier in the decade. In fact, we are now at levels of construction and price declines that we have not seen for a very long time, if ever, and so I would anticipate some stabilization in the housing market going forward and eventually demographic trends, household formation, economic growth will begin to create recovery in the housing market. Likewise, people are very reluctant right now to make commitments to consumer durables like automobiles. I think the current rates of auto sales are below what we will see once the economy begins to normalize. So I think those sectors will be part of the recovery. But in general, as we see confidence coming back, particularly consumer spending on discretionary items, those areas will begin to strengthen and we will see a broad-based recovery. " CHRG-110hhrg38392--128 Mr. Mahoney," As we go through this, we may want to continue to have these discussions with your Board and with Congress as far as what policies. We can promote some of its communication and promotion of educational understanding of savings. That is a segue to a second question; in your speech today, you mentioned that consumer spending has advanced vigorously over the last number of quarters. Sort of looking at the trend over the last number of years, savings have been going down, as you have said. Many people during this boom of real estate started with a lot of home equity loans, taking equity out of their home to support consumer spending, building up more debt that way. And now with the real estate market in many parts of the country very flat, interest rates having gone up, adjustable rates, that is not available for many people, so they have debt on top of that. And then a lot of the consumer spending is on the backs of more consumer debt in terms of credit cards. Congresswoman Pryce mentioned that as well. Again, what impact do you see that having on the long-term basis of the stability of the economy when people are borrowing more and more and more and not saving? And again, what can we do through your offices or through the Congress? " CHRG-111hhrg51698--546 Mr. Weisenborn," Thank you. Mr. Chairman, Ranking Member Lucas and Members of the Committee, thank you for the opportunity to share my views on the important questions of OTC commodity market regulation that you are now considering. Before addressing the substance of my testimony, let me place my views in context by saying a few words about Agora-X and my background. Agora-X is a development stage company located in Parkville, Missouri. It is dedicated to bringing efficiency, liquidity and transparency to the over-the-counter commodity markets by means of advanced, regulatory compliant electronic platforms for OTC transaction. Agora-X was founded by FCStone, a commodities firm headquartered in Kansas City. Agora-X is now also partially owned by NASDAQ OMX. I have been a member of both the Chicago Board of Trade and the Kansas City Board of Trade. I also have self-regulatory experience of the NASDR, now renamed FINRA. OTC markets play an important role in market innovation. They provide an alternative venue for contract formation, price discovery and risk mitigation. For institutional participants, these markets can provide substantial public benefit if they are required to be transparent, reportable, clearable, and to function within the bounds of an electronic platform. Well-organized OTC markets can dramatically improve efficiency of commodity markets. By doing so, OTC markets can reduce the cost that consumers ultimately pay for commodities. When the markets are transparent, liquid and open, transaction costs fall and spreads contract. In transparent markets, there is much less room for manipulation. With broad, transparent OTC markets, the likelihood of devastating speculative bubbles is significantly reduced. Thus, well-regulated OTC markets can contribute to the integrity of U.S. financial markets as a whole. Of course, we must not ignore the lessons taught by the current crisis, but we should be careful to identify the true nature of these problems. In my view, the major problems have been in the misuse of certain commodity contracts and have not been in the means by which they are traded. This brings me to the major point I wish to make. I urge the Committee to preserve the existing OTC commodity markets, but to modify the existing law to improve them. The present financial crisis has demonstrated the need to reform to the OTC commodity markets. Clearly these markets can be improved by means of mandatory reporting, clearing, and by moving these markets to transparent electronic facilities. In addition, an important issue for this Committee is the treatment of OTC contracts on agricultural commodities. Contracts on agricultural commodities deserve the same treatment as contracts on non-ag commodities. Existing law and regulation discriminate against these commodities by making it difficult or impossible to create OTC agricultural contracts electronically, or to clear them. These restrictions, which do not advance any regulatory goal, make no sense today. An example may help to illustrate my point. Last summer, grain prices in the United States reached a very high level, but many producers who wanted to lock in those prices with cash-forward contracts were unable to do so. The country elevators who ordinarily offer such contracts could not do so because they could not finance the margin required for offsetting future positions. I think clearable, structured OTC contracts could have emerged to bridge that gap if it were not for the restrictive regulations. We currently face a time when agricultural markets desperately need liquidity. Allowing cleared, structured OTC contracts can help facilitate and accelerate liquidity. With the safeguards this Committee will add to protect the OTC markets, it is time for eligible agricultural commodity producers, processors, and users to have full access to the OTC markets. I think four things are essential to the OTC commodity markets' reform agenda. First, all physical commodities, including agricultural commodities, should be treated equally. Second, OTC commodity markets should be transparent and reportable to the CFTC. Third, OTC markets should be clearable and less narrow. CFTC-crafted exemptions should apply. Fourth, all OTC contracts should be established on or reported to an electronic facility. Accordingly, I generally support the language of the draft bill, but propose that it be improved to allow a quality of treatment of agricultural commodities, establish electronic documentation and audit trail, trading and clearing requirements, and to give CFTC authority to craft exemptions. Finally, the bill should appropriately define and authorize electronic trading facilities. Thank you for giving me the opportunity to share my views on the draft bill. [The prepared statement of Mr. Weisenborn follows:] Prepared Statement of Brent M. Weisenborn, CEO, Agora-X, LLC, Parkville, MO Mr. Chairman and Members of the Committee, My name is Brent Weisenborn of Parkville, Missouri. I am CEO of Agora-X, LLC. Thank you for the opportunity to share my views on the important questions of regulation of the OTC commodities markets that you are now considering in the proposed bill (draft bill) to amend the Commodity Exchange Act (CEA).(1) Background. Agora-X, LLC is a development stage company that is dedicated to bringing efficiency, liquidity and transparency to over-the-counter (OTC) commodity markets by means of state of the art, regulatory compliant, electronic platforms for OTC contract negotiation as well as trading and transaction execution. Its initial focus is on cash-settled OTC contracts related to physical commodities, such as energy and agricultural commodities. Agora-X, LLC was founded in 2007 by FCStone Group, Inc, which is a commodities firm with deep roots in agricultural commodities markets. FCStone originated as a regional cooperative in the Midwest offering traditional hedging services to cooperative grain elevators, and has grown to offer commodity trading and price risk management services throughout the nation and beyond. In addition to FCStone, Agora-X is now also partly owned by The NASDAQ OMX Group, Inc. I am tremendously excited about the opportunity that exists to improve the functioning of the commodities markets by means of innovations such as the electronic platforms offered by my company and by adjustments to existing regulatory systems that you are now considering. I feel qualified to comment on these points, not only because of my role with Agora-X, but also because of years of experience in both the securities and commodities markets. I have been a member of both the Chicago Board of Trade (CBOT) and the Kansas City Board of Trade (KCBT). I traded futures and was an option market maker as a proprietary trader. I served on the Board of Directors of the KCBT from 1996 to 1998. I was a founder and served from 1987 until 2001 as President of Security Investment Company of Kansas City, an institutional only Broker-Dealer and NASDAQ Market Maker. Security Investment Company specialized in proprietary trading and wholesale market making. I was elected to the NASDR (renamed FINRA), District No. 4 District Committee in 1998 and was elected Chairman in 1999. I served as Chairman until January of 2001 and as co-Chairman of the District 4 & 8 (Chicago) Regional Committee. The NASDR (FINRA) District No. 4 covers seven states: Missouri, Kansas, Iowa, Nebraska, North Dakota, South Dakota and Minnesota. At that time I was responsible for the regulatory oversight of approximately 55,000 stockbrokers in 2,500 offices. I also served on the NASDR National Advisory Council for the year 2000. In June of 2000, I was elected to the NASDR National Small Firm Advisory Board. As a result of my experience I have observed at close hand the evolution of the electronic markets for securities, and I see strong parallels with electronic markets for commodities that are just now emerging.(2) Need for Regulatory Change. OTC markets play an important role of market innovation. They provide an alternative venue of contract formation, price discovery and risk mitigation outside the rigid and restrictive regulatory framework for ``designated contract markets'' that applies to commodity exchanges. OTC markets can provide substantial public benefit without creating systemic risk of the kind that precipitated last September's financial crisis if they are required to be transparent, reportable, clearable, and to function within the bounds of electronic communication networks (ECNs) or exempt commercial markets (ECMs). Well organized OTC markets also dramatically improve efficiency of commodity markets and by doing so OTC markets reduce the costs that consumers ultimately pay for commodities. When the markets are transparent, liquid and open, the spreads that swaps dealers can charge shrink and as a result, transaction costs fall. Efficient markets also inevitably attract liquidity and become broader. If these markets become clearable, they will also bring increased liquidity to clearing houses and registered commodity exchanges. In addition, in open markets there is much less room for manipulation and the possibility of committing fraud. Because of the transparency and breadth of these markets, the likelihood of devastating speculative bubbles is also significantly reduced. These markets will help bring interests of traders and sound market fundamentals into balance. Thus, well regulated and well managed OTC markets will contribute to the integrity of U.S. financial markets as a whole. Of course, we must not ignore the problems that have emerged from the current crisis, but we should be careful in identifying the sources of these problems. In my view, the major problems have been in the misuse of securities and commodities contracts, and have not been in the means by which they are traded. This brings me to the major point I wish to make. I urge the Committee to preserve the OTC commodity markets, but to modify the existing law to derive improvements in them. The present financial crisis demonstrated that there are inefficiencies in the regulation and functioning of the OTC commodities markets and that these markets can be improved by means of electronic audit trail and reporting, by clearing and by moving these markets to a transparent ECN or ECM facilities, where possible. In addition, an important issue for this Committee is the treatment of OTC contracts on agricultural commodities. We believe that agricultural derivatives, such as commodity swaps and options, deserve the same treatment as the non-agricultural commodities under the draft bill. Existing law and regulation discriminate against these commodities by making it difficult or impossible to create OTC agricultural contracts electronically or to clear them. Harmonization of regulation for OTC contracts on agricultural commodities with other contracts will provide the same public benefits to agricultural commodities as are available to all other commodities. In addition it will eliminate existing regulatory anomalies such as prohibitions of clearing and electronic trading that arose in the evolution of the OTC markets and were discarded over time for other commodities, but retained without critical analysis for agricultural commodities. An example may help illustrate the point. Last summer grain prices in the United States reached very high levels, but many producers who wanted to lock in those prices with cash forward contracts were unable to do so because the country elevators who ordinarily offer such contracts did not do so because of inability to finance the margin required for offsetting futures positions. I think clearable, structured OTC contracts could have emerged to bridge that gap if it were not for restrictive regulations. We currently face a time when agriculture desperately needs liquidity. The agricultural OTC market is a significant existing market that is developing entirely outside of registered commodity exchanges. Allowing cleared, structured agricultural OTC contracts on ECNs can help facilitate and accelerate liquidity, while adding transparency and efficiency. With the safeguards that this Committee will add to protect the OTC markets it is time for agricultural commodity producers, processors and users to have full access to such regulated markets.(3) Conclusions and Recommendations. During the last few decades the securities markets have been truly revolutionized by innovative electronic trading methods. Now, the commodities markets are following the same path of innovation. Based on my experience I think four things are essential to the OTC commodity markets reform agenda: (A) The OTC commodity markets should be retained, but improved; (B) Unless exempted by the CFTC, all OTC commodity contracts, agreements and transactions must be reportable to the CFTC; (C) Unless exempted by the CFTC, all OTC commodity contracts, agreements and transactions must be clearable; and (D) Unless exempted by the CFTC, all OTC commodity contracts, agreements and transactions must be negotiated on an electronic communication network (ECN) via the request for quote process (RFQ) or traded or executed algorithmically on an exempt commercial market (ECM) or posted by means of give-ups to such electronic trade reporting facilities. Accordingly, I generally support the language of the draft bill, but propose amending the draft bill as follows: 1. Clearing of all OTC commodity contracts, agreements and transactions. Repeal existing laws and regulations which prohibit electronic trading and clearing of OTC contracts on agricultural commodities and provide that agricultural commodities should be given equal regulatory treatment with non-agricultural commodities by amending section 2(g) of the CEA. The draft bill implies some of this, but it should be further clarified to assure that agricultural commodities fully benefit from the reforms enacted. 2. Electronic Documentation. Require that all OTC commodity contracts, agreements and transactions be electronically documented, whether or not cleared, to assure transparency and to facilitate the reporting of these transactions. 3. Negotiation, Trading and Execution on ECNs or ECMs. Require that unless certain limited CFTC-defined exemptions and exclusions apply, all OTC commodity contracts, agreements and transactions be negotiated, traded and executed on an ECN or ECM or posted by means of the give-ups to such electronic facilities. 4. Definition of ECN. The definition of ``Trading Facility'' in the CEA should be amended to explicitly not include the ECNs. A new definition of the ECN should be drafted and added to the CEA. Thank you for giving me the opportunity to share my views on the draft bill. I look forward to offering any assistance with drafting this proposed legislation as you may request.Brent M. Weisenborn,CEO, Agora-X, LLC.[Redacted]cc:Richard A. Malm, Esq.,Dickinson, Mackaman, Tyler & Hagen, P.C.,[Redacted];Peter Y. Malyshev, Esq.,McDermott, Will & Emery, LLP.,[Redacted]. " CHRG-109hhrg31539--4 The Chairman," The gentleman's time has expired. The Chair now recognizes the gentlelady from Ohio, the subcommittee chairwoman. Ms. Pryce. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being with us here today. I was pleased to read in your testimony that you believe that even though the economy is currently in a transition period, that it will continue to expand even under the pressure of increased oil prices, consumer spending, and a slowing housing market. I would like to talk about that just briefly. Studies have shown that housing accounted for more than one-third of economic growth during the previous 5 years. The robust housing market had enabled homeowners to reduce their debt burdens and maintain adequate levels of consumer spending by tapping into the equity of their homes. Unfortunately in research done by the National Association of Home Builders, they show a serious downtrend in housing demand that many believe correlates with the rise in interest rates by the Federal Reserve. As I have said in the past, I am concerned that this house price boom has been driven far more by investors than ever before, and could lead to a series of mortgage failures, and as the Federal Reserve tries to balance rising rates with fluctuations in the markets, I don't need to remind you that your actions have a trickle-down effect to local communities, and losses on housing investments are just one example. A study by the Mortgage Bankers Association puts my own State of Ohio at the very top of the list of foreclosures, and so we are very concerned in the Midwest. Although we would sometimes like to think of our economy as one that stands apart from the rest of the world's sociopolitical issues, the effect of volatility overseas is reaching into our economy more than we might realize. Just yesterday I held a hearing in my subcommittee on currency issues. We had representatives there from the Federal Reserve and the Mint discussing with us the rising cost of the commodities and materials that make up our coins. We heard these commodities are affected by the volatility in the world or through rising demand in other markets, and are also themselves affecting our inflation here in the United States. The more they cost, the more they drive up the cost to make our currency, and the more it drives up costs overall. In your remarks at the Senate yesterday, you touched upon a number of issues concerning citizens, such as rising rates, gas prices, and wage earnings. One of the issues that has been important to me, and a number of other members on this committee, is the ratio of consumer debt to consumer savings in America, and the effects that a slowing economy could have on a more local level. I agree with your statement yesterday that we must be forward-looking in our policy actions, and I would appreciate hearing your thoughts on what Congress can do about low savings rates, especially coupled with rising consumer costs. Some of us, Mrs. Kelly, Mrs. Biggert, Mrs. Maloney, and myself, have worked to bring this issue to a national focus for a number of years, and we mentioned it repeatedly, working with the Administration to highlight increasing financial education in the United States, but much more needs to be done. You also talked about an international savings glut that I believe we have here in America, a credit glut. I believe we can say it is almost a national epidemic. Consumer spending is key to our continued growth, but I believe we also need to send a message that consumer savings is just as important, and I appreciate hearing from you what the Federal Reserve and the rest of us can do to help consumer savings become a priority in this Nation. And I want to thank you once again, Mr. Chairman, for your appearance. I look forward to your testimony, and I yield back. Thank you. " CHRG-110hhrg38392--98 Mr. Sires," Thank you, Mr. Chairman. Thank you, Mr. Bernanke, for being here with us today. I just want to follow up on the housing issue. I represent a district that is across from New York, the northern part, the Jersey City area, which has seen a boom of housing over the last few years. With that, the prices really went up high. A lot of people had to resort to subprime lending to get housing, and it created a lot of jobs, a lot of good-paying construction jobs. I do not know whether this is regional, but I have seen the prices of the houses not really going down when we are losing a lot of those jobs that were created. I would just like to know the impact on these construction jobs. I know that approximately 10 percent of the jobs created in this country are through construction. What effect is this going to have on the economy? Do you see it as regional? Because I know they are going to--I have friends in Florida, and they are going through the same process, the same things where good-paying jobs are being lost. Do you see this trend changing? I know mortgages are getting tighter. Subprime is very difficult to get. Home equity loans to create these jobs are impossible in some cases. Do you see this trend changing anytime soon? " CHRG-111hhrg63105--144 SPOKESMAN, COMMODITY FOMC20070321meeting--59 57,MR. STOCKTON.," That’s possible. We have not taken that view. Overall housing construction had some unexplained strength over the past year, not from a bottom-up demographic addition but just in terms of what we would have expected given the growth in employment, income, and wealth. Admittedly, the evidence is still very tentative, but we think we see some signs of demand stabilizing around current levels so that, in our starts forecast, we’ll be able to drive the months’ supply of homes back down relative to the low level that it had actually been running from the mid-1990s to the middle of the housing boom. So I don’t think we’re seeing an excess supply of homes that people just won’t want at current prices, or roughly current prices, but that is a considerable risk. Adding up household formations and demolitions—there’s a lot of uncertainty about that, and there’s a lot of cyclical sensitivity as well to the overall household formation rates. So whether the housing stock outran the long-run determinants is kind of hard to nail down. We see that as a risk, but it’s not incorporated in this forecast. If that were the case, there could be a bigger drag on housing activity than we’re anticipating." CHRG-111hhrg51698--338 Mr. Masters," I would just like to put out the idea that more and more people now, especially the American public in general, have come to the conclusion that there was no doubt that there was a significant amount of speculation in crude oil markets, and indeed, most of the commodity markets over the last 9 months. You will notice in my testimony we put out a report on that in which we calculate that the excessive speculative activity over the last 6 months cost the average American $850 per capita, per household, in excess of $110 billion over that period of time. And it is interesting to me that dealers from Wall Street and other folks can come up and say, well, money moves markets in everything but commodities. Of course money moves markets in commodities. We had money coming in. We had $70 billion come in, and we had $70 billion come out. Let me just read you a couple of statements that have come out subsequent to our initial testimony about excessive commodity speculation. One of them is from Paul Tudor Jones, who is probably considered one of the greatest commodity traders of all times. He said, ``There is a huge mania, and it is going to end badly. We have seen it play out over hundreds of times over the centuries, and this is no different. It is just the nature of a rip-roaring bull market.'' I will give you another example, Dr. Bob Aliber from the University of Chicago. He is a distinguished professor. He said, ``You have got speculation and a lot of commodities, and that seems to be driving up the price. Movements are dominated by momentum players who predict price changes from Wednesday to Friday on the basis of the price change from Monday to Wednesday.'' Since our testimony, organizations such as the World Bank, the United Nations, MIT, the Austrian Ministry of Finance, the Japan Ministry of Trade and other organizations and academics around the world have come out and said there is no doubt that excessive speculation was a primary cause for the movements we saw in commodities markets over the last year. So, to your question, I would say that the speculation absolutely had a role, and could continue to have a role in prices in the commodity futures markets. " FOMC20080130meeting--110 108,MR. SHEETS.," Right. Just a word of background. The rationale for the falloff is the expected decline in these commodity prices and the expected slowing of global demand. Now, thinking about the risks, I am reasonably convinced that global demand is going to slow, which I believe will translate into reduced demand for many of these commodities that have driven up inflation. However, that says something only about the demand side of these commodity markets. There is also a lot going on on the supply side. At the last FOMC meeting, we talked about ethanol and the fact that many of these emerging-market countries are wealthier, that they want to eat better than they used to, that the relative price of energy has risen, and that it takes a lot of energy to raise these crops. So there are supply factors as well as demand factors at work in driving up these commodity prices. It is very hard for us to forecast the supply side of these markets. It is driven by things like weather and geopolitical developments and so on and so forth. On the commodities, my sense is that demand is going to shift in to some extent. As long as the supply doesn't shift in as well, we should be able to see a decline, or at least a slower rate of increase, in these prices. A very important point here is that, in order to get less of an impetus coming from commodity prices and inflation in these countries, we don't necessarily need oil prices to come down in level terms. We just need them to stop going up at such rapid rates. If we get slower rates of price increases, that will be disinflationary relative to where we have been. That is how I would characterize the risks around this forecast, mainly on the supply side of these commodity markets. " CHRG-111hhrg51698--440 Mr. Masters," The nice thing about position limits is we have 7 years of experience with them. Before the CFTC excluded some broker dealers, it basically exempted them from position limits. Before the Commodity Futures Modernization Act, which allowed swaps and other over-the-counter derivatives to be created that would allow broker dealers to trade off-exchange in significant fashion with other speculators. That is the loophole we have talked about in the past, before we had those issues, we had a very solid, working commodity futures market that served the needs of producers for years and years. In fact, in 1998, producers, physical hedgers, and consumers of commodities were the dominant force of the market. They were 70 percent of the market. Speculators were about 30 percent. " FOMC20080625meeting--41 39,MR. SHEETS.," Yes. The spike that we have seen is driven particularly by commodity prices. The depreciation of the dollar has played a secondary role, so the decline in core import price inflation to below 2 percent next year is conditioned crucially on commodity prices flattening out and the dollar not depreciating as rapidly as it has over the past few years. " CHRG-111hhrg55811--164 Mr. Gensler," I share the Congressman's view that there is a highly concentrated market here, and probably 5 or 10 years from now, it will be even more concentrated. This happens in the airline and other industries as well. But I do think on the non-bank dealers, people holding themselves out in dealing in these, that there is an appropriateness to have capital; that we don't want to have something outside the system. These are generally in the commodity swaps area, the oil and natural gas and commodity areas, and many of them have capital. It is not to be additional capital, what they currently have, but just to make sure they have a minimum amount of capital if they are holding themselves out and making markets in these commodity swaps or other swaps as a non-bank dealer. " FOMC20080805meeting--56 54,MR. KAMIN.," Sure. As I mentioned, core import price inflation shot up very rapidly to over 10 percent in the second quarter, and our approach toward modeling and predicting core import price inflation focuses on three main sources of increase. First are increases in foreign cost pressures, which we proxy by CPIs, which have not been a particularly important driver of core import prices as of late, though they are not negligible. Then the other two, which are more important, are declines in the dollar, which push up our prices, and finally increases in commodity prices because a lot of our imports, even core imports, which exclude oil and high-tech products, still have a lot of commodity input into them. For the past few years, our experience has been that the pass-through of declines in the dollar into core import prices has been relatively moderate. It has definitely contributed materially to the increase in core import prices but not as much, we feel, as the run-up in commodity prices, which has had a pretty substantial effect. One way that we can sort of confirm that impression is that we know that the prices of imported material-intensive products that have the most commodity input have gone up much more rapidly than prices of finished goods, and that has been true over the past year as well. So for all of those reasons, we feel that commodity prices have been the prime impetus for the run-up in core import price inflation. Going forward, we take our guidance from the futures markets, which indicate that oil prices and other commodity prices will flatten out. As a result, we anticipate that, relatively shortly, core import price inflation also should start to decline. At the same time, our anticipation is that, compared with the past few years, the dollar will fall less rapidly going forward than in the past, and that should be another factor supporting our view that core import price inflation should diminish. " CHRG-111hhrg74855--39 COMMODITY FUTURES TRADING COMMISSION CHRG-111hhrg63105--20 COMMODITY FUTURES TRADING COMMISSION, CHRG-111hhrg63105--15 COMMODITY FUTURES TRADING COMMISSION, FOMC20071211meeting--43 41,MR. STOCKTON.," Food is important. In fact, we devote, I would imagine, a surprising amount of resources to it. We have an agricultural economist whose job is to follow those developments and report on them. It is his view—and based on both the futures prices and some of the modeling that we have done—that we will see a deceleration going forward in retail food prices. As you know, futures prices basically are projecting a flattening-out. I assume that is part of what is in Nathan’s forecast as well. We are not trying to outguess the markets in that regard, and the reports that we have received on agricultural production look relatively favorable for the coming year. Now, most of that is a bit of winter wheat at this point and not much more in terms of production, although we have seen some significant rebuilding of both flocks and livestock herds that suggests that we are on the right track in terms of an output response to the higher prices that we have seen in the past year. Markets are tight, and I think there probably is some asymmetry in the risk surrounding the food price forecast, in that it is easier to see some possibility of stock-out problems if there is any shortfall in production over the coming year, than that there would be some massive boom in agricultural production that will depress prices sharply. But I do think—and in the Greenbook Part 2 quite often, especially in the autumn, when we are actually doing a more careful accounting of the harvest—we devote a fair amount of attention to resources to it. We can certainly do even more going forward." fcic_final_report_full--490 III. THE U.S. GOVERNMENT ’S ROLE IN FOSTERING THE GROWTH OF THE NTM MARKET The preceding section of this dissenting statement described the damage that was done to the financial system by the unprecedented number of defaults and delinquencies that occurred among the 27 million NTMs that were present there in 2008. Given the damage they caused, the most important question about the financial crisis is why so many low quality mortgages were created. Another way to state this question is to ask why mortgage standards declined so substantially before and during the 1997-2007 bubble, allowing so many NTMs to be created. This massive and unprecedented change in underwriting standards had to have a cause—some factor that was present during the 1990s and thereafter that was not present in any earlier period. Part III addresses this fundamental question. The conventional explanation for the financial crisis is the one given by Fed Chairman Bernanke in the same speech at Morehouse College quoted at the outset of Part II: Saving inflows from abroad can be beneficial if the country that receives those inflows invests them well. Unfortunately, that was not always the case in the United States and some other countries. Financial institutions reacted to the surplus of available funds by competing aggressively for borrowers, and, in the years leading up to the crisis, credit to both households and businesses became relatively cheap and easy to obtain . One important consequence was a housing boom in the United States, a boom that was fueled in large part by a rapid expansion of mortgage lending. Unfortunately, much of this lending was poorly done, involving, for example, little or no down payment by the borrower or insuffi cient consideration by the lender of the borrower’s ability to make the monthly payments . Lenders may have become careless because they, like many people at the time, expected that house prices would continue to rise--thereby allowing borrowers to build up equity in their homes--and that credit would remain easily available, so that borrowers would be able to refinance if necessary. Regulators did not do enough to prevent poor lending, in part because many of the worst loans were made by firms subject to little or no federal regulation. [Emphasis supplied] 59 In other words, the liquidity in the world financial market caused U.S. banks to compete for borrowers by lowering their underwriting standards for mortgages and other loans. Lenders became careless. Regulators failed. Unregulated originators made bad loans. One has to ask: is it plausible that banks would compete for borrowers by lowering their mortgage standards? Mortgage originators—whether S&Ls, commercial banks, mortgage banks or unregulated brokers—have been competing for 100 years. That competition involved offering the lowest rates and the most benefits to potential borrowers. It did not, however, generally result in 59 Speech at Morehead College April 14, 2009. 485 or involve the weakening of underwriting standards. Those standards—what made up the traditional U.S. mortgage—were generally 15 or 30 year amortizing loans to homebuyers who could provide a downpayment of at least 10-to-20 percent and had good credit records, jobs and steady incomes. Because of its inherent quality, this loan was known as a prime mortgage. FinancialCrisisInquiry--709 ZANDI: Well, first, let me say that one of the hallmarks of the Great Recession was how broad- based it was across industries and regions of the country. I mean, in past recessions, you always had a large region or two that avoided the recession, and that was a safety valve. People could move from Michigan and go to Florida or move from California to Nevada, and that wasn’t the case in this downturn. Now, having said that, obviously, there are some areas that are harder hit than others and those that suffer— well, were in the housing boom and bubble and now suffered the housing bust are the most severely hit, and that would include Nevada, Las Vegas, Arizona, California, particularly the Central Valley of California, Florida, Rhode Island, interestingly enough, for various reasons, and, obviously, parts of the industrial Midwest. And it will take much, much longer for an economy like Nevada and Florida to turn because its economic base is much less diversified. Obviously, it’s related to leisure and hospitality, which is a discretionary purchase and will not turn, and migration flows. And as I mentioned earlier, migration is going to be significantly impaired because one-third of homeowners with first mortgages, by my calculation, are underwater and can’t move or won’t move as easily. So Nevada’s problems are very severe and will be very long lasting. FOMC20060808meeting--12 10,MR. POOLE., Maybe we’ll see what happened there during the break. My argument is that we have very generalized inflation pressure across regions of the world and across commodity and service sectors. The pressure is not isolated. Could you comment on that observation? CHRG-110shrg50409--44 Mr. Bernanke," Well, it cuts two ways. On the one hand, it might weaken to some extent the contribution of exports and trade to our growth. But, on the other hand, if these other economies cool down, it might reduce commodity prices or flatten out commodity prices, which would be very beneficial. Senator Tester. Do you anticipate overall negative, positive, or pretty static in its effect? " CHRG-111hhrg53021--278 Mr. Thompson," Thank you, Mr. Chairman. Thank you, Mr. Secretary, for being here, for answering these questions. With your proposal, I wanted to just seek some clarification. Is it your intent to force private commodity pool operators to register with the SEC as a hedge fund instead of the CFTC? And, if so, why? " CHRG-111hhrg53021Oth--278 Mr. Thompson," Thank you, Mr. Chairman. Thank you, Mr. Secretary, for being here, for answering these questions. With your proposal, I wanted to just seek some clarification. Is it your intent to force private commodity pool operators to register with the SEC as a hedge fund instead of the CFTC? And, if so, why? " CHRG-111shrg50814--153 Mr. Bernanke," Well, I think the Fed was a very active and conscientious regulator. It did identify a lot of the problems. Along with our other fellow regulators, we identified issues with non-traditional mortgages, with commercial real estate, with leveraged lending and other things. But what nobody did was understand how big and powerful this credit boom and the ensuing credit collapse was going to be, and routine supervision was just insufficient to deal with the size of this crisis. So clearly, going forward, we need to think much more broadly, more macroprudentially, about the whole system and think about what we need to do to make sure that the system as a whole doesn't get subjected to this kind of broad-based crisis in the future. Senator Shelby. Does that include insurance, too, because insurance has been regulated under the McCarran-Ferguson Act by the States, but then you had AIG, which caused systemic stress, to say the least, to our banking system, and they were regulated primarily by the New York State Insurance Commission. " Mr. Bernanke," AIG had a Financial Products Division which was very lightly regulated and was the source of a great deal of systemic trouble. So I think that we do need to have broader-based coverage, more even coverage, more even playing field, to make sure that there aren't--as our system evolves, that there aren't markets and products and approaches that get out of the line of vision of the regulators, and that was a problem we had in the last few years. Senator Shelby. Thank you, Mr. Chairman. " CHRG-111hhrg51698--134 Mr. Cota," Congressman Thompson, you also asked the question about how much liquidity is liquidity. Talking about very dull commodities like energy, the heating oil market is about 8 billion gallons per year in the United States, 7 or 8 billion gallons. That amount in regulated U.S. exchanges is traded multiple times per day. There is no lack of liquidity in those markets. Now, it is a little bit more complex than that, because those trades also trade other types of commodities, but there continue to be huge amounts of commodities in these markets. The only time that they seem to be illiquid is when you have extreme volatility within these markets, and the last remaining portion of the floor-traded aspects, which are purely floor traded, are options trade. Options trading, because of the volatility, did dry up, and to me that meant that there was too much volatility in the markets because too much money was coming in and coming out. So I kind of argue the other side of that. " FOMC20050630meeting--321 319,MR. FERGUSON.," I’ll continue to plow that ground just for one minute. I’m struck a bit by the fact that the stories on the run-up in commodity prices and oil prices are all about China and India. You have a forecast here where China’s growth falls off fairly dramatically. Growth in the rest of the world I would describe as maybe more of a downside risk. You point out the uncertainty in Europe and Japan and you’ve even marked down economic growth in the United States. Yet your commodity prices tend to be rather flat. All this run-up was associated with China, India, and global growth. You have global growth dampening, but we don’t seem to recover much in the way of these commodity prices—oil being one, but others in general. I’m obviously missing something. What is it?" CHRG-111hhrg51698--439 Mr. Costa," You believe that the transparency of this commission would suffice in determining what would be viewed as an acceptable risk versus an excessive risk, because, unlike the commodities exchange that we are talking about, whether it be pork bellies or whether it be other future markets in agricultural commodities, in these instruments that we are talking about here, as you said, you can't eat a bowl of derivatives, I guess. And so, where has this worked in a way that there is previous practices that we could draw from experience on? " FOMC20070509meeting--43 41,MS. MINEHAN.," This works as an intervention as well as a question because it is exactly along the lines of President Plosser’s questions. First, the assumption about inventory and where is normal—the past ten years through the housing boom have created a normality, if you will, of very low inventories, as compared with the longer-run inventories. So the question is, Where is normal, and where do builders want normal to be? How much do they have to do to get back to the level where they were for the past ten years versus the level that you could figure over a twenty-year or thirty-year period? I talked to a group of builders about this a couple of months ago and did not get a whole lot of feedback from them on where they thought they might like to be, although all of them, I am sure, are making that calculation for themselves in one way or another in their business on a day-to-day basis. But I think it is hard to say that any given level of inventory—seeing how much it changed between the past ten years and the ten or twenty before that—is “normal” with any confidence. Second, I have been taking a bit of confidence, and maybe this is wrong, from the fact that, if you smooth through sales of existing homes, which of course are a much bigger volume than sales of new homes, on a three-month or a six-month moving average, you do see a dip at the beginning of this year and then you see it come back a little in the environment of reasonably low interest rates for prime borrowers and decent interest in terms of mortgage originations and so forth, but obviously not as high as it was. I am thinking that that maybe says something about the demand side, but maybe this is just cockeyed optimism on my part." CHRG-111hhrg53021Oth--180 Mr. Costa," Thank you very much, Mr. Chairman. I thank both Chairmen for holding this important hearing. And thank you, Mr. Secretary. I want to focus my questions in the area of commodities. I represent a large agricultural area, and obviously commodity trading is very important. You have spoken about a good way to avoid the future AIG situations as to ensure that all parties have a stake in the game, or skin in the action, or whatever you want to call it--skin in the game, I guess. I think that is more achievable in terms of the financial institutions, but commodity hedgers don't generally have the same access to cash and capital in order to be a player in these markets. Their assets oftentimes tend to be tied up in reinvestments and their own company growth. What sort of impact do you think this is going to have on capital requirements on nonfinancial entities that have an appropriate role to be engaged in this market and to have the access to it? " CHRG-111hhrg53021--180 Mr. Costa," Thank you very much, Mr. Chairman. I thank both Chairmen for holding this important hearing. And thank you, Mr. Secretary. I want to focus my questions in the area of commodities. I represent a large agricultural area, and obviously commodity trading is very important. You have spoken about a good way to avoid the future AIG situations as to ensure that all parties have a stake in the game, or skin in the action, or whatever you want to call it--skin in the game, I guess. I think that is more achievable in terms of the financial institutions, but commodity hedgers don't generally have the same access to cash and capital in order to be a player in these markets. Their assets oftentimes tend to be tied up in reinvestments and their own company growth. What sort of impact do you think this is going to have on capital requirements on nonfinancial entities that have an appropriate role to be engaged in this market and to have the access to it? " fcic_final_report_full--45 These funds differed from bank and thrift deposits in one important respect: they were not protected by FDIC deposit insurance. Nevertheless, consumers liked the higher interest rates, and the stature of the funds’ sponsors reassured them. The fund sponsors implicitly promised to maintain the full  net asset value of a share. The funds would not “break the buck,” in Wall Street terms. Even without FDIC insur- ance, then, depositors considered these funds almost as safe as deposits in a bank or thrift. Business boomed, and so was born a key player in the shadow banking indus- try, the less-regulated market for capital that was growing up beside the traditional banking system. Assets in money market mutual funds jumped from  billion in  to more than  billion in  and . trillion by .  To maintain their edge over the insured banks and thrifts, the money market funds needed safe, high-quality assets to invest in, and they quickly developed an ap- petite for two booming markets: the “commercial paper” and “repo” markets. Through these instruments, Merrill Lynch, Morgan Stanley, and other Wall Street in- vestment banks could broker and provide (for a fee) short-term financing to large corporations. Commercial paper was unsecured corporate debt—meaning that it was backed not by a pledge of collateral but only by the corporation’s promise to pay. These loans were cheaper because they were short-term—for less than nine months, sometimes as short as two weeks and, eventually, as short as one day; the borrowers usually “rolled them over” when the loan came due, and then again and again. Be- cause only financially stable corporations were able to issue commercial paper, it was considered a very safe investment; companies such as General Electric and IBM, in- vestors believed, would always be good for the money. Corporations had been issuing commercial paper to raise money since the beginning of the century, but the practice grew much more popular in the s. This market, though, underwent a crisis that demonstrated that capital markets, too, were vulnerable to runs. Yet that crisis actually strengthened the market. In , the Penn Central Transportation Company, the sixth-largest nonfinancial corpora- tion in the U.S., filed for bankruptcy with  million in commercial paper out- standing. The railroad’s default caused investors to worry about the broader commercial paper market; holders of that paper—the lenders—refused to roll over their loans to other corporate borrowers. The commercial paper market virtually shut down. In response, the Federal Reserve supported the commercial banks with almost  million in emergency loans and with interest rate cuts.  The Fed’s ac- tions enabled the banks, in turn, to lend to corporations so that they could pay off their commercial paper. After the Penn Central crisis, the issuers of commercial pa- per—the borrowers—typically set up standby lines of credit with major banks to en- able them to pay off their debts should there be another shock. These moves reas- sured investors that commercial paper was a safe investment. CHRG-111hhrg51698--561 Mr. Weisenborn," To this point in the OTC commodity space, because of the prohibitions, we are a development-stage company. We have not begun trading. Our software is complete, and that is why we are here to urge a level playing field for agricultural commodities, so that they can be cleared and traded electronically. But from what we know, this would be the first application of ECN technology, such as BATS and some of the other things that have developed in Kansas City in this asset class. " CHRG-111hhrg63105--152 Mr. Newman," Chairman Boswell, Ranking Member Moran, and Members, thank you for the opportunity to testify before you today. The American Feed Industry Association is the largest organization devoted exclusively to represent the business, legislative, and regulatory interests of the U.S. animal feed industry and its suppliers. AFIA applauds this Subcommittee, its Members, and the full Committee for calling today's hearing. AFIA members manufacture more than 70 percent of the animal feed in the United States, which amounts to over 160 million tons annually. Feed also represents roughly 70 percent of the cost of producing meat, milk, and eggs. With the majority of our industry input supplies priced directly on, or in reference to, regulated commodity markets, we depend significantly on an efficient and well-functioning futures market for both price discovery and also risk management. Agricultural commodity markets were established to provide an efficient price discovery mechanism and a hedging risk management tool for producers and end-users. While this system encourages and requires speculative participants to provide liquidity, the significant increase of financial investors, as well as the special exemptions from speculative position limits that have been granted over time to Wall Street banks and others who are not end-users, has distorted the function of these markets. The agriculture commodity markets functioned effectively for over 60 years after the 1936 Commodity Exchange Act first implemented speculative position limits. However, this changed in 2000 when Congress codified earlier CFTC regulatory actions granting Wall Street banks and other financial institutions an exemption from speculative position limits for hedging over-the-counter swaps and index transactions. While there are several factors that have led to increased volatility and price swings in agricultural commodities, excess speculation by index funds is certainly one of these factors. As you are aware, the size and influence of these large financial players was never contemplated during the development of the original Commodity Exchange Act. Most of the index speculators tend to hold their positions rather than sell. This allows them to create artificial demands through their long-only positions and in essence really are bets on higher prices. The magnitude of this scenario is clear in the numbers. In 2003, index speculator investment in 25 physical commodities was $13 billion. In 2008, these investments jumped to $260 billion, an 1,800 percent increase in 5 years. In 2010, these investments remain at $265 billion, with three index funds representing 94 percent of that amount and one fund representing 52 percent of those investments. Earlier this year, we applauded the work by Congress to include provisions in the Act that would authorize CFTC to set reportable position limits on commodity contracts, as well as for aggregate and exchange-specific position limits. Within this process, AFIA members support the following items: First, speculative position limits that enhance market performance and the appropriate narrowing of cash and futures market values as they near contract delivery period; the retention and equal application of the existing speculative position limits for agricultural commodities; retaining the current bona fide hedge definition which is in place; the removal of speculative position limit exemptions for financial institutions and other nontraditional participants in agricultural commodity markets. While CFTC now has this authority, without removing these exemptions the speculative position limits will have a much more limited effect when they are put in place. Given the strong relationship between crude oil and corn futures markets brought on by the dramatic and rapid expansion of the ethanol industry, establishing and enforcing energy speculative position limits is also important to secure the reliability of the entire agricultural commodity complex. We support effective speculative position limits that work for both the bona fide hedger and the speculator. However, there is rarely a perfect solution to complex issues and waiting for a perfect solution before setting speculative position limits or taking other actions will only delay that much-needed transparency and controls required in these commodity markets. Therefore, we support implementation of interim limits where data is available and which can also be adjusted by CFTC with further data to confirm and support those changes. I would be remiss if I didn't express AFIA's appreciation to Chairman Gensler, Commissioner Chilton, and the other CFTC Commissioners for their extensive outreach during this entire process. Thank you for inviting me to participate in today's hearing. AFIA and its members stand ready to assist you in these efforts. I look forward to any questions. [The prepared statement of Mr. Newman follows:]Prepared Statement of Joel G. Newman, President and CEO, American Feed Industry Association, Arlington, VA Chairman Boswell, Ranking Member Moran and Members, thank you for the opportunity to testify before General Farm Commodities and Risk Management Subcommittee as you review implementation of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 relating to speculation limits. I am Joel Newman, President and Chief Executive Officer of the American Feed Industry Association (AFIA), based in Arlington, Virginia. AFIA is the world's largest organization devoted exclusively to representing the business, legislative and regulatory interests of the U.S. animal feed industry and its suppliers. Founded in 1909, AFIA is also the recognized leader on international industry developments with more than 500 domestic and international members, as well as nearly 40 state, regional and national association members. Our members are livestock feed and pet food manufacturers, integrators, pharmaceutical companies, ingredient suppliers, equipment manufacturers and companies that provide support services to the industry. AFIA members manufacture more than 70% of the animal feed in the U.S., which amounts to over 160 million tons annually. Because feed represents roughly 70% of the cost of producing meat, milk and eggs, AFIA members are major contributors to food safety, nutrition and the environment, playing a critical role in the production of healthy, wholesome meat, poultry, milk, fish, eggs and pets. AFIA is a member of the Commodity Markets Oversight Coalition, which was formed in 2007, and is a broad coalition of organizations committed to protecting the interests of bona fide hedgers and derivatives end-users. We thank the Subcommittee for including Jim Collura in this hearing to speak on behalf of CMOC. His leadership has been invaluable to the Coalition. Your review of implementation of the Dodd-Frank Act by the Commodity Futures Trading Commission (CFTC) is both timely and appreciated by the men and women of the feed industry. As I have stated, feed represents approximately 70% of the on-farm cost of raising livestock and poultry. With the majority of our industry's input supplies priced directly on or in reference to regulated commodity markets, we depend significantly on an efficient and well-functioning futures market for both price discovery and risk management. Agriculture commodity markets were established to provide an efficient price discovery mechanism and a hedging/risk management tool for producers and end-users. While this system encourages and requires speculative participants to provide liquidity, the significant increase of financial investors, permitted by special exemption from speculative position limits, has distorted the function of these markets. Speculators are an important part of the commodity markets--without them there is no market. The agriculture commodity markets functioned effectively for 64 years after the 1936 Commodity Exchange Act first implemented speculative position limits. With these limits in place, the process of physical commodity customers using the futures markets as a price discovery and risk mitigation tool were able to rely on traditional speculator participation to provide a clear buyer/seller relationship and market liquidity. However, this changed in 2000, when Congress codified earlier CFTC regulatory actions granting Wall Street banks an exemption from speculative position limits for hedging over-the-counter swaps and index transactions. While there are several factors that have lead to increased volatility and price swings of agriculture commodities, excessive speculation by index funds is certainly one of these factors. As CFTC has recognized, speculator participation in these markets without position limits does have an impact on prices. These banks, which represent institutional investors, used the guise of ``hedging'' their invested capital to take advantage of the exemption. But in fact, their initial investments were speculative and were not hedging future needs or commitments for the underlying commodities. AFIA strongly supported ending this exemption, and we were very pleased when Congress took steps to address our concerns. Over the past few years, as the volatility and instability in the stock and financial markets exploded, speculative activity in the agricultural commodity futures markets grew substantially. In some crop contracts, there were times when the daily speculator trading volume was nearly equal to, or in the case of wheat, was more than the entire U.S. annual production volume of these same crops. This not only added to extreme price volatility as bona fide hedgers scrambled to mitigate their risks, but in many cases it pushed end-users out of the market. In at least one situation, this speculator activity pushed an organization into bankruptcy when the impact of margin calls caused by the extreme price run-ups drained the company's liquidity to unsustainable levels. As you are aware, from the Committee's analysis, when considering reforms for the futures markets and products, the size and influence of these very large financial players was never contemplated during development of the original Commodity Exchange Act (CEA). The recent dramatic increases in nearly all physical commodities values actually increased speculator demand, with the net result of commodity prices reaching unrealistic levels relative to true demand. Most of the index speculators tended to hold their positions rather than sell, which exacerbated the situation by producing artificially high demand accompanied by higher prices that negatively impacted nearly all end-users of the physical commodities. The magnitude of this scenario is clear in the numbers: In 2003, index speculator investment in 25 physical commodities was $13 billion; in 2008, these investments jumped to $260 billion--an 1,800% increase. In 2010, these investments remain at $180 billion, with three index funds representing 92% of these investments and one fund representing 61% of these investments. (Illustration 2) As a result, the feed industry was forced to pay higher prices for grains and other inputs, which were passed along to livestock, dairy and poultry producers and feed costs soared. Farmers, although receiving substantially higher prices for their commodities, were also hit by soaring costs for fertilizer and fuel, as similar speculator activities artificially further drove up oil prices. Simply put, agriculture, from farm to retail, had to deal with extreme price volatility on a number of fronts without the effective support of our primary risk mitigation tool--the futures markets--because those markets were severely compromised by Wall Street banks ability to avoid speculative position limits and invest substantial levels of monies in the physical commodity markets. This not only allowed them to avoid the volatility of the dust storm on Wall Street, it provided them a significant return on those speculative ``hedges'' because of their ability to influence the escalation of market prices by creating artificial demand. Earlier this year, we applauded the work by Congress to include provisions in the Act that would authorize the CFTC to set position limits on commodity contracts, as well as for aggregate and exchange specific position limits. Also, when commenting on CFTC's proposed position limits for energy contracts in March of this year, AFIA encouraged the Commission to consider such actions for other hard commodities to similarly protect agricultural commodities from the very large financial speculators that were masquerading as hedgers, parking their resources in physical commodity markets to ride out the extreme volatility then present in the stock and financial markets. By including clear authority for the CFTC to set a variety of reportable position limits, Congress took a solid and welcomed step toward our mutual goal of ensuring these commodity markets and products effectively serve their primary role of providing bona fide commercial hedgers reliable tools to manage their economic risks. With the expanded authority in place relative to speculation limits, AFIA is anxiously waiting for the CFTC to finalize its regulations and to put speculative limits into effect. We know this will take time and are hopeful the combination of the various categories of speculation position limits, combined with full implementation of the Act's other provisions, such as enhanced transparency and expanded regulation of nearly all derivatives, will assure bona fide hedgers of the viability of their futures-based risk management strategies. I would be remiss if I did not extend AFIA's appreciation to Chairman Gary Gensler and his fellow CFTC Commissioners for their openness and diligence in addressing our concerns, particularly during the time Congress was developing its package of reforms. Through frequent meetings, they provided frank and candid overviews of their established authorities. When Congress was deliberating its reform legislation, the CFTC team also provided regular updates on progress toward the reform goals we and others were supporting. Just as important, they helped us understand how certain provisions in the Act addressed our concerns while approaching them in a different manner than we had proposed. Importantly, the CFTC has been aggressive in its outreach over the past few months as it works to implement the Act. Like most supporters of reform in the futures industry, particularly as it relates to the topic of this hearing, AFIA would very much like to have speculation position limits set and in place today, as well the additional regulatory and transparency provisions. But we need the CFTC to ensure that when it sets limits, they also are ready to monitor and report trading activity, and ready to ensure compliance with and enforcement of the new law. It is critical for all bona fide end-users to know we are on a level playing field with speculators and each other. Modern production agriculture is complex. The linkages between producers, end-users and uses of physical commodities are constantly evolving. The feed industry, for example, is still adjusting to the dramatic and rapid expansion of ethanol and other bioenergy industries. The intersection of corn, soybeans and other oilseeds for feed, food and energy--not mention other industrial uses for these crops--is our new reality, one that poses additional competition and risk management challenges for each of our respective industry sectors. This has also had the effect of linking corn futures to crude oil futures, adding further volatility to the entire commodity complex. We are confident the CFTC is prudently moving as efficiently as it can to implement the speculative limits and other provisions of the Dodd-Frank Act under its existing and new authorities while making sure it clearly and fully understands the complexities of the derivatives markets. While being patient with the rulemaking process does produce certain levels of stress, we remain confident in and appreciative of the CFTC's efforts to date, and hope to remain so. This brings me back to the beginning of my testimony. AFIA again applauds the Subcommittee, its Members and the full Committee for calling today's hearing to check in on the CFTC's progress on speculation limits. Your individual and collective interest in making sure progress toward implementation is both steady and correct does a great deal to reduce stress levels among AFIA's members. I urge you to consider additional hearings on the Commission's progress toward implementing all provisions of the Act. Thank you for inviting me to participate in today's hearing. AFIA and its members stand ready to assist you in these efforts. I look forward to answering any questions you may have. Attachment Marshall [presiding.] Thank you, Mr. Newman.Mr. Sprecher. CHRG-111hhrg52406--10 Mr. Royce," Thank you, Mr. Chairman. Well, beyond the problems with bifurcating consumer protection and solvency protection, a fundamental question remains. And that is, would a consumer financial products agency have stopped the issuance of subprime mortgages to consumers or Alt-A mortgages to consumers? I think it is fair to say the regulators we had in place, many of whom were responsible for consumer protection, were assisting in rather than hindering the proliferation of these subprime products, the proliferation of what are now called ``liar loans.'' In fact, it was because of regulators in Congress that these various products came into existence and thrived in the manner that they did. Subprime mortgages came out of CRA regulations, according to a former Fed official. And Fannie Mae and Freddie Mac purchased subprime and Alt-A loans to meet their affordable housing goals set by their regulators and by Congress. They lost $1 trillion doing that. The consumers frequently lost their homes as a result of the collapse of the boom and bust that was thus created. Instead of adding another government agency, and unwisely separating solvency protection from consumer protection, we should take a step back and look at the artificial mandates we place on financial institutions that inevitably distort the market which ends up in the long-term walloping the consumer and creating the kind of housing problem that we have today. Thank you, and I yield back, Mr. Chairman. " CHRG-109hhrg28024--37 Mr. Bernanke," Congresswoman, with respect to the Federal Reserve's policies, of course our mandate is maximum sustainable employment. We will strive for that mandate by maintaining a level of employment which is not only high but is also sustainable. In that way, we make it possible for better jobs to be created because we don't have seasonal and fluctuating jobs as we would in a boom/bust kind of cycle. So that's the contribution that the Federal Reserve will make. With respect to the relationship between productivity and real wages, I have some confidence that there will be some catch-up. During the late 1990s in the previous episode when productivity surged ahead, there was a period where labor's share declined below its long-term average and real wages fell somewhat behind productivity gains. After a couple of years, as the labor market strengthened, we saw that those gains translated into overall real wages. And I believe that as the market continues to strengthen now that we'll see real wages rising as well. That's a statement about overall real wages. It doesn't necessarily address the entire distribution of wages, and we've already discussed some of those issues. With respect to your question about education, I think an important point to make is that education is much more than K-12 and university. It involves continuing education. Community colleges play an important role. So does job training, on-the-job training. I think we need to promote those kinds of activities, and the Government has some role in assisting on that. " CHRG-111hhrg63105--27 The Chairman," I understand. So are you saying that you kind of expect to be on schedule for the agricultural commodities in April? " CHRG-110hhrg46591--402 Mr. Ellison," Are you familiar with this piece of legislation, the Commodities Futures Regulations Act? " FOMC20050322meeting--9 7,MR. KOS.," “Softs,” as they are called—things like agricultural commodities and metals." CHRG-111hhrg51698--31 Mr. Damgard," I would yield to Mr. Gooch on that. I think he is really the expert on the commodities defaults. " CHRG-111hhrg63105--146 Mr. Collura," Chairman Boswell, Ranking Member Moran, and Members of the Committee, thank you for the opportunity to testify on the importance of speculative limits for commodity dependent businesses and consumers. I currently serve as the Vice President of the New England Fuel Institute, which represents more than 1,200 mostly small, family owned and operated home heating companies. In 2007, in response to what was perceived as unpredictable and volatile commodities futures markets, and out of concern over possible excessive speculation in these markets, we partnered with the Petroleum Marketers Association of America and other business and consumer groups to form the Commodity Markets Oversight Coalition, or CMOC. I am delivering testimony today on behalf of this coalition, and I have submitted a list of supporting groups for the record. CMOC is comprised of an array of commodity dependent bushiness and industries, as well as faith-based organizations and groups representing average American consumers. We favor policies that promote stability and confidence in the commodity markets and that preserve the interests of bona fide hedgers and consumers. Our coalition endorsed title VII of the Dodd-Frank Act, which includes the most substantial reforms of the derivative markets in more than a decade. Members of this Committee, under the leadership of Chairmen Peterson and Boswell, and Ranking Members Lucas and Moran are to be commended for their years of hard work that resulted in the passage and enactment of this monumental piece of legislation. The Dodd-Frank Act includes various regulatory initiatives necessary for market transparency and to prevent fraud and manipulation and excessive speculation, including a requirement the CFTC establish speculative position limits for regulated and currently unregulated markets. The law requires that the CFTC establish position limits for energy commodities by January 17, 2011. However, we are disappointed that the Commission has recently come under pressure to delay the imposition of these limits by the deadline as required by law. Our coalition opposes any such delay. Some argue that the CFTC has not had enough time to thoroughly vet and consider the potential effects of such limits. However, the Committee should note that the Dodd-Frank Act does not provide the CFTC with the authority to establish limits. It actually expands existing authority. The Commodity Exchange Act of 1936 requires the CFTC to set position limits in order to prevent a single market participant from controlling price movements. The law sought to prevent undue burdens on interstate commerce resulting from excessive speculation and, as a consequence, cause sudden or unreasonable price fluctuations or unwarranted changes in the prices of commodities. However, the U.S. exchanges have abandoned hard energy speculation limits in favor of softer accountability limits. Under the leadership of Chairman Gensler, the CFTC in 2009 acknowledged that accountability limits were insufficient to prevent traders from taking controlling positions. Many traders were violating them with little or no action by the exchange. The CFTC held a round of hearings in the summer of 2009 and introduced a proposal in January. In the 4 months between January and April of 2010, the CFTC received well over 8,000 comments on the proposed rule, the vast majority urging strong and meaningful limits in speculation. During that time, some argued against the CFTC's proposed action out of fear that it would drive market activity from regulated exchanges under so-called dark markets; those that reported little or no data or were subject to little or no oversight. The CFTC should not act, they argued, until it was granted authority over the OTC and foreign markets and could implement limits across the board. The CFTC under the Dodd-Frank Act enjoys this authority. Once fully implemented, the Act will bring dark OTC markets to light by requiring exchange trading or clearing. It requires that foreign boards of trade that seek U.S. access first prove that they are subject to comparable oversight and regulation, including the imposition of position limits. In addition, many overseas regulators are drawing up their own plans to impose speculation limits. If the CFTC were to delay implementation of these limits here in the United States, the impetus for regulatory reform in other jurisdictions overseas could be jeopardized. The CFTC must act. Excessive speculation is real and it hurts. When prices surge to unjustifiable levels, consumers are left with higher food, gasoline, and home heating costs. Vital U.S. businesses, including manufacturers, airlines, truckers, and other transporters are hurt as well. Even still, some continue to believe that speculation can never be a bad thing. Despite ample evidence that excessive speculation has been destructive to commodity markets, some continue to doubt, question, or outright deny that speculation was ever or could ever be excessive. Make no mistake, we believe in open, transparent, and competitive markets and that new regulation must not excessively burden market participants or unnecessarily impede market liquidity. Speculators provide the market with this liquidity. But excessive speculation drives commodity prices to levels unjustified by market forces and results in price bubbles that harm commodity hedgers and users in the broader economy, as we saw in dramatic fashion with the commodity bubbles in 2007 and 2008. Establishing and imposing timely and meaningful limits will send a signal of confidence and stability, and help create more transparent, orderly, and functional commodities markets. Thank you again for the opportunity to testify. I look forward to any questions you might have. [The prepared statement of Mr. Collura follows:] Prepared Statement of James M. Collura, Vice President for Government Affairs, New England Fuel Institute; Founding Member and Spokesman, Commodity Markets Oversight Coalition, Washington, D.C. Honorable Chairman Boswell, Ranking Member Moran and Members of the Committee; thank you for the opportunity to testify before you today on the importance of position limits for commodity dependent businesses and consumers, and the broader economy and market stability. I currently serve as Vice President of New England Fuel Institute (or ``NEFI''), a not-for-profit home energy trade association that represents more than 1,200 mostly small, family owned- and operated-businesses. In 2007, in response to what was perceived as increasingly unpredictable and volatile commodities futures markets, and out of concern over possible excessive speculation in these markets, NEFI partnered with the Petroleum Marketers Association of America (or ``PMAA'') to form the Commodity Markets Oversight Coalition.\1\ I am delivering testimony today as a spokesman for this coalition.--------------------------------------------------------------------------- \1\ The Petroleum Marketers Association of America is a national federation of 47 state and regional trade associations representing over 8,000 independent petroleum marketing companies, including convenience store/gas stations, gasoline and diesel fuel retailers and suppliers, and home heating oil dealers.--------------------------------------------------------------------------- The Commodity Markets Oversight Coalition (or ``CMOC'') is an informal coalition whose participating members represent an array of business interests, including commodity producers, processors, distributors, retailers, commercial and industrial end-users, as well as groups representing average American consumers. The CMOC advocates in favor of government policies that promote stability and confidence in the commodity markets and that preserve the interests of bona fide hedgers, consumers and the broader economy.\2\--------------------------------------------------------------------------- \2\ The coalition, when formed in August of 2007, was referred to as the ``Energy Markets Oversight Coalition,'' but was changed to the ``Commodity Markets Oversight Coalition'' to reflect its members' interests in reforming derivative trading in a broad range of commodities, including agricultural and energy commodities.--------------------------------------------------------------------------- On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.\3\ Title VII of the Dodd-Frank Act, which was endorsed by members of the CMOC, included the most substantial new regulations of the U.S. derivatives markets in more than a decade. Members of this Committee, under the leadership of Chairman Peterson, Chairman Boswell and Ranking Members Lucas and Moran, are to be commended for their years of hard work that resulted in the passage and enactment of this monumental piece of legislation.--------------------------------------------------------------------------- \3\ Pub. L. 111-203.--------------------------------------------------------------------------- Obtaining the consensus necessary to assemble and retain support for Title VII of the Dodd-Frank Act was certainly no easy task. Many proposed reforms of the U.S. derivatives markets were met with great skepticism, if not outright opposition, from various special interests. Many market participants and stakeholders, from small businesses, farmers and energy end-users to massive Wall Street banks and trading houses, got involved in the debate. Despite efforts by opponents to misrepresent or create doubt about many of the derivatives reforms in the bill, Congress included various regulatory initiatives necessary for market transparency and accountability and to prevent fraud, manipulation and excessive speculation. But rather than taking a detailed and proscriptive approach to the most controversial provisions, the Congress ceded much discretion to financial regulators such as the Commodity Futures Trading Commission (or ``CFTC''). One clear example of this delegation of Congressional authority is the law's directive to CFTC to establish speculative position limits for regulated and currently unregulated markets such as over-the-counter swaps markets.\4\--------------------------------------------------------------------------- \4\ Ibid, 737.--------------------------------------------------------------------------- The Dodd-Frank Act requires that these limits be established ``in the spot month, in each other month, and in the aggregate across all months'' and provides the CFTC with discretion in defining exemptions for bona fide hedgers. The new law requires that the CFTC establish speculative position limits for what are defined by statute as currently ``exempt commodities,'' such as energy and metals, within 180 days of enactment, and for agricultural commodities within 270 days of enactment.\5\--------------------------------------------------------------------------- \5\ The Commodity Futures Modernization Act of 2000 (Pub. L. 106-554) created a new classification for commodities to be exempt from many trading rules under the Commodity Exchange Act, called ``exempt commodities,'' which includes any commodity other than an excluded or agricultural commodity.--------------------------------------------------------------------------- We commend CFTC Commissioner Gary Gensler and his fellow Commissioners for their commitment to timely enactment and enforcement of new regulatory initiatives under this Act and for engaging stakeholders in a thoughtful and transparent rulemaking process. Tomorrow, the CFTC will hold the eighth in a series of public meetings on the implementation of the Dodd-Frank Act. Tomorrow's meeting will include discussion and review of proposed rulemakings for position limits. Despite this transparent and inclusive process, the Commission has recently come under pressure to delay the formulation and imposition of position limits by the deadline required by law. Our coalition opposes any such delay.1. Imposition of Position Limits Is Not a New Idea The Dodd-Frank Act does not provide the CFTC with the authority to establish speculative position limits; it actually expands existing authority under the Commodity Exchange Act of 1936. Section 4(a) of that Act required the CFTC to set limits on market positions that traders can take in any commodity in order to prevent a single market participant from controlling price movements. The goal was to prevent an ``undue burden on interstate commerce'' that would result from excessive speculation and, as a consequence, cause ``sudden or unreasonable fluctuations or unwarranted changes in the price'' of commodities. Like the Dodd-Frank Act, the 1936 statue was enacted following a time of crisis for the economy, a catastrophic upheaval in U.S. financial markets, volatility and uncertainty in commodity futures markets and a debate over prudent regulation to remedy these problems and their causes. Farmers, arguing that speculation can indeed become excessive and manipulative, and therefore distort fundamentals and the price discovery function of futures markets, fought hard for position limits authority and won the day. In 1936, Federal regulators acted quickly to impose position limits on agricultural markets that resulted in sixty years of relatively reliable and orderly commodities futures markets for agricultural, and eventually, energy commodities. However, in the 1990s the commodity markets began to change dramatically as a result of digitalization, globalization and the Internet. Traditional open-outcry exchanges on LaSalle Street in Chicago and Wall Street in New York found themselves in competition with new electronic and off-shore trading platforms. In an effort to remain competitive in energy commodity futures, options and swaps, many exchanges abandoned hard speculation limits in favor of softer ``accountability limits.'' Shortly after his confirmation as CFTC Chairman, Gary Gensler acknowledged that accountability limits have time and time again proved insufficient in preventing traders from taking large positions in violation of these limits and with relative inaction by the exchange. In fact, the CFTC found that in the 12 months between July 2008 and June 2009, individual month accountability limits were exceeded for crude oil, gasoline, heating oil and natural gas by 69 different traders. Some traders even exceeded limits every day during the trading period.\6\--------------------------------------------------------------------------- \6\ Statement by CFTC Chairman Gary Gensler, Public Meeting on Establishing Position Limits, CFTC Headquarters, Washington, D.C., January 14, 2010.--------------------------------------------------------------------------- There are well documented cases in which individual traders violated accountability limits and their actions had major consequences for market hedgers and consumers. This includes the $6 billion collapse of Amaranth Advisors in 2006, one of the largest hedge fund collapses in U.S. history. A Senate Permanent Subcommittee on Investigations report in June 2007 found that ``Amaranth controlled 40 percent of all outstanding contracts on NYMEX for natural gas in the winter season (October 2006 through March 2007), including as much as 75 percent of the outstanding contracts to deliver natural gas in November, 2006.'' \7\--------------------------------------------------------------------------- \7\ Excessive Speculation in the Natural Gas Market, Senate Permanent Subcommittee for Investigations Staff Report, June 25, 2007.--------------------------------------------------------------------------- Amaranth occasionally held five or more times the ``accountability limit'' for natural gas, and according to the report, the NYMEX failed to take immediate action and in many instances where traders violated limits, never took any action. When the NYMEX finally ordered Amaranth to draw down its position, they simply moved their holdings onto an off-shore exchange where the CFTC and the U.S. exchanges had access to little or no data. But the size of the Amaranth position relative to the market eventually came back to haunt it, when in September, 2006 its position collapsed. The record surge in natural gas prices at the height of the Amaranth position and the subsequent collapse demonstrated that without hard position limits one trader alone can move these markets. This event led many industries to recognize the problems associated with exempting energy commodities from position limits and catalyzed the establishment of our coalition in August of 2007. It also proved that ``too big to fail'' exists in the commodities derivative markets and that commodity speculation can be at times excessive. It also exposed in dramatic fashion the inadequacies of so-called ``accountability limits'' and lack of oversight and transparency in the commodity markets. More frightening still was evidence that a growing majority of trading was now occurring on so-called ``dark markets,'' or markets that reported little or no data and were subject to little or no oversight and regulation. As policy makers deliberated on appropriate reforms, the market continued to deteriorate for end-users. The following year, energy prices surged to unjustified levels. In the summer of 2008, and despite declining demand and historically high inventories, crude oil topped $147 per barrel. Consumers faced unprecedented gasoline and home heating costs. Food prices similarly surged to record levels. As food became unaffordable and aide declined, riots broke out in at least 30 food important dependent countries. Manufactures, airlines, truckers and other transporters saw fuel prices surge, which caused inflation in the cost of goods and services for every American. But like almost every speculative bubble, this one eventually burst, leaving many farmers, manufacturers and other end-users stuck with unaffordable commodity pricing contracts. Shortly after his confirmation as CFTC Chairman last year, Gary Gensler acknowledged the need for immediate action to restore confidence and stability. The Commission began drafting proposed rules to address trading loopholes and exemptions, and to establish position limits for energy and metals. The Commission held a round of hearings in the summer of 2009 to solicit input from commodity hedgers, speculators, consumers and academics. Several members of this coalition delivered testimony before the Commission at this time.\8\--------------------------------------------------------------------------- \8\ Held on July 28 and 29, and August 5, 2010. (www.cftc.gov/PressRoom/Events/Events2009/index.htm)--------------------------------------------------------------------------- In January 2010, the CFTC proposed a rule for the establishment of speculative position limits for energy contracts, modeled largely after existing position limits that existed for agricultural commodities.\9\ During the comment period ending April 26, 2010, the CFTC received an unprecedented number of submissions, well more than 8,000 in all, the vast majority of which indicated support for strong and meaningful limits on speculation. Several CMOC member groups were among those comments, and many expressed reservations at the relatively ``high bar'' formul# recommended by the Commission.--------------------------------------------------------------------------- \9\ Notice of Proposed Rulemaking for Federal Speculative Position Limits for Referenced Energy Contracts and Associated Regulations, Commodity Futures Trading Commission, 75 FR 4143, Washington, D.C., January 26, 2010.--------------------------------------------------------------------------- Understandably, several Commissioners expressed reservations about establishing limits that could be considered too aggressive in light of the Commissions lack of authority over certain trading environments. At least two Commissioners feared in April that position limits would drive trade to ``dark'' over-the-counter and off-shore environments. The CFTC repeatedly called on Congress to give it authority over these markets, so that broad and uniform limits could be placed on all speculative positions and in all markets. On July 21, 2010, the agency got its wish when the Dodd-Frank Act became law. The CFTC has enjoyed 75 years of authority to establish speculation limits in commodity markets. After nearly 2 years of debate and passage of the most sweeping reforms in the history of the U.S. derivative markets, they now have the authority to establish said limits across the board to all traders and in all markets. We see little merit to the argument that the CFTC has not sufficiently considered the imposition of such limits. We are discouraged that, despite ample evidence of excessive speculation in commodities markets that some continue to doubt, question or outright deny that speculation was ever and could ever be excessive.2. Hard Speculation Limits Will Not Disrupt Markets Many CMOC participating groups represent vital commodity-dependent industries that have a steadfast belief in open, transparent and competitive markets. We believe that any new rules and regulations must be well reasoned, justified and not excessively burden market participants, or unnecessarily impede market liquidity. Speculators provide the market with this liquidity, but excessive speculation drives commodity prices to levels not justified by the market forces of supply and demand, results in pricing bubbles that harm commodity hedgers, end-users and the broader economy. We also believe that the commodity derivatives markets, when they were first established more than 150 years ago, did not have as their primary constituents Wall Street speculators and investors looking to make a fast buck, nor was the CFTC established by Congress to serve such constituents to the detriment of hedgers and consumers. Commodity exchanges were established to provide legitimate commercial businesses and end-users with a means to hedge risks associated with commodity prices. When unrestrained speculation is allowed to dominate markets and their hedging and price discovery functions, as we have clearly seen, it violates the Commodity Exchange Act's prohibitions on such activity. The CMOC rejects the contention of some in the financial services industry that limits to prohibit excessive speculation could be more disruptive to our markets more than excessive speculation itself. Last week, the IntercontinentalExchange (ICE), the Chicago Mercantile Exchange (CME) and the New York Mercantile Exchange (NYMEX) denied that timely imposition of limits would disrupt markets. Reuters reported on December 8th that the ``top U.S. futures exchanges expressed confidence that a revised plan to clamp down on commodities market speculation will not unduly burden the market'' if it uses the previous (January, 2010) proposed rule as a starting point.\10\ We believe the earlier proposed rule was insufficient to address ``the burdens of excessive speculation'' due to its very high limits. However, it is a starting point and because the CFTC now has authority to apply limits to previously exempt markets and participants, our coalition would be supportive of lower limits.--------------------------------------------------------------------------- \10\ Wallace, John and Steve Orlofsky, ``ICE, CME More Optimistic on CFTC Position Limits,'' Reuters News Service, December 8, 2010.--------------------------------------------------------------------------- Some argue that establishing limits expeditiously in order to meet what they consider to be negotiable or arbitrary deadlines under the Dodd-Frank Act will drive market activity off-shore to trading environments that are free from such limits (as we saw earlier with the Amaranth case). This argument is a red herring, as the Dodd-Frank Act anticipates this response and establishes new registration requirements for foreign boards of trade (FBOTs) that seek to allow access from within the U.S., provided they meet a list of comparable regulatory criteria, including the imposition of speculative position limits.\11\ The stated intent of the Congress was to prevent limits imposed by the CFTC to ``cause price discovery in the commodity to shift to trading on the foreign board of trade.''--------------------------------------------------------------------------- \11\ Pub. L. 111-203, 738 and 737(a)(4).--------------------------------------------------------------------------- In addition, regulators in Europe and elsewhere are currently in the process of drawing up their own plans to impose speculative position limits in addition to the many other transparency requirements and other regulatory initiatives prescribed by the Dodd-Frank Act. If the CFTC were to fail to apply aggregate position limits to implement the Dodd-Frank Act, the impetus for regulatory reform in other jurisdictions could be jeopardized. As we learn of the extraordinary measures that he Federal Reserve Bank took to provide European banks with hundreds of billions of dollars of loans on extremely favorable terms,\12\ we are reminded of the high cost of relying completely on financial industry self-regulation. Weak position limits or a return to position accountability would provide industry with de facto self-regulation.--------------------------------------------------------------------------- \12\ Harding, Robin with Tom Braithwaite and Francesco Guerrera, ``Europe's banks tapped Fed,'' Financial Times, December 2, 2010.--------------------------------------------------------------------------- On November 1, 2010, our coalition submitted preliminary comments regarding the implementation of various regulatory initiatives under the Dodd-Frank Act. We announced then our opposition to any delay in the formulation and imposition of speculative position limits. We also suggested that additional stability and restraint on speculation could be achieved were the CFTC to develop limits specifically for index funds and to distinguish them as separate and distinct from more traditional speculators.\13\ These so-called ``passive investors'' and their rolling contracts in energy and food commodities places commodities in a perpetual state of contango, where out-month futures prices are perpetually higher than spot prices. Such an investment strategy ignores market fundamentals and distorts the price discovery nature of the markets. These large funds have transformed commodities markets from a means to hedge fluctuating prices into a new asset class for pure financial accumulation.--------------------------------------------------------------------------- \13\ General Comments to the CFTC on the Implementation of Title VII of the Dodd-Frank Act, Commodity Markets Oversight Coalition, November 1, 2010, p. 6.--------------------------------------------------------------------------- We also agree with a recent suggestion by CFTC Commissioner Bart Chilton that separate limits might also be considered for high-frequency trading (HFT) or so-called ``computer algorithm-based trading'' or ``algo-trading'' in commodity markets. Today, HFT accounts for \1/3\ of all trading activity in U.S. futures markets and it is growing fast. Futures regulators and the Congress need to address this trend, especially in light of the ``flash crashes'' that have been witnessed in the securities markets, for which HFT has been considered at least partly responsible (including the 1000 point plunge in the Dow on May 6, 2010). Such ``flash crashes'' in the commodity trading markets could have devastating consequences for U.S. businesses and consumers.3. Limits Will Restore Confidence in Commodity Markets Establishing and imposing timely and meaningful speculative position limits as required by the Dodd-Frank Act will send a signal of confidence and stability to all market participants that end-users will again be able to rely on transparent, orderly and functional commodity markets. Continued inaction is not an option. Our coalition and the businesses and consumers we represent rely upon the CFTC to do their best to protect against fraud, manipulation and excessive speculation and to ensure a fair, transparent and accountable marketplace. Decisive action will be a strong and long overdue step in the protection of market integrity and the stability of the broader economy. As the 111th Congress comes to a close, we commend it--and especially the Chairs and Members of the Agriculture, Banking and Financial Services Committees--for the hard work, political courage and leadership that made derivatives reform possible. Generations of Americans will be forever grateful for what you've done. But now this legislative legacy is in the hands of regulators. We trust that they will implement and enforce new authority, and that the new Congress will continue to provide them with the political support and financial resources necessary to do so. Thank you again for the opportunity to testify. We would be pleased to answer any questions that you might have. AttachmentGroups Supporting Testimony ActionAid USA Air Transport Association California Black Farmers and Agriculturalists Association Colorado/Wyoming Petroleum Marketers Association Columban Center for Advocacy & Outreach Consumer Federation of America Consumer Watchdog Florida Petroleum Marketers Association Food & Water Watch Fuel Merchants Association of New Jersey Gasoline & Automotive Service Dealers of America Inc. Illinois Petroleum Marketers & Convenience Store Association Independent Connecticut Petroleum Association Louisiana Oil Marketers & Convenience Store Association Massachusetts Oilheat Council Maine Energy Marketers Association Maryknoll Office for Global Concerns Michigan Petroleum Association/Michigan Association of Convenience Stores Montana Petroleum Marketers & Convenience Store Association National Association of Oilheating Service Managers National Association of Truckstop Operators National Farmers Union Nebraska Petroleum Marketers & Convenience Store Association New England Fuel Institute New Mexico Petroleum Marketers Association New Rules for Global Finance New York Oil Heating Association North Dakota Petroleum Marketers Association Oil Heat Institute of Long Island Oil Heat Council of New Hampshire Oil Heat Institute of Rhode Island The Organization for Competitive Markets Petroleum Marketers Association of America Petroleum Marketers & Convenience Store Association Kansas Petroleum Marketers & Convenience Stores of Iowa Propane Gas Association of New England Public Citizen R-CALF--USA South Dakota Petroleum & Propane Marketers Association United Egg Producers Utah Petroleum Marketers & Retailers Association Vermont Fuel Dealers Association West Virginia Oil Marketers and Grocers Association Western Peanut Growers Western Petroleum Marketers Association " CHRG-111shrg55117--32 Mr. Bernanke," Yes, sir. You are absolutely right. Inventory liquidation is not complete yet, but it is substantially advanced, and that will be a support to production both here and perhaps even more so abroad, which will create a stronger global economy, which will be helpful indirectly. We expect a recovery, and there is still a great deal of uncertainty, but we expect a recovery to start off relatively slow, and in part it is because of the consumer who is facing a damaged balance sheet, still has high debt on the balance sheet. Wealth has been reduced by housing and equity price declines. So we do not expect the consumer to come roaring back by any means, particularly with the labor market in the condition that it is in. So the American consumer is not going to be the source of a global boom by any means. On that very topic we are continuing to encourage our trading partners in Asia and elsewhere to understand--and I believe that they do--that they need to substitute their own domestic spending, their own domestic demand, for American consumers as the engine of growth in their economies. And we are seeing, for example, in China, with their large fiscal package there and their attempts to strengthen their infrastructure spending, we are seeing some motion in that direction. So our anticipation is for a recovery that will start slowly, begin to pick up speed over time, but it depends very much on to the extent consumers can get comfortable with their financial situations going forward, and also to the evolution of the labor market. Senator Bennett. Thank you. " CHRG-111hhrg51698--405 Mr. Pickel," Well, we look at the existing structure under the CFMA in terms of the exempt commodities, the excluded commodities, and that structure is how we look at the treatment of different types of financial instruments. Ms. Herseth Sandlin. Okay. But I would like to just understand a little bit better. Since the draft legislation includes the authority to grant exemptions, do you question the CFTC's ability in particular to grant these exemptions? Is that where your concern lies? " CHRG-110hhrg44901--135 Mr. Bernanke," I believe so. Yes. Ms. Moore of Wisconsin. All right. I know that the CFTC and the SEC have been having talks. Do you think--this committee, by the way, doesn't have jurisdiction over the CFTC, and I think most of the questions have been related to commodities. Do you think that we need to modernize our regulatory system by having these commodities come under the same jurisdiction as the SEC? I know the CFTC and SEC have been talking about such a collaboration or merger, and I am wondering, do you think there would be any benefit in that? " CHRG-111hhrg63105--192 Mr. Collura," Right, versus the index funds which have a different investment strategy when it comes to commodity investments. " FOMC20070628meeting--117 115,MR. HOENIG.," Thank you. I will spend just a couple of minutes extra on the District this time because, generally speaking, our District economy continues to perform very well despite the weakness in the housing sector. Energy and agriculture remain very strong, and manufacturing remains generally strong although we have seen some leveling-off of that in the past month. The strength in these three sectors has helped spur broad-based job growth throughout the District and a significant tightening of our labor markets and their conditions. Many of our contacts report labor shortages and higher wage pressures. Demand for skilled labor remains very strong, and some firms have limited hiring plans because of the unavailability of qualified workers. To bolster recruiting, a few companies have partnered with vocational schools to offer industry- specific training programs to try to fill the gap. Since our last meeting, hiring announcements, which we try to track, have outpaced layoff announcements by a margin of 6 to 1. One anecdotal piece of information—we have some fairly large engineering firms in Kansas City that build power plants globally, including in China, and also ethanol plants. Last year, one CEO told me that they hired 2,100 engineers and were unable to fill 900 positions on a global basis. So there is a lot of activity going on out there. Construction activity remains mixed, with weakness in residential construction balanced by strength in commercial construction. On the residential side, we have seen some pickup in sales, but high inventories have limited new construction. For us, problems with subprime loans are concentrated in Colorado and in a few other areas. But because of the strength in energy and agriculture, some parts of the region are actually experiencing a housing boom, with strong home-price appreciation. Relative to the total market, that is small, but it is a rather sharp contrast. Conditions in agriculture are the best in recent years. Spring rains have alleviated drought conditions in much of our region. Strong demand and limited supplies continue to boost farm commodity prices and farm incomes. However, we are also beginning to see the effects of higher livestock and crop prices on retail food prices themselves. An additional concern is the sharp rise in land prices throughout much of our District. First-quarter cropland values in the District rose roughly 12 percent above year-ago levels, and ranchland values have strengthened as well, that much or perhaps a little more. Our contacts in the real estate industry indicate that some of the recent surge in land prices is speculative in nature, and some District bankers have expressed concern about the bubble in farmland values driven in part by the ethanol boom that we have heard about. In recent examination reports, our supervision staff have begun to see some increases in nonperforming real estate loans, and that includes some pickup in other real estate owned as well. These developments are very preliminary, but they are reminiscent of an earlier time, and we are trying to pay a little more attention to that. On the national outlook, data released since the last meeting support the view that growth will pick up over the year. I have been encouraged by the recent pickup in retail sales and by positive news on employment and personal income. At the same time, the recent increase in longer-term interest rates, if sustained, is likely to damp growth somewhat in the period ahead. In particular, the rise in the thirty-year fixed mortgage rate may deepen and prolong the ongoing housing slump. The combined effects of weaker growth in the first quarter and the rise of long-term rates have led me to lower my estimate of growth in 2007 to about 2.3 percent. I expect growth of 2.7 in ’08 and 2.8 in ’09. I now think the risks, perhaps, are roughly balanced. While the downside risk from housing remains, the outlook for other sectors, as others have reported, has appeared to improve. Markets seem to have adopted this view as well, as removal of the expected policy easing has contributed to the flattening of the yield curve at this point. In terms of the inflation outlook, recent data have been favorable, with core CPI on a twelve-month basis down to 2¼ percent. I expect continued moderation over the year. In particular, if owners’ equivalent rent continues at the slower pace of the past three months, it will help bring down the twelve-month core inflation number over time. Despite these recent improvements, I continue to believe that upside risks to inflation remain. The possible pass-through of recent energy and food price inflation to core inflation may slow progress toward lower inflation. In addition, pressures from resource utilization and slow productivity growth, if that happens to be the case, could affect that outlook as well. Finally, I am somewhat concerned with the recent uptick in longer-term inflation expectations. We have talked about the TIPS five-year, five-year-ahead breakeven inflation rate; as mentioned in the earlier briefing, it has increased about 20 basis points over the past month. So in light of these factors, I believe it is important that we continue to signal to the markets that current inflation rates are not acceptable over the longer term. Thank you." FOMC20060328meeting--130 128,MR. HOENIG.," Thank you, Mr. Chairman. A couple of things, first, on the region. Like the nation, our region continues to grow at a fairly robust pace. But one of the questions we kept asking in our discussions was whether it was strong but leveling out, or accelerating. I think, for the most part, the consensus is that it’s strong but leveling out. Turning to just a couple of examples, manufacturing activity did expand in February and, we think, in March on a preliminary basis, but at a somewhat slower pace than in January and even in December for us. Production and new orders rose only modestly in the February and early March period. Housing activity, as others have discussed, has shown some signs of leveling off, although it is still high by historical standards. Residential construction has edged down in most areas of our District, and builders to whom we’ve talked expect further easing in the months ahead. I think it is important, too, that home sales are showing little or no growth, with high-end sales softer than most of the other segments in our markets. Just to mention commercial real estate, it has actually improved somewhat in our region. Vacancy rates have continued to edge down in the Denver and Kansas City areas, so we have seen some pickup in activity. Energy activity continues to expand very rapidly, despite shortages of labor and equipment throughout the western part of our region. In some of our Rocky Mountain communities, concern has increased that the energy boom will drive away some of the other core business because of the costs of labor, land, and houses—it is really a boom environment there. I will talk quickly about inflation in our area. Wage pressures, in fact, remain mostly subdued. We have seen some backdown in wholesale prices, although retail prices have edged up. Manufacturers reported to us somewhat slower growth in raw material prices so far this year compared with last year. However, I would say they are also concerned that they cannot pass price increases on as they work through the process. Let me just say one thing on the auto industry in our region. I talked with one of the largest retailers-dealers in the region, in Denver—actually, he goes into Texas and some other areas. He told me that in just the first two weeks of March they’ve seen a general slowdown in some demand for their products, both domestic and foreign. But he said that, obviously, the domestic market is really suffering greatly. In fact, he has seen other dealers refuse to take inventory from the domestic auto dealers, which gives him real concern about that industry going forward. Turning quickly to the national outlook, I agree that, for the most part, it is very positive. I think that in the first quarter, maybe the first half, we will see a strong GDP number, perhaps as high as the Greenbook has indicated or even higher, which will then move back down toward the trend rate of growth over the course of the year. Like President Stern, I think part of this in the first quarter and first half is reflective of a couple of things. One is the bounceback from the year-end. Another is the last effects of accommodative policy that we had in the previous year, because a lot of money is still searching to be deployed right now but is beginning to be used up. And for the first time in a while, I’ve heard more and more businesses talk about the prime rate. I haven’t heard that in four years. They are much more sensitive to it. They’ve seen it go up, and now they’re negotiating around that, which I think tells you that some of the catch-up in terms of the policy effects of our past moves has begun, and I think you’ll see more of it in the coming months and quarters." CHRG-110hhrg34673--133 Mr. Garrett," Thank you, Mr. Chairman, and thank you, Mr. Chairman, for your testimony today. I appreciate your spending the time with us. I would like to go back and begin my questioning with a topic that is of great importance to me, and we have already touched on it, at least with one series of questioning, and that is dealing with GSE reform. On the one hand, I am pleased to see that the Administration is taking what I would say is a slightly tougher tone, if you will, on pushing for a brighter line test between what is appropriate and what is inappropriate between the primary and the secondary markets and what the GSE's are involved in. That is on the positive side. On the negative side, from my position, I have seen something of a softening with the Treasury stance with regard to portfolio limitations, which I believe should be a true concern to us. I know that there are ongoing negotiations, if you will, between the Treasury and our esteemed and gracious chairman behind us to try to reach a compromise on this issue, and as part of the negotiations there is consideration of what has been dubbed the MTI, the mortgage tax increase, better known as the ``Housing Fund,'' and I would be curious to have your take on an aspect of that. I raised a similar question to you when you were here before the committee a year ago and new on board, but I know since that time you have had an opportunity to get into the weeds a little bit more on this topic. You have already testified here and before other committees with regard to the importance of the housing market in general to our boom in the economy that we have had and the slight slowness of the housing market and what impact that could have on the overall economy. My first question to you is: What additional impact could we see if we did have a tax, if you will, on that marketplace by having a fee or an assessment on the GSE's for this new Housing Fund, or the MTI? " CHRG-111hhrg51698--175 Mr. Greenberger," President Roosevelt would have agreed with you, Congressman. Because, in 1934, he proposed the Commodity Exchange Act, which included speculation limits in it. That wasn't to bar speculation. It was to bar excessive speculation. The Act does bar excessive speculation. What we did in 2000 with the Commodity Futures Modernization Act was take oil futures, agriculture futures, and swaps outside of the speculation limits to ban not speculation, which we need, but excessive speculation. " CHRG-111hhrg63105--13 The Chairman," We would like to request that the other Members submit their opening statements for the record so the witnesses may begin their testimony and ensure there is ample time for questions. I would like to welcome our first panel which, of course, is the Honorable Gary Gensler, Chairman of the Commodity Futures Trading Commission and the Honorable Bart Chilton, Commissioner of the Commodity Futures Trading Commission. Chairman Gensler, welcome. Please begin when you are ready. FOMC20080805meeting--32 30,MR. KAMIN.," For the next couple of weeks, millions of people around the world will be watching the Olympic games in Beijing. For those of us charged with forecasting the global economy, of course, China-watching is a year-round task. But notably, the most salient developments since your last meeting have arisen outside of China. Chief among them, of course, have been the precipitous fluctuations in the price of oil. When the last FOMC meeting concluded on June 25, the spot price of WTI crude oil was running at $134 per barrel. It soared to over $145 by mid-July before plunging to about $119 as of this morning. The $26 per barrel drop over a three-week period was the largest on record in nominal dollar terms, although in percent terms, the 18 percent decline we've seen has been exceeded on a couple of occasions in recent years. Notably, many other commodity prices, especially those for natural gas and many food crops, also declined sharply. It has been heartening, and a welcome change, to see oil prices undershoot rather than overshoot our previous forecast. But it would be premature to pop open the champagne. We've seen several other steep declines in oil prices in recent years that gave way to renewed upward surges, and it remains to be seen whether an important shift in the supply�demand balance has occurred. Saudi Arabia added a total of 400,000 barrels a day to its production of oil in May and June, and there are indications that its production rose in July, too. However, these increases bring total OPEC production up only to their level in early 2006, and the world economy has grown considerably larger since then. Analysts have cited gloomier forecasts of global economic growth, and thus global oil demand, as contributing to the weaker oil prices; but those forecasts have been coming down for the past year with little apparent effect. Although oil consumption in the industrial economies clearly has slowed over the past year, we have yet to see either a concerted buildup in U.S. oil inventories or any indications that oil demand among developing countries is slowing. Therefore, a further lurch upward in oil prices is a distinct possibility. Moreover, with spot and futures prices having first soared and then plunged since your last meeting, the relatively flat path of oil prices that we are projecting is only about $12 per barrel lower, on balance, than in the previous forecast. In the meantime, indicators of foreign growth have come in a bit weaker than we expected, and inflation readings have been on the high side. These gloomier aspects of the international outlook counterbalance, to some extent, the improved tone of oil and other commodity markets. Clearly, prospects appear weakest in the advanced economies. Consistent with our earlier forecasts of a sharp deceleration in activity, we estimate that growth in all four of our largest industrial country trading partners--Canada, the euro area, the United Kingdom, and Japan--came in below 1 percent in the second quarter. In the United Kingdom, a sharp contraction in the housing sector appears set to drag the economy into a mild recession in the second half of this year. The remaining major economies should skirt recession but remain quite weak in the near term amid slackening export performance, continued stresses in financial markets, tightening credit standards, and very sharp erosions in business and consumer confidence. Why are the foreign industrial economies slowing about as much as in the United States, when the subprime crisis originated in this country and the major drag on the U.S. economy is the slump in a nontradables sector, housing? Clearly, part of the story involves the international financial linkages that have led foreign markets and institutions to share in the stresses and losses induced by the U.S. subprime crisis. Another part of the story involves a common shock--the global boom in oil and food prices--that has cut into real household income and spending around the globe. Third, even as the persistent decline in the dollar since 2002 has buoyed U.S. exports and growth, this has come at the cost of trade performance and economic activity in our trading partners. Finally, the foreign industrial countries have enjoyed little or none of the substantial monetary and fiscal stimulus we've seen in the United States over the past year. We estimate that growth in the emerging market economies also slowed further in the second quarter, to a pace of roughly 4 percent, where we have it staying for the remainder of the year. Obviously, this is well above the growth rate of roughly 1 percent that we've penciled in for the industrial economies, but it is still below their likely potential rate as many developing countries struggle with softening export demand and rising food and energy prices. Notably, however, even after slowing in the second quarter, estimated Chinese growth powered on at about 10 percent. By 2009, we see both foreign advanced and emerging market economies accelerating as financial stresses ease, the U.S. economy picks up, and commodity prices stop restraining the growth of real household incomes. This recovery scenario depends crucially on our projection that headline inflation starts moving down within the next quarter or two, so that substantial monetary tightening is not needed. The recent decline in oil and other commodities prices provides some comfort that this scenario will materialize. However, we saw some surprisingly sharp increases in consumer prices in June, bringing 12-month headline inflation to around 4 percent in the euro area and the United Kingdom, 5� percent in Mexico, and 6 percent in Brazil. In most of our major trading partners, inflation excluding energy and food prices has remained better contained; and in China, headline inflation has actually moved down from its February peak of 8.7 percent, registering 7.1 percent in June. Even so, until we see several quarters in a row of declines in aggregate measures of inflation, we will not be out of the woods. So far, the imprint of slowing foreign growth and rising foreign inflation on the U.S. external sector has been limited but not negligible. Turning first to prices, core import price inflation has moved up sharply, from about 3 percent last year to 11 percent in the second quarter; this was the fastest quarterly increase since 1987. Most of this acceleration was concentrated in material-intensive goods, such as food and industrial supplies, and was likely due to rising commodity prices rather than to more-generalized pricing pressures abroad. However, inflation in imported finished goods also increased this year. As we noted in a special box in the Greenbook, prices of imports from China have been moving up briskly as a result of increases in domestic costs and in the value of the renminbi. This step-up in the so-called China price explains less than one-fifth of the overall acceleration of core import prices but about one-third of the run-up in inflation for finished goods imports. Even so, assuming commodity prices stabilize going forward, we expect changes in overall core import prices to slow quite substantially in coming quarters. So far, U.S. external sector performance has held up well in spite of the slowing global economy. Net exports added 2� percentage points to real GDP growth in the second quarter, the largest quarterly positive contribution since 1980. Admittedly, much of this reflected a 6 percent decline in imports, which were dragged down both by weak U.S. demand and the quirky seasonal pattern in the data on oil imports. Even so, exports expanded at a very healthy 9� percent, supported both by the depreciation of the dollar and by continued robust demand for commodities. Going forward, we anticipate export growth holding up at a still healthy 7 percent or so, as foreign economic growth picks up right around the time that the boost from previous dollar depreciation starts wearing off. The contribution of net exports to U.S. GDP growth should move down, but this will chiefly reflect a recovery in imports as the U.S. economy picks up. Thank you. David and I will now be happy to address your questions. " CHRG-111hhrg74855--282 Mr. English," That was 1994, and we did have jurisdiction out of my subcommittee at the Commodity Futures Trading Commission back in those days. " CHRG-111shrg54589--13 Chairman Reed," Thank you very much, Chairman Schapiro. " Chairman Gensler,"STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING CHRG-111hhrg53234--158 Mr. Berner," Thank you, Mr. Chairman, Ranking Member Paul, and other members of the committee. Thanks for inviting me to this hearing to address this important question, the role of the Federal Reserve in systemic risk regulation. I think the broader question here is how should we address the significant weaknesses in our financial system and our financial regulatory structure that the current financial crisis has exposed? Among market participants, and I talk to many of them, I think there are two policy changes that are needed that are well recognized: first, strengthen our regulatory infrastructure; and second, adopt appropriate regulation oversight to mitigate systemwide risks across financial market instruments, markets, and institutions. In addition, I believe that macroeconomic policy should lean against asset and credit booms, which create financial instability. In my view, the Federal Reserve is best equipped to take the lead on systemic risk regulation and oversight. Like others, I think this function is an essential and natural extension of the Fed's traditional monetary policy role and of its responsibilities as lender of last resort. Three factors support that claim: First, the Fed is the ultimate guardian of our financial markets, and so it should be the agency that ensures the safety and soundness of the most important financial institutions operating in those markets. Second, the process of intermediation through traditional lenders in the capital markets has become increasingly complex. Supervision of the institutions involved will enhance the Fed's ability to make the right monetary policy decisions. And, finally, the Fed's expertise in financial markets and institutions makes it the natural choice for this role. The Fed's leadership in the Supervisory Capital Assessment Program demonstrated that expertise. In short, good monetary policy and financial stability, in my view, are complementary. Asset booms and busts destabilized the economy and financial system at great cost. A financial stability mandate for the Fed requires that focus on asset and credit booms as well as systemic regulation and oversight. And the policy tools required for each overlap substantially. That may explain why the other countries that separate such responsibilities from the traditional role of the central bank have fared no better than we did in this crisis. The U.K. is a good example. While the Bank of England and the Financial Services Authority clearly have collaborated in the recent crisis, their separation of powers did not help manage the current crisis more successfully than U.S. regulators. However, naming the Fed to this role won't solve all of our problems that I just enumerated. To see why, in the rest of my time, I outline some related remedies. I will conclude by answering the four questions you posed. In my view, our regulatory system has three major shortcomings: First, we supervise institutions rather than financial activities, which allows some firms to take on risky activities with inadequate oversight. A focus on systemic risk is one remedy for that problem. Designating the Fed to take the lead will limit risky activities and important market information slipping through the cracks, and it will promote supervisory accountability. Second, our regulatory safety net is excessively prone to moral hazard, encouraging inappropriate risk-taking. Concentration, as you have all alluded to in this hearing, in our financial services industry has created institutions that are too big to fail. Remedies needed should include: more extensive oversight and supervision of large, complex financial institutions; an explicit regulatory charge on such institutions to help us offset the moral hazard created by an implicit guarantee; and a strong resolution framework that is understood by all before crisis hits. An ad hoc approach creates uncertainty and reduces the credibility of policy. The third problem is procyclicality. Our regulatory infrastructure encourages excessive leverage, which magnifies financial market volatility. Three remedies needed here are: First, we need a stronger system of capital regulation that should improve financial stability and help monetary policy lean against the wind of asset booms. We must resolve the tension between accountants who want to limit reserves and regulators who want to build them--in favor of the regulators. Second, securities must be more transparent and homogeneous and less reliant on credit ratings. And third, to reduce settlement and payment system risk, we need greater use of central counterparties for over-the-counter derivatives. I want to conclude by answering your four questions. Are there conflicts with the Fed's traditional role here? Yes, there can be. In a crisis, decisions about particular firms likely would involve the Fed in inherently political considerations and the use of taxpayer funds that could compromise its independence. We should insulate the Fed's independence with two firewalls. First, the resolution of troubled financial institutions should fall to the FDIC; and, second, and globally, we must change institutions now too big to fail into being too strong to fail. Remedies will include many of the options I just discussed. Both firewalls should strengthen the Fed's role as lender of last resort by reducing moral hazard, especially by reducing the chance that we will keep nonviable institutions alive, a concern you have expressed. What are the policy pros and cons here? In my view, the pros outweigh the cons. Interconnectedness means that supervision must look horizontally across instruments, markets, institutions, and regions rather than in vertical silos. In my view, the Fed has the most expertise and reach to provide that. The Fed is also best positioned to prescribe and enforce remedies to procyclicality and to build financial shock absorbers. Now, I hasten to state the obvious: The Fed is imperfect. As the guardian of our financial system, the Fed in the past has come up short in a number of ways. I would only say that while we consider making the Fed the lead systemic regulator, the Fed and we must examine how it can improve its functioning to take on these new duties. What about the arguments against? Well, ensuring financial stability may be too big a job for just one regulator. Even if the Fed takes the lead, coordination with other regulators will be essential for success. Coordination with regulators and central banks abroad may be even more critical than being in sync with regulators at home. Our markets and institutions are global, but our regulation is largely local. So I like the President's recommendations for the Financial Services Oversight Council and international cooperation and coordination especially. Last, what about reassigning some Federal responsibilities to other agencies? Regulators should do what they do best. And, for example, as others have said, consumer protection and promotion of financial literacy could go to another agency, but I think that the Fed may still play a useful role in supporting these areas. Mr. Chairman, let me add that these views are mine and not necessarily those of my employer, Morgan Stanley, or its staff. I want to thank you for your attention. I am happy to answer any questions. [The prepared statement of Dr. Berner can be found on page 46 of the appendix.] " FOMC20050503meeting--69 67,MS. JOHNSON.," We collect import prices at the border, so to speak. So I can’t speak to the question of this showing through to retail prices. David might want to comment on that; I don’t know. Import price inflation has been surprising us a bit on the upside, and we have attributed part of that to higher global commodities prices. It shows up in our case in the industrial supplies types of categories, but we’ve seen some in the manufacturing area as well. When we break out the actual data for how import prices have moved, we’re getting contributions from both those pieces into import price inflation. So, relative to the last Greenbook, we have extended the period of elevated import price increases into the second quarter and a little into the third quarter because the global indexes of commodity prices—based on futures at this point for those periods—show the prices not rising further but remaining high, and we think it will take some time for that to be fully reflected in May 3, 2005 25 of 116 last year was that commodity prices tended to be showing up more rapidly in U.S. import prices than our models would suggest is the historical average. We have that as a second term, in addition to foreign prices and the exchange rate and so forth. So embedded in our story is that import prices were high in the first quarter and will decelerate somewhat in the second and third quarters, but not hugely and not as much as we had thought before. It involves a somewhat more extensive pass-through of high global commodity prices into import prices, and a little bit is probably still the effect of dollar depreciation at the end of 2004. Those things, in essence, go away thereafter, and we have import price inflation dropping down very much—to less than 1 percent in 2006. That is conditioned on two assumptions: the assumption we have been making routinely for the dollar of late—because we don’t know a better one to make—which is that it will change only little going forward; and the futures path for commodity prices. So the projection that import prices will decelerate in stepwise fashion through the second half of this year and into 2006 is very much a reflection of these two conditioning assumptions. And we don’t have a whole lot of information other than that." CHRG-110shrg50369--26 Mr. Bernanke," Well, Senator, to answer that question, the PPI, the Producer Price Index, that you referred to mostly reflects the effects of large increases in prices of energy and other commodities. We live in a world where energy and metals and other commodities are globally traded, food as well, and demand of emerging market economies and a growing global economy has put pressure on the available supplies of those resources and has driven up those prices. And as I mentioned, the price of oil has quintupled or more. Senator Shelby. Do you see that abating? " FOMC20050322meeting--31 29,CHAIRMAN GREENSPAN., And the weight of steel is much larger than copper and aluminum combined. So it’s an odd sort of commodity index. CHRG-111hhrg53246--23 The Chairman," Chairman Gensler. STATEMENT OF THE HONORABLE GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION (CFTC) " FOMC20050503meeting--58 56,VICE CHAIRMAN GEITHNER.," David, you referred in your remarks to the exercise shown in the package of materials for Monday’s Board briefing. I’m looking at the pass-through into core inflation of the rise in energy prices, import prices, and commodity prices. If back in December ’03, which is your baseline for this exercise, you had had a forecast for energy prices, commodity prices, import prices, and the dollar that is consistent with what happened, would you have expected your model to show this much pass-through to core inflation prices? Or would this result have been surprising?" FOMC20080430meeting--74 72,MR. PLOSSER.," Thank you, Mr. Chairman. I have two questions. One, in comparing the staff's forecast with a lot of the private-sector forecasts--what it looks like and its shape--one thing that is striking about the forecast is the very large adjustment swing that occurs in inventories. My interpretation is that one thing that is occurring in the way you've made adjustments to your forecast--or maybe this is more of a question--is that the spending of the tax rebates appears to be occurring out of inventories. Therefore, there is no production response, or less production response, to the presumably increasing demand that may materialize. Can you give me some feeling about why you chose that way of treating this? The second question goes back to inflation. I thought your discussion of the uncertainties around inflation was excellent. Part of what you talked about in the Greenbook was the uncertainty about pass-throughs of commodity price increases and oil price increases into various measures of consumer price inflation, which you indicated were imprecise and which we don't really know much about. I was struck that, if there is more pass-through than the baseline says, we're going to get more inflation in the near term, and then disinflation will be more rapid when you assume that commodity prices are going to come down. But if commodity prices only stabilize and don't come down, then it's going to be a more complicated picture. You do have an alternative scenario that says that commodity prices keep rising, but you allow expectations to move up only fairly modestly in the model. It seems to me that, particularly if expectations become more unanchored than that, the time paths of the funds rate that are implicit in the simulations become much more aggressive on the other side. I just want to make sure that my intuition is correct here. " CHRG-111hhrg56767--114 Mr. Royce," Again, I raise this issue not because this $6.3 million is going to make Fannie and Freddie solvent again, but because as we look at the housing boom and bust, which caused the financial collapse, one of the roads leads to Fannie Mae and Freddie Mac. Some of us were raising alarms about these institutions long before their failure and well before their accounting scandals, and we understood the fundamentally flawed structure of socialized losses and privatized profits. We saw the overleveraging and the build-up in junk loans there. Frankly, the Federal Reserve came and warned us about it. We had an obligation to the taxpayers to prevent their failure, but we failed, largely because of Chuck Hagel's bill the Fed had requested which passed out of committee on the Senate side and was blocked by the lobbying of Fannie and Freddie. Fannie and Freddie executives leaned in and said no, in terms of those portfolios, in terms of the issue of the overleveraging and the arbitrage which the Fed was trying to get a handle on, we want to block that, and that legislation was blocked. Now, because of that failure, the taxpayers own 80 percent of those companies. We now have an obligation, I think, to see that those most responsible for this failure are held accountable. If the FHFA fails to take action to: first, get the money back from the legal defense fees; and second, curb these executive payouts, then I hope Congress would intervene. These are wards of the state. In my view, at the end of the day, they should be treated as wards of the state. I will yield back, Mr. Chairman. " CHRG-111hhrg53021Oth--107 Secretary Geithner," It is absolutely recognized, and it is a significant issue of concern. But, what is causing those pressures on both borrowers and banks is the fact that large parts of the financial system in this country just took on too much risk during the boom. And the costs of that--it is fundamentally unfair, but that is what happens in financial crises--fall not just on those who took too much risk, but they fall on a bunch of businesses and banks across the country which were very responsible and prudent. And that is why these things can be so damaging. And that is why it is very important that we do everything we can to put a better foundation for recovery in demand and growth, and try to make sure that the financial system has capital where it is necessary, and that these markets for credit start to get moving again. And that is the basic philosophy that has underpinned everything we have done. You are also right that there is a risk in financial crises that people overcorrect; that, after a period of taking on too much risk, that they take too little. People that got way overextended pull back too much. And that can cause, also, a lot of collateral damage. And, again, that is the basic rationale in a financial crisis for trying to make sure you do as much as you can to provide enough support for the economy to get back on track. But, I am very much aware of the concerns you expressed. I believe that the principal bank supervisors are, too. They are carefully managing those risks. And you are also right that any time you think about reform to legislation in the financial area, that is going to come with a period of uncertainty. We need to minimize that uncertainty. And, that is one reason why we want to bring clarity, relatively quickly, to the rules of the game that govern our financial system, going forward. If we were to wait years to do this, the markets would be left with a greater period of uncertainty, and that might deter more lending and risk taking. " CHRG-111hhrg53021--107 Secretary Geithner," It is absolutely recognized, and it is a significant issue of concern. But, what is causing those pressures on both borrowers and banks is the fact that large parts of the financial system in this country just took on too much risk during the boom. And the costs of that--it is fundamentally unfair, but that is what happens in financial crises--fall not just on those who took too much risk, but they fall on a bunch of businesses and banks across the country which were very responsible and prudent. And that is why these things can be so damaging. And that is why it is very important that we do everything we can to put a better foundation for recovery in demand and growth, and try to make sure that the financial system has capital where it is necessary, and that these markets for credit start to get moving again. And that is the basic philosophy that has underpinned everything we have done. You are also right that there is a risk in financial crises that people overcorrect; that, after a period of taking on too much risk, that they take too little. People that got way overextended pull back too much. And that can cause, also, a lot of collateral damage. And, again, that is the basic rationale in a financial crisis for trying to make sure you do as much as you can to provide enough support for the economy to get back on track. But, I am very much aware of the concerns you expressed. I believe that the principal bank supervisors are, too. They are carefully managing those risks. And you are also right that any time you think about reform to legislation in the financial area, that is going to come with a period of uncertainty. We need to minimize that uncertainty. And, that is one reason why we want to bring clarity, relatively quickly, to the rules of the game that govern our financial system, going forward. If we were to wait years to do this, the markets would be left with a greater period of uncertainty, and that might deter more lending and risk taking. " FOMC20080318meeting--41 39,MR. SHEETS.," Over the intermeeting period we have lived through an experience that manifests the upside risk to our inflation forecast; and I would indicate that, with the � percentage point markup to headline foreign inflation in 2008 in our forecast, the vast majority of that is a reflection of these red-hot commodity markets, which then presses the question to us, Well, what is going on there? Certainly, in the case of the demand in these markets, by now I would have expected to have seen some attenuation or a bit of softening. Really, it seems to be quite the opposite. The demand since the first of the year has accelerated. Some other factors are at work as well--idiosyncratic supply stories, electrical outages that made it harder to smelt aluminum and copper, and so on. So there are some supply factors as well. The demand side seems to be important, and to the extent that demand remains strong, I am not sure where these commodity prices are going to top out. The futures path is a reasonable guess at sort of the balance of supply and demand. There is also some upward pressure on these prices from the depreciation of the dollar. But to the extent that commodity prices move up, I would say that we will probably be marking up our forecast of foreign inflation next time. Just a broader comment on the linkages between the U.S. and the foreign economies-- again, I was surprised at the strength of demand in these commodity markets. I would have expected by this point to have seen more marked evidence of slowing in the foreign economies. So we have marked down our forecast for 2008 in line with these prospective developments, the further slowing in the United States, and the financial stresses. But we didn't mark down our forecast very much, just a tenth or two, and mainly in Canada in Q1; and the data that we have in hand are not pointing to a dramatic slowing. We are expecting more of that to come through in the second and the third quarters. " fcic_final_report_full--199 In June  Freddie Mac staff made a presentation to the Business and Risk Committee of the Board of Directors on the costs of meeting its goals. From  to , the cost of the targeted goal loans was effectively zero, as the goals were reached through “profitable expansion” of the company’s multifamily business. Dur- ing the refinance boom, the goals became more challenging and cost Freddie money in the multifamily business; thus, only after  did meeting the multifamily and single-family goals cost the GSE money. Still, only about  of all loans purchased by Freddie between  and  were bought “specifically because they contribute to the goals”—loans it labeled as “targeted affordable.” These loans did have higher than average expected default rates, although Freddie also charged a higher fee to guaran- tee them. From  through , Freddie’s costs of complying with the housing goals averaged  million annually. The costs of complying with these goals took into account three components: expected revenues, expected defaults, and foregone revenues (based on an assumption of what they might have earned elsewhere). These costs were only computed on the narrow set of loans specifically purchased to achieve the goals, as opposed to goal-qualifying loans purchased in the normal course of business.  For comparison, the company’s net earnings averaged just un- der  billion per year from  to .  In , Fannie Mae retained McKinsey and Citigroup to determine whether it would be worthwhile to give up the company’s charter as a GSE, which—while af- fording the company enormous benefits—imposed regulations and put constraints on business practices, including its mission goals. The final report to Fannie Mae’s top management, called Project Phineas, found that the explicit cost of compliance with the goals from  to  was close to zero: “it is hard to discern a fundamen- tal marginal cost to meeting the housing goals on the single family business side.”  The report came to this conclusion despite the slightly greater difficulty of meeting the goals in the  refinancing boom: the large numbers of homeowners refinanc- ing, in particular those who were middle and upper income, necessarily reduced the percentage of the pool that would qualify for the goals. In calculating these costs, the consultants computed the difference between fees charged on goal-qualifying loans and the higher fees suggested by Fannie’s own mod- els. But this cost was not unique to goal qualifying loans. Across its portfolio, Fannie charged lower fees than its models computed for goals loans as well as for non-goals loans. As a result, goals loans, even targeted goals loans, were not solely responsible for this cost. In fact, Fannie’s discount was actually smaller for many goal-qualifying loans than for the others from  to . Facing more aggressive goals in  and , Fannie Mae expanded initiatives to purchase targeted goals loans. These included mortgages acquired under the My Community Mortgage program, mortgages underwritten with looser standards, and manufactured housing loans. For these loans, Fannie explicitly calculated the oppor- tunity cost (foregone revenues based on an assumption of what they might have earned elsewhere) along with the so-called cash flow cost, or the difference between their expected losses and expected revenue on these loans. For , as the market was peaking, Fannie Mae estimated the cash flow cost of the loans to be  million and the opportunity cost of the targeted goals loans  million, compared to net income that year to Fannie of . billion—a figure that includes returns on the goal- qualifying loans made during the normal course of business.  The targeted goals loans amounted to  billion, or ., of Fannie Mae’s  billion of single-family mortgage purchases in .  As the markets tightened in the middle of , the opportunity cost for that year was forecast to be roughly  billion.  FOMC20050322meeting--36 34,MR. STOCKTON.," It is the case, however, Mr. Chairman, that there has been a broad- based upward movement in commodity prices in the last four weeks. So—" CHRG-111hhrg52397--179 Mr. Johnson," Well, I think the pricing is more stable, although we had some wild gyrations that went on after the Lehman failure. I think the more stable and the more commodities and-- " FOMC20050322meeting--10 8,CHAIRMAN GREENSPAN., Agricultural commodities. But grain prices have come down in the most recent data. I assume iron ore is in there? CHRG-111hhrg74855--168 Mr. Walden," I think one of the issues that has been raised is that this should be clear it doesn't cover the physical delivery of commodities such as electric power and gas, and is that clear? " FOMC20050630meeting--325 323,MS. JOHNSON.," Yes. And remember, what we’ve done is just decelerate foreign activity; and we’ve hugely decelerated commodity prices." FOMC20060920meeting--142 140,MR. KOHN.," Thank you, Mr. Chairman. Whatever you want to call me is fine. [Laughter] I’m just glad to be here. [Laughter] I don’t think I can follow that up. Given the initial conditions—the doubling and more of energy prices over the past two years, the overexuberant housing market coming to grips with a renormalization of interest rates, a very low personal saving rate, and an uncomfortable increase in inflation this spring—a period of modestly below-trend growth and gradually ebbing inflation, as in the Greenbook forecast, is about as good an outcome as we can expect, as Dave Stockton noted. In that regard, several developments over the intermeeting period have made me a bit more comfortable with the plausibility of such an outlook. The weakness in housing has deepened and is more definitively leading to growth of output below potential. In fact, in my view the behavior of the housing market constitutes the main downside risk to sustained moderate economic growth. We’re in the middle of a housing adjustment, which has been hard to forecast, especially because it involves the unwinding of an unknown amount of speculative demand. With inventories rising and reports of price cuts getting greater prominence, the market isn’t yet showing signs of clearing and stabilizing. In the Greenbook forecast, residential investment, though weak, is supported by continued growth of income and relatively low mortgage rates, while house prices basically level out in nominal terms. As the Greenbook notes, however, this forecast leaves some aspects of the existing disequilibrium intact, most notably the high level of prices relative to rents. Also, the cutback in construction doesn’t completely offset the apparent excess building of the boom period. As a consequence, I see the housing forecast in the Greenbook as very far from the worst-case scenario that President Minehan characterized it as. And, we are just beginning to see the effect of the downshift in house-price inflation on consumption starting to play out. Outside of housing, however, recent developments should help to sustain continued economic expansion. Financial conditions remain quite supportive of both business and household spending. Long-term interest rates have fallen appreciably since midyear, and they are low in both real and nominal terms. Risk spreads are narrow, banks have not pulled back on business credit, and equity prices have risen on balance in recent months. Lenders and investors appear to remain confident that the economy will continue to expand at a decent pace. Higher levels of labor income in the first half of the year, along with a favorable effect on disposable income of a decline in energy prices, will help support consumer spending going forward. Economies elsewhere seem to be expanding at a solid clip. Moreover, they are probably less vulnerable to spillovers from a housing-led slowdown of growth in the United States than they were to weakness in 2001. That weakness was centered in a global market for investment goods and was reflected in global declines in equity prices. The less robust economy should present businesses with a more competitive environment in which it will be harder to pass through cost increases. In addition, the decline in energy prices, along with the leveling out of other commodity prices, will reduce cost pressures on businesses and should feed through in some measure to lower core inflation, especially as slower growth damps pricing power. The drop in energy prices has already restrained inflation expectations a bit. For all these reasons, I’m also a little more comfortable with the forecast of gradually ebbing core inflation. Nonetheless, I still see significant upside risk to such a path for inflation. In part, this reflects my uncertainty as to the reasons for the rise in inflation this spring and summer. Feed- through of energy and other commodity prices must have contributed to some extent, and we can see evidence of this in the greater price increases for some of the more energy-intensive sectors, such as for airfares. A portion of the pickup is in the rent-of-shelter category, likely from a shift to rental housing as expectations of house-price appreciation have been scaled back. But price increases have picked up in a number of other categories, and although energy costs probably accounted for some of this acceleration, we can’t dismiss the possibility that other forces were at work—for example, more general pressure of demand on potential output. A reduction of those types of pressures is still only a forecast. On the cost side, as many have commented, the compensation and unit labor cost data, while flawed in many respects, could be pointing to a risk that higher labor costs will persist, putting pressure on prices that might only be partially and reluctantly absorbed by profit margins. In sum, Mr. Chairman, I’m a bit more comfortable with something like the path for the economy and inflation in the Greenbook forecast, but uncertainties are quite high. They might even justify the “higher than usual” description. The downward path for inflation remains at risk, and as others have noted, the costs of exceeding that path could be disproportionate. Thank you." CHRG-111hhrg51698--587 Mr. Marshall," I just want you to assume that we have concluded that they are destabilizing. It is because they have a different interest. It is a longer-term view of things. They have been instructed to take a position that is just part, say an endowments fund, and it is part of our portfolio management strategy. We are going to take a position in commodities, and the way we choose to do that is we go through Goldman Sachs' Commodity Index Fund, stay longer, we do it some other way, but basically we effectively get on the futures market as a way to hedge our long-term position. We have done that, and we are not really acting like the traditional speculator, each day trying to figure out where things are going. " CHRG-110hhrg44901--132 The Chairman," The gentlewoman from Wisconsin. Ms. Moore of Wisconsin. Thank you, Mr. Chairman. And thank you, Mr. Chairman, for all the work that you did over the weekend for sort of cooling out the housing crisis. I read through your testimony, and I was very interested in your comments regarding the commodities market. You say that you doubt that financial speculation is the cause, a causal factor, in the upward pressures on oil prices, but you find that you are baffled by what it could be. You say that ``this is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil and other commodities in the longer term.'' I was curious. I would like for you to expand on that and explain that to me. " CHRG-110hhrg44901--72 Mr. Bernanke," Well, as we look back on it, we see that there were just some serious failures in the management of risks. There were many firms that had exposure to the housing market in a variety of ways across the firm, including holding mortgages and other ways. And they didn't fully appreciate that in the contingency that the housing boom would turn around, that house prices would begin to drop; they didn't fully appreciate their exposure to that situation. The regulators bear some responsibility on that. It is our job to make sure that they measure and manage their risks appropriately. We have been working on that for a number of years related to bank supervision initiatives like the Basel Initiative, for example, and so on. But it is clear that we need to redouble our efforts to make sure that the risk management is sound, that the underwriting is sound, and that we don't get ourselves into this kind of situation again. Ms. Pryce. Well, you mentioned Basel. Are there further risks ahead to our system and therefore the overall economy that might arise, and the new capital adequacy standards in Basel? You know, if we are trying to have this happen simultaneously, could that create new risk to the system? Effects of a crisis in any overseas market, could that affect our system in a negative way? Further decline in the dollar. There is a list of many things that could potentially happen. One of the things I would like your comment on is the commercial real estate market. You know, many banks astutely avoided the subprime lending, and they instead expanded their commercial real estate lending. So everywhere we turn we see increased vacancy signs and downward pressure on rents. And do we expect another wave of pressure from that market? And are we planning ahead as a country to address these things as opposed to, you know, being reactionary as it seems that we have had to be of late? " CHRG-111shrg52619--106 Chairman Dodd," I am sorry, Senator. Senator Menendez. No. Thank you, Senator Dodd. I appreciate it. Just one more line of questioning. You know, we had a witness before the Committee, Professor McCoy of the University of Connecticut School of Law, and she made some statements that were, you know, pretty alarming to me. She said, ``The OCC has asserted that national banks made only 10 percent of subprime loans in 2006. But this assertion fails to mention that national banks moved aggressively into Alternate-A low-documentation and no-documentation loans during the housing boom.'' ``Unlike OTS, the OCC did promulgate one rule in 2004 prohibiting mortgages to borrowers who could not afford to pay. However, the rule was vague in design and execution, allowing lax lending to proliferate at national banks and their mortgage lending subsidiaries through 2007.'' ``Despite the 2004 rules, through 2007, large national banks continued to make large quantities of poorly underwritten subprime loans and low- and no-documentation loans.'' ``The five largest U.S. banks in 2005 were all national banks and too big to fail. They too made heavy inroads into low- and no-documentation loans.'' And so it just seems to me that some of the biggest bank failures have been under your agency's watch, and they, too, involved thrifts heavily into nil documents, low documents, Alternate A, and nontraditionals, and it is hard to make the case that we had an adequate job of oversight given those results. We have heard a lot here about one of our problems is regulatory arbitrage. Don't you think that they chose your agency because they thought they would get a better break? " CHRG-110shrg50409--85 Mr. Bernanke," Well, there are a number of pieces of evidence against the view that speculation is a primary force. I mentioned in my testimony the absence of hoarding or inventories that you would expect to see if speculation was driving prices above the supply demand equilibrium. There are a number of studies which show that there is little or no connection between the open interest taken by non-commercial traders in futures markets and the subsequent movements in prices. It is also interesting to note that there are many commodities--or at least some commodities--that are not even traded on futures markets, like iron ore, for example, which have had very large increases in prices. So I think the evidence is fairly weak. That said, I think that transparency in futures markets, information available to the overseer, the CFTC, is a positive thing. And I expect that the CFTC will come forward with some suggestions in that regard. But I just do not think it is going to be a magic bullet to address this very difficult problem of high oil and commodity prices. Senator Martinez. In other words, well, it might be helpful and useful to have more transparency ultimately. The supply and demand equilibrium is only going to be impacted by more supply or less demand. " FOMC20050322meeting--123 121,MR. BERNANKE.," Thank you, Mr. Chairman. We are experiencing a mini-inflation scare in financial markets—a development that we need to take very seriously. The primary reason for the scare was the recent rapid increase in the prices of oil and other basic commodities. Other determinants of inflation, it should be noted, seem to be largely under control. Still-strong productivity growth and subdued wage increases have been sufficient to induce some recent deceleration in unit labor costs. At the sectoral level, recent increases in auto prices seem unlikely to continue, given the industry’s inventory overhang. And I note that this morning’s report showed a 0.9 percent decline in February in auto prices. Prices of imported consumer goods have also been remarkably tame, rising about 1 percent in the year to January despite the fall in the dollar. And the influx of low-cost apparel imports associated with the end of the Multifiber Agreement should provide more help on that front. Inflation in services is stable, and far future inflation compensation, which effectively strips out oil effects, has not risen. How serious is the inflation risk posed by rising commodity prices? One view, which, if correct, would be quite worrisome, is that commodity prices are the canary in the coal mine— indicators of easy monetary policy and building inflationary pressure. I don’t find this view persuasive, and I note that the academic literature has found essentially no support for it. Instead, recent commodity price increases seem to be largely the result of economic developments unrelated to U.S. monetary policy, which I would call supply shocks, although without disagreeing with President Poole. What we’re saying here is that China is exogenous. [Laughter] In the case of oil, for example, international agencies have recently revised downward their projections of non-OPEC March 22, 2005 57 of 116 likelihood that growth in demand this year will be disproportionately concentrated in energy- inefficient countries, such as China. The weak dollar, which I suspect is responding more to the current account situation than to monetary policy per se, is also affecting the oil price. Since 2000, oil prices have risen 98 percent in dollar terms, but they have also risen by 45 percent even in euro terms and by 76 percent in yen terms. If the supply shock interpretation is correct, then the effects on core inflation of the recent run-up should be moderate. As is well known, commodities and raw materials make up a small share of producers’ costs. For example, the staff estimates that even in a full employment situation, in which firms have some pricing power, a 1 percent increase in the core PPI for intermediate goods should result in less than a 5 basis point increase in the core CPI. By the way, I think that fact helps to reconcile to some extent the benign inflation numbers with the anecdotal reports of price increases, since many of them take place at the intermediate level. An interesting datum from last week’s survey of 22 primary dealers is that, on average, they expect core PCE inflation of 1.91 percent at an annual rate during the third quarter of this year, up only 6 basis points from what they expected for the same period as of the week before the last FOMC meeting. If we are, indeed, facing a supply shock, then to some extent the situation is analogous to where we were last spring when inflation pressures proved transitory and policy patience paid off. However, all economists have two hands. And on my other hand, I agree that there are also important differences from the situation last spring. The expansion has considerably more March 22, 2005 58 of 116 would not like to see it go much higher. Finally, futures markets suggest that this time the shocks to commodity prices are expected to be relatively more permanent than they were last time. For these reasons, the risks to both the output and inflation objectives of a slightly more aggressive policy posture seem fairly modest. My bottom line is that I support raising the funds rate by only 25 basis points today. However, I believe that it would behoove the Committee to modify the statement in a way that signals the possibility of stronger actions in the near future. Thank you." CHRG-111hhrg63105--94 Mr. Luetkemeyer," What is the impact with the lack of a rule? If we keep putting this off or we delay, what is the impact on the markets? What is the impact that we can expect for our farmers and our commodity folks? " CHRG-111hhrg51698--331 Mr. Lucas," Thank you, Mr. Chairman. Mr. Pickel, would you care to comment on Mr. Taylor's testimony that this bill will not discourage speculators from participating in commodity markets? " CHRG-111hhrg56847--26 Mr. Bernanke," The signal that gold is sending is in some ways very different from what other asset prices are sending. For example, the spread between nominal and inflation index bonds, the breakeven remains quite low, suggests that markets expect about 2 percent inflation over the next 10 years. Other commodity prices have fallen quite severely, including oil prices and food prices. So gold is out there doing something different from the rest of the commodity group. I don't fully understand the movements in the gold price, but I do think that there is a great deal of uncertainty and anxiety in financial markets right now and some people believe that holding gold will be a hedge against the fact that they view many other investments as being risky and hard to predict at this point. " CHRG-111hhrg55811--16 The Chairman," We will now begin with our witnesses. We have the Chair of the Commodities Futures Trading Commission. And let me acknowledge, particularly in the presence of the ranking member of that committee, that the primary jurisdiction over this agency is in the Agriculture Committee. And I want to say I am very pleased because I think jurisdictional disputes are Congress at its worst. Egos and pettiness come out. We have worked very closely with the Agriculture Committee, that was in complete agreement, and I thank the gentleman for acknowledging that. We even had an unusual joint hearing on the subject. And we will continue to work with the Agriculture Committee because cooperation between our two committees, as between these two agencies, is essential if we are going to get this job done. " Chairman Gensler," STATEMENT OF THE HONORABLE GARY GENSLER, CHAIRMAN, COMMODITY CHRG-111hhrg74855--378 Mr. Duane," The only point I will add is to remind everyone here that electricity is an extraordinary volatile commodity and the ability to hedge that price volatility is essential. " CHRG-111hhrg51698--226 Mr. Conaway," Yes. Your interest in restricting the physical assets that go along with certain commodities, how do you--the guy that grows corn, you would restrict him from being able to work in these markets as well? " CHRG-109shrg24852--52 Chairman Greenspan," We have had such experiences in the past, and quite correctly, there have been regional problems associated with unwinding of frothy local housing markets. One thing that obviously is an issue with respect to the overall economy of these metropolitan areas, is that unlike earlier history, we have developed a mortgage instrument to a point, and the ability to extract equity from homes to such an extent, that now a surprisingly large proportion of consumer expenditures and home modernization outlays are financed by home equity extraction. That is clearly a consequence of one, house turnover, largely because, of course, the seller of the home extinguishes a mortgage which is less than the mortgage of the buyer of the home, which is essentially a reduction or extraction of equity from that home of that exact difference. Then of course there are cash-outs, which have increased over the years, associated with refinancing, and then finally, a significant amount of extraction of unrealized capital gains essentially from home equity loans. These are large enough to be an issue in the overall consumption expenditures of a local community, and in the event that you begin to get a retrenchment in house turnover, which would presumably be associated with unwinding of a frothy market, you would probably also have impacts on consumer expenditures in that particular area. There are obviously national implications of this as well. We would expect as the housing boom eventually simmers down, as we have long expected it would but find no evidence that it is about to, that it would begin to have some impact on consumption expenditures, and if not for the fact that we perceive capital investment picking up the slack, it would give us some pause as to economic consequences of the adjustment process. Senator Allard. Mr. Chairman, you kind of moved into my second question where people were extracting this equity out of their home. If the value of these homes should begin drop or something, that could create some problems for our national economy, or would it not? " FOMC20080318meeting--42 40,MR. STOCKTON.," President Fisher, I will just basically reiterate what I said earlier and amplify many of the same things that Nathan just said in terms of the influences on our headline forecast. We revised up � percentage point as well, and that really is coming from higher energy prices, higher food prices, and higher commodity prices, all of which we think are already showing through to some extent and we expect to continue to show through to headline inflation. Despite the fact that we run with a much larger output gap in this forecast, we haven't revised down our forecast for 2009 because of the lingering effects of the run-up in commodity prices that we are expecting. As I indicated, we think there has probably been some small deterioration in inflation expectations as well. " CHRG-111hhrg74855--334 Mr. Markey," Great, thank you. Mr. Duane, what changes would be made if PJM had to adhere to the principals in place under the Commodities Exchange Act as a derivative clearing organization? What effect would those requirements have on the marketplace? " CHRG-110shrg50409--46 Mr. Bernanke," I think it will be probably positive if it contributes to a slowing in commodity prices. Senator Tester. You talked about the long-term oil supplies are down. I believe that is what you said. " CHRG-111hhrg74855--169 Mr. Gensler," That is right just as in the Commodities and Exchange Act for 70-some years it has not only excluded the physical delivery but also the forward markets that is excluded. Similarly 3795 and the administration would exclude the forward, these day-ahead markets and so forth. " CHRG-111shrg49488--85 Chairman Lieberman," Mr. Nason, I take it that historically the reason we had both the SEC and the CFTC is that the CFTC grew up from the trading in agricultural commodities and they did not want to be mixed with the Wall Street regulators. " CHRG-110shrg38109--103 Chairman Bernanke," Well, there have been a number of papers, and we would be happy to send you a few surveys or summaries of some of the research that has been done. A number of papers have looked at this demographic issue and viewed it as being important, although not necessarily the whole story. The other important part of the story is that personal savings rates are out of current income, and they do not include capital gains of any kind. So the general strength of the stock market and then more recently of the housing market has meant that people could increase their wealth without saving, and that has been, I think, an important factor in leading to a lower savings rate more recently. The other technical point to make is that private saving actually consists of the sum of the household or personal savings together with the savings done by corporations. Savings by corporations has become a larger share of the private saving than overall, and in a sense, the corporations ultimately belong to the households, whether you are a small business owner who is keeping profits in your business or an investor who is enjoying capital gains in stocks. Some of that saving is not appearing in households because it is taking place in corporations. It is a measurement issue. But I think it is an issue because the national savings rate has come down, and it contributes to issues like the current account deficit we have talked about. Our anticipation, as I mentioned in the testimony, is that the household saving rate should rise a bit in the next couple of years partly because housing prices are not rising as fast and people will turn back to saving from their current income. But we do not anticipate anything like the 12 percent in 1985 anytime soon. It is going to be a slow process. Senator Sununu. Thank you very much. Thank you, Mr. Chairman, and I would note, since I am not a member of the baby-boom generation and you are, I look at every possible opportunity to blame something bad on your generation. Thank you. " CHRG-111hhrg51698--562 The Chairman," Mr. Kaswell, you are highly critical of setting the position limits, speculative position limits for all contracts. If we have limits and they have worked in the agricultural markets, why wouldn't it be appropriate to have them for all other markets of physical commodities? " CHRG-109hhrg31539--190 Mr. Bernanke," It is a trick question. As I said in my testimony, our expectation is that core inflation will be moderating over the next 2 years for a variety of reasons. However, we do see some risks, and one of the risks would be that because product markets are tight, that there would be ability of firms to pass through energy and commodity prices into other goods. " FOMC20081029meeting--263 261,CHAIRMAN BERNANKE.," Okay. Thank you. Let me try to summarize all that I heard today and yesterday, and then I'll try to add some new comments to that. The outlook for economic growth appears to have deteriorated quite significantly since the last meeting. Data on consumer spending, production, and employment had weakened more than expected even before the recent intensification of the financial crisis. Over the past six weeks or so, however, financial conditions have greatly worsened, and risk aversion has increased, despite actions here and abroad to stabilize the banking system. Equity values have declined sharply amid conditions of low liquidity and extraordinary volatility. Credit market conditions have improved modestly since the global actions to recapitalize banks and guarantee their deposits, assisted also by additional central bank liquidity actions. However, in almost all credit markets, spreads remain much wider, maturities shorter, and availability more constrained than was the case before the intensification of the crisis. Firms face continued funding risk and rollover risk. Banks have probably not reserved sufficiently for the credit losses to come, and hedge funds will be hitting their net asset value triggers in greater numbers, forcing them to liquidate assets. The duration of future financial turmoil is hard to judge, but it could be lengthy. The worst thing is that financial conditions appear already to have had a significant and remarkably quick effect on activity and consumer and business expectations and plans. Most Committee participants see us in or entering a recession and have marked down significantly their expectations for near-term growth or for the pace of the recovery. The difficulty of predicting the course of the crisis or its effects on the economy has also increased forecast uncertainty. In particular, the ultimate effects of some major policy actions, such as the creation of the TARP and the bank guarantee, are not yet known. Uncertainty about future policy actions, as well as uncertainty about the economy, has affected behavior in markets and the broader economy. Consumer spending has weakened considerably and probably fell sharply in the third quarter, reflecting in part a recessionary psychology. Consumer durables, such as automobiles and discretionary expenditures, have been particularly hard hit. This weakness reflects the same set of negative influences on consumption that we have been seeing for a while, now compounded by losses of equity wealth and confidence effects on prices, although lower oil prices may provide some relief. The labor market continues to decline, with many firms reporting that they are cutting back workers. The housing sector has not been noticeably worse than expected, and reports are somewhat mixed. But on a national basis, the contraction is continuing, and recent developments in the economy and credit markets are likely to have adverse effects. Inventories of unsold new homes remain high, putting pressure on prices. Nonresidential construction continues at a moderate pace; but backlogs are falling, and the sector is looking increasingly vulnerable to weakening fundamentals and tighter credit conditions. Whether a new fiscal stimulus package will be passed and to what extent such a package would be helpful remain open questions. Manufacturing production has weakened significantly as have expectations of demand, including export demand. Credit is becoming more of a problem for many firms and their customers. Spending on equipment and software appears to have slowed, reflecting greater pessimism and uncertainty. Falling commodity prices may reduce mining activity and cool the boom in agriculture. On the plus side, firms are reporting fewer cost pressures, and inventories do not appear excessive. Deterioration in global growth expectations has been marked. Industrial economies had already shown signs of slowing, and they have been hit hard by recent financial developments. Emerging market economies, until recently evidently not much affected by the U.S. slowdown, have in recent weeks also been hit hard by the spreading financial crisis. Together with the stronger dollar, these developments are likely to restrain future growth of U.S. exports. Inflation risks have declined materially, reflecting the fall in the prices of energy and other commodities, the stronger dollar, and the prospect of considerable economic slack. Firms report much reduced pricing power and lower markups. Inflation expectations have come down, both in the surveys and in the TIPS market, though it wasn't noted--but I will note--that the TIPS market is distorted by illiquidity and other problems there. Most participants see both overall and core inflation moderating in the coming quarters toward levels consistent with price stability, with some seeing a risk of undesirably low rates of inflation. Some note, however, that financial dislocations affect aggregate supply as well as aggregate demand and may reduce the extent to which slower growth damps inflation. So that's just my sense. Any comments? Additions? Let me make just a few additional comments, none of which will be radically different from what we have already discussed. I do think it is overwhelmingly clear that we are now in a recession and that it is going to be a severe one. To give some sense of perspective, the postwar record for duration is 16 months. If the NBER sets this experience as having begun early this year, I think we have a reasonable chance to break that record. The largest increase from peak to trough in unemployment rate was in 1981. It was 3.6 percentage points. Starting from 4.4 percent, I think we have a chance to come close to that number. Yesterday's drop in consumer confidence in one month from 61 to 38 shattered the previous low of 43 in December 1975. So I think we are talking about an episode here that could easily be among the largest postwar recessions. We don't know how things would have evolved without the developments in September, but obviously we have to deal with that reality. It was just a few weeks ago that we were dealing with what might have been a true systemic crisis, in the week leading up to the G-7 and IMF meeting. I think it has been very fortunate that Europe, the United States, and other countries have adopted vigorous responses to that, including bank capitalization, bank guarantees, and other measures. That has been very important in calming the situation somewhat and reducing the systemic aspects of investor concerns. That being said, concern about counterparties remains very strong. Risk aversion is intense, spreads remain high, and I think that this has now become really pervasive. It isn't just a question of junk bonds and weak borrowers or weak credit histories. The spreads on GSE debt, on high-grade corporate debt, and other areas have also widened, leading to a very broad based tightening in credit conditions. So I think that, overall, any reasonable reading of financial conditions suggests that the tightening of credit or financial conditions in the last six weeks or so has been quite substantial and overwhelms the effects of our coordinated rate cut. Now, normally you would expect to see a tightening of credit conditions affect the economy with some lag. It takes time for people to borrow money and to use the money they borrow to make expenditures. But compared with that prediction, we have instead seen a sudden stop--a remarkable and very rapid effect on economic activity. It is possible this is due less to the direct effects of credit availability and more to the psychological impact of these events. One possible analogy is the 1980 Carter credit controls, when the government announced what seemed to be a tightening of credit. There was a very sharp response in economic activity, probably based more on expectations than on actual credit availability. Unfortunately, the credit controls could be removed by government fiat; we are not able to do that today. One interesting development is that the labor market has not yet shown as much weakness as one would expect. Unemployment insurance claims and other indicators do not yet show a marked deterioration. I expect that we will see more deterioration of the labor market. Besides the intensification of the financial crisis that has markedly increased the restrictiveness of financial conditions, I think the other very important development since our last meeting has been the internationalization of the crisis. We had already seen weakening in Europe before the most recent intensification, but it has become much more severe. There is little doubt that the United Kingdom and Europe are in or about to enter recession. My sense is that their monetary policy responses will be stronger than what the Greenbook anticipates. I believe they will be very aggressive in responding to that. A new and particularly worrying development is the fact that the crisis has now spread beyond the industrial countries to the emerging markets. The G-7 weekend was quite an interesting one. It was a striking experience. I heard over and over again from the Indians, from the Brazilians, and from all over the world that, until the middle of September we were fine, we were not being much affected, we didn't see much effect on our trade flows, and suddenly everything changed; and now we are under severe stress. We are seeing tremendous outflows. Our currencies are plummeting. Commodity price declines are hurting many countries. I think that is going to be a very significant development as we go forward. Just to give some data, in just a few weeks the EMBI spread, the emerging market sovereign debt spread, went from 280 basis points to 850 basis points; and the emerging market equity index has fallen about 40 percent since the last meeting. It is not obvious that these changes were justified by economic fundamentals. Many of these countries are very well run and had shown a lot of progress in their domestic policies and their domestic economies. Instead, I think they are suffering contagion from us mostly. Unfortunately, the implications of this will be not only the usual trade and commodity price type of implications but also, and even more important, financial implications. We are now seeing that the adverse feedback loop, which we've been talking about for a long time in the United States, is becoming a global phenomenon. In particular, European banks are very heavily exposed to emerging market debt. So we are going to see yet more of this interaction between the financial markets and the broader economy, except at a global rather than a national level. These developments, obviously, are very disturbing and don't bode well for U.S. growth or now for global growth. Somewhat ironically, all of this deterioration in the global outlook has led the dollar to appreciate very sharply, which is interesting to say the least. For us that obviously also has important implications for inflation, and as Governor Kohn mentioned, it means that we will be less a recipient of foreign strength and more a supporter of foreign weakness than we have been until now. On inflation, I know there is some discomfort in talking about a 1 percent policy rate and promising to keep it low for a protracted period--and all those things. We have seen this movie before, and I think we all have to recognize the importance of watching the implications of that for our economy and for asset prices and to take quite seriously the responsibility for removing accommodation in a timely fashion once the crisis has begun to moderate. That being said, I don't think that there is really any case in the near term to be worrying very much about inflation--or, perhaps even less so, the dollar--as we look at our policy. Pricing power is evaporating. And given what is happening in the global economy, I don't see a commodity price boom any time soon, although I think as the economies do begin to recover in the next year or so that we might see some recovery in commodity prices. So I think that, as everyone has indicated, this is a very worrisome situation. I don't think we have control of it. I don't think we know what the bottom is, so we have to remain very flexible and very open to new initiatives as they become necessary. There has been some comparison of this to the Japanese situation. I'm beginning to wonder if that might not be a good outcome. The advantage of the Japanese was, first of all, that they were isolated. The rest of the world was doing okay, and they were able to draw strength from their exports and the rest of the global economy. Although they had very slow growth, they never really had a deep recession or big increases in unemployment. I think we are looking at perhaps a much sharper episode, and our challenge will be to make sure that it doesn't persist longer. I do think that one lesson of both Japan and the 1930s as well as other experiences is that passivity is not a good answer. We do have to continue to be aggressive. We have to continue to look for solutions. Some of them are not going to work. Some of them are going to add to uncertainty. I recognize that critique. I realize it's a valid critique. But I don't think that this is going to be a self-correcting thing anytime soon. I think we are going to have to continue to provide support of all kinds to the economy. Let me stop there and, unless there is any question or comment, ask Brian to introduce the policy round. " FinancialCrisisInquiry--221 How do you predict the long-term recovery? And how long do you think that recovery— how much longer will it take in circumstances like that? ZANDI: Well, first, let me say that one of the hallmarks of the Great Recession was how broad- based it was across industries and regions of the country. I mean, in past recessions, you always had a large region or two that avoided the recession, and that was a safety valve. People could move from Michigan and go to Florida or move from California to Nevada, and that wasn’t the case in this downturn. Now, having said that, obviously, there are some areas that are harder hit than others and those that suffer— well, were in the housing boom and bubble and now suffered the housing bust are the most severely hit, and that would include Nevada, Las Vegas, Arizona, California, particularly the Central Valley of California, Florida, Rhode Island, interestingly enough, for various reasons, and, obviously, parts of the industrial Midwest. And it will take much, much longer for an economy like Nevada and Florida to turn because its economic base is much less diversified. Obviously, it’s related to leisure and hospitality, which is a discretionary purchase and will not turn, and migration flows. And as I mentioned earlier, migration is going to be significantly impaired because one-third of homeowners with first mortgages, by my calculation, are underwater and can’t move or won’t move as easily. So Nevada’s problems are very severe and will be very long lasting. VICE CHAIRMAN THOMAS: Isn’t it also home construction? I mean, that was one of the fundamental industries in all those areas. And when that’s the problem and you can’t do it, you implode. ZANDI: Well, I—I would say housing in its totality, so that would include housing transactions, home sales. That’s demand, house prices ... and, obviously, housing construction. FOMC20050322meeting--14 12,CHAIRMAN GREENSPAN., It’s a very unusual index. The reason I raise the issue is because it doesn’t look like any commodity index I’m used to watching—unless oil is a very big component. Do we know that? We can factor out the oil part of this. CHRG-110shrg50369--18 Mr. Bernanke," The increase in commodity prices around the world as the global economy expands and increases demand for those commodities is creating an inflationary stress which is complicating the Federal Reserve's attempts to respond. In some other ways, things are different. You pointed out the dollar was very strong in 2001. That was in part reflective of a large trade deficit at that time. It has since depreciated. But, on the other hand, part of the effect of that depreciation has been that we are at least seeing some improvement in that trade deficit, which is a positive factor. On the fiscal situation, I agree we are in a less advantageous situation than we were. The deficit is certainly higher, and perhaps even more seriously, we are now 7 years further on toward the retirement of the baby boomers and the entitlements, and those costs that are certainly bearing down on us as we speak. So it is a difficult situation, and there are multiple factors. I think there are some similarities, but as a Russian novelist once said, ``Unhappy families are all unhappy in their own way,'' and every period of financial and economic stress has unique characteristics. " CHRG-111hhrg52397--86 Mr. Bachus," Thank you. Thinking about how AIG never imagined that these things could go down, I guess a lot of homeowners, a lot of people who bought commercial property and houses sort of assumed the same thing, obviously to their detriment. But I appreciate those responses, and I think they are very insightful. Dr. Johnson, you mentioned the turf battle here in Congress some time between CFTC and the SEC. Now, the Commodities Exchange Act actually excludes credit default swaps from jurisdiction of--well, they are excluded from the coverage of the Commodities Exchange Act, so the CFTC draws its jurisdiction from that Act. So if we were to give some function on credit default swaps, which are really meant to insure against default by a publicly-traded company I guess or a group of publicly-traded companies defaulting on their debt, if the CFTC was given that authority, would we have to amend the Act or would they have jurisdiction? " FOMC20050630meeting--359 357,MR. HOENIG.," Thank you, Mr. Chairman. First of all, our view regarding the national economy is basically similar to others I have heard here. We agree with the consensus of GDP growth running about 3½ percent, slightly over our potential rate. And we see that going forward through the rest of this year and into next year. I also would say that the anecdotal evidence coming from our region is very consistent with this above-trend growth rate. Consumer spending continues to grow solidly, with retailers reporting June 29-30, 2005 120 of 234 quarters. Tourism continues to expand briskly, boosting occupancy rates at hotels and resorts in our region. And energy activity remains high. One of the interesting anecdotes arose during a recent visit I made to the Cessna plant in Wichita, which is booming right now. They have back orders for their jets—general aviation aircraft—running well into 2007, with prices running from a mere $2½ million to a little better than $20 million for their Citation 10, which flies at 0.8 mach. And the demand is incredible. So the general economic environment reflected in these parts of our region really is consistent with a strong growth rate going forward. On the national inflation outlook, I understand the arguments given today for why inflation should continue to ease off. For that to occur, it is critical in my view that we continue to move policy out of its current accommodative stance. If we don’t, I think we are stimulating demand—I think it’s reflected in some of the other comments here and in some of the anecdotes that I’ve pointed out—and I think we will have future upward adjustments in inflation as we move forward. So I think it is critical that we get ourselves closer to that neutral zone that we talk about, which no one can pinpoint with certainty but which is probably somewhere between 3½ and 4½ percent. I’ll leave it at that." fcic_final_report_full--21 When the Federal Reserve cut interest rates early in the new century and mort- gage rates fell, home refinancing surged, climbing from  billion in  to . trillion in ,  allowing people to withdraw equity built up over previous decades and to consume more, despite stagnant wages. Home sales volume started to in- crease, and average home prices nationwide climbed, rising  in eight years by one measure and hitting a national high of , in early .  Home prices in many areas skyrocketed: prices increased nearly two and one-half times in Sacra- mento, for example, in just five years,  and shot up by about the same percentage in Bakersfield, Miami, and Key West. Prices about doubled in more than  metropol- itan areas, including Phoenix, Atlantic City, Baltimore, Ft. Lauderdale, Los Angeles, Poughkeepsie, San Diego, and West Palm Beach.  Housing starts nationwide climbed , from . million in  to more than  million in . Encouraged by government policies, homeownership reached a record . in the spring of , although it wouldn’t rise an inch further even as the mortgage machine kept churning for another three years. By refinancing their homes, Americans extracted . trillion in home equity between  and , including  billion in  alone, more than seven times the amount they took out in .  Real estate specula- tors and potential homeowners stood in line outside new subdivisions for a chance to buy houses before the ground had even been broken. By the first half of , more than one out of every ten home sales was to an investor, speculator, or someone buy- ing a second home.  Bigger was better, and even the structures themselves ballooned in size; the floor area of an average new home grew by , to , square feet, in the decade from  to . Money washed through the economy like water rushing through a broken dam. Low interest rates and then foreign capital helped fuel the boom. Construction work- ers, landscape architects, real estate agents, loan brokers, and appraisers profited on Main Street, while investment bankers and traders on Wall Street moved even higher on the American earnings pyramid and the share prices of the most aggressive finan- cial service firms reached all-time highs.  Homeowners pulled cash out of their homes to send their kids to college, pay medical bills, install designer kitchens with granite counters, take vacations, or launch new businesses. They also paid off credit cards, even as personal debt rose nationally. Survey evidence shows that about  of homeowners pulled out cash to buy a vehicle and over  spent the cash on a catch- all category including tax payments, clothing, gifts, and living expenses.  Renters used new forms of loans to buy homes and to move to suburban subdivisions, erect- ing swing sets in their backyards and enrolling their children in local schools. In an interview with the Commission, Angelo Mozilo, the longtime CEO of Countrywide Financial—a lender brought down by its risky mortgages—said that a “gold rush” mentality overtook the country during these years, and that he was swept up in it as well: “Housing prices were rising so rapidly—at a rate that I’d never seen in my  years in the business—that people, regular people, average people got caught up in the mania of buying a house, and flipping it, making money. It was happening. They buy a house, make , . . . and talk at a cocktail party about it. . . . Housing suddenly went from being part of the American dream to house my family to settle down—it became a commodity. That was a change in the culture. . . . It was sudden, unexpected.”  CHRG-111shrg49488--86 Mr. Nason," Historically, that is the genesis of the CFTC's creation in the 1970s. But, interestingly enough, when the CFTC was being created, Members of Congress and their staffs asked the SEC if they wanted the jurisdiction for agricultural commodities, and they declined because it was a specialized market. " CHRG-111hhrg74855--182 Mr. Stupak," Thank you, Mr. Chairman. Mr. Wellinghoff, Mr. Dingell indicated that your State of the Markets report and that report strongly indicated a lack of physical market fundamentals was used in determining the price of natural gas and electricity, and the conclusion was that large pools of capital flowed into these various financial instruments that turned the commodities like natural gas into investment vehicles as opposed to providing a product there. Does that accurately reflect FERC's current position that financial speculation in the natural gas market has increased prices? " CHRG-109hhrg23738--15 Mr. Greenspan," No, but I think it is worthwhile reviewing where we are relative to this issue. We know, with as high a level of certainty as you ever can gather, that we are going to get a very substantial acceleration in the number of retirees in this country starting in 2008; but we also know that the next generation coming in behind the baby boomers is much smaller, which means that the working labor force is going to grow at a relatively small, a very small, rate. This means that we are going to have a very substantial amount of people not productive, in the way they had been when they were in the workforce, essentially being supplied with goods and services by a labor force which is growing rather slowly. It is very difficult to convey how important it is when you take as productive a group of people coming out of the baby-boom generation--and they are now in their most productive years--and you move that group into retirement. Its impact is very substantial. But the major point I want to make is that Social Security has over the years, largely because of the demographics that we have observed in recent generations, been able to replace roughly 40 percent of the incomes that workers had prior to retirement. It strikes me that it is going to be very difficult to deliver that in real terms because of the extraordinary demographic shift which we are about to experience. But it is certainly also going to be the case that retirees are going to need something like 80 percent of their immediately pre-retirement income to maintain a reasonable standard of living, and that means a very substantial part of retirement resources is going to come from other than Social Security, of necessity; and that inevitably means private pension funds, defined benefit, 401(k)s, personal savings, other forms of income, and I suspect that we will require fairly significant expanding forms of private savings initiatives. And one of the reasons why I have been supportive of moving a significant part of Social Security toward private accounts is to develop that particular process. I have nothing, basically, new to say on the issue than what I discussed with you in February. " CHRG-111hhrg51698--211 The Chairman," Thank you, Mr. Slocum. Thank both of you for being with us today. I hadn't really thought about, Mr. Slocum, what you had brought up there. I don't really agree with the terminology ``speculation'' for what Goldman Sachs is doing. Because they have created an investment that they are selling to people. That is going into the market, and they are using the regulated market to hedge their risks and so forth. So, the fact that they are selling an index that has 10 percent corn, 40 percent oil, and eight percent copper or whatever, that is going into the market based on those percentages, and there is not a whole lot of thought going into it. It is just an investment vehicle they are selling to people. I am not sure there is anybody sitting around there scheming what is going to happen. They are just getting their commissions by selling these investments to pension funds and some of these other people. They are putting out this information, they are still running seminars trying to convince people that they ought to take their money out of other areas and put them into commodities because they can make more money because oil prices are going up or whatever. So I don't know if I can connect the dots there. But I do have, personally, a concern about this money that has been coming into this market from these areas that don't have anything to do with the underlying commodity situation. In fact, the first draft I put out last year banned pension funds from being involved in this commodity market at all, which I still personally believe we should do. I am just waiting for the day for the pension funds to come to the United States Congress and tell us that we have to bail them out because of this failed strategy that cost them all this money in their pension funds, and now they can't pay the benefits. That is probably going to come at some point here, too. But we will take that under consideration, and I guess I would like to learn more about what you think the connection is there. Mr. Roth, you have some proposed ideas on how to get a handle on this retail stuff that is going on? " FOMC20080430meeting--120 118,MR. MISHKIN.," But I do have a concern about the risk to inflation expectations because of the high commodity prices that we see. This is coming from the very adverse supply shock and the fact that we have had headline inflation so high for so long. The good news, by the way, is that it is actually quite remarkable, given how high headline inflation has been, how anchored inflation expectations have been. I think that has to do with confidence in this institution's doing the right thing. It is very important that we retain that confidence. We have to think about that when we decide what we are going to do regarding policy. About where I think inflation is going to be--I have been a 2 percent guy for a long time. I am not changing that. I think that inflation expectations are around 2 percent and that there is no expectation that we will have excess demand in the economy. If anything, it is the opposite of that. I see the risks as balanced--there are some risks on the upside, particularly because of what is happening with commodity prices. On the other hand, there are risks on the downside because of the expected slack and because there is some downside risk in the economy. So on that ground, I basically have the same story that I had before. Thank you. " CHRG-111hhrg63105--157 Mr. Jones," Good morning, Mr. Chairman, Members of the Subcommittee. I am Robert Jones, Senior Vice President of ABN AMRO Clearing in Chicago, a futures commission merchant. I serve on the Risk Management Committee of the National Grain and Feed Association, and I am here today to represent the views of the National Grain and Feed Association. We appreciate the opportunity to discuss position limits for enumerated agricultural commodities. Federal position limits are already in place for those commodities, and we believe they are at appropriate levels. Generally, we have found that the Commission understands the impacts of its actions on commercial businesses and is responsive to our concerns. However, the deadlines that have been set in the law are very challenging. For our industry, the price discovery occurs primarily in the futures market, so it's extremely important that we get these rules right. Given the choice, we would prefer to go a little slower and make sure we get it right, rather than rush rules through to meet a deadline and find out later about unforeseen consequences. To provide some context for this, I would like you to think back to 2008. Agricultural futures prices escalated rapidly, resulting in a disconnect of cash and futures values, otherwise known as convergence. Basis levels for producers, essentially the difference between the cash and the futures, widened dramatically. The situation increased risk for grain purchasers and hedgers and caused extreme financial stress due to massive margining requirements. At the same time, marketing opportunities for producers were limited. We believe that the expanded participation by nontraditional participants like index funds and pension funds played a role in the 2008 spike--not the only factor but a factor. Today, conditions exist that could lead to a repeat of that situation. If another investment-fueled futures spike occurs, grain buyers may be forced to limit their purchases from U.S. agricultural producers as occurred in 2008. Certainly buyers would be forced to consider tighter limits on forward contract purchases, and at the very time many producers would like to take advantage of those favorable prices. The NGFA believes that it would be imprudent for the CFTC to change current speculative position limits for the enumerated agricultural commodities. In particular, we have a strong reservation about an approach that would create a combined position limit for over-the-counter instruments and futures based on open interest levels. The majority of the risk management activity for the enumerated ag commodities involves futures traded on exchanges. The practical impact of a combined OTC and futures position limit likely would mean limits ratcheting steeply upward for futures. We fear the result would be a sort of perpetual motion machine leading to investment in enumerated ag commodities in ever-greater amounts and even wider basis swings occurring. In addition, the commodity exchanges, notably the Chicago Board of Trade and the Kansas City Board of Trade, have worked diligently to reestablish convergence in their wheat contracts. Getting it wrong on position limits could undo progress that the exchanges are making toward enhancing the performance of their contracts. Proper functioning of futures markets for traditional commercial users and producers should be the CFTC's overriding consideration in establishing position limits. A reliable relationship between cash and futures must be maintained. Convergence matters, not just sometimes, but consistently and predictably. The National Grain and Feed Association does not favor excluding investment capital from agricultural futures markets, as we believe it does provide liquidity to our markets. However, we believe that the CFTC must establish reasonable limits on an investment in the enumerated ag commodities so these relatively small markets are not overwhelmed by investment demand. Ignoring the unique characteristics of these markets could have highly undesirable consequences for agricultural producers and their traditional hedgers who use these markets for price discovery and risk management. Thank you, Mr. Chairman, for the opportunity to present NGFA's views today. And we will be happy to respond to any questions. [The prepared statement of Mr. Jones follows:] Prepared Statement of Robert Jones, Senior Vice President, ABN AMRO Clearing Chicago LLC; Member, Risk Management Committee, National Grain and Feed Association, Chicago, IL Good morning, Mr. Chairman and Members of the Subcommittee. I am Robert Jones, Senior Vice President of ABN AMRO Clearing Chicago LLC, a futures commission brokerage in Chicago. I serve on the Risk Management Committee of the National Grain and Feed Association (NGFA) and I am here today to represent the views of the NGFA. The National Grain and Feed Association is the national nonprofit trade association that represents more than 1,000 companies that operate an estimated 7,000 facilities nationwide in the grain, feed and processing industry. Member firms range from quite small to very large, both privately owned and cooperative, and handle or process in excess of 70% of all U.S. grains and oilseeds annually. Companies include grain elevators, feed mills, flour mills, oilseed processors, biofuels producers/co-product merchandisers, futures commission merchants and brokers, and related commercial businesses. A common thread for NGFA-member firms is that they rely heavily on efficient futures markets to provide price discovery and risk management for their commercial businesses. In particular, consistent and predictable convergence of cash and futures values is of primary importance to the NGFA. Establishing appropriate speculative position limits for the futures contracts utilized by these traditional commercial hedgers is critically important to maintaining the viability of futures contracts for risk management purposes. It also is essential in enabling our member companies to make forward contracting and other risk management tools available to farmer-customers. We are especially glad for the opportunity this morning to discuss position limits for the enumerated agricultural commodities--that is, wheat, corn, soybeans, livestock and cotton. As you know, Federal position limits already are in place for those commodities. We believe those limits are at appropriate levels and that the process for establishing those limits has worked well. However, the Dodd-Frank Act requires that the CFTC now establish speculative position limits for all commodities, including agricultural commodities. In the past, the NGFA generally had been supportive of occasional requests by futures exchanges to increase speculative position limits. However, futures price volatility in recent years and vastly increased participation by nontraditional participants has altered the situation and, at times, threatened the viability of exchange-traded futures for commercial grain hedgers. The rapid escalation of agricultural futures prices during 2008, and a resulting disconnect of cash and futures values, dramatically increased risks for grain purchasers/hedgers and caused extreme financial stress due to massive margining requirements. We believe that dramatically expanded participation in agricultural futures by nontraditional participants like index funds and pension funds played a role in the 2008 spike--not the only factor, but a significant one. Today, conditions exist that could lead to a repeat of those conditions. With investment capital now seeking enhanced returns and many advisers recommending commodities as an investment vehicle, it appears the stage could be set for another investment-fueled spike in futures prices--an increase we fear will be largely unrelated to market fundamentals and could again result in extreme financial stress. If this happens, grain buyers may be forced to limit their purchases from U.S. agricultural producers, as occurred in 2008. Certainly, buyers would be forced to consider tighter limits on forward contract purchases, at the very time that many producers would like to take advantage of favorable prices. Many Members of Congress have heard from producers about wider basis levels in recent years--that is, the difference between cash bids and futures values on-exchange. We believe strongly that artificially inflated futures values, due in part to participation of nontraditional investors, have led to a disconnect between cash and futures. The commodity exchanges, notably the Chicago Board of Trade and the Kansas City Board of Trade, have worked diligently to address the disconnect and to re-establish convergence in their wheat contracts. Getting it wrong on position limits could undo progress the exchanges are making toward enhancing performance of their contracts. For these reasons, the NGFA believes it would be imprudent for the CFTC to change current speculative position limits for the enumerated agricultural commodities. In particular, we have strong reservations about an approach that would create a combined position limit for over-the-counter instruments and futures based on open interest levels. The logic for not linking speculative position limits to open interest levels is as follows. The majority of risk management activity involving the enumerated ag commodities utilizes futures traded on-exchange. The practical impact of a combined OTC and futures position limit likely would mean limits effectively ratcheting steeply upward for futures--attracting greater investment and boosting open interest levels--which would trigger increased position limits--leading to yet greater participation levels and increased open interest--and triggering even higher position limits--and so on. We fear the result would be a sort of perpetual motion machine leading speculative investment capital to invest in enumerated ag commodities in ever-greater amounts, exacerbating artificially inflated futures values and leading us back to even wider basis swings. Instead, the NGFA strongly urges the CFTC to use proper functioning of futures markets for traditional commercial users and producers as the overriding consideration in establishing position limits. That means that a reliable relationship between cash and futures must be maintained. Convergence Matters! Not just sometimes, but consistently and predictably. We also urge the CFTC to be vigilant in reviewing corporate linkage issues through which investment firms or other nontraditional participants may technically comply with position limits through separate entities, while coordinating positions that would circumvent the intent of the rule. This would seem to us consistent with the Commission's intentions to monitor account ownership and control to help ensure compliance. Mr. Chairman, all these points lead back to one very important message: enumerated agricultural futures contracts must function effectively for traditional commercial hedgers and their farmer-customers. The NGFA does not favor excluding investment capital from agricultural futures markets. In fact, we believe that a desire to invest in our industry is a good thing. It forecasts growth and economic opportunity for U.S. agriculture and agribusiness. However, we believe Congress and the CFTC must act prudently to establish reasonable limits on investment in the enumerated ag commodities and help ensure that those relatively small markets are not overwhelmed by investment demand. Ignoring the unique characteristics of the enumerated agricultural commodities when setting position limits could have highly undesirable consequences for U.S. agricultural producers and the traditional hedgers who use these markets for price discovery and risk management. Thank you, Mr. Chairman, for the opportunity to present the NGFA's views. I would be happy to respond to any questions. " CHRG-111hhrg51698--613 Mr. Moran," Mr. Chairman, thank you very much. Let me take this opportunity to congratulate you on becoming the Subcommittee Chairman on General Farm Commodities and Risk Management, a Subcommittee that I chaired at one point in time. And now I am your humble Ranking Member, and I look forward to working with you. " CHRG-111shrg57322--1072 Mr. Blankfein," I can't say what Mr. Paulson is thinking, but there is nothing wrong--speculating--if he was, which I don't know what he was thinking, if he was just a speculator, there are people who speculate in corn and speculate in all sorts of commodities---- Senator McCaskill. I understand. Mr. Blankfein [continuing]. That allow the professional users of those markets to complete their hedges. That is a socially acceptable---- Senator McCaskill. Mr. Blankfein, there is a big difference between finding the opposite side of a certainty in a commodity hedge for a farmer that needs certainty or an airline company that needs to figure out what jet fuel is going to cost and two sides of a deal that are both just betting. There is nothing in a synthetic CDO that is essential to certainty to anybody's business other than somebody just deciding they want to take one side of a deal and the other side of a deal. That is what a synthetic CDO is. " CHRG-111hhrg63105--196 Mr. Collura," My comment was in respect to the earlier comments that Congressman Marshall had raised about index speculation. These folks take passive rolling positions in commodities and can create almost a perpetual situation of entangling a market, where outside of spot months---- " FOMC20080430meeting--129 127,MR. FISHER.," You emphasized the phrase ""reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization."" Can you just refresh my memory? For how long have we been using that phrase--just in the March statement, or have we used it before? " FOMC20080625meeting--29 27,MR. SHEETS.," 2 Thank you, Mr. Chairman. Given that developments in global commodities markets have continued to have influential effects on our forecast for domestic activity and prices, we felt that it would be useful for me to lead off with the international portion of the chart show, which will include a discussion of these markets. Following my remarks, Larry and Bill will present our outlook for the U.S. economy. As shown in the top panel of your first exhibit, total foreign real GDP growth (line 1) stepped down from an average pace of 4� percent in the first three quarters of 2007 to around 3 percent in the fourth quarter of last year and the first quarter of this year. We see growth abroad as likely to decline to 2.2 percent in the current quarter and to pick up only slightly in the second half of the year. Next year, with the expected firming of U.S. activity and diminishing headwinds from the financial turmoil, foreign growth should rise back to a 3� percent pace. Growth abroad was just a bit stronger in the first quarter than we had anticipated, but the composition of that growth came as more of a surprise. Canadian GDP (line 3) posted a slight contraction, reflecting a continuing downturn in exports and stagnant investment. In contrast, the pace of activity in Japan (line 4) and the euro area (line 5) was much more vigorous than we had expected, including a 6� percent surge in Germany. Nevertheless, recent data for these economies point to much weaker growth in the second quarter. As shown in the middle left panel, Japanese manufacturing output 2 The materials used by Messrs. Sheets, Slifman, and Wascher are appended to this transcript (appendix 2). has declined recently, and labor market conditions have softened. For the euro area (the middle right), various indicators are showing weakness, including retail sales and the purchasing managers' index. As highlighted in the bottom panel, growth in the emerging market economies is expected to step down over the next few quarters but should remain relatively resilient, especially compared with the weak performance of these economies during the U.S. recession earlier this decade. Many of the EMEs were particularly vulnerable to the high-tech- and manufacturing-led downturn that occurred at that time, and fundamentals in the EMEs are now stronger than was then the case. In addition, Chinese domestic demand has remained quite robust of late, and this has likely helped to support growth in emerging Asia. As shown in the top left panel of exhibit 2, oil prices have continued to soar with the spot price of WTI closing yesterday at $136 per barrel. The far-dated futures price has climbed to about the same level. Our forecast for the path of oil prices is now roughly $50 a barrel higher than at the time of the January chart show. Divining the causes of this staggering rise in oil prices is no doubt ground on which angels fear to tread, but we continue to assert bravely that the primary driver of higher oil prices is constrained (and price inelastic) oil supply coupled with relatively strong (and price inelastic) oil demand. These deep features of the oil market--along with stressed geopolitical conditions in many oil-producing countries, rising production costs, and concern about the reliability of medium- to long-run supply--have sent oil prices spiraling upward. As shown in the last column of the middle table, the increase in oil prices appears to have contributed to modest declines in oil consumption in the advanced economies, including the United States (line 3). But oil consumption has continued to move up in the emerging market economies, especially in China (line 5) and the Middle East (line 6). Consumers in many EMEs have been shielded from rising prices by government fuel subsidies. The economic and fiscal costs of such subsidies are becoming increasingly burdensome, however, prompting some countries (including China late last week) to allow domestic fuel prices to move toward world levels. As seen on the top right, oil inventories in OECD countries have declined over the past year and a half. Unfortunately, little information is available about the behavior of inventories outside of OECD countries. The bottom left panel shows that the rise in global oil production since 2004 has significantly lagged the expansion of world GDP (weighted by oil consumption); indeed, production has remained relatively flat during most of that period. Notably, however, the lack of oil production is not due to geological constraints. Data on years of proved reserves (shown on the bottom right) are at roughly the same level as a decade ago. But those reserves are now concentrated in areas where production is constrained by acute geopolitical risks, uncertainty about property rights, inadequate investment, and high production costs. Turning to your next exhibit, nonfuel commodity prices have also risen significantly on average since your last chart show, with most of the increase coming in the first few months of the year. Here, too, we believe that the elevated level of prices is a result mainly of strong and sustained global demand, lagging supply responses, and rising production costs. Consistent with this observation, inventories of key commodities, shown in the middle left panel, have trended down in recent years. It bears emphasizing, however, that nonfuel commodity prices certainly have not moved in lockstep with each other. As seen in the bottom left panel, the price of corn has surged to new highs, supported by ethanol demand and, more recently, as adverse weather in the Midwest has endangered a substantial fraction of this year's crop. In contrast, the price of wheat has fallen back from its recent peak, as improved growing conditions in Australia seem likely to boost supply. For metals, the price of zinc has moved down significantly since its peak in late 2006, as new smelters have come on line. The price of copper has moved sideways--but at a high level--over the past two years, as prospective increases in supply have not yet materialized. A number of other explanations for the recent run-up in oil and other commodity prices have also been advanced, including the possibility that increased purchases by ""speculators"" in commodity futures markets may be playing an important role. Given the magnitude of the financial flows into these markets, we are hesitant to slam the door completely on this explanation, but our work finds little supporting evidence. As noted on the top right, prices of a number of commodities that are not traded in futures markets have also risen substantially. Second, a sustained increase in demand by investors would suggest that inventories should be rising; instead, as I have noted, inventories are now relatively tight. Finally, we see no evidence that the positions taken by noncommercial traders in futures markets actually predict commodity prices; for example, such positions for light sweet crude oil on the New York Mercantile Exchange have been roughly flat since mid-2007. Two other frequently cited explanations for the rise in commodity prices are the depreciation of the dollar and declines in interest rates. The middle-right panel shows the correlation of the broad nominal dollar with oil prices and with an index of nonfuel commodity prices. Both correlations are negative over most of the sample, implying that depreciations of the dollar have tended to happen at the same time as rises in commodity prices. While these correlations have become more negative since mid-2007, they remain within the ranges seen in recent years, and interpreting the direction of causality for this relationship is difficult. Also, as Bill noted, the dollar has been relatively stable over the past several months, but oil prices have continued their upward climb. Similar plots of correlations of interest rates with commodity prices (shown on the bottom right) are quite noisy and fail to point to any clear conclusions. As shown in exhibit 4, the run-up in commodity prices has continued to lift headline consumer price inflation in both the advanced foreign economies and the emerging markets. We expect that inflation abroad will remain elevated in the near term but eventually move back down as slower global growth reduces pressures on resources and as commodity prices flatten out (consistent with quotes from futures markets). Of course, one clear risk to these projections is that commodity prices may, yet again, confound our expectations and continue rising. Another risk is that the high rates of inflation now being recorded may become embedded in inflation expectations. As shown in the top right panels, measures of long-term inflation compensation have recently edged up in the euro area and increased more markedly in Canada. In recent weeks, major foreign central banks have intensified their inflation-fighting rhetoric. Notably, the ECB has warned that it may raise rates at its next meeting; and in the United Kingdom, Mervyn King--in his letter to the Chancellor--underscored his determination to ensure that inflation remains contained. As shown on the bottom left, we now assume that both the ECB and the Bank of England will raise rates in the second half of this year, compared with the near-term cuts we had anticipated in the April Greenbook. In addition, we now see the Bank of Canada keeping policy on hold. In the emerging market economies, including Mexico and China (the bottom right panel), increases in inflation have largely been driven by rising food prices, which account for a substantial share of consumer expenditures. Policymakers in the EMEs have taken steps to slow the rise in food prices, with some countries introducing price controls and export bans on agricultural goods. But officials have also relied on more-orthodox policies to combat inflation, including raising policy rates and hiking reserve requirements. Indeed, over the intermeeting period, monetary policy was tightened in a range of emerging market economies, including Mexico, Brazil, China, India, Russia, and Hungary. As shown in the top left panel of exhibit 5, the path of the broad real dollar is now just a little weaker than we anticipated at the time of the January chart show. We continue to expect the dollar to depreciate at an annual rate of 3 percent through the forecast period, reflecting persisting downward pressures associated with the current account deficit. This depreciation is projected to come largely against emerging market currencies (including the Chinese renminbi), which have moved less since the dollar's peak in early 2002. It's safe to say that core import price inflation (on the right) has come in substantially higher than we projected in January. Incorporating the BLS monthly data for April and May, we now see core import prices in the second quarter surging at an annual rate of 10� percent, the fastest rise in two decades. This increase, which comes on the heels of an 8 percent jump in the first quarter, was heavily concentrated in material-intensive goods and suggests a much more rapid and, perhaps, stronger effect from the run-up in commodity prices than we saw in the past. Conditional on nonfuel commodity prices flattening out, core import price inflation should decline to less than 2 percent next year. Finally, summing up what these developments mean for U.S. activity, we now see the contribution from net exports to U.S. real GDP growth (line 3 in the table) as likely to exceed 2 percentage points in the second quarter, as exports expand at a smart pace (supported by the lower dollar) and imports contract sharply. This marked weakness in imports reflects both a steep drop in real oil imports and a continued decline in imports of core goods (reflecting sluggish U.S. GDP growth and rising prices of imported commodities). The positive contribution from net exports moderates to � percentage point in the second half of this year and to � percentage point in 2009. While the pace of export growth is projected to remain strong, at above 7 percent, imports should gradually accelerate as the U.S. economy recovers. Larry will now continue our presentation. " CHRG-109hhrg31539--111 Mr. Bernanke," Congressman, I think there are a number of factors affecting inflation, but probably one of the most important is the fact that energy and commodity prices have gone up so much. And that affects, to some extent, the strength of the global economy, which has been very strong for the 3 or 4 years, and the increased demand for energy coming from China and other places has driven up those prices, and that has been a contributing factor to our inflation issue. " FOMC20070131meeting--55 53,MR. GAGNON.," Your first international exhibit (exhibit 9) covers recent market developments. As shown by the green line in the top left panel, oil prices dropped further this month, bringing the West Texas intermediate spot price back to pre- Katrina levels. The IMF index of nonfuel commodity prices (the red line) was little changed this month after a year of remarkable increases. Readings from futures markets imply a flattening out of nonfuel commodity prices and only a moderate increase in oil prices going forward. The top right panel shows that our real trade- weighted dollar indexes declined on balance last year. In recent weeks the dollar rebounded modestly against the major industrial-country currencies (the red line), but we estimate that it continued to decline in real terms against the currencies of our other important trading partners (the green line). As usual, our forecast calls for a small downward trend from current levels, reflecting our belief that the risk of significant depreciation is slightly greater than the risk of significant appreciation, owing to the unsustainably large U.S. trade deficit. The bottom panels report equity market indexes, with industrial countries shown on the left. The lines are set to equal 100 in March 2000, the previous peak month for the Wilshire 5000. Equity prices have risen broadly across the industrial countries over the past two years and are now just above their March 2000 levels in the United States, the United Kingdom, and Japan, but not in the euro area (the red line). For major emerging markets, on the right, equity indexes are well above March 2000 levels. In Mexico (the blue line), equity prices have more than tripled over this period. In Thailand (the green line), the government’s recent attempts to slow capital inflows and relieve upward pressure on the currency have taken their toll on equity prices, but contagion to other emerging equity markets has been minimal. Overall, commodity and financial market developments are consistent with expectations of strong global growth. Exhibit 10 focuses on financial flows between emerging markets and industrial countries. As shown in the top left panel, the major developing regions have continued the downward trend in their reliance on external borrowing. Fiscal deficits have declined in most countries, and many governments have turned increasingly to local, rather than external, borrowing. The panel to the right shows that yield spreads on dollar-denominated sovereign debt of emerging market countries have dropped to historically low levels. But emerging markets, in the aggregate, have gone much further than just reducing their borrowing. In recent years, emerging markets have experienced record outflows of official capital (the gold bars in the middle panel). These official outflows are composed of the accumulation of foreign exchange reserves, the servicing and paying down of sovereign debt, and the purchase of foreign assets by government-run investment funds such as the Kuwait Investment Authority. In all the emerging market regions, official capital outflows have recently exceeded current account surpluses (the blue bars), which are themselves at record levels. For example, the IMF estimates that in 2006, governments in emerging Asia invested on balance $270 billion outside their borders, a sum that greatly exceeds their combined current account surplus of $185 billion. Most of these official flows have taken the form of additions to foreign exchange reserves, as governments have built up war chests against future financial crises and sought to counter upward pressures on their currencies. The bottom panel looks at these flows from the point of view of the industrial countries, plotting aggregate emerging market net official flows (the gold bars) relative to industrial-country GDP, with negative values denoting net flows into the industrial countries. The statistical accounts do not report the destinations of all these flows, but the available evidence suggests that the overwhelming majority is destined for the industrial countries. Before 2003, net official inflows or outflows from the emerging markets had never exceeded 1 percent of industrial-country GDP. But since 2003, things have changed. Net official outflows from emerging markets are now estimated to equal 2½ percent of the combined GDP of the industrial countries. As shown in the panel, the timing of this unprecedented increase in net official flows corresponds well with the puzzling decline in real short-term interest rates in the industrial countries (the green line) that persisted long after industrial-country GDP growth (the purple line) rebounded from the slowdown early in this decade. The evidence suggests that aggregate policy-driven capital flows from the emerging markets may be an important factor behind low real interest rates in the industrial countries. Moreover, low real rates are not limited to short-maturity instruments. The top panels of exhibit 11 show that ten-year indexed bond yields are also low and have been for several years in the major industrial countries. These rates have ticked up over the past month or two, but only by a small amount. Long-term inflation compensation (shown in the middle row of panels) remains contained. Indeed, in Japan and Canada (the two panels on the right) inflation compensation has moved down in recent months. In the euro area and the United Kingdom (the two panels on the left), where inflation compensation lingers above policymakers’ targets, we project modest additional policy tightening early this year, shown in the bottom row of panels. Despite recent and expected future inflation rates close to zero, the Bank of Japan seems poised to tighten gradually over the next two years. In Canada, policy is expected to remain on hold. If these projections prove to be the peak policy rates for this cycle, they will be the lowest cyclical peaks for short-term interest rates in these countries for at least forty years. Nevertheless, we judge that these policy stances are likely to be consistent with low and stable inflation this year and next. The large capital inflows and low real interest rates in the industrial countries have contributed to rising housing prices in many of these countries. Higher home prices in turn have stimulated housing construction. The top panel of exhibit 12 shows that the extent and timing of the house-price boom differs markedly across countries. The Netherlands (the blue line) was one of the leaders of the global housing boom, with prices rising continuously since the early 1990s, though at much slower rates in recent years. Japan (the green line), on the other hand, is a notable exception to the trend of rising house prices in recent years, reflecting the lingering effects of the bursting of the 1980s asset bubble and Japan’s extended economic slump. The middle panels focus on two countries that experienced strong house-price increases (the purple lines) early in this decade but where house-price increases subsequently halted, at least temporarily. In both Australia and the United Kingdom, as in the United States, residential investment (the green lines) responded positively to higher house prices. In Australia, on the left, real house prices have been flat for the past three years, and residential investment has declined gradually about 1 percentage point of GDP, though it remains above its historical average. In the United Kingdom, on the right, house prices stabilized in 2005 and picked up again modestly last year. Despite lower house-price inflation, residential investment has continued to rise toward historically high levels. The relevance of these foreign experiences for the United States is difficult to gauge, but they provide some support for Larry’s forecast that the downturn in U.S. housing is nearly over. In light of the signals from financial and commodity markets, as well as other real-side indicators, we project continued solid growth in the foreign economies at rates that are not likely to strain resources or to put upward pressure on inflation. As shown in the bottom panel, total foreign growth (line 1) is estimated to have stepped down last year from 4½ percent in the first half to about 3½ percent in the second half, and it is projected to remain around 3½ percent over the forecast period. This projection is about 1 percentage point stronger than the staff’s projection for U.S. growth, shown at the bottom of the panel. The foreign industrial economies (line 2) overall are projected to grow at about the same rate as the United States, Japan a bit slower (line 4), and Canada a bit faster (line 5). The emerging market economies (line 6) are projected to grow at nearly twice the pace of the industrial economies over the forecast period. We expect that emerging Asia (line 7) will continue to grow very rapidly and that Latin America (line 8) will grow at a solid, though not exceptional, rate. Our forecast assumes that the Chinese government will take additional measures if necessary to reduce the growth rate of investment, and we project that Chinese GDP growth will be slower this year than last. But the risks to our growth forecast for China are probably greater on the upside. Exhibit 13 provides an assessment of what all these foreign influences mean for the U.S. economy. Overall import prices, the black line in the top left panel, fell sharply last quarter and are projected to continue to fall in the current quarter, primarily owing to the drop in the price of imported oil. As oil prices stop falling and begin to move gradually back up, overall import price inflation should turn positive. Prices of imported core goods (the red line), which exclude oil, gas, computers, and semiconductors, rose at a rate of nearly 4 percent in the middle of last year, primarily owing to sharply higher prices of nonfuel commodities. With commodity prices projected to stabilize and with only a small depreciation of the dollar in our forecast, prices of imported core goods should increase at a subdued pace over the next two years. The contributions of exports and imports to U.S. GDP growth are shown in the lower panel. We now estimate that the external sector made a positive arithmetic contribution to growth last year, the first positive annual contribution since 1995. Import growth stepped down from previous years as U.S. GDP grew more slowly. Export growth benefited from robust foreign economic activity, but exports turned out even stronger than our models project. Line 1 in the top right panel shows that, for the first eleven months of last year at an annual rate, exports of goods grew 10½ percent from the previous year in real terms. Lines 2 through 4 show that three categories of capital goods—aircraft, machinery, and semiconductors—contributed nearly half of total export growth. Although it is possible that blistering growth rates in exports of these goods may continue, we base our forecast on a return of export growth to a rate more consistent with historical relationships. With the vast majority of aircraft production being exported in recent months and with aircraft factories running at high utilization rates, further large increases in exports from this sector, at least, do not seem likely. Returning to the bottom panel, we project that the negative arithmetic contribution of imports (the red bars) to GDP growth will outweigh the export contribution (the blue bars) in 2007 and 2008 by about ¼ percentage point (the black line). This projection is driven by the historical tendency of U.S. imports to grow at a much faster rate than U.S. GDP. In addition, the larger value of imports relative to exports means that, even if imports and exports were to grow at the same rate, the negative contribution of imports would be greater than the positive contribution of exports. The projected strong growth rates of foreign GDP, discussed in your previous exhibit, are not large enough to outweigh these factors over the next two years. On balance, relative prices have little effect on net exports over the forecast period, as the real trade-weighted dollar has moved in a relatively narrow range over the past couple years and is not projected to move substantially over the forecast period. And now Larry will complete our presentation." CHRG-111hhrg63105--76 Mr. Chilton," It is actually--we know that a lot of money went out. And it went--I mean, look, as the Chairman said, we are not price setters. We are supposed to be commodity blind, although I have a little bit of penchant for the ags, and price neutral. We are not price setters. And I also get concerned when oil is $150 but---- " FOMC20080130meeting--335 333,VICE CHAIRMAN GEITHNER.," Thank you. I agree with President Poole and President Yellen about the need to focus on compensation structures and incentives, but just two observations. One is that, if you look at compensation practices among the guys who actually look as though they did pretty well against those who didn't do so well--I'm not talking about in a mortgage-origination sense but in the major global financial institutions--the structure of compensation doesn't vary that much. What varies a lot is how well people control for the inherent problems in the basic compensation structures. Remember Raghu's presentation was mostly about hedge fund compensation, and I think he is mostly wrong when you think about that and the incentive structure. The difference really is how you design your limits to make sure that your traders' incentives are more aligned with the incentives of the firm as a whole. The biggest errors and differences are in the design of the process of the checks and balances to compensate for the inherent problems in the compensation structure. That's important to know because a lot of these things, if you look at the formal attributes of the risk-management governance structure across these firms, don't look that different. What distinguishes how well the guys did is much more subtle around culture, independence, and the quality of judgment exercised at the senior level, and this is important because, when you think about what you can do through supervision and regulation, to affect that stuff is hard. I have a question for Pat. Pat, not to overdo this, but where do you put in your diagnosis of contributing factors the constellation of financial conditions that prevailed during the boom and what those did to housing prices? You know, there's a tendency for everybody to look at regulation and supervision and the incentives that they have created or failed to mitigate, but there is a reasonable view of the world that you wouldn't have had the pattern of underwriting standards of mortgages without the trajectory of house prices that occurred. Sure, maybe what happened in the late stage of the mortgage-origination process contributed to the upside, but if you look at a chart, the rate of house-price appreciation started to decelerate about the time you had the worst erosion in underwriting practices. Anyway, my basic question is, Where do you put the constellation of financial conditions, not so much just what the Fed was doing but what was happening globally that affected long rates, expectations of future rates, et cetera? " CHRG-111hhrg72887--103 Mr. Rush," The Chair thanks the gentleman and all of the witnesses. The Chair recognizes himself for 5 minutes for the purposes of asking questions of these witnesses. In the subcommittee's last hearing on consumer credit issues, I asked the FTC Chairman, John Leibovitz, about the Commission's record in protecting consumers from unfair and deceptive practices in the past several years. I noted that the FTC arguably didn't do enough to stop the mortgage lending practices during the housing era or housing boom, I might add. The Chairman argued that the FTC argued that the FTC is ``hamstrung'' by the burdensome rulemaking process under Magnuson-Moss, and he assured me that if Congress gave the FTC the authority to issue rules under the Standard Administrative Procedures Act, the FTC would indeed be more effective in this particular area. Today we are considering legislation that would give to FTC this authority that Chairman Leibovitz requested at one of our hearings. My question to Ms. Keest--and I would also like to get a response from Ms. Harrington--Ms. Keest, Congress has duly given the FTC streamlined rulemaking authority on a case-by-case basis. We have taken another approach in this bill. The Chairman has requested we give the FTC broad APA authority to issue rulings on anything involving consumer credit or debt. My question is should we trust the FTC's discretion to essentially use this authority, or will we be better off sticking with direct rulemaking? Ms. Keest. I think it is extremely important to give them discretion for the simple reason that the velocity at which the market changes is far too fast to have to come back and make a record every single time. For example, the last time before Congress passed the H.R.--the predecessor of H.R. 72, 1728, last week, it had been 15 years before Congress acted on consumer mortgage issues. And there is a lot that goes on, and there is a lot that the FTC has on its plate. There is a lot that Congress has on its plate. And in the meantime, the markets develop and move, and I don't really think it is feasible to wait for specific direction as every problem comes up one by one. " CHRG-111hhrg53021Oth--188 Mr. Costa," In the same ballpark, in follow-up to Congressman Scott's question, you talked about capital requirements being uniform between financial and nonfinancial traders. How would you visualize that taking place between commodities, a company continuing to participate in the market, if they are required to have an extensive cash capital? " CHRG-111hhrg53021--188 Mr. Costa," In the same ballpark, in follow-up to Congressman Scott's question, you talked about capital requirements being uniform between financial and nonfinancial traders. How would you visualize that taking place between commodities, a company continuing to participate in the market, if they are required to have an extensive cash capital? " FOMC20050322meeting--16 14,CHAIRMAN GREENSPAN.," But if you take it as a meaningful index, that’s a very impressive move. And the point is that it’s the first time I’ve seen anything like that in the commodities area. I’ve always looked at the CRB futures, which does look something like this, but I assumed it was a third-order matter. Anyway, enough of that." CHRG-110shrg50369--126 Mr. Bernanke," Well, I do not think that foreign investors have lost confidence in the United States by any means. The data you are referring to shows some desire by foreign investors to shift out of corporate credits and other credit products and into treasuries. That is the same shift that American investors are making. They are getting away from what they view as risky credits toward the safety of U.S. Government debt. And, indeed, U.S. Government debt is still the safest, most liquid, desired asset in the world. There is some effect of the dollar on commodities. Oil and other commodities are traded globally. You can think of the price as being set by global supply and demand. If the dollar depreciates a bit, then you would expect to see commodity prices rise to offset that depreciation. But it is important to understand that, for example, oil has risen in euros as well as in dollars. I mean, it is not simply an issue of currencies. It also has to do with global supply and demand for the commodity. So the European Central Bank is concerned about food and energy inflation as well. With respect to the sovereign wealth funds, that is just another indication that foreigners have not lost confidence in the U.S. economy and that there has been a good bit of inflow. In particular, about something close to half of the capital that financial institutions have raised in the last few months has come from sovereign wealth funds, from other countries. I think that, in general, that is quite constructive. If we are confident, as I think we are in this case, that the investments are made for economic reasons and not for political reasons or other noneconomic reasons, and there is no issue of national defense, which the CFIUS process takes care of, then that inflow of investment is good for our economy and certainly is helping, in this case, the financial system. At the same time, allowing inflows of foreign capital through reciprocity gives us more opportunities to invest abroad. I know that Congress is very interested in sovereign wealth funds, and you should certainly take a close look at it. International agencies, like the International Monetary Fund and the OECD, are developing codes of conduct. The basic idea there is that sovereign wealth funds should be as transparent as possible. We should understand their governance and their motivations, and, in particular, we should be confident that they are investing, again, for economic rather than political or other purposes. If we are confident in that, then it is in our interest to keep our borders open and to allow that capital to flow in. And I think it will continue to flow in. " CHRG-110hhrg44901--137 The Chairman," I will say in the 10 seconds I will borrow from the gentlelady, my jurisdiction proposal is we leave with the Agriculture Committee jurisdiction over all those futures and things you can eat, and we get the rest. The gentleman from California. Mr. Miller of California. Thank you, Mr. Chairman. I kind of enjoyed the comments that the Federal Reserve is getting blamed for not dealing with the predatory issue as it applies to subprime. But I recall 5 years ago, I repeatedly tried to introduce language to effectively define what predatory was versus subprime and included the issues you have dealt with finally. So I feel guilty blaming you for something 5 years ago we should have done and didn't. The purpose and intent of the GSEs was to inject liquidity into the marketplace, which we have done. If you look at the amount of loans that are out there, I think it has proven to be very beneficial to the housing market. Having been a developer for over 35 years, I have been through the 1970's recession, 1980's, 1990's. Any time you see a housing boom, you know eventually there is a going to be a housing recession occurs. It has happened repeatedly. This one is a little different, but every one I have been through has been somewhat different. In the stimulus package we passed recently, I think the most important part on the economy was increasing conforming loan limits for FHA and GSEs. Sending people a check, yes, there is a benefit to that. But the main reason I think for the situation the economy is in today is because of the housing recession we have gone through. I think raising conforming loan limits in high-cost areas has gone a long way to mitigating an impact that could have been worse than it was. Especially in California and other areas there are many lenders that will not make a loan today if it is not conforming because they don't have the assets basically to tie their capital up if they can't make the loan and sell the loan off. Now, there has been discussion about after December 31st, we are going to be dropping those limits down to much lower levels. I believe that is going to have a major detrimental impact on the housing market because it sends--even the discussion and debate about doing that sends a message that we are not going to be committed in the future to trying to create liquidity in these high-cost areas. I would like to have your opinion on that issue. " fcic_final_report_full--74 DOTCOM CRASH: “LAY ON MORE RISK ” The late s was a good time for investment banking. Annual public underwrit- ings and private placements of corporate securities in U.S. markets almost quadru- pled, from  billion in  to . trillion in . Annual initial public offerings of stocks (IPOs) soared from  billion in  to  billion in  as banks and securities firms sponsored IPOs for new Internet and telecommunications compa- nies—the dot-coms and telecoms.  A stock market boom ensued comparable to the great bull market of the s. The value of publicly traded stocks rose from . tril- lion in December  to . trillion in March .  The boom was particularly striking in recent dot-com and telecom issues on the NASDAQ exchange. Over this period, the NASDAQ skyrocketed from  to ,. In the spring of , the tech bubble burst. The “new economy” dot-coms and telecoms had failed to match the lofty expectations of investors, who had relied on bullish—and, as it turned out, sometimes deceptive—research reports issued by the same banks and securities firms that had underwritten the tech companies’ initial public offerings. Between March  and March , the NASDAQ fell by almost two-thirds. This slump accelerated after the terrorist attacks on September  as the nation slipped into recession. Investors were further shaken by revelations of ac- counting frauds and other scandals at prominent firms such as Enron and World- com. Some leading commercial and investment banks settled with regulators over improper practices in the allocation of IPO shares during the bubble—for spinning (doling out shares in “hot” IPOs in return for reciprocal business) and laddering (doling out shares to investors who agreed to buy more later at higher prices).  The regulators also found that public research reports prepared by investment banks’ ana- lysts were tainted by conflicts of interest. The SEC, New York’s attorney general, the National Association of Securities Dealers (now FINRA), and state regulators settled enforcement actions against  firms for  million, forbade certain practices, and instituted reforms.  The sudden collapses of Enron and WorldCom were shocking; with assets of  billion and  billion, respectively, they were the largest corporate bankruptcies before the default of Lehman Brothers in . Following legal proceedings and investigations, Citigroup, JP Morgan, Merrill Lynch, and other Wall Street banks paid billions of dollars—although admitted no wrongdoing—for helping Enron hide its debt until just before its collapse. Enron and its bankers had created entities to do complex transactions generating fictitious earnings, disguised debt as sales and derivative transactions, and understated the firm’s leverage. Executives at the banks had pressured their analysts to write glowing evaluations of Enron. The scandal cost Citigroup, JP Morgan, CIBC, Merrill Lynch, and other financial institutions more than  million in settlements with the SEC; Citigroup, JP Morgan, CIBC, Lehman Brothers, and Bank of America paid another . billion to investors to settle class action lawsuits.  In response, the Sarbanes- Oxley Act of  required the personal certification of financial reports by CEOs and CFOs; independent audit committees; longer jail sentences and larger fines for executives who misstate financial results; and protections for whistleblowers. Some firms that lent to companies that failed during the stock market bust were successfully hedged, having earlier purchased credit default swaps on these firms. Regulators seemed to draw comfort from the fact that major banks had succeeded in transferring losses from those relationships to investors through these and other hedging transactions. In November , Fed Chairman Greenspan said credit de- rivatives “appear to have effectively spread losses” from defaults by Enron and other large corporations. Although he conceded the market was “still too new to have been tested” thoroughly, he observed that “to date, it appears to have functioned well.”  The following year, Fed Vice Chairman Roger Ferguson noted that “the most re- markable fact regarding the banking industry during this period is its resilience and retention of fundamental strength.”  CHRG-111shrg57322--1073 Mr. Blankfein," Every futures contract on oil or anything consists of you could characterize it as a bet, but not the underlying commodity. Some of these things just don't even settle in physical form, but they provide the liquidity and the opportunity for people who want to hedge themselves to get in and take that position. Senator McCaskill. And we can't take this too far. " CHRG-110shrg50410--107 Chairman Dodd," Senator Schumer. Senator Schumer. Well, thank you. And I apologize to the witnesses. As I am sure people have mentioned, we have our Democratic and Republican Caucus lunches, and so I had to be there. First I just, not my main point of questions, but I wanted to underscore what Senator Casey said. We are going to need broad bipartisan support to get this done. There is already word that one Republican senator said he would do everything he could to block it, which then means we need 60 votes. So we have to do this in a bipartisan way. And we just need your commitment and the President's, that they are going to do everything they can to get this done and done quickly. I, for one, think that you have put together a good plan. And you are sort of in a funny situation here. I mean, markets always get overconfident. That is the history of them. That is why we have booms and busts. But in this world of universal knowledge, everyone gets overconfident at once. And it is not one corner of a State or then one corner of a country or even one country in the world, but everybody. And so when the problem occurs and everyone thinks OK, we can all do no doc mortgages because housing values will always get up, everybody gets in trouble. And that means you need broad solutions. And so I, for one, think that the irony here is the more limits we put on this, the more worried the markets be. And if the real issue here is not the fundamental strength of Fannie and Freddie, low as their stock price is, but rather the psychology, in a certain sense the more open-ended the power, the ability--not the use but the ability, as I think you said, it is a bazooka in your pocket that you hope you do not have to use--the better. So I hope we can move this quickly and I think we ought to be careful before imposing various limitations in terms of giving the markets confidence that if, God forbid, something bad happens--and I do not think it will--the Government will be there. So I salute you on that. The two kinds of limitations that I think are appropriate are one, in time. You have had 18 months. Maybe it should just be a year and we will renew it if, God forbid, it is still bad. The second, and you have done some of this, is to make sure the Government comes first over the shareholders, that the Government is fully repaid before the stockholders and other financial interests get repaid. Can you assure us that the plan we put together will keep that limitation, which I think is a reasonable limitation that will not spook the markets in any way, is there? " fcic_final_report_full--65 A key OTC derivative in the financial crisis was the credit default swap (CDS), which offered the seller a little potential upside at the relatively small risk of a poten- tially large downside. The purchaser of a CDS transferred to the seller the default risk of an underlying debt. The debt security could be any bond or loan obligation. The CDS buyer made periodic payments to the seller during the life of the swap. In re- turn, the seller offered protection against default or specified “credit events” such as a partial default. If a credit event such as a default occurred, the CDS seller would typi- cally pay the buyer the face value of the debt. Credit default swaps were often compared to insurance: the seller was described as insuring against a default in the underlying asset. However, while similar to insurance, CDS escaped regulation by state insurance supervisors because they were treated as deregulated OTC derivatives. This made CDS very different from insurance in at least two important respects. First, only a person with an insurable interest can obtain an insurance policy. A car owner can insure only the car she owns—not her neighbor’s. But a CDS purchaser can use it to speculate on the default of a loan the purchaser does not own. These are often called “naked credit default swaps” and can inflate potential losses and corresponding gains on the default of a loan or institution. Before the CFMA was passed, there was uncertainty about whether or not state insurance regulators had authority over credit default swaps. In June , in re- sponse to a letter from the law firm of Skadden, Arps, Slate, Meagher & Flom, LLP, the New York State Insurance Department determined that “naked” credit default swaps did not count as insurance and were therefore not subject to regulation.  In addition, when an insurance company sells a policy, insurance regulators re- quire that it put aside reserves in case of a loss. In the housing boom, CDS were sold by firms that failed to put up any reserves or initial collateral or to hedge their expo- sure. In the run-up to the crisis, AIG, the largest U.S. insurance company, would ac- cumulate a one-half trillion dollar position in credit risk through the OTC market without being required to post one dollar’s worth of initial collateral or making any other provision for loss.  AIG was not alone. The value of the underlying assets for CDS outstanding worldwide grew from . trillion at the end of  to a peak of . trillion at the end of .  A significant portion was apparently speculative or naked credit default swaps.  Much of the risk of CDS and other derivatives was concentrated in a few of the very largest banks, investment banks, and others—such as AIG Financial Products, a unit of AIG  —that dominated dealing in OTC derivatives. Among U.S. bank holding companies,  of the notional amount of OTC derivatives, millions of contracts, were traded by just five large institutions (in , JPMorgan Chase, Citigroup, Bank of America, Wachovia, and HSBC)—many of the same firms that would find them- selves in trouble during the financial crisis.  The country’s five largest investment banks were also among the world’s largest OTC derivatives dealers. While financial institutions surveyed by the FCIC said they do not track rev- enues and profits generated by their derivatives operations, some firms did provide estimates. For example, Goldman Sachs estimated that between  and  of its revenues from  through  were generated by derivatives, including  to  of the firm’s commodities business, and half or more of its interest rate and cur- rencies business. From May  through November ,  billion, or , of the  billion of trades made by Goldman’s mortgage department were derivative transactions.  CHRG-111hhrg53246--71 Mr. Gensler," It is a very good point. It is why we have asked Congress and this committee to consider in over-the-counter derivatives regulation that we also make sure that the position limit authority for commodities of finite supply, that we also be able to do that in the over-the-counter market if it serves a price discovery function back into the other regulated markets. Because you are right that you could move from the futures to the over-the-counter derivatives. And we saw that in a number of cases in the last several years. " CHRG-111hhrg51698--303 Mr. Short," Thank you. Chairman Peterson, Ranking Member Lucas, I am Johnathan Short, Senior Vice President and General Counsel with IntercontinentalExchange or ICE. We are grateful for the opportunity to provide comments on the discussion draft of the Derivatives Markets Transparency and Accountability Act, and I fully support the goals of the Act to bring transparency and accountability to commodity markets. As the owner of regulated exchanges and clearinghouses in the United States, the United Kingdom and Canada, ICE has committed to facilitating global regulatory cooperation to ensure that regulatory best practices are adopted around the world. As the global nature of this financial crisis aptly illustrates, systemic market problems cannot be solved unilaterally, and solutions will require close cooperation between governments of major developed nations and a willingness on the part of those governments to implement the best financial market practices, regardless of their source of origin. Combined with commitment to open markets, such an approach will be the best way to achieve the goals of the DMTAA. Against this backdrop, we would offer brief thoughts on three sections of the Act: section 3, foreign boards of trade; section 6, trading limits to prevent excessive speculation; and section 16, limitation on the ability to purchase credit default swaps. Please note that our views on specific provisions of the Act should not be misconstrued as opposition to the Act as a whole, or opposition to the important steps that this Committee has taken to restore confidence in our financial markets. Beginning with section 3 on foreign boards of trade, ICE is generally supportive of this provision as it codifies existing obligations that ICE Futures Europe has been complying with since late last year, including implementation of position limits and accountability for DCM link contracts. And, for the first time in a European exchange regulation, the generation of large trader reporting to assist the CFTC in its markets surveillance efforts. However, section 3 of the Act contains one provision that would inappropriately discriminate against foreign exchanges and the competition that they bring to bear. Unlike the requirements applicable to domestic exchanges, section 3 requires that foreign exchanges adopt position limits taking into consideration the relative sizes of respective markets. This provision would hamper competition between exchanges and would effectively prevent foreign exchanges from attaining sufficient market liquidity to offer the type of trading markets necessary to compete with domestic exchanges as all competitors would, by definition, start with little or no market share. Domestic exchanges could ultimately be impacted as well by this provision if foreign governments adopt similar provisions in their laws. Considering the significant benefits that competition has brought to the marketplace and the need for international regulatory cooperation, we would respectfully request that this provision of the Act be modified, and would note that if the goal of the provision is to prevent multiplication of positions across numerous exchanges, the same goal could be achieved through requiring market participants to liquidate positions should they exceed an aggregate limit observed by the CFTC. Turning to section 6 of the Act, ICE's subsidiary, ICE Futures U.S., formerly the New York Board of Trade, is a designated contract market regulated by the CFTC. Among the products it lists for trading are three international soft commodity contracts: coffee, wool, sugar and cocoa; and it is the preeminent market for price discovery in these commodities. None of these commodities are grown in the United States or are subject to any domestic price support programs, unlike domestic commodities'; and all of these commodities are also traded on established exchanges in London, Brazil and the Far East. Section 6 fails to distinguish between the international agricultural commodities and domestically grown agricultural commodities that have traditionally been the focus of the Committee's oversight. Section 6 would require the CFTC, rather than ICE Futures U.S., to set position limits with respect to these international markets, and would replace ICE Futures' strong market expertise in these areas to the detriment of both the exchange and the broader markets, potentially shifting trading in these commodities to foreign markets that are not subject to CFTC jurisdiction. Finally, turning to section 16 of the Act that prohibits trading and credit default swaps without ownership and the underlying obligation. As with all trading markets, hedgers must be able to transact with another party willing to buy their risk for a price. Section 16 would likely end the CDS market in the United States due to the inability of hedgers to find counterparties legally able to buy their risk, and could prove problematic for the trading of CDS indices in which parties would apparently have to own all of the underlying bonds to trade an index. This would be counterproductive, as transparent and stable CDS markets are important for the recovery of broader financial markets. Many of the problems that have been identified in the CDS market relate to the lack of transparency in markets and outsize risks undertaken by financial entities, and we believe that these issues can be addressed through central counterparty clearing. ICE is proud to be working towards establishing ICE U.S. Trust to clear these products. In conclusion, ICE strongly supports the goals of the Act and will continue to work cooperatively with this Committee to find solutions that promote the best marketplace possible. [The prepared statement of Mr. Short follows:] Prepared Statement of Johnathan H. Short, Senior Vice President and General Counsel, IntercontinentalExchange, Inc., Atlanta, GAIntroduction Chairman Peterson, Ranking Member Lucas, I am Johnathan Short, Senior Vice President and General Counsel of IntercontinentalExchange, Inc., or ``ICE.'' We are grateful for the opportunity to provide comments on the ``discussion draft'' of the Derivatives Markets Transparency and Accountability Act (DMTAA). ICE fully supports the goal of the DMTAA to ``bring transparency and accountability to commodity markets.'' Over the past decade, we have worked with regulators both in the United States and abroad to achieve this end and appreciate the opportunity to work on additional improvements. As background, ICE operates three regulated futures exchanges: ICE Futures Europe, formerly known as the ``International Petroleum Exchange,'' is regulated by the U.K. Financial Services Authority (FSA). ICE Futures U.S., previously known as ``The Board of Trade of the City of New York (NYBOT)'' and the New York Clearing Corporation are both regulated by the CFTC. ICE Futures Canada, which was previously called the Winnipeg Commodity Exchange, is regulated the Manitoba Securities Commission. In addition, ICE operates an over-the-counter (OTC) energy platform as exempt commercial market, as defined by the Commodity Exchange Act. On these exchanges, ICE offers futures and options contracts on energy products (including the benchmark Brent and WTI contracts), agricultural commodities, currencies and equity indexes. ICE has worked to provide transparency to a varied array of markets. For example, ICE brought transparency to OTC energy markets nearly a decade ago, with a digital platform that transformed the marketplace from an opaque, telephone-based network of brokerages to a global market with real-time prices on electronic trading screens. In its 2007 State of the Markets Report, Federal Energy Regulatory Commission (FERC) observed that ICE ``provides the clearest view we have into bilateral spot markets.'' \1\--------------------------------------------------------------------------- \1\ Federal Energy Regulatory Commission, 2007 State of the Markets Report, pg. 9 (Issued, March 20, 2008).--------------------------------------------------------------------------- In 2002, in response to the credit and counterparty risk crisis that were then gripping the energy markets, we introduced clearing into the OTC energy markets. Cleared contracts now account for more than 90 percent of ICE's OTC business. Believing that centralized clearing is an essential next step in stabilizing the credit derivatives market, since last summer ICE has been working with the Federal Reserve System, the New York Banking Department and a number of industry participants to develop a clearing solution for credit default swaps (CDS). Last May, as part of the farm bill reauthorization, Congress provided the CFTC with greater oversight of electronic OTC markets, or Exempt Commercial Markets. The new law provides legal and regulatory parity between fully regulated futures exchanges and OTC contracts that serve a significant price discovery function,\2\ while also recognizing and preserving the role of OTC markets in providing innovation and customization. ICE supported this legislation, and we remain grateful for this Committee's leadership during that debate.--------------------------------------------------------------------------- \2\ This provision of the farm bill is commonly referred to as the ``Closing the Enron Loophole Act.''--------------------------------------------------------------------------- Because ICE operates markets in both domestic and foreign jurisdictions, ICE is keenly aware of the global nature of most commodity and financial derivative markets. Furthermore, ICE is committed to facilitating global regulatory cooperation and the implementation of best practices in financial markets around the world. As the global nature of this financial crisis illustrates, systemic market problems cannot be solved independently, and solutions will require both close coordination and cooperation between governments of major developed nations and a willingness to implement best practices regardless of their source of origin. Combined with a commitment to open markets, such an approach will be the best way forward toward solving the problems that have impacted economies around the world. We offer our comments on several provisions in the bill in the spirit of finding solutions that will achieve the stated purpose of improving transparency and accountability in commodity markets.Section 3--Foreign Boards of Trade Earlier last month, the G30's Working Group on Financial Reform, led by Chairman Paul Volcker, published its Framework for Financial Stability. Core recommendation two states, ``The quality and effectiveness of prudential regulation and supervision must be improved. This will require better-resourced prudential regulators and central banks operating within structures that afford much higher levels of national and international policy coordination.'' Recommendation 6b, on regulatory structure, states, ``In all cases, countries should explicitly reaffirm the insulation of national regulatory authorities from political and market pressures and reassess the need for improving the quality and adequacy of resources available to such authorities.'' By supporting coordination and information sharing among international regulators, the foreign board of trade provision in the DMTAA, advances the G30's recommendations. We are concerned; however, that one aspect of that provision could limit competition between domestic and foreign exchanges and ultimately threaten cooperation between domestic and foreign regulators, and indeed domestic and foreign governments, in implementing uniform standards to improve markets. Since 2006, ICE has worked with the United Kingdom's Financial Services Authority to provide the CFTC with visibility into markets traded on its foreign board of trade to allow the CFTC to properly surveil domestic regulated markets. On June 17, 2008, the CFTC revised the conditions under which ICE Futures Europe operates in the United States by amending the ``no-action relief letter'' that permits that exchange to have direct access to U.S. customers for its WTI Crude Oil Futures Contract. The amended letter conditioned ICE Futures Europe's direct screen based access on the adoption of U.S. equivalent position limits and accountability levels, together with reporting obligations, related to contracts that are linked to the price of a U.S. designated contract market price. Since October, ICE Futures Europe has been complying with the revised No Action letter. Section 3 of the DMTAA essentially codifies the conditions set forth in the CFTC's revised No Action letter for ICE Futures Europe, with one important exception. Unlike the requirements applicable to domestic exchanges, section 3 requires foreign exchanges to adopt position limits for the affected contract taking ``into consideration the relative sizes of the respective markets''. This provision discriminates against foreign exchanges, and would effectively prevent them from attaining sufficient market liquidity to compete with domestic exchanges as all competitors would by definition start out with little or no market share. In addition, domestic exchanges could be impacted through the adoption of similar provisions of law in foreign countries which have a larger relative share of the underlying commodity market. In recent years, the only effective competition in the futures industry has come from foreign exchanges and exempt commercial markets. That competition has led U.S. exchanges to transition markets to transparent electronic trading, with full audit trails and improved risk management through straight through processing. It has also resulted in more efficient markets bringing about many benefits for market participants such as lower trading costs and tighter bid/ask spreads. With one exchange in control of more than 97 percent of U.S. futures market, competition is more important than ever. Requiring foreign markets to set position limits according to respective market size would effectively bar foreign exchanges from competing in the U.S., would likely be viewed was extraterritorial regulation by foreign market regulators, and would be inconsistent with the higher level of international policy coordination contemplated by the G30 policy recommendations. ICE respectfully requests that this particular provision of section 3 be reconsidered for the broader policy goals that are sought to be achieved by the G30 policy recommendations and in recognition of the fact that no single piece of legislation adopted here or elsewhere will achieve its ends unless appropriate standards are adopted on an international basis.Section 6--Trading Limits To Prevent Excessive Speculation ICE's U.S. subsidiary, ICE Futures U.S. (formerly the New York Board of Trade) is a designated contract market regulated by the CFTC. Among the products it lists for trading are three international soft commodities--coffee, world sugar and cocoa--and it is the pre-eminent market for price discovery of these commodities. None of these commodities is grown in the United States or is subject to domestic price support programs. Moreover, none of them was the subject of hearings last year conducted by Congressional Committees or reviews by the CFTC into the rise and fall of certain commodity prices. Because they are liquid contracts traded on a designated contract market, our futures and options contracts in these commodities have been subject to position accountability levels and spot month position limits that have been established and administered by the Exchange for more than a decade without incident. Under the terms of the standardized futures contracts, ICE Futures U.S. also regulates physical delivery of those three international commodities from ports or warehouses located in more than two dozen foreign countries around the world. Section 6 of the proposed legislation fails to distinguish between ICE's international agricultural contracts and the domestically-grown agricultural commodities that we believe were the bill's intended subjects. Specifically, the legislation would require the CFTC to set position limits on the number of futures and option contracts that a person could hold in any one futures month of a commodity, in all combined futures months of a commodity, and in the spot month. In contrast, ICE Futures U.S. sets limits for its coffee, sugar and cocoa contracts based on its extensive experience with these markets. In addition, the proposed legislation would amend the Commodity Exchange Act core principles applicable to designated contract markets like ICE Futures U.S. by eliminating the availability of ``position accountability'' levels for speculators in international agricultural commodities. As noted previously, ICE Futures U.S. has set and administered position accountability levels in its internationally-based products for over a decade. For example, through its market oversight, ICE Futures U.S. has been able to respond to market conditions and the needs of its users in a flexible manner, while maintaining transparent and liquid markets relied upon throughout the world. This provision, if implemented, would replace ICE Futures U.S.'s strong market surveillance role with an inflexible regime that would be established, and possibly administered, by the CFTC. This could very well drive business to London, Brazil and the Far East where these products already trade on established futures markets. We do not believe this was the drafters' intent.Section 6--Limitations on index traders Section 6 defines bona fide hedging in a way that would prohibit index traders from taking a position in excess of position limits. This would be a significant change in market structure and will have an immediate and deleterious impact. A recent market study performed by Informa examined the impact of index funds on market volatility. The study employed both Granger causality and vector auto-regression tests and determined that there was no link between index funds and market volatility. Greatly reducing the participation of index funds in the market would be disadvantageous to the market at-large and would most likely only benefit the very largest participants in a given market. In a soft commodities market (e.g., coffee, sugar or cocoa), the removal of this additional liquidity could potentially enable a single large entity or a small group of entities to wield considerable influence on the market dynamics. Section 9 requires the CFTC to study the impact of commodity ``fungibility'' and whether there should be ``aggregate'' position limits for similar agriculture or energy contracts traded on DCMs, DTEFs, 2(g) and 2(h) markets. Sec. 10 requires a GAO study of international regulation of energy commodity markets. Both reports are due in a year. ICE supports these studies without reservation, and we believe this legislation would be improved if it were informed by equally thorough reports on the issues we have discussed today.Section 16--Limitation on Ability To Purchase Credit Default Swaps Section 16 of the bill would prohibit trading in credit default swaps without ownership of the underlying reference obligation. This provision is problematic on several levels. First, CDS perform an important market function in allowing parties to hedge credit risk. Section 16 is titled ``Limitation on Eligibility to Purchase a Credit Default Swap.'' However, the language in subsection (a) prohibits parties from ``entering into a credit default swap'' unless they own the underlying bonds. As with all trading markets, another party must be willing to assume the hedger's risk; therefore, section 16 would likely end the CDS market in the United States due to the inability of hedgers to find counterparties legally able to ``buy their risk''. This would be counterproductive, as a transparent and stable CDS market is important for the recovery of financial markets. Furthermore, not all credit risk has a tailored credit default swap. Section 16 would prohibit parties from hedging default exposure by purchasing credit default indices, unless the party owned every underlying bond in the index. Second, ICE believes that the goals of transparency and mitigation of counterparty credit risk and systemic risk can be achieved through central clearing of CDS and through resulting public and regulatory transparency. Section 16 would run counter to this goal as it would impair the liquidity needed to efficiently manage risk within a clearinghouse in the event of a default or similar event. ICE respectfully requests that the Committee consider eliminating this provision of the draft bill. During the financial crisis, as cash markets evaporated, and markets for commercial paper, corporate bonds and other debt instruments dried up, the CDS market has remained liquid, offering lenders and investors a way to hedge risk and--just as important--a market-based, early-warning price discovery function. Broader availability of credit protection can encourage sovereign and corporate lending. As lenders and investors consider ways to improve credit risk evaluations, CDS spreads have proven to be more reliable indicators of an institution's financial health than credit agency ratings. Finally, on the note of global cooperation, last week in Davos, E.U. Financial Services Commissioner Charlie McCreevy said he would not support a ban on trading credit default swaps unless the party held a position in the underlying bonds. Prohibiting this trade in the United States will almost certainly lead to a wholesale migration of the CDS marketplace overseas, outside the reach of U.S. regulators and this Committee. We do not believe that is the intent of this legislation.Conclusion ICE is a strong proponent of open and competitive derivatives markets, and of appropriate regulatory oversight of those markets. As an operator of global futures and OTC markets, and as a publicly-held company, we understand the essential role of trust and confidence in our markets. To that end, we are pleased to work with Congress to address the challenges presented by derivatives markets, and we will continue to work cooperatively for solutions that promote the best marketplace possible. Mr. Chairman, thank you for the opportunity to share our views with you. I am happy to answer any questions you may have. " fcic_final_report_full--202 Synthetic CDOs boomed. They provided easier opportunities for bullish and bearish investors to bet for and against the housing boom and the securities that de- pended on it. Synthetic CDOs also made it easier for investment banks and CDO managers to create CDOs more quickly. But synthetic CDO issuers and managers had two sets of customers, each with different interests. And managers sometimes had help from customers in selecting the collateral—including those who were bet- ting against the collateral, as a high-profile case launched by the Securities and Ex- change Commission against Goldman Sachs would eventually illustrate.  Regulators reacted weakly. As early as , supervisors recognized that CDOs and credit default swaps (CDS) could actually concentrate rather than diversify risk, but they concluded that Wall Street knew what it was doing. Supervisors issued guid- ance in late  warning banks of the risks of complex structured finance transac- tions—but excluded mortgage-backed securities and CDOs, because they saw the risks of those products as relatively straightforward and well understood.  Disaster was fast approaching. CDO MANAGERS: “WE ARE NOT A RENTAMANAGER” During the “madness,” when everyone wanted a piece of the action, CDO managers faced growing competitive pressures. Managers’ compensation declined, as demand for mortgage-backed securities drove up prices, squeezing the profit they made on CDOs. At the same time, new CDO managers were entering the arena. Wing Chau, a CDO manager who frequently worked with Merrill Lynch, said the fees fell by half for mezzanine CDOs over time.  And overall compensation could be maintained by creating and managing more new product. More than had been the case three or four years earlier, in picking the collateral the managers were influenced by the underwriters—the securities firms that created and marketed the deals. An FCIC survey of  CDO managers confirmed this point.  Sometimes managers were given a portfolio constructed by the securities firm; the managers would then choose the mortgage assets from that portfolio. The equity in- vestors—who often initiated the deal in the first place—also influenced the selection of assets in many instances. Still, some managers said that they acted independently. “We are not a rent-a-manager, we actually select our collateral,” said Lloyd Fass, the general counsel at Vertical Capital.  As we will see, securities firms often had particu- lar CDO managers with whom they preferred to work. Merrill, the market leader, had a constellation of managers; CDOs underwritten by Merrill frequently bought tranches of other Merrill CDOs. According to market participants, CDOs stimulated greater demand for mort- gage-backed securities, particularly those with high yields, and the greater demand in turn affected the standards for originating mortgages underlying those securities.  As standards fell, at least one firm opted out: PIMCO, one of the largest investment funds in the country, whose CDO management unit was one of the nation’s largest in . Early in , it announced that it would not manage any new deals, in part be- cause of the deterioration in the credit quality of mortgage-backed securities. “There is an awful lot of moral hazard in the sector,” Scott Simon, a managing director at PIMCO, told the audience at an industry conference in . “You either take the high road or you don’t—we’re not going to hurt accounts or damage our reputation for fees.” Simon said the rating agencies’ methodologies were not sufficiently strin- gent, particularly because they were being applied to new types of subprime and Alt- A loans with little or no historical performance data.  Not everyone agreed with this viewpoint. “Managers who are sticking in this business are doing it right,” Armand Pastine, the chief operating officer at Maxim Group, responded at that same confer- ence. “To suggest that CDO managers would pull out of an economically viable deal for moral reasons—that’s a cop-out.”  As was typical for the industry during the cri- sis, two of Maxim’s eight mortgage-backed CDOs, Maxim High Grade CDO I and Maxim High Grade CDO II, would default on interest payments to investors—in- cluding investors holding bonds that had originally been rated triple-A—and the other six would be downgraded to junk status, including all of those originally rated triple-A.  CHRG-111hhrg51698--9 Mr. Buis," Thank you, Chairman Peterson, Ranking Member Lucas, and Members of the Committee. It is indeed an honor to be able to testify on this important issue before the Committee. We got involved in this last winter and spring, when we started receiving numerous phone calls from farmers. As wheat prices hit record levels, corn prices were also in the record category. Farmers were calling and saying they couldn't market their grain the way they would normally market it, which is, by and large, being able to price their grain after harvest for delivery. When they were precluded, they were told that the reason was many of the local elevators and co-ops were running up against their credit limits because the prices of the commodities were going up to the limit day after day and having to meet those margin calls; and their only alternative was to quit offering futures contracts after harvest. So, we contacted the CFTC and urged them to take a look at it, not long after they held a hearing. There were a number of people there, but they started out the hearing, and basically they went through all of their data and concluded before the hearing was even over that nothing out of the ordinary was happening. Well, Mr. Chairman, something out of the ordinary was happening. Farmers, who were probably the original derivative, were being precluded from the marketplace at a time when they could have really capitalized on the higher market prices. So we were a little frustrated with the reaction. As the year went on, we began to find out more and more that really what was causing higher food prices, really what was causing higher input costs was the excessive speculation that was going on in the commodity markets. Whether you look at oil, whether you look at grains, you look at any of the inputs, fertilizer, they were all based on either energy and/or future feed use or future use for other processing. As a result, farmers and ranchers didn't get the high prices and had to wait for prices to come down at harvest in order to sell their wheat and other commodities. We also witnessed something that I don't think anyone can explain, and that is the cotton market virtually doubled overnight. Our impression is that we have a lot of cotton in storage. It is difficult to move. As a result, it was definitely a speculative market that lasted a very short time. I have yet to meet a cotton farmer that got those pries up in the 90 cents range for their cotton. So we were impacted tremendously. I think it caused higher food prices, which impacted consumers. It caused a divisive attitude among agriculture producers, because livestock producers were being told that corn prices and feed prices were going to go even higher. So they had to lock in their prices. I just got back from Central Valley of California, Mr. Chairman, and many of those producers that locked in feed prices because they believed all the speculative reports that prices were going to continue to rise, and they did the prudent thing in locking in their future feed uses, and now they are all in as bad a financial shape as I have ever seen in the dairy industry. It is the same for other livestock producers and livestock processors. Ethanol companies did the same thing. They were all sort of wrapped up in this speculative environment. So I really commend you for your efforts, both last year and this year, to move forward. It is badly needed. Your legislation is right on target establishing speculative limits for all commodities, the increased transparency, providing the resources for CFTC, and including even carbon credits to be traded on the marketplace and a regulated marketplace. Actually being able to give the regulators a chance to know how much money is in there, who it is by, whether it is commercial, whether it is speculative, or whether it is under an exemption or over-the-counter or foreign exchanges has to be done. I think it is the most important thing for the rural economy, which, as you know, has certainly flipped in the last few months. Thank you, Mr. Chairman. [The prepared statement of Mr. Buis follows:] Prepared Statement of Tom Buis, President, National Farmers Union, Washington, D.C. Good afternoon, Mr. Chairman and Members of the Committee. I appreciate the opportunity to testify on behalf of the farm, ranch and rural members of National Farmers Union (NFU). NFU was founded in 1902 in Point, Texas, to help the family farmer address profitability issues and monopolistic practices while America was courting the Industrial Revolution. Today, with family farm, ranch and rural family members, NFU continues its original mission to protect and enhance the economic well-being and quality of life for family farmers and ranchers and their rural communities. Last spring, NFU called upon the Commodity Futures Trading Commission (CFTC) to conduct a thorough and comprehensive investigation regarding the activity and volatility in the commodities markets. In particular, the role of speculative commodity futures trading, both on and off-exchange, in increasing that volatility, with much of that trading hidden from view of the CFTC in the derivatives and other off-exchange markets. Farmers and ranchers are generally relieved to end the 2008 agriculture market roller coaster, but they are extremely anxious as they approach the 2009 production year. During 2008 we witnessed periods of record or near record nominal prices for many commodities traded on U.S. exchanges. As the year ended, we have also witnessed a historic collapse in market prices for major grains and dairy products. NFU was frustrated by remarks from some CFTC officials who suggested that the market volatility was simply a response to market fundamentals. This assessment did not adequately explain the price shock in the cotton market or lack of convergence between cash and futures markets during the contract settlement period. This assessment also failed to explain why many farmers were precluded from utilizing traditional market risk management tools, such as forward cash contracts, because of excessive margin risk to those who typically would offer such products to their customers. As speculators created a market bubble and attitude that higher prices were set to stay, crop, livestock and dairy producers locked in higher inputs and feed costs. The false signals were not reserved for agricultural producers, but extended beyond production agriculture to the ethanol and biodiesel industries and input suppliers, all locking in higher feedstocks and supplies. The 2008 economic collapse and bursting of bubble have jeopardized the economic livelihoods of all these players, which will ripple throughout our rural communities. This impact will not be short-lived, as it could take up to a year or longer before the negative impact is resolved. In these times of despair, commodities and industries become pitted against each other creating a divisive environment in which to establish helpful policy. As you can imagine, it was very frustrating for farmers who were paying record amounts for inputs, but could not implement effective marketing plans or strategies to take advantage of the higher prices for their crops. While this activity was occurring in 2008, the media, with help from food processors, held fast to the position that farmers and ranchers were getting rich from record high commodity prices and cited these prices as the sole cause of increasing retail food prices. Nothing could have been further from the truth. The reality of what happened has come to light as commodity prices have plummeted, yet retail food costs remain high. The effort being made by this Committee to ensure that we do not experience a repeat of 2008, is to be commended. It became obvious, in a number of areas, that modernized regulations were warranted to ensure the mistakes of the past are not repeated. The broad, bipartisan support for increased oversight and transparency with the House-passed Commodity Markets Transparency and Accountability Act of 2008 provided a good starting point. The Derivatives Markets Transparency and Accountability Act (DMTAA) of 2009 would be of even greater benefit to agricultural producers and the entire economy. In a letter to the CFTC last year, NFU cited the single biggest concern among producers as a lack of market transparency. This is still the case. Provisions within the DMTAA, seek to inject necessary transparency through the detailed reporting and disaggregation of market data and the over-the-counter (OTC) transparency and record-keeping authorities as outlined in the legislation. Without these provisions, the public will continue to be in the dark regarding who is involved in commodity markets and to what capacity. These new authorities are needed to ensure regulators are able to keep pace with the use of new financial and market instruments that result in market manipulation, fraud or excessive speculative market volatility. NFU has called for an investigation to determine the role and impact that OTC trading and swaps have on markets. Without full access to data and other information concerning these types of trading activities, it is impossible to determine whether manipulation, fraud or excessive speculation is occurring. DMTAA requires all prospective OTC transactions to be settled and cleared through a CFTC regulated clearinghouse or other appropriate venue. The addition of principles for the designated clearing organizations, including (1) daily publication of pricing information; (2) fitness standards; and (3) disclosure of operational information, will protect the integrity of the new OTC requirements by assuring the clearinghouses remain transparent. The legislation also requires the CFTC to study and report on the effects of potential position limits within OTC trading. Again, this information will enhance the public's confidence that markets are not being manipulated, fraudulently exploited or overwhelmed by speculation and if so, corrective action can be launched. When the CFTC proposed increasing speculative position limits in 2007, NFU filed public comments in opposition to such action. Speculators have an important role to play in the commodity markets in terms of providing market liquidity. However, when left unregulated and allowed to become excessive, the positive attributes that speculators bring to the markets undermines the legitimate price discovery and risk management functions these markets were designed to provide to commercial market participants. DMTAA establishes new standards and limits for all commodities. Moreover, we are pleased to see the establishment of a Position Limit Agricultural Advisory Group. By involving producers and traditional users of the market in making recommendations concerning position limits, the new limits will be legitimized and fair. With the rapid growth of market speculation, we are in unchartered waters today and we believe this third-party review function can significantly help in ensuring market integrity in the future. NFU believes the CFTC needs to take a broader look at the concept of manipulation and it implications for price discovery. Unfortunately, the CFTC's test to determine manipulation requires that an individual or group of traders acquire a market position that enables them to consciously distort prices in noncompliance with market fundamentals. What the CFTC is failing to recognize is that the deluge of money from Wall Street, hedge funds and other large traders in and of itself is driving prices in ways that may not reflect the fundamentals of the underlying markets. In 2006, NFU became an approved aggregator for trading carbon credits on the Chicago Climate Exchange (CCX). Currently, we are the largest aggregator of agricultural soil carbon offsets to CCX. The CCX is the world's first greenhouse gas emissions registry, reduction and trading system, trading more than 86 million tons of carbon offsets to date. As carbon trading continues to advance rapidly, NFU appreciates the provision within the legislation that will protect the integrity of carbon credit trading by requiring those contracts to be traded on a designated contract market. Furthermore, the cross pollination between the CFTC and the U.S. Department of Agriculture to develop procedures and protocols for market-based greenhouse gas programs will help ensure these markets will perform a legitimate function for participants and the public in general. This legislation will begin to answer many of the questions from 2008. We are currently enduring the train wreck caused in large part by the dysfunction of the futures market--in 2008. NFU strongly endorses this bill and looks forward to its swift approval; I am hopeful Congress will continue its bipartisan efforts to establish greater oversight of the commodity and energy futures markets. I thank the Committee for the opportunity to be here today and look forward to any questions you may have. " CHRG-111hhrg63105--40 Mr. Moran," Let me broaden my question by asking a similar question but with a different conclusion. Has the CFTC or its staff completed a report that found excessive speculation positions in commodity futures markets were leading to market manipulation? Which I think is the direction you were telling me is more important; that you are there to regulate market manipulation. " FOMC20070509meeting--16 14,MS. JOHNSON.," The basic message from the rest of the global economy is that economic conditions are favorable and appear likely to remain so through the end of next year. Although small variations in the basically optimistic outlook are present, real GDP growth in the foreign economies seems poised to continue at an average annual rate of about 3½ percent throughout the forecast period. Inflation risks are present as slack has been reduced in several foreign economies. However, we anticipate that central banks abroad will respond further as needed such that inflation abroad will edge up only slightly through the end of 2008. In this forecast round, the staff had to contend with a move back up in global crude oil prices and further increases in nonfuel commodities prices—shocks common to the whole global economy. In addition, for the U.S. outlook, we needed to take account of the depreciation of approximately 2 percent in the foreign exchange value of the dollar over the intermeeting period, as Dave discussed. We have recently revisited the question of whether we could improve upon the forecast for crude oil prices embedded in market futures prices and have convinced ourselves based on empirical evidence that we cannot. As a result, our projections for future WTI spot oil prices and the average oil import price are shifted up and down over time by fluctuations in spot and futures oil prices. This has been an “up” forecast round. After reaching a peak around August of last year, global oil prices fell through very early this year and then reversed to trend back up, but not smoothly. The upward move of oil prices over the intermeeting period was apparently a response to the surprising degree of continued production restraint from OPEC and heightened concerns about supply from Iran, Iraq, and Nigeria. The strength in global demand for energy, too, no doubt provided support for continued elevated prices. In this forecast we also had to take into account a deviation in the usual price spread between West Texas intermediate and other grades of oil. Reduced refinery activity has led to an unusually large accumulation of crude oil stocks in the Midwest, the delivery area for WTI, and depressed its price relative to that for other grades. When we were finalizing the baseline forecast, spot and futures prices implied an increase to our projection for WTI crude oil in the current quarter of about $4.50 per barrel relative to the projection in the March Greenbook; however, this change understates a bit the upward shift in overall oil prices because of the change in spreads. These considerations led us to revise upward the average oil import price in the Greenbook for the current quarter about $6.50 per barrel. We expect that over the forecast period the relative prices of WTI and other grades will gradually move back toward normal, so our upward revision narrows somewhat in future quarters, particularly by the second half of 2008. The baseline forecast reflects the consequences of these higher oil prices for the U.S. economy and the rest of the world. Turning points in the ups and downs of oil prices have an uncanny way of happening at the time that we are finishing the Greenbooks, and such a turning point might have happened again. Since the Greenbook path was set, crude oil prices have moved back noticeably. If we were concluding our forecast today based on yesterday’s futures prices, we would show an upward revision in the near term of only about half that in the Greenbook. For 2008, our upward shift would be about two-thirds of that in the Greenbook. The effects of this more benign level for oil prices would be slightly positive for real GDP growth both in the United States and abroad. Such a lower projected path for oil prices would also slightly lessen the pressures on headline inflation rates that are a feature of the baseline forecast. Another element in the forecast worth a brief mention is the upward revision to both core import price inflation and core export price inflation for the second quarter, to annual rates of 4.5 percent and 5.5 percent, respectively. Prices for core imports and core exports accelerated in the first quarter as prices for food and industrial supplies, particularly fuels and metals, surged. Metals prices have continued to rise in recent weeks, and the increase, along with the recent depreciation of the dollar, led us to revise up our current-quarter projections. In constructing our forecast for these trade prices, we base our projection of the commodity-price component on market futures prices. Again, we have done recent work to see if a better alternative is available, but we have concluded that none is. Despite rapid increases in prices of various traded commodities over the past few years, the futures markets are implying a path through the end of 2008 that is about flat for an index of nonfuel commodities. In combination with our projection for only modest real dollar depreciation and no major changes in overall inflation rates here and abroad, such an outlook for commodity prices yields a deceleration in both core import prices and core export prices. Our forecast for the increase in these prices in 2008 remains low, at 1.3 percent. Although oil prices have been revised up this time, their projected path flattens in mid-2007. This outlook and the flat projected paths for commodity prices and the dollar imply a waning of the upward push to consumer prices that has resulted from rising oil and commodity prices. Consequently, in the Greenbook forecast, only limited further tightening by some foreign central banks is required to contain inflation. That events in these markets may surprise futures traders and us for yet another year with additional commodity-price increases is a major risk to our outlook for inflation. David and I will be happy to take any questions." FOMC20080625meeting--37 35,MR. SHEETS.," In the process of preparing our forecast, we do come up with estimates of slack for the emerging market economies, but we are not inclined to put a whole lot of weight on them. The concept of an output gap is not really a well-defined construct for, say, China. Nevertheless, these economies will be growing a little more slowly than they have in the past, and some of the pressures on resources associated with that growth may abate a bit. I think that is at least a piece of the story of what you see here as the decline. But at the end of the day, it has to be a story about commodity prices. Food prices and energy prices have pushed this up. Depending on exactly which emerging market economy you're in, food prices will range anywhere from 25 percent to 33 percent of their basket. As long as those food prices and energy prices are moving up dramatically, you are going to see rapid increases in inflation. So the decline that you are seeing in this chart really is conditioned first and foremost on commodity prices flattening out. I wish I had a better story. " CHRG-111hhrg63105--36 Mr. Moran," Has there yet been a--one of the conversations we have had in this Committee for a long time is about the connection between excessive speculation and price fluctuations. Is there--there is--make sure I understand this to be true--I'll ask it this way: Has the CFTC or its staff completed a report that found excessive speculation caused an unwarranted or unreasonable price fluctuation in commodity markets? " CHRG-111hhrg51698--204 Mr. Roth," Thank you, Mr. Chairman. My name is Dan Roth, and I am the President of National Futures Association. I would like to thank you very much for the opportunity to be here today to discuss our views. Certainly the draft bill that you have been discussing this afternoon couldn't be more timely. I think we all know that the current financial crisis has highlighted the importance of these issues. So I applaud you for your efforts to deal with these very complex issues. We have some suggestions in our written testimony regarding some improvements that we think could be made to the bill, and we would be happy to discuss those. But one thing I want to talk about today, at risk of getting us off on a little bit of a tangent, and I certainly don't mean to do that. But, as important as the issues are that are covered by the bill, I hope we don't lose sight of an important customer protection issue that needs to be addressed and is somewhat overdue. As we sit here today, we have to recognize that we have completely unregulated futures markets aimed expressly at unsophisticated retail customers. That is not a good situation to be in. Through a series of bad cases, starting with the Zelener decision, we have had a series of decisions which essentially gutted the CFTC's ability, gutted the CFTC's jurisdiction with respect to bucket shops. Those contracts, those cases basically hold that certain contracts that may walk like a futures contract, talk like a futures contract, smell like a futures contract will be deemed by the courts not to be a futures contract if the scammer drafts the contract in a certain way, and therefore deprives the CFTC of jurisdiction. Congress addressed this issue last May with respect to forex contracts--and God bless you for doing that--but, as we said at the time, the problem isn't limited to forex contracts and the solution can't be limited to that way, either. We testified previously that if we only dealt with the forex aspect of this problem, then we would simply see a migration of problematic contracts from forex to other commodities; and that is exactly what we have seen. I don't have exact numbers, because, of course, these entities are unregistered, but just in our routine Internet surveillance and through customer complaints we are aware of dozens, dozens of these markets that are aimed exclusively at retail customers that are offering futures look-alike products for gold, silver, and energy. For all these markets, there is no capital requirement. There is no registration requirement. There is no one doing audits and examinations. There is no sales practice rules. There is no arbitration. There is no nothing. These are completely unregulated markets, and they are taking advantage of retail customers. We had a caller a couple weeks ago, a gentleman lost over $600,000 with one of these outfits. It was essentially all of his life savings. I think it is safe, given the volume of the activity that we see, that there are thousands of customers who have lost millions of dollars through these types of unregistered, unregulated markets. It is not right, and the time has come to fix that problem. We have a solution. It is a solution we have discussed before. It is a solution that we have worked on with the exchanges. Basically, what we have proposed in the past, and have proposed now, would be a statutory presumption that any market that offers a leveraged contract offered to retail customers, and that retail customer has no commercial use for this product and no ability or capacity to take delivery, that under those circumstances there would be a presumption that those were in fact futures contracts, and therefore had to be traded on-exchange. This is simply nothing more than the codification of the Co Petro case, which the Zelener case overturned. That presumption would ensure that customers get the regulatory protections they deserve and need if trading in a regulated environment, and it is a change which is long overdue. So, Mr. Chairman, I know there are other very important, very complex issues on the table. We have our opinions about some portions of the draft bill. We have included that. But I hope we don't lose sight of this important customer protection issue while you are dealing with this legislation. Thank you, Mr. Chairman. [The prepared statement of Mr. Roth follows:] Prepared Statement of Daniel J. Roth, President and CEO, National Futures Association, Chicago, IL My name is Daniel Roth, and I am President and Chief Executive Officer of National Futures Association. Thank you, Chairman Peterson and Members of the Committee, for this opportunity to present our views on legislation to bring greater transparency and accountability to commodity markets. NFA is the industry-wide self-regulatory organization for the U.S. futures industry. NFA is a not for profit organization, we do not operate any markets, we are not a trade association. Regulation and customer protection is all that we do. NFA certainly understands the importance of responding to the current financial crisis, dealing with systemic risk and creating greater transparency in OTC markets. NFA would like to point out that as a result of bad case law, more and more retail customers are being victimized in off-exchange futures markets. This is a customer protection issue that needs to be addressed now.Customer Protection For years, unsophisticated, retail customers that invested in futures had all of the regulatory protections of the Commodity Exchange Act. Their trades were executed on transparent exchanges, their brokers had to meet the fitness standards set forth in the Act and their brokers were regulated by the CFTC and NFA. Today, for too many customers, none of those protections apply. A number of bad court decisions have created loopholes a mile wide and retail customers are on their own in unregulated, non-transparent OTC futures-type markets. Congress acted to close those loopholes last May with respect to forex trading but customers trading other commodities, such as gold and silver, are still stuck in an unregulated mine field. It's time to restore regulatory protections to all retail customers. Let me remind you how we got here. In the Zelener case, the CFTC attempted to close down a boiler room selling off-exchange forex trades to retail customers. The District Court found that retail customers had, in fact, been defrauded but that the CFTC had no jurisdiction because the contracts at issue were not futures, and the Seventh Circuit affirmed that decision. The ``rolling spot'' contracts in Zelener were marketed to retail customers for purposes of speculation; they were sold on margin; they were routinely rolled over and over and held for long periods of time; and they were regularly offset so that delivery rarely, if ever, occurred. In Zelener, though, the Seventh Circuit based its decision that these were not futures contracts exclusively on the terms of the written contract itself. Because the written contract in Zelener did not include a guaranteed right of offset, the Seventh Circuit ruled that the contracts at issue were not futures. For a short period of time, Zelener was just a single case addressing this issue. Since 2004, however, various Courts have continued to follow the Seventh Circuit's approach in Zelener, which caused the CFTC to lose enforcement cases relating to forex fraud. Last year Congress plugged this loophole for forex contracts but not for other commodities. Unfortunately, the rationale of the Zelener decision is not limited to foreign currency products. In testimony before this Subcommittee in 2007, I predicted that if Congress only addressed the forex aspect of the Zelener decision, the fraudsters would merely move their activities to other commodities. That's just what has happened. We cannot give you exact numbers, of course, because these firms are not registered. Nobody knows how widespread the fraud is, but we are aware of dozens of firms that offer Zelener contracts in metals or energy. Some of these firms are being run by individuals that we have kicked out of the futures industry for fraud. Several weeks ago, we received a call from a man who had lost over $600,000, substantially all of his savings, investing with one of these firms. We have seen a sharp increase in customer complaints in the last 3 months. It is safe to say that these unregulated bucket shops have plundered millions of dollars from retail customers. NFA and the exchanges have previously proposed a fix to Zelener that goes beyond forex and does not have unintended consequences. Our approach codifies the approach the Ninth Circuit took in CFTC v. Co Petro--which was the accepted and workable state of the law until Zelener--without changing the jurisdictional exemption in section 2(c) of the Act. In particular, our approach would create a statutory presumption that leveraged or margined transactions offered to retail customers are futures contracts if the retail customer does not have a commercial use for the commodity or the ability to make or take delivery. This presumption is flexible and could be overcome by showing that the transactions were not primarily marketed to retail customers or were not marketed to those customers as a way to speculate on price movements in the underlying commodity. This statutory presumption would effectively prohibit off-exchange contracts--other than forex--with retail customers when those contracts are used for price speculation. This is the cleanest solution and the one NFA prefers. If Congress is hesitant to ban these transactions, however, they should at least be regulated in the same manner as retail OTC forex futures contracts. (See section 2(c)(2)(B) of the Act.)Commission Resources NFA strongly supports the bill's effort to provide the Commission with much-needed resources. CFTC staffing levels are at historic lows. As trading volume rose over the years, staffing levels moved in the other direction. Something here is not right. It is always a struggle for a regulator to keep up with an ever changing market place, but that becomes harder and harder to do when you have fewer people on hand to do more work. NFA applauds proposals for emergency appropriations to the CFTC to hire additional people and upgrade its technology.Position Limits NFA is concerned with the proposal to impose position limits on futures contracts for excluded commodities. In 2000, Congress amended the Commodity Exchange Act to define certain commodities as ``excluded commodities.'' These are primarily financial commodities, indices, and contingencies. By their very nature, excluded commodities are not susceptible to manipulation, either because there is such a large supply that it cannot be cornered or because, as with the contingencies, the contracts are based on events that are beyond anyone's control. Therefore, position limits in excluded commodities serve no purpose except to reduce the liquidity that helps banks and other institutions manage their risks. Furthermore, this reduced liquidity would come at a time when risk management is more critical than ever.Credit Default Swaps Section 16 of the draft bill is an even greater threat to liquidity. That section appears to restrict the use of credit default swaps to hedgers. NFA supports efforts to bring greater transparency to these transactions and to reduce their systemic risk. This proposed remedy, however, is likely to kill the patient. You cannot have an effective market if you do not have liquidity and you cannot have liquidity if you do not have speculators. Eliminating speculators from the credit default swap market will make it much more difficult for firms to manage their risks, which cannot be good for those firms or for the economy.Mandatory Clearing of OTC Derivatives Clearing organizations in the U.S. futures markets have performed superbly for over 100 years. The current financial crisis has posed the ultimate test to the clearing system--a test that was passed with the highest possible grades. Even under the greatest market stress we have seen for generations, no futures customers lost money due to an FCM insolvency and positions were transferred from distressed firms to healthy ones smoothly and efficiently. There has been no Federal bailout necessary for the futures industry. Clearing in the futures markets works and the spread of clearing to OTC markets can be a very positive development. All OTC derivatives, however, are not like futures. It is the standardized nature of futures contracts and the ability to mark them to a liquid and transparent market that make clearing work so well. Many OTC instruments are quite standardized and susceptible to clearing. Others, though, are highly individualized and privately negotiated and difficult to mark to a market. The bill attempts to recognize these problems by providing the CFTC with exemptive authority. That authority, however, is circumscribed. I suspect it is impossible to draft legislation that can take into account all of the factors that might make it appropriate to exempt an OTC transaction from mandatory clearing. We would suggest that the bill give the CFTC greater flexibility to exercise its exemptive authority. In conclusion, NFA's overriding concern with the bill is in what it does not contain. Retail customers trading in OTC metals and energies should not be left at the mercy of scammers. We encourage the Committee to revise the draft to prohibit--or at least regulate--Zelener-type contracts in commodities other than currencies. As always, NFA looks forward to working with the Committee, and I would be happy to answer any questions. " CHRG-111hhrg51698--20 Mr. Cota," Thank you, Honorable Chairman Peterson and Ranking Member Lucas, distinguished Members of the Committee. Thank you for the invitation to testify before you today. I appreciate the opportunity to provide some insight on your draft legislation. First, I would like to thank Chairman Peterson and the Committee for their tireless efforts in bringing greater transparency and accountability to commodity markets. Without your dedication, this issue would never have gained the attention it deserves and needs. I serve as an officer of the Petroleum Marketers Association of America. PMA is a national federation of 47 states and regional associations, representing over 8,000 independent fuel marketers. These marketers account for nearly half of the gasoline and nearly all of the distillate fuel consumed in the United States. I am also here representing the New England Fuel Institute, which represents over 1,000 heating oil dealers in the Northeast. Further, I am a third generation co-owner and operator of a home fuel delivery company in Vermont and New Hampshire. My business provides home heating fuel to 9,000 homes and businesses. I also market motor fuels and biofuels. Unlike larger energy companies, most retail fuel dealers are small, family-run businesses that personally deliver products to the doorstep of American homes and businesses. We respectfully urge the Committee to impose aggregate position limits at the control entity level on noncommercial traders across all trading environments, including the over-the-counter markets that do not have any direct physical connection to the underlying commodity. We have been voicing our concerns to Congress regarding dark markets for more than 3 years. Large-scale institutional investors speculating in the energy markets continue to act as the driving force behind energy prices. The rise in crude oil prices, which reached $150 a barrel for December delivery in July of last year, only to fall to a low of $33, was not the result of supply and demand. It was the direct result of large and excessively leveraged speculators, index traders, and hedge funds. According to a CBS News 60 Minutes investigation last month, oil should not have skyrocketed to the levels seen last year. The piece highlighted how investment speculators, or ``invesculators,'' looking to make a fast buck in a paper trade caused oil prices to rise faster and fall harder than ever could be explained by ordinary market forces alone. American consumers, small businesses, and the broader economy were forced into a roller coaster ride of greed and fear. The retail petroleum industry is one of the most competitive industries, dominated by small, independent businesses. As gas prices go up, markets become even more competitive; and, at times, retailers sell gasoline below cost. In addition, because they must pay for their inventory before they sell it, credit lines were stretched to the max, creating a credit crisis with marketers' banks. The resulting liquidity problems caused serious financial hardship for many petroleum marketers and gas station owners. Many were forced to close shop. This problem extends to the heating fuel industry. In the summer of 2008, Goldman Sachs, which trades commodities, predicted that crude oil would hit $200 per barrel, translating to $6 per gallon heating oil by winter. Heating oil dealers, who typically hedge fuel in warmer months, were experiencing the highest prices ever. Some consumers, scared by these statements made by Goldman Sachs and others, demanded fixed-price agreements with their dealers in an attempt to shelter their family from higher prices. Many dealers offered these contracts. They committed to purchase fuel they needed to supply these contracts during the winter months; and when the invesculators exited the market this fall, heating fuel dealers and their customers who had locked in were committed to a fuel at a much higher cost than it is currently worth. Commodity markets were not designed as an investment class. They are set up for physical hedgers and to manage price risk by entering into futures contracts to hedge price for future delivery. Bona fide hedgers, like my company, rely on these markets to provide the consumer with quality product at a price that is reflective of market fundamentals. Traditional speculators are important and healthy in this role; invesculators are not. We support the bill and urge Congress to move it quickly through the legislative process. Do not allow this important bill to be stalled by the financial service regulatory reform debate that is ongoing or by Wall Street's opposition. We strongly support the following provisions in this bill: expanding transparency, record-keeping, and clearing requirements to the OTC trades; closing the foreign markets or the London loophole; closing the swaps trading loophole to distinguish between legitimate hedgers and pure speculation; and providing the CFTC with sufficient staff and resources to do its job. We also urge you to make further adjustments to the bill by immediately mandating aggregate speculation limits in energy futures trades across all markets at the control level or the ownership level for contracts traded within the United States or by U.S. traders. Additionally, we urge you to mandate the aggregate position limits, regardless of any study that takes place required under section 9 of the bill. We are encouraged by your desire to take a strong stand against excessive speculation and abusive trading practices that have artificially inflated energy and severely damaged our economy. Let's return these markets so that they are driven by supply and demand and not purely by the speculative whims and greed of Wall Street. Thank you for this opportunity to testify. [The prepared statement of Mr. Cota follows:] Prepared Statement of Sean Cota, Co-Owner and President, Cota & Cota, Inc.; Treasurer, Petroleum Marketers Association of America, Bellow Falls, VT; on Behalf of New England Fuel Institute Honorable Chairman Peterson, Ranking Member Lucas and distinguished Members of the Committee, thank you for the invitation to testify before you today. I appreciate the opportunity to provide some insight on draft legislation entitled the ``Derivatives Markets Transparency and Accountability Act.'' I am also pleased to speak to the affect that opaque, inadequately regulated commodities markets and abusive trading practices have had on our nation's independent fuel marketers and home heating fuel providers. First, I would like to thank Chairman Peterson and the Committee for their tireless efforts to bring greater transparency and accountability to commodity markets. Without your dedication, this issue would never have gained the attention it deserved. I serve as Treasurer on the Petroleum Marketers Association of America's (PMAA) Executive Committee. PMAA is a national federation of 47 state and several regional trade associations representing over 8,000 independent fuel marketers. These marketers account for approximately half of the gasoline and nearly all of the distillate fuel consumed by motor vehicles and home heating equipment in the United States. I am also here representing the New England Fuel Institute (NEFI), a 60 year old trade association representing well over 1,000 heating fuel dealers and related service companies within the Northeastern United States. In addition, I speak before you today as co-Owner and President of Cota & Cota, Inc. of Bellows Falls, Vermont, a third generation family-owned and operated home heating fuel provider in southeastern Vermont and western New Hampshire. My business provides quality home heating fuel, including propane, heating oil and kerosene, to approximately 9,000 homes and businesses. I also market motor fuel, off-road diesel fuel, jet fuel and biofuels. Unlike larger energy companies, most retail fuel dealers are small, family-run businesses. Also unlike larger energy companies, we personally deliver product directly to the doorstep of American homes and businesses. Before I begin, I would like to highlight the fact that PMAA and NEFI are hereby respectfully urging the Committee to impose aggregate position limits at the control entity level on noncommercial traders and across all trading environments, including over-the-counter markets that do not have any physical connection to the underlying commodity. Our organizations have been voicing concern to Congress regarding the activities in ``dark'' commodity markets for more than 3 years now. It has become abundantly clear that large-scale, institutional investors speculating in the energy markets, were and continue to act as the driving force behind energy prices. The rise in crude oil prices, which reached $147 in July of last year only to fall dramatically to as low as $33 in December was not a result of supply and demand fundamentals--it was the direct result of excessively-leveraged speculators, index investors and hedge funds. After 3 years of advocating for greater transparency and accountability in these markets, we have seen very little progress to this end. I would like to thank the Members of this Committee for passing the ``Close the Enron Loophole Act'' which was enacted as part of last year's farm bill. It was an important first step. However, as addressed by this Committee last year in H.R. 6604, this is a serious problem that needs a more aggressive legislative response, especially in light of the 2008 unprecedented run-up in commodity prices. The solution requires an unwavering commitment to vigorous oversight and enforcement by the new President and the Commodity Futures Trading Commission, which we believe to have been lacking in recent years. According to a January 11, 2009 60 Minutes investigation titled, ``Did Speculation Fuel Oil Price Swings?'' several experts agreed that oil should not have skyrocketed to previously mentioned record levels last year, only to see prices dramatically collapse few months later. The piece highlighted how investors were looking not to actually buy oil futures, but to make a fast buck in a ``paper trade.'' This practice caused oil prices to rise faster and fall harder than could ever be explained by ordinary market forces alone. American consumers, small businesses and the broader economy were forced onto a roller coaster ride of greed, fear and uncertainty. However, the greatest victim of the 2008 energy crisis was consumer confidence in these markets' ability to determine a fair and predictable price for energy. In 2007 and most of 2008, gasoline and heating oil retailers saw profit margins from fuel sales fall to their lowest point in decades as oil prices surged. The retail motor fuels industry is one of the most competitive industries in the marketplace, which is dominated by small, independent businesses. Retail station owners offer the lowest price for motor fuels to remain competitive, so that they generate enough customer traffic inside the store where station owners can make a modest profit by offering drink and snack items. As gas prices go up, the market becomes even more competitive and at times retailers are selling gas at a loss. In addition, because petroleum marketers and station owners must pay for the inventory they sell, their lines of credit were approaching their limit due to the high costs of gasoline, heating oil and diesel. This created a credit crisis with marketers' banks, which created liquidity problems and caused serious financial hardship for many petroleum marketers and station owners--some even were forced to close up shop. In the summer of 2008, Goldman Sachs, a firm that trades in the crude oil market, predicted that crude oil would hit $200 per barrel (translating to $6 per gallon heating oil) by winter. Heating oil dealers, who typically purchase fuel in the summer months when seasonal product costs are typically at their lowest, were experiencing higher prices than ever before. Some customers, scared by statements made by Goldman Sachs and others, began demanding a fixed-price agreement with their dealer in an attempt to shelter their family budgets from higher prices. Many dealers offered such contracts to meet this demand, driving many of them to purchase the fuel needed to supply these contracts up front during the summer months; for fear that prices would only head higher. When institutional investors exited the market in the fall, heating fuel dealers and their customers who had ``locked in'' to a price contract were put in a very bad spot, committed to fuel at a much higher cost than its current worth. Many of these consumers are elderly Americans and struggling families trying to make ends meet in a slumping economy riddled with high unemployment rates and evaporating savings and retirement accounts. Ignoring or unaware of the potential consequences of their actions, investment-only speculators were concerned only about turning a profit. They were completely disconnected from the commercial marketplace and the struggling consumers that fuel retailers like me serve personally every day. Commodity markets were not designed as an investment class--they were set up for physical hedgers to manage price risk by entering into a futures contract in order to lock in a price for future delivery. These ``Investulators,'' funds who believe commodities are an asset class, are really unwitting speculators, and are so large and lack any commodity market fundamental knowledge; they have dramatically distorted the markets we rely on. The abuse of this original intent must end now. We rely on these markets to provide the consumer with a quality product at a price reflective of market fundamentals. Traditional speculators serve an important and healthy role by providing needed liquidity in the commodities market for this to be accomplished. However, institutional investors have wreaked havoc on the price discovery mechanism that commodity futures markets provide to bona fide physical hedgers, including heating fuel dealers. Congress should act quickly to restore the transparency and oversight needed for secure and stable commodities markets and help restore the confidence in these markets that physical hedgers and consumer once had. Therefore, PMAA and NEFI urge Congress to pass the ``Derivatives Markets Transparency and Accountability Act'' and enable the critical changes to the Commodity Exchange Act (CEA) needed for fully regulated futures markets. We further urge Congress to expedite commodity markets reform legislation through the legislative process and not allow the bill to be stalled by the financial services regulatory overhaul debate. PMAA and NEFI strongly support most provisions in the ``Derivatives Markets Transparency and Accountability Act,'' including: Distinguishing between legitimate hedgers in the business of actually delivering the fuel to consumers, and those who are in the market for purely speculative purposes; Closing the ``London Loophole'' by requiring foreign exchanges with energy contracts for delivery in the U.S. and/or that allow U.S. access to their platforms to be subject to comparable U.S. rules and regulations; Closing the ``Swaps Loophole'' which allows so-called ``index speculators'' (that now amount to \1/3\ of the market) an exemption on position limits which enable them to control unlimited amounts of energy commodities; and Increasing staff at the CFTC with an additional 200 employees and other resources. While we applaud the Committee for its diligent work on this legislation, we urge you to make the necessary adjustments to the ``Derivatives Markets Transparency and Accountability Act of 2009'' by mandating aggregate speculative position limits on energy futures across all contract markets at the control or ownership level for contracts traded within the U.S. or by U.S. traders. This important measure will help return the market to the physical market participants it was intended to serve. Aggregate position limits will also prevent a trader from going into one commodity exchange and trading the maximum amount of crude oil allowed and then going into another exchange to trade another large amount of futures positions, thereby circumventing anti-manipulation measures in order to take a massive and controlling position in one commodity. Additionally, PMAA and NEFI urge you to either strike Section 9--Review of Over-the-Counter Markets, which requires the CFTC to study and report on the effects of potential position limits in OTC trading and aggregate limits across the OTC market, designated contract markets, and derivative transaction execution facilities. Or to include section 9 but still mandate aggregate OTC position limits immediately before any study takes place. We and our customers need our public officials in the new Congress, including those on this Committee, in the new Administration and the CFTC, to take a stand against excessive speculation and abusive trading practices that artificially inflate energy prices. We strongly support the free exchange of commodity futures on open, well regulated and transparent exchanges that are subject to the rule of laws and accountability. Reliable futures markets are crucial to the entire petroleum industry and the American economy. Let's make sure that these markets are competitively driven by supply and demand and not the speculative whims and greed of Wall Street. Thank you again for allowing me the opportunity to testify before you today. " CHRG-111hhrg55814--157 The Chairman," The gentleman's time has expired. The gentleman from Texas? Dr. Paul. Mr. Secretary, more and more people today are looking critically at the Federal Reserve and wondering what's going on and of course, the people are asking more questions and they want to know exactly what role the Federal Reserve has played in our financial crisis. In the past, the Federal Reserve was held in very high esteem; that they produced prosperity and full employment and stable prices. Today, they are viewed somewhat differently. And many economists are joining in this. Today the Congress is, by the number of 307, who are asking for more transparency of the Federal Reserve. But also, everybody agrees that we have a financial crisis and we're working very hard on regulations. And I think, sometimes, we get misdirected in this because if indeed the source of our problem is coming from the Federal Reserve, then you're depending too much on regulations without looking at the real cause. We're treating symptoms rather than the cause. Just the idea that the Federal Reserve is the lender of last resort, contributes horrendously to moral hazard, especially when we're dealing with the reserve currency of the world. But everybody knows that, no matter what happens, the lender is going to be there to bail them out. But, you had an interview this year and you were asked what you thought were the really, the causes of this crisis, and I was fascinated with your answer. Because, in a way, it seems like you might have agreed a little bit with what I'm saying. Because you listed as number one, you say, one, the monetary policy was too loose, too long, and that created this just huge boom in asset prices, money chasing risk, people trying to get a higher return. That was just overwhelmingly powerful. And I think that really makes my point and unless you deal with that, and the suggestion is, is that what we do is move in with more regulations and hope and pray that'll work. But again, if this is true, that a monetary policy way too loose lasted too long, how can the solution be speeding it up? How can you say, this is the real problem, so we'll double the money supply. Interest rates were too low at 1 percent, let's make them \1/4\ percent. I can't reconcile this. How can you reconcile this on just common sense? " fcic_final_report_full--226 THE BUST CONTENTS Delinquencies: “The turn of the housing market” .............................................  Rating downgrades: “Never before” ...................................................................  CDOs: “Climbing the wall of subprime worry” .................................................  Legal remedies: “On the basis of the information” .............................................  Losses: “Who owns residential credit risk?” ......................................................  What happens when a bubble bursts? In early , it became obvious that home prices were falling in regions that had once boomed, that mortgage originators were floundering, and that more and more families, especially those with subprime and Alt-A loans, would be unable to make their mortgage payments. What was not immediately clear was how the housing crisis would affect the fi- nancial system that had helped inflate the bubble. Were all those mortgage-backed securities and collateralized debt obligations ticking time bombs on the balance sheets of the world’s largest financial institutions? “The concerns were just that if people . . . couldn’t value the assets, then that created . . . questions about the solvency of the firms,” William C. Dudley, now president of the Federal Reserve Bank of New York, told the FCIC.  In theory, securitization, over-the-counter derivatives and the many byways of the shadow banking system were supposed to distribute risk efficiently among investors. The theory would prove to be wrong. Much of the risk from mortgage-backed securi- ties had actually been taken by a small group of systemically important companies with outsized holdings of, or exposure to, the super-senior and triple-A tranches of CDOs. These companies would ultimately bear great losses, even though those in- vestments were supposed to be super-safe. As  went on, increasing mortgage delinquencies and defaults compelled the ratings agencies to downgrade first mortgage-backed securities, then CDOs. Alarmed investors sent prices plummeting. Hedge funds faced with margin calls from their repo lenders were forced to sell at distressed prices; many would shut down. Banks wrote down the value of their holdings by tens of billions of dollars.  FOMC20060808meeting--22 20,MS. YELLEN.," Thank you. I have a question for David and Karen, and it picks up on President Poole’s. My question has to do with what, if anything, we can learn about the role of energy-price increases as a factor raising core inflation here from the experience of other countries. Since we’re not the only country experiencing increases in energy and other commodity prices, my question is whether or not there is some econometric or other evidence that pertains to the degree of energy-price pass-through into core inflation in other developed economies. I’m thinking particularly of economies in which inflation expectations are reasonably well anchored—for example, the United Kingdom, Canada, and the euro area. What do we know about energy-price pass-through into core inflation? Is there evidence of that?" FOMC20060328meeting--149 147,MR. POOLE.," Okay. Mr. Chairman, it is a great delight to see a 200 percent increase in the number of beards around this table. [Laughter] Half of that was in my point forecast, and the other half was not. [Laughter] The contacts that I’ve talked to recently are very optimistic about activity—with one exception, which I’ll start with. My contact at a major trucking firm said that he sees what he called a little bit of a slowdown. Volume is essentially flat year over year across all regions and products. He doesn’t have an explanation, but he’s the only one of my contacts who had anything negative to say about the situation. My contact at UPS had some interesting comments. He said that both UPS and FedEx together have their networks operating at a higher level at this time of year than they have ever seen and that, at the fourth-quarter peak, they will not be able to meet demand without some new strategies. In particular, they’re going to use pricing and incentives, I guess, to try to reduce some demand that is less profitable. They will be working with customers to ship stuff out on Sundays that previously went on Mondays, that kind of thing. But he says that, unless they do that sort of thing, he anticipates that they will be unable to meet demand in the fourth quarter. Of course, they talk with their customers all the time, and they’re very optimistic. They have had very good earnings statements, as you may have seen. My contact with Wal-Mart said something that I thought was very interesting, which I’m going to try to explore in more detail. He said that their wages, and these are for hourly workers (possibly just for sales associates), are absolutely flat—no increases whatsoever in the last year and no increases planned going forward. Individual workers are getting some increases, which probably average about 1 percent, as a consequence of seniority. They have a pay scale by which workers are paid more after they have stayed there some months—I don’t know exactly how many. And I think they also have some productivity or performance bonuses built into their pay structure, but the structure has not changed at all, so wages are increasing about 1 percent year over year. He said that about 20 percent of their associates are part time and that they are going to be increasing that share to 40 percent so they can staff at peak times and get more productivity out of their workforce. On a national basis, the main thing I’d like to comment on is construction, and I’ll start with a local story. There is an absolutely tremendous boom in nonresidential construction going on in St. Louis. As a consequence of our own building project, we have close contact with the construction industry in St. Louis, and our people received a spreadsheet listing of projects in the city. I will start with the bottom line and give you some examples of the kind of thing that is taking place. The average St. Louis construction volume is $600 million to $700 million a year in nonresidential construction. Now, listed in this table are multiyear projects, some are two- and three-year projects, starting last year and this year. The total here is $5.681 billion. It is probably several times over the normal annual volume in St. Louis. To give you some examples, there’s $930 million worth of casino projects, including casinos and some casino hotels. So we’re building casinos. I guess in Dallas they’re building condos." CHRG-111hhrg51698--351 Mr. Neugebauer," Now you advocate for aggregate position limits for noncommercial traders. One of the things this body is struggling with is making sure that we don't push so many people out that we can't actually handle the appropriate amount of liquidity in the marketplace, so that our producers can use this as an effective price discovery and risk management tool. When I think about a bale of cotton in the 19th Congressional District, I think about all of the people who really have some commercial interest in that. All the way from the seed company to the fertilizer and the equipment company, the gins and merchants, and other people relying on the behavior of the cotton commodity price for their livelihood. So kind of two things begin to come to my mind there. When we start picking, who can and cannot participate in hedging a risk that they perceive, or putting together a business model where they can manage those risks? And, also, if we push too many people out of the marketplace, then if you have this many people trying to use a commodity as somewhat of a business hedge, that we don't have enough people to be on the other side. What is the right prescription of who you allow to play and who you don't allow to play? " fcic_final_report_full--61 The derivatives markets are organized as exchanges or as over-the-counter (OTC) markets, although some recent electronic trading facilities blur the distinctions. The oldest U.S. exchange is the Chicago Board of Trade, where futures and options are traded. Such exchanges are regulated by federal law and play a useful role in price discovery—that is, in revealing the market’s view on prices of commodities or rates underlying futures and options. OTC derivatives are traded by large financial institu- tions—traditionally, bank holding companies and investment banks—which act as derivatives dealers, buying and selling contracts with customers. Unlike the futures and options exchanges, the OTC market is neither centralized nor regulated. Nor is it transparent, and thus price discovery is limited. No matter the measurement—trad- ing volume, dollar volume, risk exposure—derivatives represent a very significant sector of the U.S. financial system. The principal legislation governing these markets is the Commodity Exchange Act of , which originally applied only to derivatives on domestic agricultural products. In , Congress amended the act to require that futures and options con- tracts on virtually all commodities, including financial instruments, be traded on a regulated exchange, and created a new federal independent agency, the Commodity Futures Trading Commission (CFTC), to regulate and supervise the market.  Outside of this regulated market, an over-the-counter market began to develop and grow rapidly in the s. The large financial institutions acting as OTC deriva- tives dealers worried that the Commodity Exchange Act’s requirement that trading occur on a regulated exchange might be applied to the products they were buying and selling. In , the CFTC sought to address these concerns by exempting cer- tain nonstandardized OTC derivatives from that requirement and from certain other provisions of the Commodity Exchange Act, except for prohibitions against fraud and manipulation.  As the OTC market grew following the CFTC’s exemption, a wave of significant losses and scandals hit the market. Among many examples, in  Procter & Gamble, a leading consumer products company, reported a pretax loss of  million, the largest derivatives loss by a nonfinancial firm, stemming from OTC interest and foreign exchange rate derivatives sold to it by Bankers Trust. Procter & Gamble sued Bankers Trust for fraud—a suit settled when Bankers Trust forgave most of the money that Procter & Gamble owed it. That year, the CFTC and the Securities and Exchange Com- mission (SEC) fined Bankers Trust  million for misleading Gibson Greeting Cards on interest rate swaps resulting in a mark-to-market loss of  million, larger than Gibson’s prior-year profits. In late , Orange County, California, announced it had lost . billion speculating in OTC derivatives. The county filed for bankruptcy—the largest by a municipality in U.S. history. Its derivatives dealer, Merrill Lynch, paid  million to settle claims.  In response, the U.S. General Accounting Office issued a re- port on financial derivatives that found dangers in the concentration of OTC deriva- tives activity among  major dealers, concluding that “the sudden failure or abrupt withdrawal from trading of any one of these large dealers could cause liquidity prob- lems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole.”  While Congress then held hearings on the OTC derivatives market, the adoption of regulatory legislation failed amid intense lob- bying by the OTC derivatives dealers and opposition by Fed Chairman Greenspan. In , Japan’s Sumitomo Corporation lost . billion on copper derivatives traded on a London exchange. The CFTC charged the company with using deriva- tives to manipulate copper prices, including using OTC derivatives contracts to dis- guise the speculation and to finance the scheme. Sumitomo settled for  million in penalties and restitution. The CFTC also charged Merrill Lynch with knowingly and intentionally aiding, abetting, and assisting the manipulation of copper prices; it settled for a fine of  million.  FOMC20080430meeting--102 100,MS. PIANALTO.," Thank you, Mr. Chairman. Regardless to whom I talk with these days, the conversation quickly turns to both the fragile condition of financial markets and the spectacular rise in energy and commodity prices. I had hoped that one of these problems would have gone away by now, but clearly that is not how conditions have unfolded since our last meeting. The bankers with whom I talked are paying close attention to their capital and liquidity positions. They remain concerned about wide bid�asked spreads and low trading volumes in a broad array of securities markets. Indeed, the repercussions of financial turmoil appear to have touched every channel of credit intermediation. It appears that a rewiring of credit channels is simply going to take some time to work out. The most significant financial news coming out of the Fourth District is the $7 billion investment of new capital into National City Bank. National City is the country's tenth largest commercial bank, and its problems with mortgage-related credits are now well known. National City still has much work to do to clean up its balance sheet, just as many other financial institutions with impaired capital positions must do before they can stand on solid ground again. Although the fragile state of the financial sector represents a pretty sizable risk to my economic outlook, the National City situation, along with other stories I'm hearing, suggests that modest progress is being made. With regard to District business conditions, the stories I hear remain downbeat. Commercial builders are reporting mixed though generally positive first-quarter numbers. But their expectations for retail sales in the stores that they lease out across the country have deteriorated, and they are fairly pessimistic about 2008 growth prospects. One large national commercial developer whom I talked with told me that, for the first time in his 45-year career, his company has seen sales declines in March in every retail center that they own across the country. The manufacturers I talked with indicated moderate first-quarter revenue growth as export markets, especially in Asia and Eastern Europe, are still helping to sustain production despite weak domestic demand. At the same time, manufacturers report intense commodity price pressures, and they report little resistance as they attempt to pass along the rising cost of commodities to their customers. The projection I submitted for this meeting shows real GDP growth under 1 percent in 2008, with virtually all of that growth coming in the second half of the year. This is a decidedly more pessimistic projection than the one I submitted in January but not materially different from the outlook when we met just six weeks ago. I have, however, boosted my headline inflation projection for 2008 compared with what I submitted in January, and it is somewhat higher than what I was estimating when we met in mid-March. Although I am still projecting that the slack in the economy will be sufficient to bring the core inflation number under the 2 percent threshold sometime next year, I am now anticipating a little more pass-through of commodity prices into core measures than I thought probable six weeks ago. Indeed, every time I see commodity prices ratcheting up, I become less confident that slack alone will be able to prevent an upward drift in the inflation trend. To be clear, I think the downside risks that we face in the real economy remain substantial, and I am inclined to believe that some insurance against those risks is probably warranted. But in taking such a step, I am inclined to judge that the downside risks we face in the real economy will be roughly in balance with the upside risks that we face from a rising inflation trend. Thank you, Mr. Chairman. " CHRG-110hhrg46591--398 Mr. Ellison," My next question is, you know, we have been debating over whether or not deregulation was a causal factor in the financial circumstance that we find ourselves in. And I guess my question is, you know--and I think it was the year 2000--I think then-Senator Gramm introduced a piece of legislation, I think it was called the Commodity Futures Modernization Act. To what degree did the passage of this amendment exempt derivatives from regulation? Or in your view, Mr. Ryan, did they? Do you understand my question? " CHRG-111hhrg51698--403 Mr. Pickel," Well, let's look at the full range of the market. We focused a lot on CDS, and we will talk about that in a second. But if we look at interest rates, currency transactions, many commodity transactions, those are still very much custom tailored to the particular needs of the counterparties, the interest rate dates of the loans, or the delivery dates of the commodities. So in that area, yes, that continues to be the case. Custom tailored, the creditworthiness of the parties is very important. Collateral is used to address that credit exposure. In the credit default swap markets, it is fair to say that in our documentation and in market practices, yes, on the spectrum of standardization we have moved further down that spectrum to more standardized products. And, that is why at this point clearing for those products becomes very compelling. The major dealers have been working on developing a clearing initiative here, which is now housed within ICE. They have been working on that for at least 2 and maybe 3 or more years. It has taken on a greater urgency in the last few months with the credit crisis, but they have understood the need, the attractiveness of a clearing option for those contracts in part because they are more standardized. Ms. Herseth Sandlin. But you still continue to have concerns and perhaps oppose clearing provisions in the draft bill? " FinancialCrisisInquiry--478 BASS: When you look back—Mr. Mayo talked about loan growth doubling that of GDP growth. When you look back at the housing market—and you can go back through OFHEO’s raw data, all the way back to about I think it’s 1971, you look, you can go back and plot the housing price appreciation x inflation and chart that against median income. January 13, 2010 It only makes sense that as income moves up, housing prices should be able to move up in a perfectly parallel fashion—you make a little bit more money, you can afford a little bit more house. Those lines were parallel for the good part of 40 years. And what happened in 2001, when Dr. Greenspan traded the dot.com bust for the housing boom, he lowered rates down to 1 percent. He made money free, and encouraged all of the lending possible to try to restart the economy after the dot.com bust. I simply think he did a bad job. Other people think he did a great job. But I think that he enabled this housing market. So when you started seeing rates—rates started—they started raising rates in 2004? When rates started to be—started an increasing path, you saw prime mortgage origination in 2004 drop 50 percent. That just makes sense. Everybody refinanced their homes that could. Everyone got reset and settled, but subprime origination in 2004 doubled. And then it doubled again in ‘05, as prime originations fell off a cliff because rates were moving up. So what happened is Wall Street had these machines built to manufacture mortgages. We wanted affordable housing, so they could lower rates with exotic mortgages. And what you saw from 2001 on is you saw those two parallel lines, home price—median home price and median income—diverge. And not only did they diverge by—for those of you that are statisticians, it was an eight standard deviation divergence. OK? That doesn’t happen very often. I know we talk about once-in-a- lifetime calamities every 10 years, that one just hasn’t happened. CHRG-111hhrg51698--623 Mr. Boswell," You are very welcome. Anyone else? Mr. Marshall? I think that concludes our panel today. We cannot thank you enough for your time, your presence. I also think it is fair and reasonable to say we are going to need to continue the dialogue. As I think you may have heard earlier today, we have to do this right. We are counting on your input. So, again, thank you very much, and we will call this meeting adjourned. [Whereupon, at 3:18 p.m., the Committee was adjourned.] [Material submitted for inclusion in the record follows:] Submitted Statement of Hon. Bart Chilton, Commissioner, U.S. Commodity Futures Trading Commission I commend Chairman Peterson for his continued leadership and support his efforts to restore the public's confidence in U.S. futures markets by ensuring appropriate oversight. The proposal incorporates needed changes to our current regulatory structure that will greatly improve our ability to protect consumers and businesses alike. In a speech last week, I quoted the American folklorist Zora Neale Hurston, who said; ``There are years that ask questions, and there are years that answer.'' This year must be a year of answers. During my remarks, I went on to lay out what I see as necessary steps to healing our fractures in our regulatory system. I'm pleased that the Chairman's proposal also addresses several of these critical components. (1) Require OTC reporting and record-keeping. This will enable the CFTC to examine trading information, particularly information about sizable, look-alike or price discovery transactions that could impact regulated markets--markets that have a bearing on what consumers pay for products like gasoline or food, or even interest rates on loans. (2) Oversee mandatory clearing of OTC Credit Default Swap (CDS) transactions, and encourage clearing for other OTC products as appropriate. The stability and safety of our financial system is significantly improved by enhancing clearing systems for CDSs--in a manner that does not lead to cross-border arbitrage--as well as for other OTC derivatives. Such clearing would not only provide counterparty risk, but a data audit trail for regulators. (3) Regulate OTC transactions if the Commission determines that certain trades are problematic. The CFTC should be given the authority to determine and set position limits (aggregated with exchange positions, and eliminate bona fide hedge exemptions) to protect consumers. Congress should also extend CFTC anti- fraud, anti-manipulation and emergency authorities as appropriate to OTC transactions to allow greater openness, transparency and oversight of our financial markets. These provisions are included in the Chairman's proposal. I am hopeful that the Committee will also consider two other items, one within its jurisdiction--the other an appropriations matter. (4) Public Directors on Investment Industry Boards. Corporate boards would benefit greatly from the inclusion of public directors who bring a diversity of backgrounds and experiences to the boardroom. Such a provision would allow farmers, consumer representatives or other individuals to serve and provide different, yet important perspectives. All too often, these boards look more like an extension of the companies themselves than a group of individuals that are there to spot problems and deliver constructive criticism. Unfortunately, what we witnessed in the securities world is that this had to be mandated rather than simply encouraged. For that reason, I would urge Congress to consider a requirement that a third of board members be considered public directors. (5) Congress should appropriate immediate full funding ($157 million for Fiscal Year 2009) in additional resources, which would allow the CFTC to hire an additional 150 employees, and fund related technology infrastructure so that the agency can properly effectuate our duties under the Commodity Exchange Act, as amended by the farm bill. Many in Congress have joined together to call for increased resources for the Securities and Exchange Commission (SEC). By comparison, the CFTC oversees exchanges with significantly greater market capitalization than the SEC. For example the CME Group alone has a market capitalization of roughly $11 billion, while NYSE/Euronext (largest U.S. securities exchange regulated by the SEC) has a market capitalization of $5.5 billion. The SEC has 3,450 employees, while the CFTC struggles with roughly 450--fully 3,000 less staff. It is not a popular thing to call for more money for Federal employees, but cops on the beat are needed to detect and deter crimes. The CFTC needs these additional resources and we need them now. There are many other provisions in the Chairman's proposal that I support, such as closing the London Loophole and ensuring exclusive jurisdiction over environmental futures market regulation. Simply put, the success of a cap-and-trade system requires an experienced regulator. The Chairman's proposal, if enacted, will bring much needed transparency and accountability to both over-the-counter and certain overseas markets; provide the CFTC the authorities necessary to prevent market disruptions from excessive speculation; and give regulators a window into currently ``dark markets'' by requiring reporting and record-keeping. ______ Supplemental Material Submitted by Michael W. Masters, Founder and Managing Member/Portfolio Manager, Masters Capital Management, LLC Dear Congressman Marshall: Thank you for your insightful questions and your leadership on the issue of excessive speculation. I wanted to respond promptly to your request for written answers to the two questions you posed during the hearing. Your first question pertained to a scenario wherein the commodities derivatives markets are balanced, with an equal number of speculators seeking trading profits on the one hand, and physical producers and consumers hedging their real business on the other. What happens, then, if a large number of ``invesculators'' enter the markets? What problems would that pose and what solutions would we need? I believe the scenario you describe is precisely what has happened to our commodity markets in the last 5 years, culminating with the extreme price movements of the last 18 months. ``Invesculators,'' as you referred to them, are extremely damaging to the commodities derivatives markets, due to their belief that commodities are an ``asset class.'' Commodities are raw materials that are consumed by individuals and corporations. They are not an ``asset'' (like a stock or a bond) that can be bought and held for the long term. As much as institutional investors want to believe that commodities can be considered assets, they simply cannot. Physical hedgers--those who produce and consume actual commodities--never suffer from ``irrational exuberance.'' When prices rise, producers are motivated to produce more (that's their business), and consumers are motivated to consume less. In contrast, the ``Invesculator'' responds to an increase in price by thinking, ``oh, that would be a good investment,'' and jumps on the bandwagon by submitting their own buy orders. This is the dynamic that causes price bubbles to form. Every capital asset category has had its bubbles through history: the Japan bubble, the emerging markets bubble, the Internet bubble, the housing bubble, the credit bubble, etc. Eventually, wherever investors go, price bubbles appear. When physical hedgers dominate the commodities derivatives markets then traditional speculators, because they are outnumbered, will emulate the behavior of the physical hedgers. But when speculators rule these markets then they can drive prices to irrational heights that have nothing to do with supply and demand. In the scenario that you described, wherein five speculators and five physical hedgers are transacting in the derivatives market, and then 45 ``invesculators'' show up, the result is a bubble, just as if you put your house on the market, had an open house, and 45 people showed up with their checkbooks. You're going to get a much higher price than if no one, or even a couple of people, showed up. While bubbles in asset markets can be intoxicating, bubbles in commodities are devastating. Every human being around the globe suffers when we experience bubbles in food and energy prices. So what can Congress do about it? Fortunately, the solution is simple, and Congress has already done it since 1936: put a limit on the size of positions that speculators can hold in order to prevent them from dominating the market. This worked superbly from 1936 until about 1998. It is simple and proven, and carries no unintended consequences. Unfortunately in 1998 the CFTC began to let speculative position limits slide. For them the term ``excessive speculation'' came to mean basically the same as ``manipulation.'' At which point the CFTC decided position limits were only necessary to prevent manipulation. Then, in 2000 the Commodities Futures Modernization Act (CFMA) allowed the formation of the Intercontinental Exchange (ICE), and exempted over-the-counter (OTC) swaps dealers from all regulation. The result was that there were no longer any real speculative position limits in energy. Also, the OTC markets effectively rendered position limits in agricultural commodities meaningless. What ensued was rampant speculation, which led to the bubble that finally burst in the second half of 2008. It's easy to see why it is not only essential to reinstate a system of speculative position limits on the exchanges, but it is also critical for those limits to apply to ICE and other exchanges, as well as the OTC markets. When there is a clearly defined limit placed on the money flowing into a market, then prices cannot expand fast enough to cause a bubble. Your question seemed to also pose a more nuanced scenario: assuming a market in which the speculative position limit is, for example, 1,000 contracts, and further assuming that 50,000 contracts are held by speculators and 100,000 contracts are held by physical producers and consumers, what if 300 new speculators show up and they all stay below the 1,000 contract limit, they can still buy 300,000 contracts combined, what should be done then? The answer is that speculative position limits need to be adjusted as market conditions dictate. This scenario provides an excellent illustration of why we recommend the formation of a physical hedgers' panel that would serve to adjust speculative position limits every 3-12 months. If the ratio of speculators to physical hedgers becomes too high (like 350,000 : 100,000--which, for reference, was the approximate ratio in 2008), then the panel should lower the speculative position limit from 1,000 contracts down to, say, 500 contracts. Similarly, if the ratio of speculators to physical hedgers is too low and the markets need more liquidity, then the panel would have the ability to raise the limit to allow speculators to take larger positions. Think of speculative position limits like a valve that controls the level of speculative money in the markets, as well as the speed with which money flows into the markets. We believe that the optimal ratio of speculators to physical hedgers is one to two (34% speculative). The commodities futures markets operated efficiently with no liquidity issues for decades while open interest stayed generally in the range of one speculator for every four physical hedgers. So if the physical hedgers' panel would target a ratio of one speculator for every two physical hedgers that would give the commodities derivatives markets abundant liquidity. Your second question pertained to the possible challenges of implementing across-the-board speculative position limits. The simplest and most effective way to implement speculative position limits is to enforce an ``aggregate'' speculative position limit that a speculator will face regardless of the transaction venue (e.g., a CFTC-regulated futures exchange like NYMEX, a non-CFTC-regulated futures exchange like ICE, or in the OTC market). Let's say that the physical hedger panel determines that the speculative limit for oil should be 5 million barrels or 5,000 contracts. Speculators would be told that they can buy up to 5 million barrels anywhere they want as long as they do not exceed this limit. Consider the problems that can arise if a system of speculative position limits is not established on an aggregate basis and instead individual trading venues are assigned their own unique limits. No matter what system is used for assigning those limits it will run into problems. As an example, if the aforementioned 5,000 contract speculative position limit for crude oil is apportioned as follows: NYMEX: 1,000 ICE: 1,000 OTC: 1,000 contract equivalent (1 million barrels) IPE: 1,000 (International Petroleum Exchange) DME: 1,000 (Dubai Mercantile Exchange) Then, under this scenario, speculators will be forced to spread their trading around in order to access their entire 5,000 contract speculative position limit. Since the amount of liquidity varies from one exchange/venue to the next, it would not make sense to encourage an equal amount of trading on each venue. For example, ICE has half the volume of NYMEX, so should they have the same limit as NYMEX or half the limit of NYMEX? Different problems arise however if unequal speculative position limits are imposed. If the limits were set to match current liquidity like this: NYMEX: 1,000 ICE: 500 OTC: 2,500 IPE: 800 DME: 200 Then the growth of ICE and other exchanges would be stunted due to their low relative limits. This system has the further effect of forcing speculators to trade OTC in order to reach their 5,000 contract maximum. This is not something that I believe Congress wants to do. If limits are placed on some venues but not others, then trading will flow to the places that offer unlimited speculation (currently the OTC markets). This would fail to safeguard against future speculative bubbles, which is what the speculative limits are designed to do. The best system for implementing aggregate speculative position limits would entail the following: (1) All OTC commodity derivative transactions must clear through an exchange. (2) Each speculator would have a trader identification number which would be associated with every trade, just like a customer account number. (3) Foreign boards of trade would have to supply information to the CFTC on U.S. traders (looking at the parent entity level). Those who oppose exchange clearing will complain about ``chicken fat'' swaps and the like, but in reality, 99% of all commodity swaps are composed of futures contracts and basis trades, which would all clear. Congress should resist attempts by Wall Street to avoid exchange clearing by claiming that their derivatives are too exotic and that therefore large segments of the market need to be exempted from the clearing requirement. Almost all OTC commodity derivatives should clear. As part of the clearing process OTC derivatives are transformed into futures contract equivalents. Therefore the process of applying speculative position limits to OTC derivatives that have exchange cleared is as simple as applying limits to futures contracts. Under this system of speculative position limits and exchange clearing, the aggregate activity for an individual trader can be calculated simply by tracking the trader identification number and adding up how much each trader has bought through each venue in each commodity. A trader who exceeds their limit could face a stiff financial penalty (100% of which can go to the CFTC to fund their operations) and that trader's positions could be liquidated on a last-in, first-out basis. In order for this regulation to capture transactions on foreign boards of trade, they must be required to submit the necessary information to the CFTC on a real-time basis in exchange for the CFTC allowing them to place direct terminals in the United States. The CFTC has many ``hooks'' that would allow them to ensure that aggregate speculative position limits apply to foreign boards of trade as well. In summary, the idea is to give speculators one limit and let them ``spend'' it wherever they see fit. I hope I have clarified why aggregate speculative position limits and exchange clearing are the surest protection against a future commodity bubble. Please let me know if I can be of any further assistance. Best regards,Michael W. Masters,Portfolio Manager,Masters Capital Management, LLC. ______ FOMC20080805meeting--107 105,CHAIRMAN BERNANKE.," President Fisher, I'm going to ask you a very innocent question. You've given many chilling anecdotes over the last few meetings about increases in prices, but the official statistics just don't show anything like that outside of oil, gas, gasoline, and the direct commodity price increases. Do you believe that the CPI is not an accurate measure? " FOMC20050630meeting--338 336,MR. LEAHY.," Well, our forecast, obviously, is for import prices to decelerate. That’s based on forecasts that the dollar will flatten out, roughly, or decline only moderately going forward, and that commodity prices will also be relatively flat. So, to the extent you put a lot of confidence into those forecasts, I think you could transfer that to our outlook for import prices. That’s how we do the forecasts." CHRG-111hhrg51698--258 Mr. Roth," I mean, there are laws on the books right now against manipulation of markets; and there have been cases brought by the CFTC in which an integral part of the manipulation effort was a control over the delivery points, or the control of the delivery ability of the underlying commodity. So it is an interesting question that you pose, but there are anti-manipulation laws in effect that have been applied to the circumstances similar to those that you describe. " fcic_final_report_full--413 THE FORECLOSURE CRISIS CONTENTS Foreclosures on the rise: “Hard to talk about any recovery” ..............................  Initiatives to stem foreclosures: “Persistently disregard” .....................................  Flaws in the process: “Speculation and worst-case scenarios” ...........................  Neighborhood effects: “I’m not leaving” .............................................................  FORECLOSURES ON THE RISE: “HARD TO TALK ABOUT ANY RECOVERY ” Since the housing bubble burst, about four million families have lost their homes to foreclosure  and another four and a half million  have slipped into the foreclosure process or are seriously behind on their mortgage payments. When the economic damage finally abates, foreclosures may total between  million and more than  million, according to various estimates.  The foreclosure epidemic has hurt families and undermined home values in entire zip codes, strained school systems as well as community support services, and depleted state coffers. Even if the economy began suddenly booming the country would need years to recover. Prior to , the foreclosure rate was historically less than . But the trend since the housing market collapsed has been dramatic: In , . of all houses, or  out of , received at least one foreclosure filing.  In the fall of ,  in every  outstanding residential mortgage loans in the United States was at least one payment past due but not yet in foreclosure—an ominous warning that this wave may not have crested.  Distressed sales account for the majority of home sales in cities around the country, including Las Vegas, Phoenix, Sacramento, and Riverside, California.  Returning to the , borrowers whose loans were pooled into CMLTI - NC: by September , many had moved or refinanced their mortgages; by that point, , had entered foreclosure (mostly in Florida and California), and  had started loan modifications. Of the , still active loans then,  were seriously past due in their payments or currently in foreclosure.  The causes of foreclosures have been analyzed by many academics and govern- ment agencies. Two events are typically necessary for a mortgage default. First, monthly payments become unaffordable owing to unemployment or other financial  hardship, or because mortgage payments increase. And second (in the opinion of many, now the more important factor), the home’s value becomes less than the debt owed—in other words, the borrower has negative equity. “The evidence is irrefutable,” Laurie Goodman, a senior managing director with Amherst Securities, told Congress in : “Negative equity is the most important predictor of default. When the borrower has negative equity, unemployment acts as one of many possible catalysts, increasing the probability of default.”  FinancialCrisisInquiry--153 It only makes sense that as income moves up, housing prices should be able to move up in a perfectly parallel fashion—you make a little bit more money, you can afford a little bit more house. Those lines were parallel for the good part of 40 years. And what happened in 2001, when Dr. Greenspan traded the dot.com bust for the housing boom, he lowered rates down to 1 percent. He made money free, and encouraged all of the lending possible to try to restart the economy after the dot.com bust. I simply think he did a bad job. Other people think he did a great job. But I think that he enabled this housing market. So when you started seeing rates—rates started—they started raising rates in 2004? When rates started to be—started an increasing path, you saw prime mortgage origination in 2004 drop 50 percent. That just makes sense. Everybody refinanced their homes that could. Everyone got reset and settled, but subprime origination in 2004 doubled. And then it doubled again in ‘05, as prime originations fell off a cliff because rates were moving up. So what happened is Wall Street had these machines built to manufacture mortgages. We wanted affordable housing, so they could lower rates with exotic mortgages. And what you saw from 2001 on is you saw those two parallel lines, home price—median home price and median income—diverge. And not only did they diverge by—for those of you that are statisticians, it was an eight standard deviation divergence. OK? That doesn’t happen very often. I know we talk about once-in-a- lifetime calamities every 10 years, that one just hasn’t happened. THOMPSON: The Fed would have certainly seen that. Why, in your opinion was there no action taken there? BASS: You know, I mean, why—why do politicians not want to take the punch bowl away when things are going well is kind of what you’re asking me. It’s just a difficult decision. And, politically—even appointments at the Fed, right? Everyone’s on somewhat of a re- election cycle. If you make that difficult decision when things are good, you’re the bad guy. You’d rather be the guy that helps clean it up once it breaks. So you get into more of a—an ideological question when you ask. CHRG-110shrg46629--140 PREPARED STATEMENT OF SENATOR JIM BUNNING Chairman Bernanke, I watched your testimony yesterday with interest. Apparently the markets did too, but I am not sure if they did or did not like what they heard. You covered a lot of ground yesterday, but there is some new ground I will cover in the questions and some things that are worth repeating. First, it has been interesting to watch market reactions and expectations to Fed policy statements over the last few months. For a while, the markets did not believe your clear statements that the biggest concern was that inflation would not moderate as expected. Market indicators have moved more in line with your view in the last month or two, and I hope both the markets and you have learned about communication and the way each other think. While this is a monetary policy hearing, I think it is worth repeating that many of us believe the Fed and other regulators share some responsibility for the current state of the housing market. Low interest rates fueled the housing boom, and loose supervision of mortgage writing allowed it to proceed. The market is certainly punishing bad behavior by lenders, but some of the damage could have been prevented by more careful scrutiny of some of the most undisciplined lending. The Fed should have been especially careful because of the credit bubble it created with cheap money. I am glad you and your fellow regulators have taken action, and that you did not overreact and cause further damage. It is important for you to remain vigilant, but not to give in to pressure to over regulate. I would also say to Chairman Dodd that I hope we can quickly confirm the new nominees so that the Fed board will have more industry experience when tackling these issues. I continue to be impressed by the current economy, which seems to have passed through the worst of the slowdown caused largely by Fed tightening. My biggest concerns are rising food and energy prices, and the negative effects on the economy of the massive tax increases the new majority in Congress seems determined to allow. The current economic expansion is driven by the 2001 and 2003 tax cuts, and allowing a tax increase in 2010 will reverse years of gains in the economy and the stock markets. I look forward to hearing your responses. ______ CHRG-111hhrg51698--300 Mr. Masters," Chairman Peterson and Members of the Committee, thank you for the opportunity to appear before you to discuss this critical piece of legislation. As we witnessed in the last 18 months, what happens on Wall Street can have a huge impact on the average American. There are three critical elements that must be part of any effective regulatory framework. First, transparency. Effective regulation requires complete market transparency. In recent years, the big Wall Street banks have preferred to operate in dark markets where regulators are unable to see what is occurring. This limited transparency has enabled them to take on massive amounts of off-balance-sheet leverage, creating what amounts to a shadow financial system. Regulators cannot regulate if they cannot see the whole picture. Given the speed with which financial markets move, this transparency must be available on a real-time basis. The best way to bring transparency to over-the-counter (OTC) transactions is to make it mandatory for all OTC transactions to clear through an exchange. For that reason, I am very glad to see the sections of this bill that call for exchange clearing. This is a critical prerequisite for effective, regulatory oversight. The second thing that regulators must do is eliminate systemic risk. A lack of transparency was one of the primary factors in the recent financial meltdown. The other primary factor was the liquidity crisis brought on by excessive leverage at the major financial institutions. One of the most dangerous things about OTC derivatives is that they offer virtually unlimited leverage, since typically no margin is required. This is one of the reasons that Warren Buffett famously called them financial weapons of mass destruction. By mandating that OTC transactions clear through an exchange, your bill provides for the exchange to become the counterparty to all transactions. Since the exchange requires the posting of substantial margin, the risk to the financial system as a whole is nearly eliminated. When sufficient margin is posted on a daily basis, then potential losses are greatly contained and will prevent a domino effect from occurring. I do not know the specifics of the clearinghouse that ICE and the major swaps dealers are working to establish, but I would encourage policymakers to look very closely at the amount of margin the swaps dealers were required to post on their trades. If there is a substantial difference between what ICE requires and what CME Group requires, then swaps dealers, in a quest for maximum leverage will flock to the clearing exchange that has the lowest margin requirements. This is exactly opposite of what regulators and policymakers would want to see. The stronger the margin requirements, the greater will be the mitigation of systemic risk. The weaker the margin requirements, the greater chance we face of another systemic meltdown. The third thing that regulators must do is eliminate excessive speculation. Speculative position limits are necessary to eliminate excessive speculation and protect us from price bubbles. In commodities, if they had been in place across all commodity derivatives markets, then we would not have seen last year's spike and crash in commodities prices. The fairest and best way to regulate the commodities derivatives market is to subject all participants to the same regulations and speculative position limits, no matter where they trade. Every speculator should be regulated equally. The over-the-counter markets are dramatically larger than the futures exchanges. If speculative position limits are not imposed on all OTC commodity derivatives, it would be like locking one's doors to prevent a robbery, while leaving the windows wide open. This bill needs to include aggregate speculative position limits. If it does not, there is nothing protecting your constituents from another, more damaging bubble in food and prices. Once OTC commodity derivatives are cleared through an exchange, regulators will be able to easily see every trader's position; and the application of speculative limits will be just as simple for over-the-counter as it is for futures exchanges today. In summary, we have now witnessed how damaging unbridled financial innovation can be. The implosion on Wall Street has destroyed trillions of dollars in retirement savings and has required trillions of dollars in taxpayer money. Fifteen years ago, before the proliferation of OTC derivatives and before regulators become enamored with deregulation, the financial markets stood on a much firmer foundation. It is hard to look back and say that we are better off today than we were then. I think it is clear to everyone in America that this grand experiment, rather than delivering on its great promise, has in fact turned out to be a great disaster. Thank you. [The prepared statement of Mr. Masters follows:] Prepared Statement of Michael W. Masters, Founder and Managing Member/ Portfolio Manager, Masters Capital Management, LLC, St. Croix, U.S. VI Chairman Peterson and Members of the Committee, thank you for the opportunity to appear before you today to discuss this critical piece of legislation. As we have witnessed in the last 18 months, what happens on Wall Street can have a huge impact on Main Street. The implosion of Wall Street has destroyed trillions of dollars in retirement savings, has required trillions of dollars in taxpayer money to rescue the system, has cost our economy millions of jobs, and the devastating aftershocks are still being felt. Worst of all, this crisis was completely avoidable. It can be characterized as nothing less than a complete regulatory failure. The Federal Reserve permitted an alternative, off-balance sheet financial system to form, which allowed money center banks to take on extreme amounts of risky leverage, far beyond the limits of what your typical bank could incur. The Securities and Exchange Commission allowed investment banks to take on the same massive amount of leverage and missed many instances of fraud and abuse, most notably the $50 billion Madoff Ponzi scheme. The Commodities Futures Trading Commission allowed an excessive speculation bubble to occur in commodities that cost Americans more than $110 billion in artificially inflated food and energy prices, which in turn amplified and deepened the housing and banking crises.\1\--------------------------------------------------------------------------- \1\ See our newly released report entitled ``The 2008 Commodities Bubble: Assessing the Damage to the United States and Its Citizens.'' Available at www.accidentalhuntbrothers.com.--------------------------------------------------------------------------- Congress appeared oblivious to the impending storm, relying on regulators who, in turn, relied on Wall Street to alert them to any problems. According to the Center for Responsive Politics ``the financial sector is far and away the biggest source of campaign contributions to Federal candidates and parties, with insurance companies, securities and investment firms, real estate interests and commercial banks providing the bulk of that money.'' \2\ Clearly, Wall Street was pleased with the return on their investment, as regulation after regulation was softened or removed.--------------------------------------------------------------------------- \2\ ``Finance/Insurance/Real Estate: Background,'' OpenSecrets.org, Center for Responsive Politics, July 2, 2007. http://www.opensecrets.org/industries/background.php?cycle=2008&ind=F.--------------------------------------------------------------------------- So I thank you today, Mr. Chairman and Members of this Committee for your courageous stand and your desire to re-regulate Wall Street and put the genie back in the bottle once and for all. I share your desire to focus on solutions and ways that we can work together to ensure that this never happens again. I have included with my written testimony a copy of a report that I am releasing, along with my co-author Adam White, which provides additional evidence and analysis relating to the commodities bubble we experienced in 2008, and the devastating impact it has had on our economy (electronic copies can be downloaded at www.accidentalhuntbrothers.com). I would be happy to take questions on the report, but I want to honor your request to speak specifically on this piece of legislation that you are proposing. I believe that the Derivatives Markets Transparency and Accountability Act of 2009 goes a long way toward rectifying the inherent problems in our current regulatory framework and I commend you for that. While Wall Street will complain that the bill is overreaching, I believe that, on the contrary, there are opportunities to make this bill even stronger in order to achieve the results that this Committee desires. I am not an attorney and I am not an expert on the Commodity Exchange Act, but I can share with you what I see as the critical elements that must be part of any effective regulatory framework, and we can discuss how the aspects of this bill mesh with those critical elements.Transparency Effective regulation requires complete market transparency. Regulators, policymakers, and ultimately the general public must be able to see what is happening in any particular market in order to make informed decisions and in order to carry out their entrusted duties. In recent years, the big Wall Street banks have preferred to operate in dark markets where regulators are unable to fully see what is occurring. This limited transparency has enabled them to take on massive amounts of off-balance-sheet leverage, creating what amounts to a ``shadow financial system.'' Operating in dark markets has also allowed the big Wall Street banks to make markets with wide bid-ask spreads, resulting in outsized financial gains for these banks. When a customer does not know what a fair price is for a transaction, then a swaps dealer can take advantage of informational asymmetry to reap extraordinary profits. Regulators cannot regulate if they cannot see the whole picture. If they are not aware of what is taking place in dark markets, then they cannot do their jobs effectively. Regulators must have complete transparency. Given the speed with which the financial markets move, this transparency, at a minimum, must be available on a daily basis and should ideally be sought on a real-time basis. The American public, which has suffered greatly because of Wall Street's failures, deserves transparency as well. Individuals should be able to see the positions of all the major players in all markets on a delayed basis, similar to the 13-F filing requirements of money managers in the stock market. The best way to bring over-the-counter (OTC) transactions out of the darkness and into the light is to make it mandatory for all OTC transactions to clear through an exchange. Nothing creates transparency better than exchange clearing. All other potential solutions, like self-reporting, are suboptimal for providing necessary real-time information to regulators. For these reasons, I am very glad to see the sections of this bill that call for exchange clearing of all OTC transactions. This is a critical prerequisite for effective regulatory oversight. For that reason, it should be a truly rare exception when any segment of the OTC markets is exempted from exchange clearing requirements. I am further encouraged by sections 3, 4 and 5, which bring transparency to foreign boards of trade and make public reporting of index traders' and swaps dealers' positions a requirement. Lack of transparency was a primary cause of the recent financial system meltdown. Unsure of who owned what, counterparties assumed the worst and were very reluctant to trade with anyone. The aforementioned provisions in this bill will help ensure the necessary transparency to avoid a crisis of confidence like we just experienced. Wall Street would much prefer that the OTC markets remain dark and unregulated. They will push to keep as much of their OTC business as possible from being brought out into the light of exchange clearing. They will argue that we should not make major changes to regulation now that the financial system is so perilously weak. From my perspective this sounds like an intensive care patient that refuses to accept treatment. The system is already on life support. Transparency is the cure that will enable the financial system to recover. Congress must prioritize the health of the financial system and the economy as a whole above the profits of Wall Street. The profits of Wall Street are a pittance when compared with the cost to America from this financial crisis. We must clear all OTC markets through an exchange to ensure that this current crisis does not recur.Systemic Risk Elimination The other primary factor in the meltdown of the financial system was the liquidity crisis, brought on by excessive leverage at the major financial institutions. By mandating that OTC transactions clear through an exchange, the Derivatives Markets Transparency and Accountability Act of 2009 provides for the exchange to become the counterparty to all transactions. Since the exchange requires the posting of substantial margin, the risk to the financial system as a whole is nearly eliminated. When margin is posted on a daily basis, then potential losses are greatly contained and counterparty risk becomes virtually nil. To protect its interests, Wall Street will try to water down these measures. The substantial margin requirements will limit leverage, and limits on leverage, in turn, mean limits on profits, not only for banks, but for traders themselves. Because traders are directly compensated with a fraction of the short-term profits that their trading generates, they have a great deal of incentive to use as much leverage as they can to maximize the size of their trading profits. These incentives also exist for managers and executives, who share in the resulting trading profits. One of the most dangerous things about OTC derivatives is that they offer virtually unlimited leverage, since typically no margin is required. This is one of the reasons that Warren Buffet famously called them ``financial weapons of mass destruction.'' This extreme over-leveraging is essentially what brought down AIG, which at one time was the largest and most respected insurance company in the world. While by law they could not write a standard life insurance contract without allocating proper reserves, they were able, in off-balance-sheet transactions, to write hundreds of billions of dollars worth of credit default swaps and other derivatives without setting aside any significant amount of reserves to cover potential losses. If AIG were clearing its credit default swaps through an exchange requiring substantial margin, it would never have required well over $100 billion dollars in taxpayer money to avoid collapsing. I do not know the specifics of the clearinghouse that the IntercontinentalExchange (ICE) and the major swaps dealers are working to establish but I would encourage policymakers to look very closely at the amount of margin that swaps dealers will be required to post on their trades. If there is a substantial difference between what ICE requires and what CME Group requires then swaps dealers, in a quest for maximum leverage, will flock to the clearing exchange that has lower margin requirements. This is exactly opposite of what regulators and policymakers would want to see. The stronger the margin requirements, the greater will be the mitigation of systemic risk. The weaker the margin requirements, the greater chance we face of having to bail out more financial institutions in the future. I strongly urge Congress to resist all pressure from Wall Street to soften any of the provisions of this bill. We must eliminate the ``domino effect'' in order to protect the system as a whole, and exchange clearing combined with substantial margin requirements is the best way to do that.Excessive Speculation Elimination Speculative position limits are necessary in the commodities derivatives markets to eliminate excessive speculation. When there are no limits on speculators, then commodities markets become like capital markets, and commodity price bubbles can result. If adequate and effective speculative position limits had been in place across commodity derivatives markets, then it is likely we would not have seen the meteoric rise of food and energy prices during the first half of 2008, nor the ensuing crash in prices when the bubble burst. The fairest and best way to regulate the commodities derivatives markets is to subject all participants to the same regulations and speculative position limits regardless of whether they trade on a regulated futures exchange, a foreign board of trade, or in the over-the-counter markets. Every speculator should be regulated equally. If you do not, then you create incentives that will directly favor one trading venue over another. The over-the-counter (OTC) markets are dramatically larger than the futures exchanges. If speculative position limits are not imposed on all OTC commodity derivatives then there is a gaping hole that speculators can exploit. It would be like locking one's doors to prevent a robbery, while leaving one's windows wide open. The best solution is to place a speculative position limit that applies in aggregate across all trading venues. Once OTC commodity derivatives are cleared through an exchange, regulators will be able to see every trader's positions and the application of speculative limits will be just as simple for OTC as it is for futures exchanges today. This type of aggregate speculative position limit is also better than placing individual limits on each venue. For example, placing a 1,000 contract limit on ICE, a 1,000 contract limit on NYMEX and a 1 million barrel (1,000 contract equivalent) limit in the OTC markets will incentivize a trader to spread their trading around to three or more venues, whereas with an aggregate speculative position limit, they can trade in whichever venue fits their needs the best, up to a clear maximum. I applaud the provisions of your bill that call for the creation of a panel of physical commodity producers and consumers to advise the CFTC on the level of position limits. I believe it affirms three fundamental truths about the commodities derivatives markets: (1) these markets exist for no other purpose than to allow physical commodity producers and consumers to hedge their price risk; (2) the price discovery function is strengthened and made efficient by the trading of the physical hedgers and it is weakened by excessive speculation; and (3) speculators should only be allowed to participate to the extent that they provide enough liquidity to keep the markets functioning properly. Physical commodity producers and consumers can be trusted more than the exchanges or even the CFTC to set position limits at the lowest levels possible while still ensuring sufficient liquidity. I understand the legal problem with making this panel's decisions binding upon the CFTC. Still, I hope it is clear that this panel's recommendations should be taken very seriously, and if the CFTC chooses to not implement the recommendations they should be required to give an account for that decision. I further believe that the exchanges and speculators should not be part of the panel because they will always favor eliminating or greatly increasing the limits. CME and ICE may perhaps oppose speculative position limits in general out of a fear that it will hurt their trading volumes and ultimately their profits, but I believe this view is shortsighted. If CME, ICE and OTC markets are all regulated the same, with the same speculative position limits, then trading business will migrate away from the OTC markets and back to the exchanges, because OTC markets will no longer offer an advantage over the exchanges. I am glad that this bill gives the CFTC the legal authority to impose speculative position limits in the OTC markets, but I openly question whether or not the CFTC will exercise that authority. Like the rest of our current financial market regulators, they have been steeped in deregulation ideology. While I hope that our new Administration will bring new leadership and direction to the CFTC, I fear that there will be resistance to change. When Congress passed the Commodity Futures Modernization Act of 2000, they brought about the deregulation that has fostered excessive speculation in commodities derivatives trading. Now Congress must make it clear that they consider excessive speculation in the commodities derivatives markets to be a serious problem in all trading venues. Congress must make it clear to the CFTC that they have an affirmative obligation to regulate, and that a critical part of that is the imposition and enforcement of aggregate position limits to prevent excessive speculation.Summary We have now witnessed how damaging unbridled financial innovation can be. Wherever there is growing innovation there must also be growing regulation. Substantial regulation is needed now just to catch up with the developments on Wall Street over the last fifteen years. This bill is ambitious in its scope and its desire to re-regulate the financial markets, and for that I am encouraged. These drastic times call for bold steps, and I am pleased to support your bill. My sincere wish is that it be strengthened and not weakened by adding a provision for aggregate speculative position limits that covers all speculators in all markets equally. Fifteen years ago, before the proliferation of over-the-counter derivatives and before regulators became enamored with deregulation, the financial markets stood on a much firmer foundation. Today, with all of the financial innovation and the deregulation of the Clinton and Bush years, it is hard to look back and say that the financial markets are better off than they were 15 years ago. I think it is clear to everyone in America that this grand experiment, rather than delivering on its great promise has, in fact, turned out to be a great disaster. Attachment[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] " CHRG-111hhrg55811--166 Mr. Gensler," Our concern is overall to lower risk in the system and enhance transparency, to promote the competition that you, too, as well want. But we want to ensure that there then wouldn't be some regulatory arbitrage that a non-bank could have zero capital and all the banks have to have capital. So we do think it is appropriate to have some minimum amount of capital if you are holding yourself out to the public as a dealer. This is the dealers themselves. And that is generally only in, as I said, the energy commodity swaps. " FOMC20080318meeting--86 84,MR. KOHN.," Thank you Mr. Chairman. I agree with the others around the table who have said that the prospects for economic activity have taken another sizable leg down over the intermeeting period. I think we have been, for a time, in that adverse feedback loop between financial markets and spending that everybody--Governor Mishkin and others--has been talking about. That is not an unusual kind of loop to be in during a soft economic period. I think it is probably characteristic of a lot of slow growth and recessionary periods. But certainly it has been more intense this time because the financial turmoil has spread well beyond housing and has intensified significantly over the intermeeting period. The incoming data on spending, employment, and production were weaker than expected. House prices are moving lower by more than we or the markets expected. All of these data have accentuated concerns about the creditworthiness of households and businesses and, hence, about the creditworthiness of the people who lend to them, especially those who lend in the mortgage market. As perceptions of risk and risk aversion rose, there was a flight to safety and liquidity. I think we see that a little in the growth of M2 over the past couple of months, which has been very, very strong and suggests that households are retreating to money market funds, probably the ones that hold government securities, and to insured deposits. In wholesale markets there has been unwillingness to take positions and rising concerns about an array of intermediaries. Bill described this process much better than I could--illiquid markets, extreme volatility, deleveraging, margin calls, forced sales, especially in mortgage-backed securities, wider spreads, equity prices falling, and lending and funding tenors collapsing toward the overnight, again. So financial conditions have tightened for everybody but the government--and some of the European governments have seen them tighten, I guess. Mortgage rates have risen, and business bond yields have risen as well, even with Treasury rates going down. Tighter credit and declining equity and house prices are reducing wealth, and all of this weakens spending further. Now, to this process, the staff has judged that the economy has entered a recessionary state in which we can expect household and business spending to fall short of normal levels, given income and interest rates. I am not sure how much weight to put on this. I am a bit uncomfortable with constructs that don't have a clear story behind them. But I must say that, looking at the sentiment indicators and listening to what I have heard around the table today from almost every Federal Reserve District reporting, I now put more credence in Dave's recessionary state than I did before the meeting started. Obviously, something is going on that is undermining confidence and making people much more cautious than you would think, given the exogenous variables. I do think talking about the recessionary state underlines the extraordinary uncertainty we are dealing with. President Stern pointed out the 1990-91 precedent. There are some precedents for some aspects of this, but we don't have many; and I think it is really difficult to know how financial markets will evolve and how that will feed through to the variables that affect household and business spending--the reaction of households, businesses, and state and local governments to tighter credit conditions. I agree with President Stern, President Evans, and others who said they thought that the financial stresses are deeper and will last longer than we thought and will, therefore, put more restraint on spending. Until markets stabilize on a sustained basis, the risk to satisfactory economic performance by the U.S. economy will remain skewed very much to the downside. Now, Federal Reserve liquidity tools that we have used are necessary to reduce the odds on even more-intense, downward-spiral crises and market liquidity feeding back onto spending. So I think our innovations here have been useful to reduce the downside risks a little and thereby to promote spending. But I agree with the others who say that they don't directly deal with the underlying macro risk, which is really a story about capital, solvency, wealth, and prices. I think monetary policy easing is a necessary aspect of addressing these macroeconomic risks. I agree with President Fisher, President Plosser, and others that there is more going on and that monetary policy easing may not be a sufficient way of addressing these risks. But I do think, as long as the economy is weakening the way it is and we have these risks, that easing monetary policy will be helpful. It will help bolster asset prices. It will make the cost of capital lower than it otherwise would be. It may not be sufficient to turn the thing around, but I do think that without the easing that we have done-- and that I hope that we do today--the situation would be far worse than it otherwise would be. We need to ease to compensate for the substantial headwinds that we are facing. Now, the forecast for inflation has not been marked down despite the greater output gap. As others have remarked, this output gap is offset, to a considerable extent, by the upward pressure on prices from oil and commodities and import prices as the dollar has fallen and prices have risen in our exporting partners--China, for example. I have to confess that I don't really understand what has been happening to commodity prices in recent months. I don't think the rise has been justified by the news on the underlying conditions of supply and demand. It is much larger than the dollar weakness has been, and the dollar�commodity price has always been a weak relationship. So, in fact, commodity prices are rising in a bunch of currencies. This isn't just a dollar weakness problem. I have to believe that there is a speculative element here. Partly as a consequence, I am comfortable with the forecast of a flattening commodity price picture in the future--it might even decline, but at least a flattening out. I do think a shift from financial assets, especially dollar assets, into commodities is going on, and mostly this has been triggered by concerns about the U.S. economy and financial markets. In some sense, that shift is okay. It is driving down the dollar, and that is helping to stabilize the economy. The decline that we saw in oil prices yesterday suggests that, when people get more confidence about where those financial markets are going, some of those commodity prices will actually fall as the concerns about the U.S. economy are alleviated. It is sort of an upside-down relationship, but I do think we saw a bit of it that way. But I also sense that some of the rise in commodity prices and the fall in the dollar reflects concerns about the inflation outlook here. It is not surprising to me, in a very volatile and uncertain environment, that inflation expectations are not as well anchored and that they fluctuate a lot in response to new information. I expect that inflation will come down as commodity prices level off; then the output gap will increase, and that in turn will keep inflation expectations down. Still, navigating this appreciably weaker economic outlook for the real economy and the threats to financial stability, on the one hand, and the tenderness of inflation expectations, on the other, will require some discussion in the next section of our meeting, Mr. Chairman. " CHRG-110shrg50369--52 Mr. Bernanke," Well, Mr. Meltzer, who is an excellent economist and indeed who is a historian of the Federal Reserve, is concerned that the current situation will begin to look like the 1970s, with very high inflation and high unemployment. I would dispute his analysis on the grounds that I do believe that monetary policy has to be forward looking, has to be based on where we think the economy and the inflation rate are heading. And as I said, the current inflation is due primarily to commodity prices--oil and energy and other prices--that are being set in global markets. I believe that those prices are likely to stabilize, or at least not to continue to rise at the pace that we have seen recently. If that is the case, then inflation should come down, and we should have, therefore, the ability to respond to what is both a slowdown in growth and a significant problem in the financial markets. He is correct, however, that there is some risk, and if the inflation expectations look to be coming unmoored, or if the prices of energy and commodities begin to feed into other costs of goods and services, we would have to take that very seriously. I mentioned that core inflation last year was 2.1 percent, so it is food prices and energy prices, which are internationally traded commodities, which are the bulk of the inflation problem. Again, we do have to watch it very carefully, but I do not think we are anywhere near the 1970s type situation. Senator Bennett. Thank you. I wanted to get that on the record. As I look at the housing market and talk to some of my friends who are in the housing market, they tell me that the inventory is not monolithic, the inventory overhang--that is that the bulk of the overhang is in the higher-priced homes, because home builders wanted to build places where they would get the highest margin return, and if they built houses in the moderate housing area or affordable housing, their margins were not nearly as great and there were plenty of speculators willing to buy the bigger homes. And, indeed, they tell me that for affordable housing, there is, frankly, not a sufficient supply right now. They are urging me to do something on fiscal policy to stimulate people to build cheaper houses, that the housing construction would begin to catch up--not catch up. Construction levels would begin to pick up, whereas now they are dormant, waiting for the overhang to be worked off. Do you have any data that supports that anecdotal report? " CHRG-110shrg50369--30 Mr. Bernanke," Senator, we are facing a situation where we have simultaneously a slowdown in the economy, stress in the financial markets, and inflation pressure coming from these commodity prices abroad. And each of those things represents a challenge. We have to make our policy in trying to balance those different risks in a way that will get the best possible outcome for the American economy. Senator Shelby. Would you be trying to avoid stagflation, as some people call it? " CHRG-111hhrg51698--462 Mr. Hale," Chairman Peterson, Ranking Member Lucas, Committee Members, thank you. My name is Bill Hale. I have been in the grain merchandising business with Cargill for 35 years. I am joined this morning by David Dines, who has managed our OTC business for the past 15 years. As a merchandiser and processor of commodities, the company relies heavily upon efficient and well-functioning futures markets. First, I would like to thank the Chairman for holding this hearing and for his willingness to listen and address some of our concerns. We appreciate the changes made in the draft to better accommodate highly customized risk management products. Cargill encourages policymakers to develop regulatory systems that foster efficient, well-functioning, exchange-traded and OTC markets for agriculture and energy products. This can best be achieved by establishing better reporting and transparency for market participants, establishing and ensuring enforceable position limits. The existing draft of the Derivatives Markets Transparency and Accountability Act takes several positive steps, especially in the area of reporting, which will enhance the ability of the regulator to properly monitor market activities. However, the draft bill has two areas of concern. Section 6, position limits which are not constructed in the same manner for exchange-traded and OTC markets. This can be addressed by modifying how position limits are structured. This is not a question of whether they should apply. To put this in perspective, think in terms of highway speed limits. They apply to individual drivers. You do not send a car-maker a ticket when someone speeds. The same structure currently applies in the Chicago futures markets, and the same structure should apply in the OTC market. The other area of concern is section 13, mandatory clearing, which will stifle activity in the OTC market and reduce hedging opportunities in the agricultural and energy markets. This can be addressed by increased reporting requirements for OTC providers. While Cargill supports better reporting, transparency, and enforceable position limits, we urge caution and restraint for policymakers. We believe there is real danger in treating all over-the-counter products across all asset classes the same. In addition, the changes needed to improve some commodity-specific exchange-traded markets, particularly wheat and cotton, are often contract issues that have to be resolved between the exchanges and the market participants. Legislative measures are poor instruments to resolve these specific issues. Products provided by the OTC markets help hedgers, such as food, feed, industrial companies, meet risk management needs with tailored alternatives. Too often it is thought that the OTC market is solely used by speculators. However, it is critical to note that the majority of our OTC activity is for commercial and producer hedgers seeking tailored management solutions. Most critically during this unprecedented volatility, systemic risk was avoided because of the availability of both OTC and exchange-based hedging tools. Given the stress on the markets, some weaknesses were exposed, and the bill seeks to address those areas. But much of the basic functionality of the agriculture and energy markets performed well. It is important to remember that the dramatic volatility and price rise in 2008 was influenced by many variables. With strong fundamentals, commodity markets attracted many participants, both hedgers and speculators. Regarding section 6, Cargill supports enforceable position limits for noncommercial participants. However, as it was designed in the draft bill, position limits are not applied in the same manner for the OTC market as they are in exchange-traded markets. They should be structured in a similar manner for both markets. The draft bill seeks to apply the same position limit to the OTC provider as it does to the noncommercial participant. This is too restrictive to the OTC provider, since its role is to serve as an intermediary to more than one customer. This restriction will limit the size of the OTC market beyond the intended noncommercial position limits. The Committee will be able to achieve its objective of ensuring position limits in OTC transactions by applying position limits to the noncommercial participants. For section 13, we do not believe that mandatory clearing is needed. The stated benefits of central clearing are better transparency, reporting, and mitigation of counterparty risk. This can be accomplished efficiently by having standardized reporting requirements to the CFTC. The CFTC would have the ability to investigate and curtail any OTC customer whose position they believe is to large for the underlying commodity market. Centralized clearing has a role and should be encouraged for financially weaker market participants. However, financially strong food companies, industrials, commercials, and producers should have the flexibility to negotiate credit terms. Removing this flexibility from both simple and tailored OTC products will greatly reduce hedging activity through the working capital requirements of margin. Changes to the current system would be occurring at a time when liquidity and credit are already constrained, and at a time when hedging should be encouraged. Agriculture and energy OTC providers for many years have effectively used collateralized margining agreements and other credit support mechanism to manage credit and market exposures. This system works very well. It was simple OTC swaps on the grains that helped enable Cargill and other grain buyers to reopen deferred grain purchases from the farmer during 2008. Had the bill been in place in its current form, Cargill and other grain buyers would have been unable to use simple swaps to mitigate the margin requirements imposed on futures hedges. As a consequence, farmers would have been further burdened by the lack of pricing and liquidity for their crops. While the bill currently has provisions that allow for exceptions to centralized clearing for highly customized transactions, it is a little unclear to us what will and will not qualify for this exception. It is critical that no changes be made that would inhibit customized hedges, as this would also significantly reduce prudent hedging among market participants. If you think of the futures contract as one type of product, Cargill has over 130 different types of OTC products. The hedging customer can choose to further tailor the protection time frame, price level, and transaction size. Given this, no two 0TC transactions are identical, which is why centralized clearing is problematic. Clearing organizations do not have the systems and processes necessary to value and clear a wide range of products with a high degree of customization. In conclusion, Cargill appreciates the work of the House Agriculture Committee, ensuring that both exchange-traded and OTC markets perform well. These markets provide critical functions. This past year was clearly a volatile and difficult time for the commodity markets. Steps can and should be taken to improve market transparency and reporting, as well as ensuring that position limits are effectively enforced. We have serious concerns about sections 6 and 13 in the draft legislation, but we are confident that we can work constructively with Members of the Committee to develop policy alternatives that will help ensure the integrity of the markets. Thank you. [The prepared statement of Mr. Hale follows:]Prepared Statement of William M. Hale, Senior Vice President, Grain and Oilseed Supply Chain North America, Cargill, Incorporated, Wayzata, MN My name is Bill Hale, Senior Vice President, Grain and Oilseed Supply Chain North America. I am testifying on behalf of Cargill, Incorporated and have been in the grain merchandising business for 35 years. I am also joined this morning by David Dines, President of Cargill Risk Management. Cargill is an international provider of food, agricultural, and risk management products and services. As a merchandiser and processor of commodities, the company relies heavily upon efficient and well-functioning futures markets. Cargill is also active in the energy markets, offering risk management products and services to commercial customers. Cargill encourages policymakers to develop regulatory systems that foster efficient, well-functioning exchange-traded and over-the-counter markets for agricultural and energy products. This can be best achieved by: Establishing better reporting and transparency for market participants. Establishing and ensuring enforceable position limits. This past year was a period of remarkable volatility driven by many factors and, by large measure, the agriculture and energy commodity markets responded appropriately. The existing draft of the Derivatives Markets Transparency and Accountability Act of 2009 takes several positive steps, especially in the area of reporting which will enhance the ability of the regulator to properly monitor market activities. However, the draft bill has two areas of concern: Section 6: Position limits, which are not constructed in the same manner for exchange-traded and OTC markets. This can be addressed by modifying how the position limits are structured. This is not a question of whether they should apply. Section 13: Mandatory clearing, which will stifle activity in the OTC market and reduce hedging opportunities in the agricultural and energy markets. This can be addressed by increased reporting requirements for OTC providers and segmenting credit default swaps from traditional agriculture and energy contracts. While Cargill supports better reporting, transparency and enforceable position limits, we urge caution and restraint for policymakers. The agricultural and energy over-the-counter markets are not the source of systemic risk and abuse that the credit default swap market has been. We believe there is real danger in treating all over-the-counter products across all asset classes the same. In addition, the changes needed to improve some commodity-specific exchange-traded markets, particularly wheat and cotton, are very often contract issues that have to be resolved between the exchanges and the market participants. A well-informed regulator can be helpful in making sure balanced decisions are made that ensure contract functionality and market integrity, but broad legislative measures are poor instruments to resolve these specific issues.Role of Commodity Futures Markets and Over-the-Counter Markets The objective of a commodity futures market is to provide a price discovery mechanism and allow for effective risk transfer. For a commodity futures market to meet this objective, there must be both convergence with the futures price relative to the underlying cash value of the commodity at the time of delivery and a balanced range of market participants to provide adequate liquidity and efficiency. In addition to buyers and sellers with a physical interest in the underlying commodity, speculators also play a vital role in enhancing liquidity and futures contract performance. In effect, they help bridge the gap between buyers and sellers and ensure that contracts are quickly filled with the least possible transaction costs. Beginning with farmers and other commodity producers, and extending all the way through the supply chain to end-users, it is critical to have well-performing futures markets. Futures products allow farmers to know what their product is worth and to better manage their risks by setting a price for the commodity that is close to their actual delivery time. For consumers or processors, the same is true in allowing them to hedge their risks and gain greater certainty over their costs. Products provided by the over-the-counter (OTC) markets help hedgers meet risk management needs with tailored alternatives that cannot realistically be provided by traditional commodity futures and options markets. Too often is it thought that the OTC market is solely used by speculators, however it is critical to note that a majority of our OTC activity is for commercial and producer hedgers seeking risk management solutions tailored for their business needs.Unprecedented Commodity Market Volatility During 2008 During 2008, we experienced an unprecedented increase in commodity prices, only to be immediately followed by a decline of the same historical magnitude. This in itself has been tough for market participants to bear, but we now know that this has been followed by one of the worst economic crises in 80 years. In the world of risk management, we often talk of stress events and this was one of epic proportions. No risk manager could have ever contemplated what the markets have just gone through. I mention this because if there was ever a test for the agricultural and energy futures and over-the-counter markets it was these past twelve months. Fortunately, in many ways, these markets performed well as demonstrated by limited credit issues and limited contract defaults. Most critically, during this unprecedented volatility, systemic risk was avoided because of the availability of both OTC and exchange-based hedging tools. Given the stress on the markets, some weaknesses were exposed and the bill seeks to address those areas, but much of the basic functionality of the agriculture and energy markets performed well.Fundamental Factors Influencing Market Behavior and Speculation It is important to remember that the dramatic volatility and price rise in 2008 was influenced by many variables. Ending stocks for many of the key commodities were tight. In wheat, for example global supplies had been reduced by 2 years of major drought in Australia, a major wheat exporter. Global stocks of grain and key oilseeds[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Source: USDA. Foreign Agricultural Service. The ethanol mandate increased demand for corn. In response, producers planted more corn acres during the 2007 crop year and fewer soybeans, resulting in a very tight carryout balance for soybeans prior to the 2008 harvest. Also on the demand side, projections for continued growth in China, India and much of the developing-world showed growing needs for many of the basic agricultural and energy commodities. These factors were widely known within the farming, trading, processing, and investing communities. USDA Ag Outlook 2008 Projected Demand Growth 1996 = 100[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Source: USDA. With strong fundamentals, commodity markets attracted many participants, both hedgers and speculators, who believed commodity prices would rise. These fundamentals did not only attract capital to futures markets, but also attracted resources toward physical commodity production. Land costs increased for good quality farmland and producers stepped up investments in production technology through equipment, seeds and fertilizer. It is also important to note that even exchange-traded markets with no index fund participation also experienced extreme volatility this year. The volatility and price movements of the Hard Red Spring Wheat contract traded at the Minneapolis Grain Exchange were especially dramatic. Prices rallied 500% from May 2007 through February 2008, reaching a high of $25 per bushel.Derivatives Markets Transparency and Accountability Act of 2008 Cargill supports many of the components of the draft bill before the Committee today and appreciates the work of the Chairman. The bill would improve reporting and transparency. However, we are concerned with two specific areas under consideration by the Committee: Section 6, regarding how position limits may be applied to OTC product providers. Section 13, regarding mandatory clearing of OTC transactions through a derivative clearing organization. Both provisions have negative unintended consequences.Section 6: Application of Position Limits Cargill supports enforceable position limits for noncommercial participants. However, as designed in the draft bill, position limits are not applied in the same manner for the OTC market as they are in the exchange-traded markets. They should be structured in a similar manner for both markets.[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] In exchanged traded markets, the clearing broker serves as an intermediary or aggregator of positions, just like the dealer does in the OTC market. Position limits are applied to noncommercial participants in exchange-traded markets and not to the clearing broker. Limits in the OTC market should be categorically applied in the same manner, only to the noncommercial participant and not the OTC provider. The draft bill seeks to apply the same position limit to the OTC provider as it does to the noncommercial participant. This is too restrictive to the OTC provider since its role is to serve as an intermediary to more than one customer. This restriction would limit the size of the OTC market beyond the intended noncommercial position limits. The Committee will be able to achieve its objective of ensuring position limits in OTC transactions by applying position limits to only the noncommercial participants. Addressing this issue in this manner will ensure enforceable position limits and continue the functionality of this segment of the market.Section 13: Clearing of Over-the-Counter Transactions Substantial benefits can be achieved through better reporting by OTC providers. Segment the OTC market to focus on areas with the greatest challenges. Tailored risk management OTC contracts for hedgers cannot be cleared. Standardized swaps convey substantial benefits to a wide range of market participants and these benefits will be lost if clearing is mandatory. A stated benefit of central clearing is better transparency and data reporting. However, this is a restrictive and expensive means for collecting data about OTC market positions and participants. Cargill believes that this can accomplished efficiently by having standardized reporting requirements to the CFTC by the OTC provider community. Other sections of the draft bill directly address the issue of better data and reporting, and will achieve the needs of the Commodity Futures Trading Commission and Congress. One solution would be to have the CFTC restrict OTC activity to approved OTC providers. These approved OTC providers would have a reporting requirement to the CFTC in a standardized format and on a regular basis of all OTC transactions by customer that exceed a certain size threshold. The CFTC would have the ability to investigate and curtail any OTC customer whose position they believe is too large for the underlying commodity markets. The CFTC has this existing authority for investigating customer positions at the clearing broker on listed futures and it works well. Another stated benefit of centralized clearing is the mitigation of counterparty credit risk, since it requires both initial margin and the daily settlement or margining of 100% of the mark-to-market differences between the two parties. While centralized clearing has a role and should be encouraged for financially weaker market participants, financially strong food companies, industrials, commercials and producers should have flexibility to negotiate their own credit terms. As they stand today, the agriculture and energy OTC markets allow for efficient and prudent extension of credit by the OTC provider to financially strong hedging customers. Removing this flexibility for both simple and tailored OTC products will greatly reduce hedging activity due to the working capital requirements of margining. Changes to the current system would be occurring at a time when liquidity and credit are already critically constrained, and at a time when hedging should be encouraged, given the volatility in today's commodity markets. Agricultural and energy OTC product providers for many years have effectively used margining agreements and other credit support mechanisms to manage credit exposures. OTC product providers, including Cargill, have developed processes and built systems that enable us to value our customers' OTC positions and send position statements daily with updated and transparent product valuations. Based upon these valuations and statements, the parties pay or receive margin collateral daily once a credit threshold is reached. This system works very well. Again, if there was ever a test for this it was during the past year. Changing this flexibility in setting credit terms will have the perverse effect of reducing the hedging activity across financially stronger customers since they are the ones currently receiving margining credit from the OTC provider community. Financially weaker customers are either not receiving the margining credit from the OTC provider or they are already using futures because it is their only option. It must be recognized that centralized clearing penalizes participants with strong financial positions.Mandatory Clearing Can Impact Producer Pricing Opportunities Within the agriculture and energy markets, simple OTC swaps convey many benefits through the flexibility in setting credit terms. In the physical grain business, cash flow mismatches exist for grain buyers since they are required to meet the daily margining requirements of futures hedges and are not able to collect an offsetting margin payment from the farmer since physical grain purchase contracts are typically not margined with the farmer. Last Spring, many U.S. grain buyers, including Cargill, curtailed their deferred purchases of grain from farmers because of the historic run-up in commodity prices and the significant amounts of working capital that were needed for operational inventories and to fund the margin requirements of the underlying futures hedges for deferred contracted grain. This was an extremely difficult time for farmers and for grain buyers. Critically, it was simple OTC swaps on the grains that helped enable Cargill and other grain buyers to reopen deferred purchases of grain from the farmer during 2008. Using simple OTC swaps, grain buyers were able to move their hedging for contracted bushels from futures to OTC swaps with OTC providers that put in place margin credit thresholds on the mark-to-market exposure. The bill in its current form only grants an exception to centralized clearing for highly customized swaps, but not for simple swaps. Had the bill been in place in its current form, Cargill and other grain buyers would not have been able to use simple swaps to help mitigate the margin requirements imposed on futures hedges. As a consequence, farmers would have been further burdened by a lack of pricing and liquidity for their crops.Mandatory Clearing Is Extremely Difficult for Customized Products While the bill currently has provisions that allow for exceptions to centralized clearing for highly customized transactions, it is unclear what will and will not qualify for this exception. It is critical that changes are not made that would in any way inhibit customized hedges, as this would also significantly reduce prudent hedging among market participants. A key attribute of the OTC markets in agricultural and energy is the broad menu of product choices, as well as specific tailoring of the hedging instrument to precisely meet the hedger's needs. The advantages of product choices and tailoring are that they deliver both a more efficient hedge and a more cost-effective hedge because the hedger is not paying for something that they do not need. It also allows for diversification of products, which is so critical in today's marketplace. OTC product choices include protection size, protection periods, protection levels, and types of protection. If you think of a futures contract as one type of product, Cargill has over 130 different types of OTC products that we are offering our hedging customers. From these 130 different product types, the hedging customer can choose to further tailor the protection timeframe, price level and transaction size. Given this, no two OTC transactions are identical, which is why centralized clearing is problematic. Clearing organizations do not have the systems and processes necessary to value and clear a wide range of products with a high degree of customization. If this were the case, tailored risk management services would have become available on exchanges years ago. OTC providers such as Cargill create new products by having strong customer relationships, listening to and understanding our customers' commodity risks, and developing products to address these risks. This requires a significant investment of time, human and technological resources, and financial capital. Centralized clearing will put intellectual property in the public domain immediately which will eliminate any economic incentive that OTC providers have for new product development. Now more than ever, customers need new and better products to help them hedge.Summary Cargill appreciates the work of the House Agriculture Committee in ensuring that both the exchange-traded and OTC market perform well. These markets provide critical functions in allowing open price discovery and enhance risk management opportunities. Well performing markets benefit all participants across the supply chain. This past year was clearly a volatile and difficult time for the commodity markets. Steps can and should be taken to improve market transparency and reporting, as well as ensuring that position limits are effectively enforced. We have serious concerns about sections 6 and 13 in the draft legislation, but we are confident that we can constructively work together with Members of this Committee to develop policy alternatives that will help ensure the integrity of the markets, while minimizing the unintended consequences. Thank you for the opportunity to testify before the Committee today and we look forward to working together as the legislation continues to develop. " CHRG-111hhrg51698--585 Mr. Marshall," Thank you, Mr. Chairman. I guess we are trying to address here two related but different problems. One, the recent economic crisis that seems to have been compounded by systemic risk caused by an interwoven relationship that is very difficult to understand, as a result of the fact that this is a very opaque market. There are a lot of people that are involved in the market, and there would be lots of different ways of addressing that. Certainly clearing could be one. You have heard, I guess over the couple days, the different discussions we have had about clearing and compromises with regard to clearing. We started this legislation last summer though, because we were quite concerned about the volatility of commodity markets. And we passed legislation in the late summer or early fall that was designed to address that problem. I guess I would like to hear Mr. Kaswell and Mr. Rosen's thoughts, but I am going to have to make it a hypothetical question to you. I would like you to assume that we have concluded that passive investment money, it has been described as index fund money, et cetera, is a culprit in the sharp rise in commodity prices. Not necessarily all, some of it is demand-driven. But let's assume that we have concluded that a substantial amount of the upswing, and now a substantial amount of the downswing, is explained by the presence of this money in these markets that hasn't been there before. It is a fairly recent phenomena. And what we would like to do is figure out a way to have the markets go back to functioning appropriately as they had, or at least functioning as well as they did, not perfectly, of course, but as well as they did prior to the presence of this money. A number of different suggestions have been made. One is aggregate position limits across all markets, so OTC, on-exchange. Other suggestions have been position limits that apply only to the exchange-traded commodities and not to the OTC market. Others have suggested that the CFTC needs to be given some tools that would be a combination of maybe position limits and possible exemptions, and directed to minimize the inappropriate impact as we find it to be, of this kind of passive money or index money, or whatever you want to call it, in the futures markets, rather than directing the CFTC to set equal position limits, et cetera. I would like to hear you guys, your thoughts, if we are trying to accomplish this, how we would best go about accomplishing this without otherwise messing up the market? " CHRG-111hhrg74855--96 Mr. Waxman," If market manipulation or fraud occurred in a FERC regulated marketplace under CFTC's jurisdiction, would the exclusivity clause of the Commodities Exchange Act prevent FERC from exercising its anti-market manipulation authorities? In other words, would FERC regulation be displaced by CFTC regulation? You don't think so but that is what we are concerned about. I think it needs to be clarified if you don't think--if you agree with us. " CHRG-111hhrg55811--178 Mr. Gensler," Well, I was going to say it depends on the market today, but in the rates-based various estimates, close to 80 percent of the market is already standard in some regard. In the commodity and the credit default space, it is lower, but still probably 60 or 70 percent. These is anecdotal evidence of that. But we are not trying to homogenize the other 20 to 40 percent. There is no goal in the Administration proposal or in the discussion draft to do that. " FOMC20060131meeting--60 58,MR. STOCKTON.,"2 As we see it, the recent configuration of data suggests that, to the extent that there was any noticeable weakness in the fourth quarter, it was short-lived, and we are Thank you, Mr. Chairman. A few years back, I noted that my briefings could largely be characterized as a collection of confessions and excuses. This morning I would like to add a new element to that list: denial. As you know, the BEA’s advance estimate for the growth in real GDP in the fourth quarter—shown in the top left panel of your first exhibit—came in last Friday at an annual rate of 1.1 percent, about half the pace that we had projected. But at this point, we don’t believe that this estimate should be taken as a signal that the economy has fundamentally weakened. To be sure, after a first round of sorting through the details of that report, we haven’t found a smoking gun that gives us any strong reason to override the BEA’s estimate. But we have assumed that there will be a bounceback in some areas that were surprisingly weak last quarter, most notably motor vehicle output and federal spending. 2 The materials used by Messrs. Stockton, Struckmeyer, and Sheets are appended to this transcript (appendix 2). heading into the first quarter on a reasonably solid trajectory. As seen in the top right panel, after spiking up this autumn, initial claims quickly returned to pre-hurricane levels and have dropped even further in recent weeks, giving no suggestion of any softening in the labor market. Industrial production (line 1 of the middle left panel) actually peaked in the fourth quarter, driven by a sharp acceleration in manufacturing output (line 2). Moreover, as shown to the right, recent manufacturing surveys are supportive of our forecast of moderate gains in production as we move into the new year. Consumer spending and capital outlays have also remained solid. Setting aside the effects of the large swings in motor vehicle purchases that occurred in the second half of last year, consumer spending, shown in the bottom left panel, has been on a steady uptrend. And yesterday’s reading on real PCE excluding motor vehicles in December suggests that the first quarter started on a strong note. Shipments of nondefense capital goods (plotted as the red line in the bottom right panel) were released last week after the Greenbook was published, and they were stronger than we had projected. Moreover, new orders (the black line) have remained above shipments, suggesting that equipment spending should be buoyant in coming months. The top left panel of your next exhibit lays out our longer-term outlook for real GDP. As seen by the blue bars, the growth of real GDP is projected to step up this year to 3.9 percent before falling back to 3 percent in 2007. That pattern is influenced importantly by our assumed hurricane effects, and as shown by the red bars, aside from those effects we are expecting a gradual deceleration in activity over the next two years. Our inflation projection is shown to the right. Overall PCE prices are expected to decelerate over the next two years as consumer energy prices slow sharply. We continue to expect a small bump-up in core inflation this year as higher prices for energy, nonfuel imports, and commodity prices are passed through into the prices of final goods and services. But we expect core inflation to edge back down in 2007 as these influences abate. Although this story is pretty much the same as the one in December, we did have, in addition to last Friday’s GDP excitement, a few other developments to deal with over the intermeeting period. As shown in the middle left panel, crude oil prices rose further in recent weeks and are now projected to average $6.50 per barrel higher than in the December Greenbook. As Nathan will be discussing shortly, we also revised up a bit our projection for foreign activity, lowered our projection for the dollar, and—as shown in the middle right panel—raised our forecast for nonfuel import prices. With oil and imports providing a little more upward pressure on costs, we nudged up our forecast for core PCE prices this year and, along with it, our fed funds assumption over the next year—plotted as the black line in the bottom left. We made no substantive changes to our fiscal policy assumptions. As shown in the bottom right panel, fiscal policy provides some impetus to activity this year, related largely to hurricane spending and the implementation of the prescription drug benefit, but is expected to be a nearly neutral influence next year. The principal source of slowing in aggregate activity in our forecast continues to be the housing sector, the subject of exhibit 3. The accumulating data have made us more confident, though far from certain, that we are reaching an inflection point in the housing boom. The bigger question now is whether we will experience the gradual cooling that we are projecting or a more pronounced downturn. I’ll be interested to hear your reports this morning. As for the recent data, sales of existing homes (the red line in the top left panel) have dropped sharply in recent months and by more than we had expected. New home sales (the black line) have also moved off their peaks of last summer but are more consistent with our expectation of a gradual softening. That expectation receives some further support from the more-timely mortgage bankers’ purchase index—plotted to the right. Purchase applications also are off their highs but are not indicating any sharp retrenchment through January. With respect to house prices, the recent data and anecdotes also have pointed to some weakening. As a result, our forecast of a sharp deceleration in home prices— shown in the middle left panel—seems less of a stretch than it did a while back. As shown to the right, the bottom line is that, after contributing importantly to the growth of real GDP over the past four years, residential investment is expected to decelerate sharply this year and to turn down a bit in 2007. As we have noted before, our house- price forecast also has implications for consumer spending. Slower growth of house prices is the chief factor causing the wealth-to-income ratio (the black line in the bottom left panel) to drift down over the projection period. That downdrift, along with the lagged reaction to higher interest rates, results in a gradual rise in the personal saving rate over the next two years. As shown to the right, although spending growth falls short of that of income, overall PCE receives considerable support from the strong gains in disposable income that result from the projected flattening of energy prices, ongoing employment gains, and a step-up in the pace of hourly compensation. Business investment is the subject of exhibit 4. Spending on equipment and software, plotted as the black line in the top left panel, slows gradually over the projection period, largely because the accelerator effects that propelled the earlier recovery in capital outlays begin to wane. Nevertheless, with the cost of capital remaining moderate and corporate balance sheets strong, we are forecasting solid increases in real E&S spending this year and next. Our projection for total nonresidential structures, shown in the panel to the right, reflects some divergent patterns in the components. We expect outlays for drilling and mining (line 2) to increase sharply further this year in response to the run-up that has occurred in the prices for crude oil and natural gas. Although those prices are expected to level off, the lagged effects of the earlier gains should result in some further, albeit diminished, increase in drilling activity in 2007. Excluding drilling and mining (line 3) we are projecting a modest recovery in nonresidential construction activity in response to ongoing gains in employment and gradually declining vacancy rates in the office and industrial sectors. One of the reasons that we are reasonably optimistic about the investment outlook is that the total return to capital—plotted in the middle left panel—remains quite favorable. And although we expect that return to recede a bit as labor costs pick up, it would still remain elevated by historical standards over the forecast period. The remainder of the exhibit is something of a going-away present to the Chairman. While he always seemed to have a grip on where productivity was headed in the future, we always seemed to be struggling to explain what had happened in the past. Most recently, those struggles have centered on understanding the continuing strong gains in productivity in the first half of this decade. One important element of our story has been that the investment boom of the late 1990s was at least partly responsible for sowing the seeds of the further acceleration in multifactor productivity that we have experienced this decade. That capital equipment embodied rapidly improving technologies and allowed firms to sometimes radically restructure business processes. More broadly, as adjustment costs associated with absorbing those investments waned, the productivity advantages showed through more clearly. The bottom panel provides some modest support for the proposition that some of the improved performance of multifactor productivity of the first half of the decade can be traced to the earlier investment boom. That panel employs a new data set based on research spearheaded by my colleagues Carol Corrado, Paul Lengermann, and Larry Slifman that calculates multifactor productivity for detailed industries. Along the x-axis, we measure for each of 60 industries the average rate of growth in investment over the 1995-to-2000 period relative to that industry’s historical norm. On the y-axis, we plot the acceleration in MFP experienced by each industry from the 1995-to-2000 period to the 2000-to-2004 period. As seen by the red regression line, those industries for which the growth of equipment and software was unusually high in the late 1990s were more likely than others to experience a subsequent acceleration in multifactor productivity in the first part of this decade. Obviously, this is not a structural relationship and is meant to be impressionistic. But the recovery in equipment spending over the past few years leaves us optimistic that multifactor productivity can continue to grow at a rapid clip, though perhaps not quite at the pace registered over the first half of the decade. Sandy will now continue our presentation." CHRG-110shrg50369--15 Chairman Dodd," Thank you very much, Mr. Chairman. We will make these 7 to 8 minutes, and, again, I will not be rigid about the time constraints. Let me begin, Mr. Chairman, by going back to that old question that was asked more than, I guess, 30 years ago. I will sort of paraphrase on it, and that is, are we better off today to respond to this situation than we were--in this case I want to ask 7 years ago. The question that Ronald Reagan asked, I think, in 1980 in that campaign, Are we better off today than we were yesterday? And the reason I raise that is because I have been struck by the similarities between 2001 and that period going into, potentially falling into a recession, and here we are in 2008. The parallel seems striking to me in some ways, and I want you to comment on this, if you could. At both moments in this 7-year period, we are on the brink of a recession--at least it seems so. The Fed was cutting interest rates very aggressively. A major asset bubble--in this case, it was the high-tech community rather than housing--was bursting. Yet despite those similarities, the differences in the basic economic information seems to be very, very different as well. Americans had just experienced the greatest economic boom in a generation. Real wages had gone up substantially. Income inequality had narrowed. The Federal Government was in a surplus. In fact, on this very Committee, your predecessor came to a hearing--I do not know who else was on the Committee in those days, but he came and talked about the things we ought to think about by retiring the national debt entirely. There were some downsides to that, and we actually had a very good hearing with Alan Greenspan about that very question in 2001. The dollar was at record highs as well, and, of course, today we are in the opposite position, with the dollar at its lowest level since we began floating currencies in 1973. Inflation is at a 17-year high. Real wages are falling, and we are faced with record Government debt and deficits. A very different fact situation than was the case in 2001. In 2001, as well, one might argue that there were deliberate actions taken by the Federal Reserve to deal with rising inflation. So the steps were in response to inflation here. Obviously, what is provoking, I think, the action--and you can certainly comment on this--is a different fact situation. So the question appears in a sense: Are we in a--what would be your analysis? Are we in a--comparing these two periods in time of history, relatively close to each other, faced with similar situations, it would appear to me that we are not in as strong a position to respond to this as we were in 2001. And so the question is, Are we better off? And if so, I would like you to explain why. And if not, what should we be doing and what different steps should we be taking if we cannot rely on these basic underlying strengths that occurred in 2001 that helped us at that time as opposed to where we are today? " FOMC20080430meeting--54 52,MR. SHEETS.," Much as Dave just described for the domestic economy, our forecast for economic activity abroad also is little changed from the last Greenbook. Recent data have come in consistent with our view that the slowdown in U.S. activity and the ongoing financial turbulence will leave an unmistakable imprint on economic growth abroad. But the extent of this imprint appears to be somewhat less pronounced than was the case in the high-tech-led recession earlier this decade, particularly for the emerging market economies. Thus we continue to see foreign growth stepping down from last year's 4 percent pace to near 2 percent during the second and third quarters of this year, as foreign activity is constrained by the weakening U.S. economy and headwinds from the ongoing financial turmoil. With these factors projected to abate, we see growth abroad rising back to near its trend rate of around 3� percent in 2009. Suffice it to say, the risks around this forecast remain significant. On the upside, China's surprisingly strong first-quarter GDP growth--which we estimate was nearly 11 percent at an annual rate--highlights the possibility that growth in emerging Asia, and perhaps elsewhere as well, may remain more resilient than we anticipate. On the downside, the softer-than-expected German IFO data last week and the negative tone of the Bank of England's recent credit conditions survey suggest that growth in Europe may slow more than we now project. The exchange value of the dollar, after falling sharply in the month before the March FOMC meeting, has rebounded somewhat during the intermeeting period. Against the major currencies, the dollar is up almost 2� percent, with a particularly sizable gain against the yen. Going forward, we continue to see the broad real dollar depreciating at a 3 percent pace, reflecting downward pressures associated with the large (albeit narrowing) current account deficit. This depreciation is expected to come largely against emerging market currencies (including the Chinese renminbi), which have moved less since the dollar's peak in early 2002. Turning to the U.S. external sector, we now see the arithmetic contribution from net exports to first-quarter U.S. real GDP growth as likely to be around 0.3 percentage point, down a few tenths from the last Greenbook. Recent readings on exports have continued to point to strength, but imports in February bounced back from their December and January weakness more vigorously than we had expected. For 2008 as a whole, we continue to believe that the demand for imports will be significantly restrained by the weak pace of U.S. activity and, to a lesser extent, by the depreciation of the dollar and rising prices for imported commodities. We thus see imports contracting nearly 2 percent this year. In contrast, exports are expected to post 7 percent growth this year, supported by the weaker dollar. The projected contraction of imports, coupled with still-strong export growth, suggests that net exports will contribute nearly 1� percentage points to U.S. GDP growth this year-- the largest positive contribution from net exports to annual growth in more than 25 years. In 2009, import growth is expected to bounce back to around 4 percent as the U.S. economy recovers, and the positive contribution from net exports should accordingly decline to just under � percentage point. Oil prices have continued their apparently relentless march upward, with spot WTI now trading at $115 per barrel. Since your last meeting, the spot price of WTI has increased $6 per barrel, and the far-futures price has moved up almost $5 per barrel. Over the past year, spot oil prices have risen a staggering 80 percent. While the high level of oil prices appears to be taking a bite out of oil demand in the United States and other industrial countries, the demand for oil in the emerging market economies--particularly in China and India--has been supported by the resilience of GDP growth there. In addition, fuel subsidies in some countries (including India) have sheltered consumers from the effects of higher oil prices. In line with these observations, India's state-owned oil company recently released projections indicating that oil demand in the country will increase 8 to 10 percent this year. The supply-side response to the rising demand for oil has been only tepid. Stated bluntly, OPEC remains unwilling--or unable--to increase its supply to the market. Indeed, OPEC has actually cut its production over the past two years. In addition, oil production in the OECD countries has been on a downward trajectory, primarily reflecting the decline in the North Sea fields and in Mexico's giant Cantarell field. Mexico's state-owned oil company recently indicated that, for the sixth consecutive year, additions to its reserves had failed to keep pace with production. The grim outlook for Mexico's oil industry has prompted the government to consider allowing foreign investment in the country's energy sector, a move that would require constitutional reform. Finally, although the potential supply from non-OECD nonOPEC countries is substantial, production continues to be hampered by inadequate infrastructure and by uncertainties about property rights and the stability of tax regimes. In the absence of any better approach, we continue to base our forecast on quotes from futures markets, which see oil prices as likely to remain high--at or above $110 per barrel--through the end of the forecast period. But the confidence bands around this forecast are exceptionally wide given uncertainties surrounding the outlook for oil supply and demand. Nonfuel commodity prices have also been on a wild ride of late. The prices of many of these commodities increased particularly sharply in January and February, before peaking in early March. On balance, our index of nonfuel commodity prices rose at a hefty annual rate of 50 percent during the first quarter. We project a further 13 percent rise in the second quarter, but--again in line with quotes from futures markets--we see these prices flattening out thereafter. The underlying drivers of the sustained run-up in the prices of nonfuel commodities have been broadly similar to those for oil--sharp increases in demand (particularly from emerging-market economies) coupled with typically lagging and often muted supply responses. Notably, however, moves in nonfuel commodity prices since the March FOMC meeting have been quite varied. For example, copper and aluminum prices are up whereas nickel and zinc prices are down. For foods, corn, rice, and soybean prices have risen while wheat prices have declined substantially. The overall strength of commodity prices continues to put upward pressure on inflation in many countries and to complicate life for central banks. Notably, in the euro area, 12-month headline inflation in March rose further, to 3.6 percent, well above the ECB's 2 percent ceiling. In the United Kingdom, inflation pressures stemming from rising utility, gasoline, and food prices are likely to push inflation toward 3 percent during the summer, raising the risk that Mervyn King will be required to write another letter to the Chancellor of the Exchequer explaining why inflation has deviated from the 2 percent target. Concerns about the inflation outlook have limited the willingness of both the ECB and the Bank of England to cut policy rates to address slowing growth. Perhaps even more striking, faced with upward pressures on inflation from rising food and energy prices coupled with still-solid economic growth, central banks in a broad array of emerging market economies tightened policy over the intermeeting period. This group included China, Singapore, India, Brazil, Russia, Poland, Hungary, and South Africa. In addition, some countries have recently responded to social unrest and other strains brought on by higher food prices by restricting exports of foodstuffs, particularly rice, and this has exacerbated upward pressure on the global prices of these commodities. The run-up in commodity prices, coupled with the weaker dollar, has pushed up U.S. core import price inflation of late. Core import prices are now estimated to have increased at a 7� percent annual rate in the first quarter, more than twice the pace of increase in the second half of last year. Prices of material-intensive imports (including industrial supplies and foods) are seen to have surged at a surprisingly rapid pace of 20 percent in the first quarter, on the back of the rapid rise in commodity prices. Prices of imported finished goods (including consumer goods, capital goods, and autos) are estimated to have risen at a comparatively muted rate of 3� percent, but this also was up sharply compared with recent quarters. The acceleration in finished goods prices seems well explained by recent moves in the dollar, however, and does not suggest any notable increase in the extent of exchange rate pass-through. Going forward, we see core import price inflation remaining elevated in the second quarter, at around 6 percent. Thereafter, core import price inflation should abate, given the projected flattening out of commodity prices and the slower pace of dollar depreciation. " CHRG-110shrg50409--93 Mr. Bernanke," Yes, of course. With almost no exceptions, speculators in commodities never take delivery. They have to sell their position when it comes due, and so they are not in any way using up the physical resource that underlies the contract. So there has always to be two sides to every transaction. Senator Crapo. And the liquidity that we are talking about, am I correct, is primarily being provided for those who are not actual users of petroleum. This liquidity is primarily coming from pension funds. Is that not correct? " fcic_final_report_full--419 On November , , a bankruptcy court ruled that the Bank of New York could not foreclose on a loan it had purchased from Countrywide, because MERS had failed to endorse or deliver the note to the Bank of New York as required by the pooling and servicing agreement. This ruling could have further implications, be- cause it was customary for Countrywide to maintain possession of the note and re- lated loan documents when loans were securitized.  Across the market, some mortgage securities holders have sued the issuers of those securities, demanding that the issuers rescind their purchases.  If the legal challenges succeed, investors that own mortgage-backed securities could force the is- suers to buy them back at the original price—possibly with interest. The issuers would then be the owners of the securities and would bear the risk of loss.  The Congressional Oversight Panel, in a report issued in November , said it is on the lookout for such risks: “If documentation problems prove to be pervasive and, more importantly, throw into doubt the ownership of not only foreclosed prop- erties but also pooled mortgages, the consequences could be severe.”  This sentiment was echoed by University of Iowa law professor Katherine Porter who has studied foreclosures and the law: “It is lack of knowledge of how widespread the problems may be that is turning the allegations into a crisis. Lack of knowledge feeds specula- tion and worst-case scenarios.”  Adam Levitin, a Georgetown University associate professor of law, has estimated that the claims could be in the trillions of dollars, ren- dering major U.S. banks insolvent.  NEIGHBORHOOD EFFECTS: “I ’M NOT LEAVING ” For the millions of Americans who paid their bills, never flipped a house, and had never heard of a CDO, the financial crisis has been long, bewildering, and painful. A crisis that started with a housing boom that became a bubble has come back full cir- cle to forests of “for sale” signs—but this time attracting few buyers. Stores have shut- tered; employers have cut jobs; hopes have fled. Too many Americans today find themselves in suburban ghost towns or urban wastelands, where properties are va- cant and construction cranes do not lift a thing for months. Renters, who never bought into the madness, are also among the victims as lenders seize property after landlords default on loans. Renters can lose the roof over their heads as well as their security deposits. In Minneapolis, as many as  of buildings with foreclosures in  and  were renter-occupied, according to sta- tistics cited in testimony by Deputy Assistant Secretary Erika Poethig from the U.S. Department of Housing and Urban Development to the House of Representatives Subcommittee on Housing and Community Opportunity.  FOMC20080625meeting--34 32,MR. FISHER.," If I may, I would like to ask Nathan, Mr. Chairman, about exhibit 4 and exhibit 5. Particularly noteworthy is that exhibit 4 is the forecast period showing a significant decline in inflation in the emerging market economies. I am wondering what that is based on. Do we have a sense of capacity utilization or slack, if it is all reliable, or is it based on a sense of commodity prices? What is that noticeable down-swoop? " CHRG-111hhrg55811--303 Mr. Bachus," We didn't really have any problem with commodity derivatives. What we had problems with was basically the subprime market, that it was junk, and they put junk in derivatives, and if you put junk in, then the derivative is junk. And so if you regulate, if you put rules which the Congress has on subprime loans, and you--we have regulations on underwriting, and we had unregulated subprime lenders, but if we regulate those, and we try to have some credit-rating reform, and we have had subprime lending reform, that wouldn't be repeated hopefully, would it? " CHRG-111hhrg51698--349 Mr. Neugebauer," Mr. Taylor, I know that I heard from a number of my producers when we had the anomalies in the cotton market, and everybody was scrambling as they wanted to certainly find a way to sell at the prices the commodity contracts moved to. Since then, things have seemed to have stabilized some. Can you kind of give me a quick snapshot? Currently, are the markets behaving in a more normal way and are producers able to cover or put in place the risk management that they need to do? " CHRG-111shrg54589--10 Chairman Reed," Thank you very much. Let me at this juncture introduce our witnesses. We are very pleased to be joined today first by the Honorable Mary Schapiro, Chairman of the Securities and Exchange Commission. Prior to becoming SEC Chairman, she was CEO of the Financial Industry Regulatory Authority, FINRA, the largest nongovernmental regulatory for all securities firms doing business within the United States. Chairman Schapiro previously served as a Commissioner of the SEC from December 1988 to October 1994 and then as Chairman of the Commodity Futures Trading Commission from 1994 until 1996. Thank you, Chairman. Next is the Honorable Gary Gensler. Gary Gensler is the Chairman of the Commodity Futures Trading Commission. He previously served at the U.S. Department of the Treasury as Under Secretary of Domestic Finance from 1999 to 2000 and as Assistant Secretary of Financial Markets from 1997 to 1999. Prior to joining the Treasury, Chairman Gensler worked for 18 years at Goldman Sachs, most recently as a partner and cohead of finance. Our third witness is Ms. Patricia White, Associate Director of the Federal Reserve Board's Division of Research and Statistics. Ms. White has oversight responsibilities for sections that analyze risk and process microeconomic data, and she has participated in domestic and international working groups on central counterparties, securities settlement, and financial regulation. I very much thank all of you joining us here this afternoon, and, Chairman Schapiro, would you begin your testimony? CHRG-110shrg50409--95 Mr. Bernanke," Well, as I have indicated, I think that it is worthwhile making sure that, there is some transparency, that we are doing all we can to make sure these markets are as liquid and as efficient as possible. CFTC has the primary responsibility for that. We are happy to work with them and try to support that. So I am not saying there cannot be improvements made in these markets, but my best guess, as I have indicated a few times now, is that I do not think that speculative activity per se, or particularly manipulation, is the principal cause of the increases in energy and other commodity prices that we have been seeing. Senator Crapo. Thank you. " CHRG-111hhrg74855--52 Mr. Markey," Thank you, Mr. Chairman, very much. Our next witness is Gary Gensler. He is the chairman of the Commodity Futures Trading Commission. Chairman Gensler previously served at the United States Department of Treasury as Undersecretary of Domestic Finance during the Clinton Administration and prior to joining Treasury he worked for 18 years at Goldman Sachs where he was a partner and co-head of finance. He was sworn in as chairman of the Federal, of the CFTC in May by President Obama. We welcome you back to the committee actually, Mr. Chairman. Whenever you feel comfortable, please begin. CHRG-110hhrg46591--98 Mr. Seligman," The system has to be comprehensive. That means it has to address some gaping holes such as right now like credit default swaps. Second, there has to be some sort of risk avoidance or crisis manager at the top. This could be the same agency that would address things like financial holding companies. Third, you have to have sufficient expert knowledge to address a series of specialized industries including securities and investment banks, insurance, and commodities. " CHRG-111hhrg48875--195 Mr. Minnick," Mr. Secretary, two questions. As you are aware, the House Agriculture Committee passed H.R. 977, which conveys to the Commodities Futures Trading Commission, the SEC, and other qualified regulatory authorities some of the oversight, the clearing, and the regulatory authority that you were talking about that would be subordinate to those exercised guidelines from a systemic regulator. Do you think that the regimen proposed by that legislation would be consistent with the regimen you are attempting to--that the Administration will be attempting to implement? " CHRG-111hhrg63105--55 Mr. Johnson," Back in the heartland, a lot of people believe, rightly or wrongly, that prices don't always reflect supply and demand. I think you have expressed that too. I have a question and then kind of an unrelated comment. In your judgment, either witness's judgment, do you think the level of prices that ag commodities are at today is a result of the supply and demand factors and/or speculation? And how would you allot each in terms of what impact you think those respective forces are having in our market prices? " CHRG-109hhrg31539--124 Mr. Castle," Thank you, Mr. Chairman. Chairman Bernanke, let me just agree with Mr. Baker on the GSE's and leave that at that. Let me also agree with the gentleman from Iowa, Mr. Leach, on the clarity of your comments and on your statements. I spent many a day up here listening to Chairman Greenspan, trying to figure out what he had written and never quite understanding it, trying to figure out what he had said, but never understanding it, but having great admiration for him because the economy always did well under him. And I understand you with clarity, and I hope this does as well--I don't know if clarity is good or not. But I would like to have some reassurance here, because I listened to and read your comments as you were reading them with respect to the area of inflation, and when it is all said and done, that is what people really look at. And you can't comment on what seems to drive the stock market, what you are going to do with interest rates, or whatever. And I am not saying I see it differently, I just want to be reassured--and you may even say it in the same words, or perhaps in different words--but with energy prices and other commodity prices, even by your statement, we are probably not through with increases. And it is highly unpredictable, as you have indicated and as we all know. But it is beyond just oil prices; I mean, there are a whole lot of commodity prices that are up tremendously, and it is a trickle-down effect. For example, in Delaware we entered into some cockamamie agreement whereby we didn't increase electric rates for 7 years or something, and now all of a sudden there is about a 50 percent jump at one time. But that is maybe atypical, but those kinds of things are happening out there. So all commodity prices concern me. Labor costs, I think, are definitely--I mean, we see it here--there is definitely going to be a push as far as labor costs are concerned, which I think is going to be a major issue before it is all said and done. I am going to ask you a question later if I have time on housing, because I am not sure where that is going with respect to this. Plus this sort of public expectation in terms of inflation is there as well. I am taking most of this, at least I am summarizing, from what is written here. So I am not saying anything is wrong, I just, based on what we see and know and sort of the uncertainty--and I realize economics is an uncertain practice, as you also said in your testimony. What reassurance can you give us that these projections of inflation being somewhat more in control than they have been in recent months, which has been of--well, maybe not the last couple of months, but before that was pretty significantly higher than anticipated, I think, by anybody, what reassurance can you give us that these projections are correct, that the inflation rate will hopefully stay where it is now or even decline slightly? " FinancialServicesCommittee--13 So it is important that we listen to you: The Securities and Ex- change Commission, you have to make it work; the Commodities Trading Commission; NASDAQ; the Chicago Mercantile Exchange; and, of course, the New York Stock Exchange. But we have a very complex system. We have nearly 50 markets. We have hundreds of millions of computers that are making these sales in megaseconds, far outpacing our human capacity to deal with it. If we do get the circuit breaker concept, we have to make sure how that is going to work. Will it do the job? What is impor- tant here is to move carefully and thoughtfully to get the right cor- rection to this problem. The American investors and the world in- vestors are depending on us. Chairman K ANJORSKI . Thank you, Mr. Scott. We will now hear from Mr. Perlmutter for 2 minutes. Mr. P ERLMUTTER . Thank you, Mr. Chairman. I just would like to remind the committee and the panelists that in the financial re- form bill that we passed to the Senate, we were sort of directed to this nanotrading high-frequency trading issue by some of our prior hearings; and there is a section of the bill, section 7304, asking the SEC and other regulators to take a look at high-frequency trading and its impact upon the markets. The good news is, it is in the bill. The bad news is that Thursday hit us before there was any action on the bill. I know that the regulators have been looking at this under their own authority, and I would encourage them to continue to do this. I am surprised by my friends on the other side of the aisle who question whether it is too early to look at this. We should be look- ing at this high-frequency trading; 5,000 trades per second, how do you manage something like that? That is the real question. In the blink of an eye, by a mistake or by an intentional act, whatever it might be, boom, this country lost $1 trillion over 20 minutes. My friends on the other side of the aisle complain about the spending and all this stuff by the Obama Administration; when, be- cause of failures in the market, because of sales and failure of the uptick rule, not having those kinds of things, we lost $17.2 trillion in the last 18 months of the Bush Administration. Since the Obama Administration has come in, we have gained about $6.5 trillion back. We lost $1 trillion last Thursday, and then have gained most of that back. There has to be a real good understanding of the algorithm-driv- en nanotrading that we have. It has benefits, Mr. Hensarling is right, the liquidity that it brings. But certainly if you were on the wrong side of that sale, you lost a lot of money, and we can’t have that in this system. I yield back, Mr. Chairman. Chairman K ANJORSKI . Now, the last presenter, Mr. Foster, for 2 minutes. Mr. F OSTER . Thank you. I want to thank the chairman for hold- ing this important and timely hearing. As a high-energy particle physicist, I spent many years program- ming and debugging large systems of high-speed digital logic com- puters. So the fact that large interconnected processing systems, in- dividually programmed by very smart individuals, exhibit complex and erratic behavior when they are simply thrown together, does not surprise me at all. However, the fact that these complex sys- tems are put in control of a large and important section of our economy, without sufficiently robust testing of their interoper- ability and immunity to coherent instabilities is an outrage. The absence of systemwide circuit breakers to limit the damage when a single element or set of elements malfunctions is indefen- sible, as is the absence of uniform legal clarity when it comes time to bust trades that have been made on a clearly erroneous basis. Part of the problem that we are facing is the mismatch between the time scales of human thought and machine action. While the logic of circuit breakers and market pauses to restore liquidity has been understood for decades, we see now that it must be imple- mented on a time scale of computer trading and it must be imple- mented uniformly across a wide variety of trading platforms. The race towards lower latencies and higher-speed trading shows no sign of abating. Startup companies are already developing trad- ing and matching engines based not on clusters of computer serv- ers, which will be too slow to compete, but on dedicated pipeline logic based on field-programmable data arrays that will typically perform a dedicated calculation 100 times faster than a dedicated computer processor. fcic_final_report_full--245 EARLY 2007: SPREADING SUBPRIME WORRIES CONTENTS Goldman: “Let’s be aggressive distributing things” .............................................  Bear Stearns’s hedge funds: “Looks pretty damn ugly” .......................................  Rating agencies: “It can’t be . . . all of a sudden” .................................................  AIG: “Well bigger than we ever planned for” ....................................................  Over the course of , the collapse of the housing bubble and the abrupt shutdown of subprime lending led to losses for many financial institutions, runs on money mar- ket funds, tighter credit, and higher interest rates. Unemployment remained rela- tively steady, hovering just below . until the end of the year, and oil prices rose dramatically. By the middle of , home prices had declined almost  from their peak in . Early evidence of the coming storm was the . drop in November  of the ABX Index—a Dow Jones–like index for credit default swaps on BBB- tranches of mortgage-backed securities issued in the first half of .  That drop came after Moody’s and S&P put on negative watch selected tranches in one deal backed by mortgages from one originator: Fremont Investment & Loan.  In December, the same index fell another  after the mortgage companies Ownit Mortgage Solutions and Sebring Capital ceased operations. Senior risk officers of the five largest investment banks told the Securities and Exchange Commission that they expected to see further subprime lender failures in . “There is a broad recogni- tion that, with the refinancing and real estate booms over, the business model of many of the smaller subprime originators is no longer viable,” SEC analysts told Di- rector Erik Sirri in a January , , memorandum.  That became more and more evident. In January, Mortgage Lenders Network an- nounced it had stopped funding mortgages and accepting applications. In February, New Century reported bigger-than-expected mortgage credit losses and HSBC, the largest subprime lender in the United States, announced a . billion increase in its quarterly provision for losses. In March, Fremont stopped originating subprime loans after receiving a cease and desist order from the Federal Deposit Insurance Corporation. In April, New Century filed for bankruptcy.  CHRG-109shrg30354--93 Chairman Bernanke," We could try to do an evaluation with our models and the like. I am not sure how accurate it would be. In addition, the interesting thing about the energy price increases is that if you go back for 3 or 4 years and you look at each month at what the futures market was expecting, it was always expecting these things. We have had these increases, the energy prices are going to finally stabilize. And every single month it has been wrong. And so this increase in energy prices and commodity prices certainly has been a significant contributor. And I think that we would not really be talking about this now if energy prices were still $30 or $40 a barrel. Senator Sununu. Thank you, Mr. Chairman. " FOMC20060629meeting--8 6,MR. KOS.," It’s reasonable that all of those factors would have had some influence. I suppose another factor would be the extent to which some market participants may have seen not only positioning but also future weakness from the global tightening that is occurring, especially in the industrial countries but also in China—that such tightening will at some point affect the demand for commodities and for resources. Some of those positions and adjustments may have been fundamentally based. If one had to explain the scale of the price moves, that would probably be a secondary factor." FOMC20060808meeting--66 64,MR. HOENIG.," Mr. Chairman, thank you. Obviously we are dealing with a difficult set of circumstances. We have information that the growth of the economy is slowing and inflation is rising, not something we particularly like to see. We have seen slowing consumption nationally, and certainly our District has seen some of it. The one exception is in some areas where we have an energy boom going on, which is not necessarily advantageous to other parts of the country. We also have slowing residential investment in our District. Inventories are building up rapidly, both in the eastern side of the District and in the Denver western side, and we have some pretty sharp increases in bankruptcy levels in the Denver area. The shocks of energy costs have affected consumption, and I think that effect will carry through. We have been more optimistic about manufacturing. Even though our surveys have shown some slowdown recently, the six-months-ahead forecasts are still fairly optimistic. There is no denying that the inflation level is up, and I think that increase reflects past policy accommodation that is still in play. I also think that some of the supply shocks are having their effects, and the shocks themselves are continuing forward. That situation is being aggravated a bit for our District, and perhaps will be even more for the nation, by the drought that we are experiencing, which is reducing some of the crop output in the area. The outlook, therefore, is not particularly encouraging. I think consumption will show some further slowing going forward, especially as we see further shocks in the economy related to energy. Some of the wealth effects related to the housing industry will also affect consumption going forward. The outlook in terms of business fixed investment is unclear. BFI has been pretty good. The outlook seems fairly good right now, but it is slowing to some degree. Policy is moderately, not significantly, restrictive, but it seems to be working its way through fairly slowly. While these factors are in place, we worry about whether the real rate will decline, which I think Mike Moskow mentioned. I also worry that the decline will affect inflation expectations and cause them to shift—that is an upside risk to the economy in terms of the inflation that I do worry about. Still, I suggest that we are moving as expected. We have some short-term inflationary pressures that are going to continue, that are “baked in the cake,” as they say. And I do worry that—as we move forward and if the economy slows, as I suspect it will—our big challenge will be not to ease too soon. Thank you." CHRG-111hhrg63105--25 The Chairman," Well thank you. I thank both of you. I think the main purpose of what we are doing here today is to get daylight on what the process is, how it is going, and for us to understand better as we talk to our constituents who are out there and trying to fulfill our obligation. A couple of questions and we will right go right down the line. But first, Mr. Peterson, do you have any questions? Mr. Lucas? Mr. Gensler, what impact, since we are talking what you just said, would a delay in the January energy and metals position limit rule have on the agricultural commodities rule expected in April? " CHRG-109hhrg31539--188 Mr. Bernanke," Well, I will answer your question indirectly. One of the reasons we pay attention to the core inflation rate, which excludes energy, is we don't have a lot of control, obviously, over the price of energy, and so one of our concerns is that higher energy commodity raw materials costs don't get passed through into other goods and services. If we can sort of stop it at the first round, that will lead us to a more stable inflation situation when energy prices level off. " CHRG-111hhrg63105--207 Mr. Marshall," And it may, again, I don't know, I just don't think that we here in this Committee or in Congress are competent to judge this. That is why we defer to the CFTC and specifically told the CFTC, ``Don't do it if it is not appropriate to do it. Figure out whether or not you have a problem and then tailor the solution to that specific problem.'' But we did hear this testimony that maybe the influx of commodities money into the market could pull--force prices to go up for a period of time and then there would be a stable state that you have described where they are just rolling and they are not really affecting price. " CHRG-111hhrg55811--375 Mr. Cleaver," Yes. You are segregated. Earlier today, Mr. Gary Gensler, the Chairman of the Commodities Futures Trading Commission was here. He actually delivered a speech last month. And in his speech, he said that he believed that institutions are becoming ``too-interconnected-to-fail'' and not ``too-big-to-fail,'' that the real problem is that we are developing a pyramid financial system in this country and so everybody is connected and so if one block falls it could conceivably knock down all the other blocks because of their connectivity. None of you agree with that, do you? " CHRG-111hhrg53021--7 Mr. Minnick," First we should merge the SEC and the Commodity Futures Trading Commission. Financial derivatives whether they originate in a commodity, a security, or neither, like weather futures are functionally identical and must be traded, cleared and settled subject to the same rules. Bifurcated responsibility might be made to work temporarily, but is a poor long-term solution which will discourage bold action when crises arise and will encourage regulatory arbitrage. Second, banking regulation should be removed from an already overburdened Federal Reserve and the remaining three Federal depository institution regulators, the OTS, the FDIC and the OCC should be combined into a single Federal bank regulator; which should also be given broad consumer protection responsibility and resolution authority for both banks and all other entities deemed systemically risky. Powerful global institutions like Citibank, Bank of America, or AIG should not be allowing to shop for the weakest Federal regulator. Finally, the proposed systemic risk oversight counsel should have the highest quality permanent staff if it is to respond appropriately as future dangers arise. Because the Federal Reserve is the more institutionally independent Executive Branch agency, and has increasing global responsibilities, that staff should be housed in the Fed and the counsel should be chaired by the Fed Chairman. I thank both chairs and yield back. " CHRG-111hhrg53021Oth--7 Mr. Minnick," First we should merge the SEC and the Commodity Futures Trading Commission. Financial derivatives whether they originate in a commodity, a security, or neither, like weather futures are functionally identical and must be traded, cleared and settled subject to the same rules. Bifurcated responsibility might be made to work temporarily, but is a poor long-term solution which will discourage bold action when crises arise and will encourage regulatory arbitrage. Second, banking regulation should be removed from an already overburdened Federal Reserve and the remaining three Federal depository institution regulators, the OTS, the FDIC and the OCC should be combined into a single Federal bank regulator; which should also be given broad consumer protection responsibility and resolution authority for both banks and all other entities deemed systemically risky. Powerful global institutions like Citibank, Bank of America, or AIG should not be allowing to shop for the weakest Federal regulator. Finally, the proposed systemic risk oversight counsel should have the highest quality permanent staff if it is to respond appropriately as future dangers arise. Because the Federal Reserve is the more institutionally independent Executive Branch agency, and has increasing global responsibilities, that staff should be housed in the Fed and the counsel should be chaired by the Fed Chairman. I thank both chairs and yield back. " fcic_final_report_full--434 The Commission heard convincing testimony of serious mortgage fraud prob- lems. Excruciating anecdotes showed that mortgage fraud increased substantially during the housing bubble. There is no question that this fraud did tremendous harm. But while that fraud is infuriating and may have been significant in certain ar- eas (like Florida), the Commission was unable to measure the impact of fraud rela- tive to the overall housing bubble. The explosion of legal but questionable lending is an easier explanation for the creation of so many bad mortgages. Lending standards were lax enough that lenders could remain within the law but still generate huge volumes of bad mortgages. It is likely that the housing bubble and the crisis would have occurred even if there had been no mortgage fraud. We therefore classify mortgage fraud not as an essential cause of the crisis but as a contributing factor and a deplorable effect of the bubble. Even if the number of fraudulent loans was not substantial enough to have a large im- pact on the bubble, the increase in fraudulent activity should have been a leading in- dicator of deeper structural problems in the market. Conclusions: • Beginning in the late s and accelerating in the s, there was a large and sustained housing bubble in the United States. The bubble was characterized both by national increases in house prices well above the historical trend and by more rapid regional boom-and-bust cycles in California, Nevada, Arizona, and Florida. • There was also a contemporaneous mortgage bubble, caused primarily by the broader credit bubble. • The causes of the housing bubble are still poorly understood. Explanations in- clude population growth, land use restrictions, bubble psychology, and easy fi- nancing. • The causes of the mortgage bubble and its relationship to the housing bubble are also still poorly understood. Important factors include weak disclosure standards and underwriting rules for bank and nonbank mortgage lenders alike, the way in which mortgage brokers were compensated, borrowers who bought too much house and didn’t understand or ignored the terms of their mortgages, and elected officials who over years piled on layer upon layer of gov- ernment housing subsidies. • Mortgage fraud increased substantially, but the evidence gathered by the Com- mission does not show that it was quantitatively significant enough to conclude that it was an essential cause. FinancialCrisisInquiry--563 BORN: You know, in 2000, Congress passed a statute called the Commodity Futures Modernization Act that virtually deregulated the over-the-counter derivatives market and also preempted most state laws from governing over-the-counter derivatives. And I was struck, Mr. Solomon, by your discussion and your written testimony about the impact of deregulation on the financial situation and as a cause of financial crisis. And I wondered—I gathered from your written testimony that you attributed part of the deregulation that we’ve seen in the last 20 years to the political power of large financial institutions. Is that right? CHRG-111hhrg51698--398 Mr. Masters," I think common sense says that is not the case. We have plenty of studies that we can show that say that index funds were in fact an issue, and excessive speculation was a driver in creating the commodity markets bubble. There are studies from MIT, from the World Bank, from the United Nations. I saw one a couple days ago from the Austrian Ministry of Finance. There is one from the Japanese Ministry of Trade. There have been a lot of studies that have come to the opposite conclusion. So I could submit those if you would like to see them. " FinancialCrisisReport--224 In addition to a policy of deference to management, weak standards, and demoralized examiners, OTS employed an overly narrow regulatory focus that allowed WaMu’s short term profits to excuse its risky practices and that ignored systemic risk. For a time, its short term profits masked the problems at Washington Mutual, and regulators allowed practices which they knew to be risky and problematic to continue. Because it mishandled its responsibilities, OTS gave the illusion to investors, economists, policy makers, and others that the bank was sound, when in reality, it was just the opposite. Unfortunately, the truth of the matter was not revealed until it was too late, and the bank collapsed. Using Short Term Profits to Excuse Risk. OTS justified not taking enforcement action against WaMu in part by pointing to Washington Mutual’s profits and low loss rates during the height of the mortgage boom, claiming they made it difficult to require the bank to reduce the risks threatening its safety and soundness. In 2005, when faced with underwriting problems at WaMu, the OTS Examiner-in-Charge put it this way: “It has been hard for us to justify doing much more than constantly nagging (okay, ‘chastising’) through ROE [Reports of Examination] and meetings, since they [WaMu] have not been really adversely impacted in terms of losses. It has been getting better and has not recently been bad enough to warrant any ratings downgrade.” 854 The OTS Handbook was explicit, however, in stating that profits should not be used to overlook or excuse high risk activities: 853 10/7/2008 emails from OTS examiner Thomas Constantine to OTS Examiner-in-Charge Benjamin Franklin, “West Region Update,” Franklin_Benjamin-00034415_002, Hearing Exhibit 4/16-14. 854 9/15/2005 email from Examiner-in-Charge Lawrence Carter to Western Region Deputy Director Darrel Dochow, OTSWMS05-002 0000535, Hearing Exhibit 4/16-6. “If an association has high exposure to credit risk, it is not sufficient to demonstrate that the loans are profitable or that the association has not experienced insignificant losses in the near term.” 855 CHRG-111hhrg63105--149 Mr. Duffy," Chairman Boswell, Ranking Member Moran, and Members of the Subcommittee, thank you for inviting us to testify regarding the implementation of Dodd-Frank's provisions relating to position limits. I am going to focus on the requirements of Dodd-Frank and then briefly discuss this theory that speculators are distorting futures markets. Dodd-Frank requires the Commission to make a finding that position limits are necessary to diminish, eliminate, or prevent burdensome excessive speculation before imposing such limits. The CFTC is not permitted to act on the basis of assumptions or political demands. Core principle 5, section 5 of the CEA also demonstrates that position limits are not required in every case since it permits exchanges to adopt accountability levels as an alternative to rigid position limits. Dodd-Frank also requires that CFTC wait to impose limits on futures exchanges until it can simultaneously impose limits on economically equivalent swaps. The purpose of this provision is to prevent a flight of trading from regulated exchanges with no limits to unregulated markets with limits. Given these requirements, it is clear that the CFTC lacks sufficient data to impose limits on swaps and therefore may not act against futures. The Commodity Exchange Act allows limits to be imposed only on excessive speculation, not speculation generally. This is a clear recognition that futures markets cannot operate without the participation of speculators. Arbitrary position limits distort markets, increase cost to hedgers, and increase cost to consumers. Position limits are unnecessary unless burdensome excessive speculation is present or is likely. Academic literature and all the studies produced by the CFTC's economists demonstrate that position limits in futures trading are not the means to deal with real supply-demand issues. It is my firm belief that efforts to focus on position limits rather than the underlying issues are certain to divert attention from the real problems and do more harm than good. Worse yet, position limits in derivatives markets that preclude investors from seeking economic exposure to particular asset classes drive those investors to speculate in physical commodities. This, in turn, has a significant and often detrimental impact on the flow of commodities in commercial channels. We have already seen the beginnings of such distortions in the metals and energy markets in anticipation of the imposition of limits on derivatives. This is not a development that any of us should favor but one that is an unfortunate result of position limits based on bad economics. CME Group is not opposed to position limits and other similar measures if used correctly. For example, we employ limits on most of our physically delivered contracts. However, we use limits and accountability levels, as permitted by the Core Principles, to mitigate potential congestion during delivery periods and to help us respond in advance to any effort to manipulate our markets. CME Group believes that the core purpose that should govern Federal and exchange-set position limits, to the extent such limits are necessary and appropriate, should be to reduce the threat of price manipulation and other disruptions to the integrity of prices. Such activity destroys public confidence in the integrity of our markets and harms the acknowledged public interest in legitimate price discovery. CME Group appreciates the opportunity to offer the foregoing comments regarding the implementation of Dodd-Frank provisions for position limits on certain contracts involving exempt and agricultural commodities. We hope that the views expressed today are helpful, and we look forward to answering any questions the Committee will have. [The prepared statement of Mr. Duffy follows:]Prepared Statement of Terrance A. Duffy, Executive Chairman, CME Group Inc., Chicago, IL I am Terrence A. Duffy, executive Chairman of CME Group Inc. Thank you, Chairman Boswell, and Ranking Member Moran for inviting us to testify today. You asked us to discuss the implementation of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to position limits. CME Group is the world's largest and most diverse derivatives marketplace. We are the parent of four separate regulated exchanges, including Chicago Mercantile Exchange Inc. (``CME''), the Board of Trade of the City of Chicago, Inc. (``CBOT''), the New York Mercantile Exchange, Inc. (``NYMEX'') and the Commodity Exchange, Inc. (``COMEX'') (collectively, the ``CME Group Exchanges''). The CME Group Exchanges offer the widest range of benchmark products available across all major asset classes, including futures and options on futures based on interest rates, equity indexes, foreign exchange, energy, metals, agricultural commodities, and alternative investment products. CME Clearing, a division of CME, is one of the largest central counterparty clearing services in the world, which provides clearing and settlement services for exchange-traded contracts, as well as for over-the-counter derivatives contracts through CME ClearPort'. Using the CME ClearPort' service, eligible participants can execute an OTC swap transaction, which is transformed into a futures or options contract that is subject to the full range of Commodity Futures Trading Commission (the ``Commission'' or ``CFTC'') and exchange-based regulation and reporting. The CME ClearPort' service mitigates counterparty credit risks, provides transparency to OTC transactions and enables the use of the exchange's market surveillance monitoring tools. The CME Group Exchanges serve the hedging, risk management and trading needs of our global customer base by facilitating transactions through the CME Globex' electronic trading platform, our open outcry trading facilities in New York and Chicago, as well as through privately negotiated CME ClearPort' transactions. The theory that speculators in futures markets cause unwarranted price volatility and excessively high and/or low prices is not new; Congress has dealt with that notion since the late 1800s. The Commodity Exchange Act (``CEA''), however, does not limit speculation, but only ``excessive speculation.'' This is an implicit recognition that futures markets cannot operate without the participation of speculators. The so-called ``speculators,'' such as index funds and swap dealers, who are the focus of recent intense criticism, are not engaged in traditional speculative activity, i.e., trying to beat the market. Rather, swap dealers use futures markets to facilitate the hedging of more complex and specific risks accepted in connection with swap transactions with commercial customers and others. Denying or limiting their access to the futures markets will simply impede hedging activity by commercial market participants. Index funds aggregate the buying and selling decisions of many thousands of investors, most of whom are doing what they have been taught for decades to do: diversifying their investment portfolios and hedging inflation risks to their investment returns in order to maximize their retirement savings and their individual wealth. Position limits are not a costless palliative. Position limits, when improperly calibrated and administered, can easily distort markets, increase the costs to hedgers and effectively increase costs to consumers. Unfortunately, many demands for speculative limitations assume that severe limits on speculation will bring prices to some favored level. On the contrary, position limits on futures contracts will not and do not control cash market prices. There is a complete disconnect between the implied promise to drive prices down or up, whichever the most vocal constituency desires, and the ability of position limits to deliver on that promise.Introduction We disagree with those who contend, in contravention of the clear academic evidence and of the clear intent of Congress, as expressed in Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203, July 21,2010) (``DFA'' or ``Dodd-Frank''), that speculative positions must be limited in order to eliminate price volatility and/or high prices or low prices for essential commodities. Some of the proponents for limits are well intentioned, but have no credible evidence to support their claims. Some contend for example that strict limits on silver futures will allow the price of silver to go up to levels that they think is appropriate. Other proponents of strict position limits contend that limits on oil positions will cause the price of gasoline to fall to levels that are ``better'' for the economy or their constituents. The Wall Street Journal reported on December 8, 2010, that: ``[T]he latest data also show an increase in speculation doesn't necessarily bring with it an increase in prices. Natural gas, for example, is down 21% this year despite a surge in speculative bets. In opposite circumstances with sugar, prices rallied despite a withdrawal of speculative bets.'' The Wall Street Journal--Investors Pile Into Commodities, Carolyn Cui and Susan Pulliam. All of the serious academic literature, including all of the studies produced by the CFTC's economists demonstrate that position limits in futures trading are not the means to deal with real supply and demand issues that are prevalent in markets for many physical commodities. It is my firm belief that efforts to focus on position limits rather than the underlying economic issues are certain to divert attention from the real supply and demand dynamics and do more harm than good. Worse yet, position limits in derivative markets that preclude investors from seeking economic exposure to particular asset classes drives those investors to speculate in physical commodities, which has a significant and often detrimental impact on the flow of commodities in commercial channels. We have already seen the beginnings of such distortions in metals and energy markets in anticipation of the imposition of limits on derivatives. This is not a development that anyone should favor, but one that is the logical result of even the threat of position limits based on bad economics. CME group is not opposed to position limits and other similar measures in all circumstances; we employ limits in most of our physically delivered contracts. However, we use limits and accountability levels, as contemplated by the Congressionally-approved Core Principles for Designated Contract Markets, to mitigate potential congestion during delivery periods and to help us identify and respond in advance to any threat to manipulate our markets. CME Group believes that the core purpose that should govern Federal and exchange-set position limits, to the extent such limits are necessary and appropriate, should be to reduce the threat of price manipulation and other disruptions to the integrity of prices. Such activity destroys public confidence in the integrity of our markets and harms the acknowledged public interest in legitimate price discovery. CME Group is therefore vigilant in seeking to deter and prevent price manipulation or other illegitimate distortions of market prices. Speculation, however, is not manipulation, nor is it an abusive practice. As CME Group observed in its response to the Commission's January 2010 energy position limits proposal, speculation is essential to the orderly functioning of futures markets--it provides market liquidity which promotes more effective commodity price discovery and allows for the efficient transfer of price risk. See CME Group Comments, 10-002 Comment CL-02714, at 2 (Apr. 26, 2010) (``CME Comments''). The Commission's responsibility and challenge is not to restrict speculation per se, but to act when necessary to prevent ``excessive speculation'' from burdening interstate commerce through what the Commodity Exchange Act (``CEA'') calls ``unreasonable'' and ``unwarranted'' fluctuations in the price of a commodity. To this end, Congress has granted to the Commission the authority to impose speculative position limits under Section 4a of the CEA, as amended by DFA. CME Group understands the extensive demands being made on the Commission's limited resources. However, the Commission must gather critical data regarding swap markets and individual traders' swap positions. Without a thorough understanding of such data, the Commission runs the risk of inappropriately setting position limits. CME Group appreciates the great challenge this presents to the Commission.I. Statutorily Required Basis for Imposing Position Limits Section 4a(a)(1) provides in pertinent part: ``For the purpose of diminishing, eliminating, or preventing such burden [of unwarranted or unreasonable price fluctuations resulting from excessive speculation], the Commission shall . . . fix such limits on the amount of trading which may be done or positions which may be held . . . as the Commission finds are necessary to diminish, eliminate, or prevent such burden.'' (emphasis added) By its terms, DFA requires the Commission to make a finding that position limits ``are necessary to diminish, eliminate, or prevent'' burdensome excessive speculation before imposing such limits. Dan Berkovitz, CFTC General Counsel, confirmed that Section 4a(a)(1) sets forth a conditional mandate during the CFTC's July 2009 hearings on energy position limits. In response to Chairman Gensler's question, ``What does the word `shall' mean in 4a?,'' Berkovitz replied, ``If the Commission finds that position limits are necessary to prevent, diminish, or eliminate such burdens, then there is a directive that it shall establish position limits.'' Transcript of July 28, 2009 CFTC Hearing on Energy Position Limits at 35-36 (emphasis added). The above quoted language from Section 4a(a)(1) was not deleted or in any way altered by DFA. New CEA subsection (a)(2) (``Establishment of Limitations'') even reaffirms that any position limits must be established ``[i]n accordance with the standards set forth in paragraph 1 of this subsection,'' which include the requisite ``necessary'' finding. Core Principle 5, Section 5(d)(2)(5) of the CEA as amended by DFA, also recognizes that ``accountability levels'' are an alternative to rigid position limits: (5) Position limitations or accountability.-- (A) In general.--To reduce the potential threat of market manipulation or congestion (especially during trading in the delivery month), the board of trade shall adopt for each contract of the board of trade, as is necessary and appropriate, position limitations or position accountability for speculators. (emphasis supplied) Moreover, the Commission must publish the statutorily required finding and the information in support thereof in any notice of proposed rulemaking to comply with the Administrative Procedure Act (``APA''). The APA requires that the notice of a proposed rule include ``sufficient detail on its content and basis in law and evidence to allow for meaningful and informed comment.'' See, e.g., Am. Med. Ass'n v. Reno, 57 F.3d 1129, 1132 (D.C. Cir. 1995). Absent a finding with supporting evidence that position limits are ``necessary,'' this APA requirement cannot be met because the public will not know the Commission's specific reasoning for the essential finding that triggers its proposed rulemaking. DFA indicates that such limits would be ``unnecessary'' where burdensome excessive speculation does not exist or is unlikely to occur in the future. CME Group's comment letter on the Commission's energy position limits proposal discussed at length the absence of any credible empirical evidence of the existence of burdensome excessive speculation or its likely future occurrence. See CME Comments at 17-24. The weight of empirically sound analysis and research demonstrates that movements in commodity prices are attributable to fundamental market conditions rather than speculative trading. CFTC studies, for example, have found that supply and demand factors were largely responsible for the 2008 rise in oil prices and that, far from harming the market, speculators serve as an important source of liquidity for other participants. See, e.g., CFTC Interagency Task Force on Commodity Markets, Interim Report on Crude Oil at 3-4 (July 22, 2008); Michael Haigh et al., Market Growth, Trader Participation and Pricing in Energy Futures Markets (Feb. 7, 2007), available at http://web.uvic.ca/econ/research/seminars/robe.pdf. Like CFTC staff, the Government Accountability Office (``GAO'') has not identified a causal relationship between speculation in the futures market and changes in commodity prices. See GAO, GAO-09-285R, Issues Involving the Use of the Futures Markets to Invest in Commodity Indexes at 5 (Jan. 30, 2009). The conclusions of these governmental studies and reports are consistent with those of academic and private sector economists. See, e.g., Paul Krugman, The Oil Nonbubble, N.Y. Times, May 12, 2008, http://www.nytimes.com/2008/05/12/opinion/12krugman.html (``[T]he rise in oil prices isn't the result of runaway speculation; it's the result of . . . the growing difficulty of finding oil and the rapid growth of emerging economies like China.''). To the extent there are any legitimate concerns with the potential for excessive speculation to cause unwarranted or unreasonable price fluctuations, CME Group believes that futures exchanges effectively address such concerns through their existing market surveillance programs. CME Group provided a detailed account of the futures exchanges' capabilities in its April 26, 2010 comments filed with the CFTC. See CME Comments at 8-12. Briefly stated, the exchanges independently have the ability to establish position limits as warranted by the characteristics of their traded contracts, and to employ position accountability provisions as appropriate given particular market constructs and market conditions. This flexible regulation is a much more appropriate and effective means of addressing potentially manipulative or disruptive positions than are blunt position limits that fail to account for variability in specific contract months, market conditions, and market participation. Insofar as the existing exchange programs are and have been proven to be effective, CME Group believes the Commission would lack the statutory basis for establishing new Federal position limits on certain contracts involving exempt and agricultural commodities.II. Mechanics of Imposing Position Limits Assuming the Commission is able to find that position limits ``are necessary to diminish, eliminate, or prevent'' burdensome excessive speculation, CME Group offers the following views on how to impose those limits:A. The Imposition of Limits Should be Deferred Until the Commission Can Properly Determine and Ensure Compliance with Appropriate Limits Dodd-Frank sets forth several seemingly inconsistent timing requirements for the exercise of the Commission's position limit authority. New CEA 4a(a)(2)(B) directs the Commission to impose limits for certain contracts, within 180 days for exempt commodities and within 270 days for agricultural commodities, respectively, of Dodd-Frank's enactment. Meanwhile, new CEA 4a(5)(A) requires that limits for swaps that are economically equivalent to futures and options be established simultaneously with the limits under Section 4a(a)(2)(B). The statute, however, also vests the Commission with discretion to establish limits ``as appropriate,'' thereby indicating that the Commission is not bound by the aforementioned dates. CME Group believes that DFA requires the Commission to defer imposing limits until doing so would be ``appropriate''--that is, when it has the data needed to accurately set and enforce those limits and when it is in a position to impose limits simultaneously on futures (and options on futures) and swaps.B. Position Limits Should Be Set with Due Regard for Legislative Objectives and Considerations Under Dodd-Frank, the Commission is required to take into account several factors when setting position limits. New CEA 4a(a)(3) provides that, to the maximum extent practicable, the Commission should use its discretion to establish limits to: (i) diminish, eliminate, or prevent ``excessive speculation''; (ii) deter and prevent market manipulation, squeezes, and corners; (iii) ensure sufficient market liquidity for bona fide hedgers; and (iv) ensure that the price discovery function of the underlying market is not disrupted. Additionally, new CEA 4a(a)(2)(C) states that the Commission must act to avoid shifting the price discovery function to FBOTs in establishing limits. In mandating these considerations, Congress recognized that limiting trading positions has the potential to reduce liquidity and adversely affect the hedging and price discovery functions of U.S. commodity markets. The Commission is obliged to give due weight to each consideration in setting any position limits and may not focus solely on imposing limits to diminish, eliminate, or prevent ``excessive speculation.''C. The Commission's Exemptive Authority Should Be Interpreted Broadly To Accommodate All Non-Speculative Positions New CEA 4a(a)(7) gives the Commission authority to exempt from any position limit rule, with or without conditions, ``any person or class of persons, any swap or class of swaps, any contract of sale for future delivery or class of such contracts, any option or class of options, or any transaction or class of transactions.'' Under this provision, the Commission's statutory power to exempt any person or class of person from position limits is greater than it has ever been before. CME Group believes that DFA authorizes the Commission to use its broad new exemption authority under 4a(a)(7) to grant exemptions to market participants who use futures, options, or swaps when economically appropriate to the reduction of the risks they face in their enterprises. Although it is impossible to enumerate the breadth of exemptions that should be permitted in order to ensure that entities are able to effectively manage exposure that is highly correlated to fluctuations in the price of exempt and agricultural commodities, an application for exemption should be judged on its merits in terms of the specific risks to be hedged, the relevant price relationships, the proposed position sizes, and the operational procedures for establishing and lifting the hedge. If the Commission were to narrowly construe its 4a(a)(7) exemptive authority to exclude non-speculative trading activity, then market participants could be forced to either actually speculate on those price risks (i.e., not establish any positions to mitigate the risk), and potentially increase costs to consumers, or hedge their risks through transactions that lie outside the CFTC's position limit authority. Either strategy would undermine the Commission's mission to promote liquidity and protect the price discovery function of its regulated markets. The Commission should thus broadly interpret its exemptive powers and grant exemptions to market participants who are not seeking to establish positions in the futures market for speculative purposes but rather to serve their legitimate commercial and financial hedging needs.III. Conclusion CME Group appreciates the opportunity to offer the foregoing comments respecting the implementation of DFA's provisions respecting position limits on certain contracts involving exempt and agricultural commodities. We hope that the views expressed herein prove to be helpful and we are available to answer any questions the Committee may have. " CHRG-111hhrg53246--66 Mr. Neugebauer," Thank you, Mr. Chairman. Chairman Gensler, I understand that the CFTC is going to have some public hearings regarding hedge exemptions and position limits in the energy markets. As you are aware, in the 2008 farm bill we had quite a bit of discussion about that, and we expanded some of the CFTC's authority in that area. There is a lot of disagreement about the role of speculators in the marketplace. And my opinion is that they provide liquidity and price discovery by the fact that they are in the marketplace. But what do you think might be the impact if you move to limit, and in some cases prohibit, some institutional investors from actually being in the energy commodities? " CHRG-111shrg54675--77 PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON It is no exaggeration to say that our economy is currently experiencing extraordinary stress and volatility. As Congress and the Administration look at corrective policy changes, I am pleased to hold this hearing today to take a closer look at the role smaller financial institutions, specifically community banks and credit unions, play in our economy, especially in many rural communities. Throughout our Nation's economic crisis there has often been too little distinction made between troubled banks and the many banks that have been responsible lenders. There are many community banks and credit unions that did not contribute to the current crisis--many rural housing markets that didn't experience the boom that other parts of the country did, and community lending institutions didn't sell as many exotic loan products as other lenders sold. Nonetheless, small lending institutions in rural communities and their customers are feeling the effects of the subprime mortgage crisis and the subsequent crisis in credit markets. Jobs are disappearing, ag loans are being called, small businesses can't get the lines of credit they need to continue operation, and homeowners are struggling to refinance. Smaller banks play a crucial role in our economy and in communities throughout our Nation; we need to be mindful that some institutions are now paying the price for the risky strategies employed by some larger financial institutions. In coming weeks, the Banking Committee will continue its review of the current structure of our financial system and develop legislation to create the kind of transparency, accountability, and consumer protection that is now lacking. As this process moves forward, it will be important to consider the unique needs of smaller financial institutions and to preserve their viability as we come up with good, effective regulations that balance consumer protection and allow for sustainable economic growth. I would like to welcome our panel of witnesses, and thank them for their time and for their thoughtful testimony on how small lending institutions in rural communities have been affected by our troubled economy. I would also like to thank Senator Kohl for his interest in today's hearing topic. I will now turn to Senator Crapo, the Subcommittee's Ranking Member, for his opening statement. ______ FOMC20081029meeting--218 216,MR. HOENIG.," Thank you, Mr. Chairman. Let me just briefly say that, in our region, we have continued to do actually better than the national average, but that is beginning to wane. We are seeing, obviously, the energy effect show itself as rigs are being put out of production and you see a slowing there. We are seeing some concerns being raised about agricultural prices and the boom that has been going on in that part of the economy. That said, there's still a reasonable amount of business going on that they haven't frozen up. We asked our directors and our other advisers how they were seeing things, and it varies. There were some organizations that say that our non-investment-grade borrowers from the banks, if they had credit already, are still able to access those lines. If they lost some portion because of a bank problem or something like that, they cannot get new credit, so it is cut off in that way. I think that's important to keep in mind. Businesses themselves are beginning to pull back on their capital plans. They've said that. Their balance sheets--obviously outside the auto industry--are still decent, but they're saying, ""We're looking at this, and we're pulling back until we see how it plays out."" You are beginning to hear more of that. They feel that they can get credit. Some of them are talking about actually trying to pull down their lines to make sure they have the money, and the only thing keeping them from doing that is they don't know what to do with it once they get it. So that's their dilemma. They're afraid of losing their credit, but they also know that it costs if they pull it down. So the dynamics there are interesting. On the national outlook, I'll be brief. I think that obviously the projections for recession are in place. Down is where we're going. How much, though, is speculation right now. I don't know. I don't know that anyone does until we begin to see things settle out. Inflation should be down as well. Obviously, when you have a recession, you will back off from that, but how much? That's not clear at this point. There is a lot in play, and that's why we don't know the answers to those questions. We have these liquidity facilities and an enormous amount of liquidity out. We have the TARP that is now in process but not completed. That's going to have an impact, and I think those are very important. As we discuss our own policy, we are very close to the point of the quantitative easing discussion that we had, as you said, in 2003. Pulling that material out and taking a look at that is important as we decide what we're going to put our money into as we try to stimulate this economy. Right now we're subject to waiting and seeing. There's been a lot done, and attitudes are a critical part of this now, and we just have to wait to see how those change over the next quarter or two. Thank you. " FOMC20050322meeting--107 105,MS. MINEHAN.," Thank you, Mr. Chairman. Economic activity seems definitely on the upswing in New England. As we discussed conditions with our Beige Book contacts, met with our small business advisory group, and talked in some depth with local temporary-help agencies and software developers—as we did our usual round of contacts—the themes of solid growth and increasing confidence were repeated with some frequency. Manufacturers, especially those that have some defense business, report very good sales, and, at least in the case of one large manufacturer, an inability to keep up with demand. Labor markets have strengthened as well, and benchmark revisions to employment data indicate that 2004 was a better period for job growth in New England than previously thought. Temporary help agencies report good demand for labor, and help-wanted is stronger, as judged by both traditional measures and the indexed data on the region that are available from Monster.com. Housing remains strong, though we don’t see much sign of speculation and there is some softness at the upper end of the price range. Retail business is reported to be good, and both business and consumer confidence has increased. Contacts in the regional economy appear to be moving from a focus on concerns about March 22, 2005 45 of 116 of small businesses in the period since our February meeting, and they almost uniformly report rising costs of raw materials and labor that are starting to impact their prices. In a growing number of cases, these firms have been able to make price increases stick, even to big buyers like Wal-Mart, though, largely, the price increases have been in the form of surcharges. Skilled workers are becoming difficult to find. Businesses report that they’re in a hiring mode and have to pay up to get the people they need. Some companies have begun to hire in advance of need, simply to have a pool of available workers. Capital spending plans seem quite solid, and now there is a mixture of firms spending not only to further increase productivity but also to expand to handle increased business. Two areas of concern emerged beyond those related to rising costs. The first involves tourism in northern New England. Evidently, while this was a snowy year in the southern part of our region, the northern areas have suffered from both too little snow and the timing of storms, which created weekend travel problems. The second is a continued sluggishness in commercial real estate markets. Given the number of large mergers affecting the region, both in the financial services industry and elsewhere, and the reduction of headquarters staff that has resulted, commercial vacancy rates remain high and rents low—especially in downtown and suburban Boston. I should say the rents are relatively low, since Boston rents tend to be high anyway. This has not, however, seemed to put much of a crimp in the market for purchasing commercial buildings, which continues to be quite strong. Turning to the national scene, I’ve been struck by the strength of the incoming economic data, as has everyone else. We in Boston have adjusted our forecast upward, especially in the near March 22, 2005 46 of 116 Greenbook over the forecast horizon, though our calculations suggest some greater economic capacity and less downward pressure on the unemployment rate. However, there is not a lot to argue about here, given the continuing upside surprises in overall economic growth and in price pressures. Indeed, it seems clear to me that the underlying rationale we have used in moving policy slowly and gradually to a less accommodative place is becoming questionable. Unlike last year when growth seemed fragile and uncertain, economic growth now seems solid and resilient and in less need of policy accommodation. Overall credit and financial conditions are supportive, if not encouraging, to spending and growth. Business investment is not taking a breather with the ending of the tax incentive, and consumers aren’t either, except in their post-holiday purchases of autos. Surely it is possible to see downside risks from a rise in the saving rate, from an untoward increase in oil prices that impacts demand, or from an impact arising out of the external deficit. But I think it’s even easier to imagine upside inflation surprises as rising energy, raw material, import, and labor costs get embedded into economic activity. In that regard, I found the Greenbook alternatives focused on a spending boom and on a boom with rising inflation expectations very interesting. I should also note that while my admiration for the FRB/US model is enormous, I think it’s difficult for any model to correctly anticipate the full interplay of economic factors once the unexpected happens. The baseline, I think, is still pretty much a good, solid forecast. Continued solid productivity growth will keep nascent cost pressures and inflation expectations under control. However, the risks that this will not happen seem to me to have grown and to have become a bit more one-sided. That is, I think we need to be more focused on the risks that rising cost pressures will get out of hand. March 22, 2005 47 of 116 case could be made for moving faster rather than slower toward that so-called neutral place. Taking larger steps now would have the benefit of affecting market attitudes toward risk in a positive way, largely because it is not what markets expect us to do. That option has some attraction to me. But it could be too much of a surprise and indicate too much concern about future prospects than perhaps is necessary. However, we could take advantage of this point in time by preparing the markets for greater policy flexibility. That is, we could change the language of the announcement by following the Chairman’s example in taking out the reference to a measured pace. In my view, anyway, that would have two benefits. It would continue the process of removing policy accommodation, and it would focus markets better on the uncertainties of the future." CHRG-111hhrg53021--37 Secretary Geithner," I do believe that. And I have a stack of letters here in my book from companies across the country in the power business, in the commodities business, in the business of producing large-scale machinery, that speak to the importance of maintaining that option. But I want to underscore that, because those products come with a lot of risk--and a lot of the losses that were so conspicuous in the monoline insurance companies and AIG were from institutions writing protections against the customized products. And, therefore, it is important that there be, as I said, a comprehensive framework of oversight and authority over those instruments, as well. " FOMC20050630meeting--345 343,MR. FISHER.," I just have a quick question, going back to the oil issue. There are some 770,000 outstanding futures contracts on the NYMEX. If you look at the CFTC [Commodity Futures Trading Commission] data, 11 percent of those are noncommercial players—what they call June 29-30, 2005 108 of 234 as to what percentage of the spot price or of futures prices do you consider to be weighted by the nonfinancial players? Are they a driving force or are they inconsequential?" CHRG-111hhrg53021Oth--37 Secretary Geithner," I do believe that. And I have a stack of letters here in my book from companies across the country in the power business, in the commodities business, in the business of producing large-scale machinery, that speak to the importance of maintaining that option. But I want to underscore that, because those products come with a lot of risk--and a lot of the losses that were so conspicuous in the monoline insurance companies and AIG were from institutions writing protections against the customized products. And, therefore, it is important that there be, as I said, a comprehensive framework of oversight and authority over those instruments, as well. " CHRG-110hhrg34673--185 Mr. Bernanke," Well, it is certainly true that where we are today is that there are a lot of immigrant workers, many of them undocumented, who are working in various industries ranging from manufacturing to agriculture to leisure and hospitality and construction and other areas, and if they were all to leave immediately then there would be obviously a disruption in those industries and labor shortages in those industries. Mr. Davis of Tennessee. I ask that mainly to make a point. We have a lot of folks out here today who have a lot of ideas about America's economy, and we have a lot of ideas about some of the comments that have been made by many about the illegal immigration situation. My real question to you is this: As I go back from about the 1970's, late 1960's, up through about right now, we have gone from having a balance of trade in our favor to where we have gradually gone to a whole other level, over $700 billion for the last 2 or 3 years in deficits in trade. Now that means that we are sending $700-some billion more out of America's economy to other nations of the world that are holding that money. They are our dollars. It is a part of our capital assets of this country that is showing that up, and when I look at that, I get kind of frightened at it, and I look at the district that I represent and I see a Saturn plant in Spring Hill that has temporary layoffs, perhaps, and I fear that they may become more permanent than temporary, those 5,000 or 6,000 jobs that we may be losing. The Carrier Corporation just left my district. So when I look at my Congressional district, which is the fourth most rural in America, this great booming economy that we seem to have throughout America does not exist in my district, and it does not exist I believe, perhaps, in most rural areas of America. As to the trade deficits and the budget deficits that we continue to elevate, are we just looking for a train wreck to happen, and are we sitting here in Congress kind of like Nero did in Rome as it burned, doing nothing about it? How do we stop this bleeding of huge deficit spending? Because we have seen us grow from 18.5 percent in a gross domestic spending percentage of government to about 20 percent in the last 5 or 6 years. We have seen an increase in spending, a dramatic increase, and our revenues have gone down to fund government as the Congress for the last 5 or 6 years has seen fit to spend. So, in essence, there are two or three problems that I have, and I think it is hurting a lot of the more rural areas and maybe not the more urban areas, but we have lost 3 million industrial jobs. We are no longer producing. In export and production, we are consuming someone else's production. So how do the trade deficits, the budget deficits impact us, and when will we be in a situation where we no longer enjoy the great economy supposedly that we have, and when will it become a threat even to the world economy if that does happen? " fcic_final_report_full--11 Unfortunately—as has been the case in past speculative booms and busts—we witnessed an erosion of standards of responsibility and ethics that exacerbated the fi- nancial crisis. This was not universal, but these breaches stretched from the ground level to the corporate suites. They resulted not only in significant financial conse- quences but also in damage to the trust of investors, businesses, and the public in the financial system. For example, our examination found, according to one measure, that the percent- age of borrowers who defaulted on their mortgages within just a matter of months after taking a loan nearly doubled from the summer of  to late . This data indicates they likely took out mortgages that they never had the capacity or intention to pay. You will read about mortgage brokers who were paid “yield spread premiums” by lenders to put borrowers into higher-cost loans so they would get bigger fees, of- ten never disclosed to borrowers. The report catalogues the rising incidence of mort- gage fraud, which flourished in an environment of collapsing lending standards and lax regulation. The number of suspicious activity reports—reports of possible finan- cial crimes filed by depository banks and their affiliates—related to mortgage fraud grew -fold between  and  and then more than doubled again between  and . One study places the losses resulting from fraud on mortgage loans made between  and  at  billion. Lenders made loans that they knew borrowers could not afford and that could cause massive losses to investors in mortgage securities. As early as September , Countrywide executives recognized that many of the loans they were originating could result in “catastrophic consequences.” Less than a year later, they noted that certain high-risk loans they were making could result not only in foreclosures but also in “financial and reputational catastrophe” for the firm. But they did not stop. And the report documents that major financial institutions ineffectively sampled loans they were purchasing to package and sell to investors. They knew a significant percentage of the sampled loans did not meet their own underwriting standards or those of the originators. Nonetheless, they sold those securities to investors. The Commission’s review of many prospectuses provided to investors found that this crit- ical information was not disclosed. T HESE CONCLUSIONS must be viewed in the context of human nature and individual and societal responsibility. First, to pin this crisis on mortal flaws like greed and hubris would be simplistic. It was the failure to account for human weakness that is relevant to this crisis. CHRG-110hhrg34673--197 Mr. Castle," I have last year introduced legislation about transparency in hedge funds. I am concerned about hedge funds. You answered this yesterday in Senate testimony and basically indicating that the liquidity of hedge funds could be very important. I don't have a problem with that either, but I do have a problem in terms of what hedge funds could do with respect to commodity markets and a variety of things they get into because of the enormity of it and the number of them that have opened in recent years and where they are going. I am not one who looks for overregulation or overtransparency, if there is such an expression, but I think proper transparency is in order. I would like your thoughts, if you could, about where we are with respect to hedge funds, and what do you think the role of the--regulatory role or perhaps our committee role in this area should be. " CHRG-111hhrg63105--213 Mr. Jones," I would say all or at least most of our members would fall into the qualified hedger category. What we are referring to there is, as I said early on, the majority of and particularly in the enumerated commodities of corn, soybeans, wheat, the majority of the trading that goes on, the price discovery occurs on the exchange and most of it is hedged. And so, unlike the energy markets, which I am no expert in, but there is a much larger OTC portion of that that occurs. So if we were combined with the OTC, it actually would create a much larger position limit that specs could have if they combined the two than what exists right now, if it were to flow into the futures market. " CHRG-111hhrg63105--104 Mr. Chilton," Certainly Congress told us to put the limits in. We had the authority actually before this, but we didn't have support to do this. So we were instructed in the Dodd-Frank bill to put limits in. And the original purpose in the Commodity Exchange Act doesn't say that you have to jump some hurdle that proves beyond a shadow of a doubt in a court of law that speculators moved gas prices ten percent. The law says that we are to prevent and deter fraud, abuse, and manipulation; and so that is sort of the guiding onus that I look at, sir. " FOMC20080805meeting--175 173,MR. PLOSSER.," Thank you, Mr. Chairman. As you can imagine, as we've discussed, this meeting presents a difficult policy position for us--and for me in particular. I think we must pay careful attention to the financial market volatility; and to the extent that it has consequences for the real economy, I'm certainly sensitive to that concern. I had a similar experience with my board of directors that President Evans did. I went into my board recommending no change and got considerable push-back in discussion about how we dissent and what the consequences of doing that are. They are concerned about inflation, and I'm concerned about our mandate to keep longerterm and intermediate-term inflation in check. We're unlikely, in my view, to get confirming or convincing evidence about whether expectations have become unanchored until well after the fact. I agree there has been very little wage�price pressure to date. But that will be the last shoe to drop in this sequence of raising expectations, and by the time we get to that, I'm afraid it will be too late. I think in the near term we might see some relief in headline inflation; but as has been discussed, whether that will persist is highly dubious. My real concern is that I believe that monetary policy is accommodative, and with all due respect, Mr. Chairman, when I look at the data comparing the levels of borrowing rates of consumers and businesses, both the levels in real and nominal terms and the spreads, what we see in this period looks remarkably similar to what we've seen in lots of other recessionary, slow growth periods. So, again, following the analogy that President Lacker was using, I see this period as less atypical and more typical of what we see in slow-growth periods. I think it's important that we begin to prepare the markets for an impending shift to a tighter policy. I agree with President Hoenig. The request here is not for tight policy but somewhat less accommodative policy; and if we choose to go with no funds rate increase today, I think the language must help prepare the markets going forward. I'm pleased with a lot of the discussion around the table. We are actually beginning to talk, I think, about what our exit strategy is going to be from this. I think it's very important to have those conversations, and I appreciate them. I, too, share the observations that President Evans had about talking with people who say, ""Well, we can't possibly remove accommodation until we get rid of the facilities."" I think that is wrong. As you said, Mr. Chairman, actually having the facilities might make it easier for us to correct monetary policy, and I think that's very, very important. I guess my bottom line is that I can accept leaving the funds rate unchanged today as long as our language is sufficiently strong about inflation. To that end, I was actually a little more comfortable with the draft table 1. I didn't like the addition of the word ""also."" I thought that weakened the statement. I would prefer paragraph 4 without the ""also."" I also have one other, minor observation about paragraph 3, and that's the first sentence, which says that ""inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities."" Well, I think that's partly true, but I'm concerned that somehow it conveys the impression that the problem with inflation is oil and commodities, when in fact more correctly my concern about inflation is not just oil. My concern is about the stance of policy. So I would put on the table the possibility of saying that ""inflation has been high, partly spurred by high oil and commodity prices"" to say that it's more than just the short-term behavior of commodity prices. I think the word ""also"" means that inflation concerns there are added as an afterthought, which is my reading of the change from the draft table 1 to paragraph 4. So I prefer that ""also"" be eliminated. Thank you, Mr. Chairman. " CHRG-110hhrg44901--136 Mr. Bernanke," I know that they work very closely, and there are areas where there is some overlap of responsibility and jurisdiction. The Treasury Blueprint for reform envisions that we would merge at some point. I don't really have a recommendation to make on that. I think it would depend in part on the overall plan for regulatory reform if, in fact, that takes place in the context of that broader plan. Ms. Moore of Wisconsin. Well, I just only say that because so many of these commodities are paper transactions and futures contracts versus bringing your hog to the marketplace to sell. It seems to me that the modern thing would be to bring these together and have perhaps a better regulatory framework. I yield back. " CHRG-111shrg52966--21 Mr. Sirri," I think we all--I won't speak for others. I think we understood, and my impression was all of these regulators understood, that we were limited in part. We had dialog amongst ourselves. Staff on the ground talked to staff from other regulators. In addition, the firm--it is not like the firms drew up walls and said, we won't give you information on that bank, or we won't give you information on that thrift. They would provide such information. But in the sense of integrated enterprise risk management, I think it was not what it could be. Senator Reed. Senator Bunning, and take as much time as you want. Senator Bunning. Thank you, Mr. Chairman. Welcome back from your vacations that you have been on for the last 5 years, and I say that not kiddingly. I say that as meaningful as I can, because if we would have had good regulators, we wouldn't be in the crisis we are in right now. Ms. Williams, at the bottom of page 24, you said the Fed did not identify many of the issues that led to the failure of some large institutions. Can you tell us what some of these issues that they are, what they missed? Ms. Williams. Absolutely. I would direct your attention to a couple of pages later, on page 26. We note that the Fed began to issue risk committee reports, and in February of 2007 they issued perspectives on risk, and we list a number of issues that we pulled from that report. For example--the report stated that there were no substantial issues of supervisory concern for large financial institutions; that asset quality across the systemically important institutions remains strong; in spite of predictions of a market crash, the housing market correction has been relatively mild and while price appreciation and home sales have slowed, inventories remain high and most analysts expect the housing boom to bottom out in mid-2007. Overall, the impact on a national level will likely be moderate. However, in certain areas, housing prices have dropped significantly. They also noted that the volume of mortgages being held by institutions or warehouse pipelines had grown rapidly to support collateralized mortgage-backed securities and CDOs and noted that the surging investor demand for high-yield bonds and leveraged loans, largely through structured products such as CDOs, was providing a continuing strong liquidity that resulted in continued access to funding for lower-rated firms at relatively modest borrowing costs. So those are some of the---- Senator Bunning. Would you like to comment on counterparty exposures, particularly to hedge funds? Ms. Williams. This was another area that was identified. The regulators had focused on counterparty exposures, particularly to hedge funds. Senator Bunning. Mr. Cole, would you like to respond? " FOMC20060328meeting--107 105,MS. MINEHAN.," Next meeting, okay. [Laughter] We’ve had a wide range of contacts in New England since our last meeting, so what I’m going to do is try to summarize five or six different things that came out as a result of this range of contacts. The first point is basically driven by the data. New England continues to grow more slowly than the nation. Actually, employment growth year over year is about a third of the pace of the nation as a whole—sort of normal, in a way. New England tends to have a slower-growing population and labor force than the rest of the nation. But the recent pace of job growth is decidedly slower than the long-run average. Nonetheless, regional businesses seem to be broadly participating in the growth of the overall economy, and even the pace of losses in manufacturing jobs seems to be slowing. Indeed, merchandise exports for the region were quite strong despite continuing manufacturing job losses, suggesting that regional manufacturers have figured out a way to enjoy some productivity growth and to keep their output relatively high. Almost all contacts have been quite upbeat about sales and revenue expectations for this year. Most state corporate tax collections have been booming, and retail sales and state sales tax revenues are at or above budget almost everywhere except Rhode Island. Rhode Island seems to be going through a kind of flattening of growth. I’m not exactly sure why. At a recent conference of regionwide Realtors, optimism was expressed by heads of state Realtor groups that, so far, home sales and prices, although they are certainly moderating, have held up fairly well. And that’s even considering the fact that in the fourth quarter of last year, sales in the Northeast, unlike for the nation, declined for both new and existing homes. But ’06 was viewed by this group as proceeding fairly well. There is some evidence of tight labor markets for certain skilled jobs. We have in one of our advisory groups a CEO of a software firm that does software and consulting services oriented toward recruitment for Global 2000 customers. She reported that their clients around the world are having difficulty hiring health care, technology, finance, and professional-level sales personnel. So she was seeing some real uptick in labor market tightness at the high end. And I must say that when you look at commercial vacancy rates, which have declined for Class A downtown and suburban space, not just in Boston but elsewhere, you seem to get the impression that maybe businesses haven’t started to hire yet but they do have plans to hire and they do have plans to hire at the high end. Finally, local measures of price growth remain quite contained, though headline CPI data indicate that the region has suffered more than the nation from high energy and utility costs, even with the quite mild winter. In assessing the reaction of contacts about cost increases, we heard a bit less complaining this time around. Maybe people have just given up complaining, or perhaps they have found ways—and I think this is probably more true than not—to offset high commodity and energy costs through rising productivity. The picture for the nation is even better than it is for New England. We, like the Greenbook authors, have been a bit surprised and pleased at the strength of the incoming data after the bump in the fourth quarter. David mentioned all the good reasons to be pleased—strong employment, solid consumer spending, not much evidence yet of a large drag from housing, solid business investment and production, very favorable financing conditions, faster growth than the rest of the world, and through it all, moderating headline and rather flat core inflation, whether you look at the CPI or the PCE, reflecting a leveling-out of energy prices and continued strong productivity growth. True, some luck has been involved, particularly the rather temperate winter weather in the Northeast, with its good news for overall energy and electricity costs. And the drop in new home sales may be a harbinger of worse to come. But the first quarter is over, and it was stronger than we expected, even allowing for a bounceback from Q4. Looking ahead, we agree with the general trajectory of the Greenbook forecast, as we have for some time. However, we have penciled in a somewhat greater effect in ’06 on growth from the expected falloff in housing—that is, an actual small decline in residential investment in every quarter this year and a related effect on consumption from a flattening of the growth in household wealth. So our GDP forecast for ’06 is somewhere between three- and four-tenths lower than the Greenbook’s, though ’07 is just about the same. We also see a smaller uptick in core inflation this year, largely because we see labor markets as having a bit more capacity than does the Greenbook, which we believe accounts for some of the moderation in wage and salary growth, at least by some measures. It may be splitting hairs to mention what in the end are small differences between Boston’s forecast and the Greenbook’s. After all, we don’t have the same number of resources in Boston focusing on making a forecast as you do here for the Greenbook. But I think we are at a point where small differences in outlook really do affect how each of us sees the policy choices. Now, what are the risks around this benign, if not rosy, outlook? Will they continue to revolve around growth that is higher than expected, prompted by a continuation of consumer strength—if, for example, housing takes less of a bite out of growth than we expect—and by financial conditions that could remain more stimulative as well? Indeed, when we look both at where we’ve been off in evaluating the outlook over the past couple of years and at our own Boston forecast, the surprises have mostly been the result of rising household wealth and a related set of very favorable financial market conditions. If these conditions continue, greater inflationary pressure than we expect could well result, given where we are in terms of resource utilization. And of course, new energy shocks are possible, given the possible geopolitical unrest and tight supply conditions. Alternatively, looking at risks on the other side, a greater-than-expected slowdown in housing, with a related larger pickup in saving rates, could put an unexpected damper on growth. Absent new energy shocks, this would act to moderate both growth and inflationary pressures more than expected. So we see housing as integral to both upside risks and downside risks. As I see it right now, the risks to the forecast appear relatively well balanced, maybe a touch to the side of inflation. That’s mostly because we’ve had a lot of recent experiences with surprises on the upside relative to growth, with rising energy and commodity prices, and overall resource capacity is hard to be very precise about. However, I really don’t see large upside inflation risks, mostly because of what we’ve seen in terms of ongoing productivity growth. It remains solid, and it continues to act as a powerful buffer. Indeed, despite the temporary drop-off in Q4, I have not seen or heard anything from my contacts that suggests the underlying business drive to be ever more productive will slow, or slow anytime soon. So although my assessment of risks has a small upside tilt and I am concerned about how expensive being very wrong on the inflation side would be, I don’t see the situation as significantly unbalanced." CHRG-111shrg57322--411 Mr. Sparks," Can I just, Dr. Coburn, I thought you said we were changing our positions. We were oftentimes changing our positions. I thought you meant did---- Senator Coburn. I understand, but there has never been a position change like what took place in the last 4 years in this country in the mortgage markets. There has never been anything like that. Maybe when we shut off exports of commodities to the Russians during the Afghanistan invasion, but there has never been a change like that before in this country. So I understand you change positions all the time, but there has never been anything to compare to what happened in terms of the collateralized debt obligations and the residential mortgage-backed securities in this country. Would you agree with that? Do you know anything in your history? I am 62 years old. I have never seen anything like it. " fcic_final_report_full--171 All along the assembly line, from the origination of the mortgages to the creation and marketing of the mortgage-backed securities and collateralized debt obligations (CDOs), many understood and the regulators at least suspected that every cog was reliant on the mortgages themselves, which would not perform as advertised. THE BUBBLE: “A CREDITINDUCED BOOM ” Irvine, California–based New Century—once the nation’s second-largest subprime lender—ignored early warnings that its own loan quality was deteriorating and stripped power from two risk-control departments that had noted the evidence. In a June  presentation, the Quality Assurance staff reported they had found severe underwriting errors, including evidence of predatory lending, legal and state viola- tions, and credit issues, in  of the loans they audited in November and December . In , Chief Operating Officer and later CEO Brad Morrice recommended these results be removed from the statistical tools used to track loan performance, and in , the department was dissolved and its personnel terminated. The same year, the Internal Audit department identified numerous deficiencies in loan files; out of nine reviews it conducted in , it gave the company’s loan production depart- ment “unsatisfactory” ratings seven times. Patrick Flanagan, president of New Cen- tury’s mortgage-originating subsidiary, cut the department’s budget, saying in a memo that the “group was out of control and tries to dictate business practices in- stead of audit.”  This happened as the company struggled with increasing requests that it buy back soured loans from investors. By December , almost  of its loans were going into default within the first three months after origination. “New Century had a brazen obsession with increasing loan originations, without due regard to the risks associated with that business strategy,” New Century’s bankruptcy examiner reported.  In September —seven months before the housing market peaked—thou- sands of originators, securitizers, and investors met at the ABS East  conference in Boca Raton, Florida, to play golf, do deals, and talk about the market. The asset- backed security business was still good, but even the most optimistic could read the signs. Panelists had three concerns: Were housing prices overheated, or just driven by “fundamentals” such as increased demand? Would rising interest rates halt the market? And was the CDO, because of its ratings-driven investors, distorting the mortgage market?  CHRG-111hhrg51698--122 Mr. Fortenberry," Thank you, Mr. Chairman, for holding this very important hearing and for delving very deeply into this complex issue, and I thank the panel as well for the lively and informative exchange. It has been very productive. When gasoline went over $4 in Nebraska last year, I stopped in to see Bill Sapp. He does something similar to you, Mr. Cota. Any of you who have gone down Interstate 80 right outside of Omaha might see a big coffee pot sitting 100 feet in the air. That is Bill's business. I said, Bill, what is going on, and he said, speculation. I want to follow up with your comments, Mr. Cota, talking last year when we hit $140 or so on oil futures, and now we are back down to $40. Your suggestion that this is being driven by greed and fear, being untethered from any supply or demand conditions, simply being accelerated because of artificial factors, outside, again, of the underlying fundamentals, led to such disruption not only in terms of gasoline prices, but all of the other commodities. And you, sir, had mentioned consequences for the other agricultural markets. If we presume that is true, and last year we held numerous hearings on this with the CFTC to figure out what systemically was potentially failing, where has regulation gone wrong. Their conclusion was we can't find a smoking gun, but we need more time and more help to potentially find a smoking gun. Let us unpack the reasons for, again, that rapid spike in speculation that everyone agrees has been terribly disruptive and not normal. Mr. Gooch, you alluded to it, to a portion of the reason, maybe the significant portion, in terms of credit and credit bubbles and investing in commodities as an inflationary hedge or for other reasons, because people were just getting on this accelerating train. If we can get to that underlying question, and then we know a lot more as to how to potentially prevent this type of systemic failure, disruption into the future, which has been, again, underlying a big portion in this economic malaise that we are in. " FOMC20060629meeting--47 45,MR. KAMIN.," I will answer the small question. Then Larry can answer the big one. [Laughter] I agree with you that there is actually a certain disjuncture, if you will, between the fact that steel prices have stayed up and the growing capacity in China. I don’t have a full answer to your question, but I would offer just a couple of thoughts. The first is that, unlike a homogeneous primary commodity, steel comes in many forms, and there are different markets. So the very substantial increases in Chinese capacity in some products don’t necessarily lead to price declines in other products that may be particularly important to the United States. The second point to mention, which is much more obvious, is that iron ore prices actually have gone up very significantly. According to the data that we’re looking at, basically they are 18 percent higher than they were a year earlier. What seems to be going on is some tension between increases in ore prices, on the one hand, and improvements in capacity, on the other hand, which might reduce the margin between the ore and the final steel products. Perhaps those circumstances will go some way toward explaining the anomaly." FOMC20050630meeting--11 9,MR. RUDEBUSCH.," I will review some general issues related to monetary policy and asset prices. Let me start—at the top of page 1—by assuming that an asset price can, in theory at least, be separated into a component determined by underlying economic fundamentals and a non-fundamental or bubble component. An asset price may be in line with its fundamentals, so the bubble component is zero, or bubbles could be positive or negative—perhaps representing irrational euphoria or pessimism. June 29-30, 2005 15 of 234 of monetary policy. For example, a booming stock market is usually followed by higher demand and increased inflationary pressures, so tighter policy would be needed to offset these consequences. Even for the Standard Policy response, it will likely be useful to identify, if possible, the separate components of the asset price. In particular, the bubble component may exhibit more volatile dynamics and be a pernicious source of macroeconomic risk, so optimal policy would likely react more to bubbles than to movements in the fundamental component. The second type of response, the “Bubble Policy,” follows the Standard Policy as a base case, but, in certain circumstances, it also takes steps to contain or reduce the asset price bubble. Proponents of a Bubble Policy argue that movements in the bubble component can have serious adverse consequences for macroeconomic performance that monetary policy cannot readily offset after the fact, so it is preferable to try to eliminate this source of macroeconomic fluctuations directly. Furthermore, because bubbles often seem to display a self-reinforcing behavior, a little preemption and prevention early on can avoid later excesses. A best-case scenario for these two policies is illustrated in the lower half of the first page. Under ideal circumstances, the policymaker knows the fundamental and bubble components, and as history unfolds, the Standard Policy would likely recommend higher interest rates to offset any economic stimulus generated by the bubble before the crash and lower rates afterward. A Bubble Policy would go further and try to mitigate the fluctuations in the bubble and achieve an asset price path like AP′t . This would likely require higher interest rates than the Standard Policy before the crash and lower rates afterward, and it will likely trade off near- term deviations from the central bank’s macroeconomic goals for better overall macroeconomic performance later on. The fundamental difference between the two policies is that the Standard Policy takes the bubble component essentially as given or exogenous, while the Bubble Policy takes into account the endogenous nature of the bubble component—specifically, a linkage between the policy instrument and the bubble. A decision tree for choosing between the Standard and Bubble Policies is shown on page 2. In brief, it asks three questions: (1) Can policymakers identify a bubble? (2) Will fallout from a bubble be significant and hard to rectify ex post? and (3) Is monetary policy the right method to use to deflate the bubble? The answer to the first question—can policymakers identify a bubble?—is “no” if the particular asset price appears aligned with fundamentals. Some have argued that this is nearly always the case because estimates of fundamentals are so imprecise and because asset prices reflect the collective information and wisdom of professional traders in organized markets. If policymakers cannot discern a bubble, then the Standard Policy is the only feasible response. June 29-30, 2005 16 of 234 policy cannot readily offset after the fact. A negative answer to this question is appropriate in two situations. First, if the bubble is in an asset market that is small in domestic economic terms—for example, a localized real estate market—then a central banker should avoid attempts at asset price realignment. Second, even when there are significant macroeconomic consequences from an asset price bubble boom and bust, if they occur with a sufficient lag so the policymaker can adopt a wait-and­ see attitude, then the Standard Policy is again appropriate. This second case seems relevant if fluctuations in the bubble component have only conventional effects on aggregate demand and supply through changes in wealth, the cost of capital, and balance sheets. Then, to a first approximation, the lags involved in these channels are about as long as the lags in the monetary transmission mechanism; therefore, the Standard Policy should suffice. For example, fluctuations in equity prices will affect wealth and consumer demand, but a nimble central banker can essentially offset these consequences by changing interest rates in reaction to—that is, after—the equity price movements. Now to the case where asset price movements have significant macroeconomic consequences and those consequences are hard to clean up after the fact through monetary policy. The most often mentioned possibility is that a bursting asset price bubble will lead to a broad financial crisis and credit crunch. Such financial instability is likely to be transmitted to the economy much more quickly than can be offset by interest rate policy. This may set the stage for invoking a Bubble Policy. Another example is when the asset price misalignment results in significant misallocations of resources, which distort aggregate demand and supply across sectors and over time and impede the achievement of the highest possible long-run economic growth. For example, the dot-com bubble spurred overinvestment in fiber optic cable and decimated the provision of venture capital for new technology startups for years. Of course, after the fact, it is difficult to unwind these problems with the blunt instrument of monetary policy, and, depending on the specifics, it is possible to conceive of a situation in which reducing the bubble in advance is a preferred policy strategy. The final hurdle before invoking a Bubble Policy involves assessing whether monetary policy is the right way to deflate the asset price bubble. Ideally, for the Bubble Policy, a moderate adjustment of interest rates could constrain the bubble and greatly reduce the risk of severe future macroeconomic dislocations. However, bubbles, even if identified, often do not appear influenced by monetary policy actions in a predictable way. Furthermore, even if changing interest rates could alter the bubble path, such a strategy may involve substantial costs, including near-term deviations from the macroeconomic goals of the central bank as well as potential political or moral hazard complications. Finally, even if monetary policy can affect the bubble, alternative strategies to deflate it, such as changes in financial regulations or supervision, may be more targeted and have a lower cost. June 29-30, 2005 17 of 234 questions for two historical episodes. The first episode is the run-up in the stock market during the late 1990s. In 1999 and 2000, one could have made the case that there was an equity price bubble in the high-technology sector and perhaps in the overall market as well. Also, during that time, the possible capital misallocation from the run-up in prices and the possible financial instability that might have followed a bursting of the bubble may have appeared difficult to rectify. However, it was also unlikely that monetary policy could have deflated the equity price bubble without substantial costs to the economy. In the event, of course, a Bubble Policy was not followed, but arguably, the consequences from any bubble boom and bust have been manageable. A different example is provided by the bond market collapse in 1994. One could argue that this “inflation scare,” which pushed up yields on 30-year bonds by over 2 percentage points, resulted in an asset price misalignment that was fairly apparent to the FOMC during the second half of 1994. If this bond bubble had persisted, the widespread propagation of the associated fears of higher inflation could have had severe consequences that would have been costly to unwind with monetary policy later on. Finally, with regard to deflatability, it did appear likely that monetary policy could guide bond prices back to fundamentals. Indeed, one interpretation of the FOMC’s actions in 1994 is that it purposefully and successfully contained a bond market bubble with sizable increases in the funds rate. It is an open question which of these two episodes is the more relevant one today. That concludes my remarks." FOMC20080318meeting--101 99,CHAIRMAN BERNANKE.," Thank you very much. Thank you for all of your comments. Let me just briefly summarize and add a few points. To summarize the discussion, incoming data have been weak, and some view the economy as having entered recession. Housing demand and construction have continued to decline sharply, and house-price declines have been somewhat greater than expected. Housing weakness has implications for employment, for consumer spending, and for credit conditions. It also leads to 21 miles of empty boxcars. [Laughter] Financial conditions have worsened considerably, reflecting weakness in housing prices, and credit markets in particular are highly stressed and illiquid. Wider spreads have offset some or all of the decline in safe rates for many credit products, and credit conditions are tighter for most borrowers. Financial conditions are likely to be a significant drag on economic growth. Some noted the risk that continued financial turmoil could lead to a more serious and prolonged recession, implying possibly large downside risk to growth. With respect to households, consumption growth has flattened out, and there was generally greater pessimism about the labor market and economic prospects. Consumer credit quality may be worsening. Payroll employment growth has turned negative. There was little expectation expressed of strong help from the fiscal stimulus package. Firms are generally more pessimistic and cautious but also remain concerned about cost pressures. Inventories look to be in balance. Exports continue to be an important source of final demand and will continue to contribute significantly to growth, although it's possible that growth abroad may slow. Readings on core inflation have been mixed. Increases in energy and commodity prices are important sources of increased headline inflation, and some producers have adopted a cost-plus mentality. Agricultural prices, in particular, are up a good bit. Inflation breakevens are up somewhat, especially at the five-by-five horizon. The dollar has depreciated, potentially adding to longer-term inflation pressures and adding some risks. However, nominal wage increases are moderate, as are unit labor costs, and U.S. and global economic weakness could moderate gains in commodity prices and create domestic economic slack. Several members warned about the risk of losing inflation credibility. Any comments, thoughts? Let me make just a few comments. Again, I'm very sympathetic to what almost everyone has said around the table, in particular the fact that we're facing a three-front war, if you will, which makes this extraordinarily difficult and delicate. I thought in January that we were in recession. That was my view at that time, and I certainly believe it now. The Greenbook has done a good job of trying to factor in the data and the other types of evidence. I think I'm actually slightly darker on growth than the Greenbook is. The reason is that I don't see where the recovery is coming from in the beginning of next year. In particular, we won't have a recovery until financial markets stabilize, and the financial markets won't stabilize until house prices stabilize, and there is simply no particular reason to choose a time for that to happen. So I do think that the downside risks are quite significant and that this so-called adverse feedback loop is currently in full play. At some point, of course, either things will stabilize or there will be some kind of massive governmental intervention, but I just don't have much confidence about the timing of that. I would like to say a word. I would just agree with Governor Mishkin about the efficacy of our policy. I think that it has had an effect and it has been beneficial. We obviously affect shortterm rates, including commercial paper rates and the like, which have implications for financing and for borrowing. We affect the dollar, which has mixed effects, but on the growth side has some positive effects. It's true, as President Fisher pointed out, that medium-term and long-term rates have not fallen because lower Treasury rates have been offset by higher spreads, but again, the question is the counterfactual. Where would we be if we had not lowered rates? I think that lower rates have both lowered safe rates and offset to some extent the rising concerns about solvency, which have caused the credit spreads to widen. I think this argument can go either way. You can say that our policy is less effective and, therefore, we should do more of it. So there are two ways of looking at that. In addition, there may be some benefits for capital formation of low financing rates and a steep yield curve in keeping bank share prices from entirely collapsing. On inflation, I agree with much of what's been said, and I'm very concerned about it. Let me make one simple point, though, which I don't think has been adequately discussed. Ninety-five percent of the inflation that we're seeing is either the direct or the indirect effect of globally traded commodity prices--food, energy, and other commodities. What is happening is that there is a change in the relative price of, say, oil and the wage of an Ohio manufacturing worker. There's a relative price change going on. That has to happen one way or the other. It can happen either by overall increases in the nominal price of oil, which are reflected in overall increases in headline CPI inflation, or by lower or negative growth in nominal wages. Now, if we have temporary movements in these relative prices, I think all the theory tells us that the best way to let that relative price change happen is to let the shock feed through; let the prices of energy, commodities, and so on rise; accept a temporary increase in headline inflation; and focus on making sure that the increase in headline inflation doesn't feed through into domestic core inflation, say, through wages or domestic prices. A good response to that is, well, we've had a lot of ""temporary"" shocks here and they have gone on for a long time. That's certainly true. But again, it was very difficult to anticipate how these prices have moved. Looking forward, the futures markets have been wrong and wrong, but they are the best we have. In my view, if we think about the likely slowdown in the U.S. economy and the global economy, there are going to be some forces that will prevent commodity prices from continuing to rise the way they have been rising, which ought to take the pressure off the inflation process. That being said, I fully recognize that there has been a bit of movement in some of the indicators. I think I like the use of the index measure. It uses lots of different indicators. I don't think we should overemphasize inflation compensation. For example, the one-year inflation compensation three and four years out has moved up less than the five-by-five, and I think for good reasons. The five-byfive could reflect, again, general uncertainty. It could also reflect more volatility in the relative price changes of oil, for example. If we think there's more volatility in that, if it's up or down, that would create more uncertainty about headline inflation and would feed through into that spread. Frankly, in thinking about inflation, I am concerned about inflation expectations and the general psychology. I'm hopeful at least that it will moderate as commodity prices moderate although, of course, no one can know for sure. I agree with Governor Warsh that, from a financial perspective on the inflation side, the greater dangers are in the currency area. Exchange rates are very poorly tied down by fundamentals, except over very long periods of time--I think Ken Rogoff had a paper in which he said that over maybe 600 years or so the PPP finally works. [Laughter] So a lot of psychology is there. I think that it is an important issue. We need to think about what the Treasury will say and those sorts of things. That is a concern, and I consider that in some sense a greater risk at this point. So there are risks on both sides. I think that the downside risks, including the financial risks, at this point are greater--not to belittle inflation risks, which I think are quite significant. We are obviously going to have to make tradeoffs about how to deal with these. Using both our policy tools and our communication is very important. I agree with Vice Chairman Geithner that we need and I need--and I have a very important role here--to maintain clarity in communication about our attention to inflation, that we are not ignoring that side of the mandate. Finally, let me just say, as I said last night at the dinner with the presidents, that I think we are getting to the point where the Federal Reserve's tools, both its liquidity tools and its interest rate tools, are not by themselves sufficient to resolve our troubles. More help, more activity, from the Congress and the Administration to address housing issues, for example, would be desirable. We are certainly working on those issues here at the Board, and I will be talking to people in Washington about what might be done to try to address more fundamentally these issues of the housing market and the financial markets. So those are my comments. Why don't we turn now to Brian for an introduction to the policy round. " CHRG-110hhrg44901--134 Mr. Bernanke," Well, with respect to possible steps, as I indicated, the Federal Reserve is part of a task force being led by the CFTC, which is trying to get as much clarity as we can on exactly this question, and that includes right now we and the CFTC in particular has been gathering information from other petroleum futures exchanges like the ones in U.K., has been gathering information on the activities of swaps dealers and index traders who invest in these economies. We are trying to understand how these investments are made and how they relate to price movements, those sorts of things. So we are looking at that seriously. It is possible that the CFTC may decide, and, of course, it is their province to do so, that changes in the information requirements or in positions, limits or things of that sort might be justified under certain circumstances. There is a lot of evidence, though, on which I base my earlier statement in the testimony that makes it seem unlikely that speculation or, better termed, manipulation is driving up energy prices. I mentioned the absence of inventories. There are a number of other things. For example, there seems to be no empirical relationship between long, open positions by noncommercial traders and movements in prices. It is striking that there are many or at least some commodities which are not even traded on future markets which have had big price run-ups, like coal and iron ore, for example. So it doesn't seem to us to be the central issue. It does mean that energy prices in the very short run can respond quite sensitively to news that comes in because they begin to trade like a stock price, for example. But that is not necessarily a bad thing; that means that information is being incorporated into those prices, and that helps suppliers and demanders know how better to respond. Ms. Moore of Wisconsin. Mr. Chairman, thank you for that. Is the SEC a part of this committee that is looking at the commodities irregularities? " CHRG-111hhrg49968--50 Mr. Hensarling," If the Fed will not monetize the debt and if the Congress refuses to deal with the spending curve, which will average about 23 percent of GDP for the next 10 years, that is either going to leave us with a massive tax increase or massive borrowing. But yet, apparently, as we send representatives to China to encourage them to continue to buy our debt, they are shifting to commodities; they are indicating concerns about the level of our debt. Recently, as I believe you know, S&P downgraded UK's debt on May 21st from stable to negative. So what is going to happen if the U.S. loses its AAA rating, or what happens if we have a 60 percent tax increase over the next 10 years to deal with this massive infusion of debt? " CHRG-111hhrg53021--273 Secretary Geithner," I would be happy to respond. The overall estimates of magnitude of the total face value of these markets are in the $600 trillion range. The market value of those contracts, my testimony, says are more in the $20 trillion range. That still itself doesn't really capture the risk. It probably substantially overstates it. But these are enormously large markets, enormously important to how our markets function. These markets include interest rate risk, exchange risk, equity derivatives, commodity derivatives, energy, food, et cetera. And the way this happened in credit derivatives was very similar to what happened in commodity derivatives and others, which is that decades ago people figured out a way to offer a company the ability to hedge against a particular risk, the cost of energy, cost of seeds, cost of movement in exchange rates, cost of a change in interest rates, and over time products emerged to meet that economic demand. What we did not do in our country is stay abreast of that innovation and put in place the framework of protections over those markets that was commensurate with the risk they proposed. We were behind that curve. And we had a lot of institutions, including regulated institutions like the monoline insurance companies and AIG that wrote a huge amount of protections without the capital to back it, and that combination of factors helped bring us to the edge of this very severe crisis. And it is an obligation we all share to make sure that we not just address those principal causes of this crisis, but we have a stronger framework to address future vulnerabilities, and that our framework adapts more quickly in the future. And that is what we are trying to do. " CHRG-111hhrg53021Oth--273 Secretary Geithner," I would be happy to respond. The overall estimates of magnitude of the total face value of these markets are in the $600 trillion range. The market value of those contracts, my testimony, says are more in the $20 trillion range. That still itself doesn't really capture the risk. It probably substantially overstates it. But these are enormously large markets, enormously important to how our markets function. These markets include interest rate risk, exchange risk, equity derivatives, commodity derivatives, energy, food, et cetera. And the way this happened in credit derivatives was very similar to what happened in commodity derivatives and others, which is that decades ago people figured out a way to offer a company the ability to hedge against a particular risk, the cost of energy, cost of seeds, cost of movement in exchange rates, cost of a change in interest rates, and over time products emerged to meet that economic demand. What we did not do in our country is stay abreast of that innovation and put in place the framework of protections over those markets that was commensurate with the risk they proposed. We were behind that curve. And we had a lot of institutions, including regulated institutions like the monoline insurance companies and AIG that wrote a huge amount of protections without the capital to back it, and that combination of factors helped bring us to the edge of this very severe crisis. And it is an obligation we all share to make sure that we not just address those principal causes of this crisis, but we have a stronger framework to address future vulnerabilities, and that our framework adapts more quickly in the future. And that is what we are trying to do. " fcic_final_report_full--67 DEREGULATION REDUX CONTENTS Expansion of banking activities: “Shatterer of Glass-Steagall” ............................  Long-Term Capital Management: “That’s what history had proved to them” ....................................................  Dot-com crash: “Lay on more risk” .....................................................................  The wages of finance: “Well, this one’s doing it, so how can I not do it?” .............  Financial sector growth: “I think we overdid finance versus the real economy” ...................................  EXPANSION OF BANKING ACTIVITIES: “SHATTERER OF GLASS STEAGALL” By the mid-s, the parallel banking system was booming, some of the largest commercial banks appeared increasingly like the large investment banks, and all of them were becoming larger, more complex, and more active in securitization. Some academics and industry analysts argued that advances in data processing, telecom- munications, and information services created economies of scale and scope in fi- nance and thereby justified ever-larger financial institutions. Bigger would be safer, the argument went, and more diversified, innovative, efficient, and better able to serve the needs of an expanding economy. Others contended that the largest banks were not necessarily more efficient but grew because of their commanding market positions and creditors’ perception they were too big to fail. As they grew, the large banks pressed regulators, state legislatures, and Congress to remove almost all re- maining barriers to growth and competition. They had much success. In  Con- gress authorized nationwide banking with the Riegle-Neal Interstate Banking and Branching Efficiency Act. This let bank holding companies acquire banks in every state, and removed most restrictions on opening branches in more than one state. It preempted any state law that restricted the ability of out-of-state banks to compete within the state’s borders.  Removing barriers helped consolidate the banking industry. Between  and ,  “megamergers” occurred involving banks with assets of more than  bil- lion each. Meanwhile the  largest jumped from owning  of the industry’s assets  to . From  to , the combined assets of the five largest U.S. banks—Bank of America, Citigroup, JP Morgan, Wachovia, and Wells Fargo—more than tripled, from . trillion to . trillion.  And investment banks were growing bigger, too. Smith Barney acquired Shearson in  and Salomon Brothers in , while Paine Webber purchased Kidder, Peabody in . Two years later, Morgan Stanley merged with Dean Witter, and Bankers Trust purchased Alex. Brown & Sons. The assets of the five largest investment banks—Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns—quadrupled, from  trillion in  to  tril- lion in .  CHRG-109shrg24852--120 RESPONSE TO A WRITTEN QUESTION OF SENATOR CORZINE FROM ALAN GREENSPANQ.1. This morning, the Senate Agriculture Committee is marking up legislation reauthorizing the Commodities Futures Trading Commission. The proposed legislation would modify the Commodity Futures Modernization Act (CFMA) of 2000, which, as you know, this Committee and Agriculture jointly worked on to develop. That effort was based on recommendations from the President's Working Group (the Federal Reserve, Treasury, SEC, and CFTC) on Financial Markets. Yesterday, you expressed concerns to Agriculture Committee Chairman Chambliss about the legislation in response to a letter from Senator Crapo. Those concerns seem to revolve around the fact that the President's Working Group has not had the opportunity to review or deliberate key proposals contained in the draft reauthorization legislation. SEC Acting Chairman Glassman has expressed a similar concern, and Chairman Shelby and Ranking Member Sarbanes have done so as well. As you know, of major concern with the draft legislation are the provisions that would modify portions of the CFMA that were painstakingly crafted to balance the differing interests of all Federal financial regulators. I wonder if you could discuss more in depth the nature of the concerns you expressed in your letter and what specific harm could come from Congressional action that, done in haste, could disrupt the balance and legal certainty the CFMA struck which has aided the development of important financial markets and reaped significant benefits for the broader economy?A.1. The Federal Reserve Board believes the CFMA has unquestionably been a successful piece of legislation. It enacted provisions that excluded transactions between institutions and other eligible counterparties in over-the-counter financial derivatives and foreign currency from regulation under the Commodity Exchange Act (CEA). This exclusion resolved long-standing concerns that a court might find that the CEA applied to these transactions, thereby making them legally unenforceable. Another important part of the CFMA addressed problems associated with ``bucket shops'' that were marketing foreign currency futures to retail customers (that is, an individual or business that does not meet the definition of eligible counterparty). The legislation marked up by the Senate Agriculture Committee in July 2005 would apply the CEA as a whole to certain retail foreign currency contracts, regardless of whether they are futures contracts. We seriously question whether it is necessary to apply all the provisions of the CEA to these transactions in order to enable the CFTC to address fraud, and believe that a broad application of the Act could have unintended consequences." fcic_final_report_full--102 SUBPRIME LOANS:  “BUYERS WILL PAY A HIGH PREMIUM ” The subprime market roared back from its shakeout in the late s. The value of subprime loans originated almost doubled from  through , to  billion. In ,  of these were securitized; in , .  Low interest rates spurred this boom, which would have long-term repercussions, but so did increasingly wide- spread computerized credit scores, the growing statistical history on subprime bor- rowers, and the scale of the firms entering the market. Subprime was dominated by a narrowing field of ever-larger firms; the marginal players from the past decade had merged or vanished. By , the top  subprime lenders made  of all subprime loans, up from  in .  There were now three main kinds of companies in the subprime origination and securitization business: commercial banks and thrifts, Wall Street investment banks, and independent mortgage lenders. Some of the biggest banks and thrifts—Citi- group, National City Bank, HSBC, and Washington Mutual—spent billions on boost- ing subprime lending by creating new units, acquiring firms, or offering financing to other mortgage originators. Almost always, these operations were sequestered in nonbank subsidiaries, leaving them in a regulatory no-man’s-land. When it came to subprime lending, now it was Wall Street investment banks that worried about competition posed by the largest commercial banks and thrifts. For- mer Lehman president Bart McDade told the FCIC that the banks had gained their own securitization skills and didn’t need the investment banks to structure and dis- tribute.  So the investment banks moved into mortgage origination to guarantee a supply of loans they could securitize and sell to the growing legions of investors. For example, Lehman Brothers, the fourth-largest investment bank, purchased six differ- ent domestic lenders between  and , including BNC and Aurora.  Bear Stearns, the fifth-largest, ramped up its subprime lending arm and eventually ac- quired three subprime originators in the United States, including Encore. In , Merrill Lynch acquired First Franklin, and Morgan Stanley bought Saxon Capital; in , Goldman Sachs upped its stake in Senderra Funding, a small subprime lender. Meanwhile, several independent mortgage companies took steps to boost growth. CHRG-111hhrg63105--98 Mr. Luetkemeyer," I see as my time runs out here I just want to make one comment. And, Mr. Chilton, you made this earlier, that the intent is to protect the markets for their original purpose. And I sincerely hope that you continue to use that as your guiding thought in all of your deliberations. Because, to me, that is why we are here today, is to protect these markets for the original intent of the farmers and original commodity folks to be able to use these things, to use them to enhance their businesses and their ability to do business. It is not a speculative forum that we are worried about here. It is the original folks who use these things to manage their businesses. So that would be my only comment and my only concern and my wish to you. Thank you. And, Mr. Chairman, I yield back. " fcic_final_report_full--180 Clayton Holdings, a Connecticut-based firm, was a major provider of third-party due diligence services.  As Clayton Vice President Vicki Beal explained to the FCIC, firms like hers were “not retained by [their] clients to provide an opinion as to whether a loan is a good loan or a bad loan.” Rather, they were hired to identify, among other things, whether the loans met the originator’s stated underwriting guidelines and, in some measure, to enable clients to negotiate better prices on pools of loans.  The review fell into three general areas: credit, compliance, and valuation. Did the loans meet the underwriting guidelines (generally the originator’s standards, some- times with overlays or additional guidelines provided by the financial institutions purchasing the loans)? Did the loans comply with federal and state laws, notably predatory-lending laws and truth-in-lending requirements? Were the reported prop- erty values accurate?  And, critically: to the degree that a loan was deficient, did it have any “compensating factors” that offset these deficiencies? For example, if a loan had a higher loan-to-value ratio than guidelines called for, did another characteristic such as the borrower’s higher income mitigate that weakness? The due diligence firm would then grade the loan sample and forward the data to its client. Report in hand, the securitizer would negotiate a price for the pool and could “kick out” loans that did not meet the stated guidelines. Because of the volume of loans examined by Clayton during the housing boom, the firm had a unique inside view of the underwriting standards that originators were actually applying—and that securitizers were willing to accept. Loans were classified into three groups: loans that met guidelines (a Grade  Event), those that failed to meet guidelines but were approved because of compensating factors (a Grade  Event), and those that failed to meet guidelines and were not approved (a Grade  Event). Overall, for the  months that ended June , , Clayton rated  of the , loans it analyzed as Grade , and another  as Grade —for a total of  that met the guidelines outright or with compensating factors. The remaining  of the loans were Grade .  In theory, the banks could have refused to buy a loan pool, or, indeed, they could have used the findings of the due diligence firm to probe the loans’ quality more deeply. Over the -month period,  of the loans that Clayton found to be deficient—Grade —were “waived in” by the banks. Thus  of the loans sampled by Clayton were accepted even though the company had found a basis for rejecting them (see figure .). Referring to the data, Keith Johnson, the president of Clayton from May  to May , told the Commission, “That  to me says there [was] a quality control issue in the factory” for mortgage-backed securities.  Johnson concluded that his clients often waived in loans to preserve their business relationship with the loan originator—a high number of rejections might lead the originator to sell the loans to a competitor. Simply put, it was a sellers’ market. “Probably the seller had more power than the Wall Street issuer,” Johnson told the FCIC.  The high rate of waivers following rejections may not itself be evidence of some- thing wrong in the process, Beal testified. She said that as originators’ lending guide- lines were declining, she saw the securitizing firms introduce additional credit fcic_final_report_full--228 With over  metro areas representing nearly one-half of the na- tion’s housing stock experiencing or about to experience price declines, national house prices are also set to decline. Indeed, odds are high that national house prices will decline in .  For , the National Association of Realtors announced that the number of sales of existing homes had experienced the sharpest fall in  years. That year, home prices declined . In , they would drop a stunning . Overall, by the end of , prices would drop  from their peak in .  Some cities saw a particularly large drop: in Las Vegas, as of August , home prices were down  from their peak. And areas that never saw huge price gains have experienced losses as well: home prices in Denver have fallen  since their peak. In some areas, home prices started to fall as early as late . For example, in Ocean City, New Jersey, where many properties are vacation homes, home prices had risen  since ; they topped out in December  and fell  in the first half of . By mid-, they would be  below their peak. Prices topped out in Sacramento in October  and are today down nearly . In most places, prices rose for a bit longer. For instance, in Tucson, Arizona, prices kept increasing for much of , climbing  from  to their high point in August , and then fell only  by the end of the year.  One of the first signs of the housing crash was an upswing in early payment de- faults—usually defined as borrowers’ being  or more days delinquent within the first year. Figures provided to the FCIC show that by the summer of , . of loans less than a year old were in default. The figure would peak in late  at ., well above the . peak in the  recession. Even more stunning, first payment de- faults—that is, mortgages taken out by borrowers who never made a single payment— went above . of loans in early .  Responding to questions about that data, CoreLogic Chief Economist Mark Fleming told the FCIC that the early payment de- fault rate “certainly correlates with the increase in the Alt-A and subprime shares and the turn of the housing market and the sensitivity of those loan products.”  Mortgages in serious delinquency, defined as those  or more days past due or in foreclosure, had hovered around  during the early part of the decade, jumped in , and kept climbing. By the end of , . of mortgage loans were seriously delinquent. By comparison, serious delinquencies peaked at . in  following the previous recession.  Serious delinquency was highest in areas of the country that had experienced the biggest housing booms. In the “sand states”—California, Arizona, Nevada, and Florida—serious delinquency rose to  in mid- and  by late , double the rate in other areas of the country (see figure .).  CHRG-111hhrg53021Oth--120 Mr. Neugebauer," Thank you, Mr. Chairman. Thank you, Mr. Secretary, for coming. We had a little bit of a dialogue, the other night, about capital and equity, and I want to go back to that. Because when we look at the standardized and the customized transactions, the question I have is--I hear you talking about margin requirements, capital equity. In traditional commodities, the clearinghouses set the margins for clearing those transactions. The regulator then determines whether the clearing agency has adequate capital for the activities they are involved in. As we move to the trading of these derivatives, do you see that same structure? Because, sometimes, I hear you saying that the regulator would start setting the margin requirements for these transactions. And I wanted to be clear about my understanding of where you are on that issue. " CHRG-111hhrg53021--120 Mr. Neugebauer," Thank you, Mr. Chairman. Thank you, Mr. Secretary, for coming. We had a little bit of a dialogue, the other night, about capital and equity, and I want to go back to that. Because when we look at the standardized and the customized transactions, the question I have is--I hear you talking about margin requirements, capital equity. In traditional commodities, the clearinghouses set the margins for clearing those transactions. The regulator then determines whether the clearing agency has adequate capital for the activities they are involved in. As we move to the trading of these derivatives, do you see that same structure? Because, sometimes, I hear you saying that the regulator would start setting the margin requirements for these transactions. And I wanted to be clear about my understanding of where you are on that issue. " CHRG-111shrg54789--189 RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM TRAVIS B. PLUNKETTQ.1. Both Mr. Yingling and Mr. Wallison testified repeatedly that the Administration's plan would result in credit being rationed to consumers, particularly consumers who need the credit the most. They also argued that the requirement that additional disclosures or warnings accompany products that are not ``plain-vanilla'' products would result in only those standard products being offered. Specifically, Mr. Wallison testified that `` . . . when a provider is confronted with the choice of whether to offer only the plain-vanilla product or the more complex product, he has to decide whether this particular consumer is going to be able to understand the product.'' Because lenders will be reluctant to make such judgments, they will, by default, offer the plain-vanilla product only, thereby constraining consumer choices. How do you respond to these arguments?A.1. Poor regulation of abusive credit products by Federal regulators over many years has led to exactly the result that Mr. Yingling and Mr. Wallison are concerned about: credit rationing. Deceptive and unsustainable lending practices by credit card companies and mortgage lenders led to record defaults and foreclosures by consumers, record losses by lenders, a crisis in the housing markets and the recession. These developments, in turn, have led to a ``credit crunch'' where credit card lenders, for example, have significantly reduced credit lines and sharply increase interest rates, even for borrowers with stellar credit scores. Had a Consumer Financial Protection Agency existed to prevent the excesses that occurred in the lending markets, there is a very good chance that this country could have avoided the worst aspects of the housing and economic crisis, and of the somewhat indiscriminate reduction in credit availability that has occurred. In other words, proper regulation will create the kind of stability in the credit markets that encourages lenders to offer credit to consumers, especially those who do not have perfect credit ratings. Similarly, the ``plain-vanilla'' requirement is designed to create choices in the credit marketplace that don't exist now, and certainly did not exist during the credit boom. ``Choices,'' such as prepayment penalties that lock consumers into unaffordable loans and ``exploding ARM'' loans that lenders knew many of their borrowers could not afford, crowded out less abusive options from the marketplace and ultimately harmed consumers and the economy. Lenders are quite capable of designing simple, understandable financial products that are profitable for them and useful for consumers, if they chose to do so." FOMC20080130meeting--269 267,CHAIRMAN BERNANKE.," I don't think so. I would just point out that with the 1990-91 episode, inflation after the recession--after the whole episode was over--was significantly lower than in the period before it. So if there are headwinds that are bringing the economy below potential and are causing high unemployment, for example, there has to be a mechanism. Expectations have to be tied to something, and there has to be some way in which excessively low interest rates are stimulating inflation, through either commodity prices or wage pressures or some other mechanism. If those pressures aren't there because of headwinds or some other factor, then unusually low interest rates will not by themselves create inflation. Vice Chairman, did you have anything else you wanted to add? " FOMC20080430meeting--112 110,MR. KOHN.," Thank you, Mr. Chairman. My forecasts of output and inflation for this and the next two years are in the central tendencies of the Committee forecasts. My Okun's law machine went haywire under the pressure of Debbie's deadline, [laughter] so my unemployment forecasts need to be revised. But I hit the 5:00 deadline, I think. I have stronger growth in 2008 than the Greenbook because I was hesitant to adopt the staff's assumption about persistent, serially correlated downside misses relative to fundamentals in consumption and investment implied by entering a recessionary period when we haven't seen those misses yet. But I didn't discount this possibility entirely, reasoning that the extraordinarily depressed business and household sentiment was significant. I came out between the Greenbook baseline and the ""nearterm upside risk"" alternative scenario. Despite slightly stronger growth than in the Greenbook, I have roughly the same headline and core inflation paths that are declining gradually through the next few years. I took some slight encouragement from recent better readings on core. I reasoned that flat commodity prices would reverse any recent tendency for inflation expectations to rise, and I anticipate that vacant housing units will continue to put downward pressure on rent increases. I have a couple of observations on the outlook. First, I think the expectation of improving financial conditions is critical to the favorable medium-term outcome for the economy that President Geithner was just talking about. We don't really know what the current state of overall financial conditions is and how spending is likely to respond to them. Directionally, I think we can say that the severe deterioration that was much in evidence around the time of the last meeting has stopped, as concerns about an even more generalized set of failures--the seizing up of markets and lending--have abated with our actions and with successful capital-raising by intermediaries. We have seen improvements in many segments of the markets, but continued deterioration in term funding suggests to me that there are continued worries about and pressures on credit availability, and credit availability and the cost of credit will be under some pressure as credit is re-intermediated through the banks. Even with some of the recent gains, markets are still fragile and impaired. Spreads have retraced only a small portion of the run-up since last summer. I noticed in Bill's charts that most of those spreads are back down to, say, those in January; and in January, we thought the markets were pretty impaired. So they are still very, very high by historical standards. Mortgage securitization markets away from GSEs remain broken. There are problems in some other securitization markets, including CMBS. A number of intermediate- and longer-term interest rates are still higher than they were before the crisis hit in August. Baa corporate bonds, which is about the median borrower rating for a corporation, long-term muni bonds, and prime jumbo mortgages are all higher than before we did any easing. Nonprice terms and standards are being tightened considerably, judging in part from the Senior Loan Officer Opinion Survey, and I think that process is likely to continue for a while. To be sure, short-term interest rates are a lot lower than they were in August. But I suspect that a continuation of current conditions would not be consistent with much of a pickup in growth and an eventual return toward full employment. This is a circumstance in which relationships between the federal funds rate and other measures of financial conditions have changed very, very substantially, and characterizing the stance of policy and financial conditions by looking at some measure of the real federal funds rate can be quite misleading in these circumstances. I think we need to be careful about how we characterize and think about the stance of policy. The sense that it is neutral right now, much less accommodative, depends very much on our expectations of substantial increases in risk-taking in financial markets. Now, I do think that the most likely path is improving financial market conditions, lower spreads, reopened securitization markets, and stabilization and maybe partial reversal of some of the tighter terms that have evolved. But this process is going to be slow. Until the housing market shows more signs of stabilizing, it is more likely to be subject to backsliding than to sudden unexpected improvements. A corollary to this line of thinking is that there isn't a lot of ease in the pipeline in the conventional sense. Our reductions in the fed funds rate have not eased financial conditions. They have kept them from tightening even more than they would have done otherwise. The lagged effects of policy easing come from improvements in financial markets. That is, as we look forward, the lagged effects of policy easing come from the improvements in financial markets that allow the reductions in the actual and expected paths of short-term rates to show through to the cost of capital more broadly defined. This is a longer and more nuanced process than the usual rules of thumb about seeing the effects of ease on output after X quarters and inflation after Y quarters. My second point about the outlook is that the risks around my forecast for growth are still to the downside. Uncertainty is huge. We are sailing in a fog in uncharted waters, and the depth finder is on the fritz. So much for sailing analogies. [Laughter] Too bad Bill Poole is not here, though I am glad Jim is here. Let me note that for the record. [Laughter] Downside risks from financial market meltdown have been reduced, though not eliminated. But I think an important source of downside risk now is the economy itself--the threat of recessionary tendencies taking hold. I am told we have never had three months of substantial employment declines and business and household sentiment as depressed as they are right now without sliding into a recession. Businesses and households have been unusually cautious in how they invest their savings, moving into government-only money funds and bank deposits, boosting M2, and demanding much larger compensation for taking risks. They are facing much tighter terms for their credit and uncertainty about its availability. It seems to me there is a reasonable possibility that this extraordinary caution in managing their financial portfolios and uncertainty about credit availability will carry over into their spending decisions. That is not my projection or apparently the central tendency of the Committee, but it must be a significant downside risk. In contrast, the risk to total inflation seems skewed to the upside by the potential behavior of commodity prices. I don't understand why these prices have risen so much over the last six months or so. To be sure, over the last several years the rise in prices must have reflected increasing demand in emerging-market economies, but over the past half-year the prospects for global growth have weakened. In those circumstances, I would expect the effects of lower interest rates--say, in the United States--to be offset by weaker demand. Still, prices have risen. The possibility that those types of surprises will continue poses an upside risk to headline inflation and, along with that, a risk to inflation expectations. Nonetheless, I saw the risk around a gradual downtrend in core inflation as about balanced, with the possibility of greater slack offsetting the possibility of higher commodity prices. I take some comfort in my projection for core inflation and implicitly for the more persistent aspects of overall inflation from the continued moderate increases in labor compensation. Those increases have been moderate for some time despite very high headline inflation for several years along with still-elevated markups for nonfinancial businesses. Outside of commodities, cost pressures appear to be muted, and businesses are able to absorb increases. Still, I agree that commodity price increases, like any supply shock, have complicated our choices. We are facing a sluggish economy with downside risks as well as uncomfortably high total inflation that is feeding through to some limited extent into core inflation and, by some measures, into inflation expectations, especially near-term expectations. I do think, however, that we need to keep in mind that the higher inflation is largely a function of these commodity prices rather than a broad acceleration in overall prices. Core inflation has come in less than we anticipated it would. I also take some comfort, relative to some of the tone I have heard around the table, in what has happened in markets over the intermeeting period. Markets have built in another � point decline in the fed funds rate but then an increase further out. So somehow they are taking this promise of an increase seriously. At the same time they did that, the dollar rose--it didn't fall--and the long-term inflation compensation built into markets came down. So I don't see the evidence in financial markets that we are on the cusp of the broad decline in our credibility that I have sensed that some others see around the table. Thank you, Mr. Chairman. " FOMC20070131meeting--39 37,MR. DUDLEY.," As you know, this topic is undergoing a lot of further research. The academic literature that I’ve surveyed has yet to uncover a strong causal relationship between a climb in speculative open interest and the effect on price. One reason that is hard to imagine happening to a powerful degree in the end is that the speculators really don’t want to take actual delivery of the physical commodity, and so the price really should clear in the spot market on what’s happening to underlying supply and demand. But this topic certainly remains under investigation by a number of researchers. I don’t think we have the definitive answer to the question at this point." CHRG-111hhrg74855--224 Mr. Markey," Thank the gentleman very much. I would just like to ask one final question and then we will move to the next panel. Ask this of Chairman Gensler, if the CFTC is doing an antifraud or anti-manipulation investigation of oil futures trading on the New York Mercantile Exchange and you believe that part of the fraudulent scheme may have involved wrongdoing in the cash market, you have the power under the Commodities Exchange Act to extend your investigation to cover that part of the fraud and you wouldn't want the Congress to deny the CFTC the power to look at transactions in both the NYMEX futures market and the cash market in your own investigation, is that correct? " CHRG-109shrg24852--118 RESPONSE TO A WRITTEN QUESTION OF SENATOR REED FROM ALAN GREENSPANQ.1. I mentioned in my opening remarks the study by the Boston Federal Reserve with respect to labor participation, which suggests there is a significant and growing lack of participation in the labor force which distorts our ability to see how well we are doing with respect to recoveries. In fact, one thing that I found interesting was the ratio of employment to population, 62.7 percent, is below the level at the start of the economic recovery in November 2001. And this is the first time the ratio has failed to surpass its trial level so far into a recovery. Can you comment?A.1. At my July 21 testimony before the Senate Banking Committee, you asked if I could provide additional detail concerning the Board staff's assessment of recent developments in labor force participation and their implications for the interpretation of the unemployment rate as a measure of slack in the labor market. As I noted in my response at the hearing, while cyclical factors likely have contributed to the weak recovery in labor force participation, our staff estimates that part of that weak performance in recent years can also be traced to a downtrend in the underlying rate of participation. The change in the overall trend has occurred both because the trend in the participation of adult women appears to have flattened out and because the large baby boom cohorts are moving into the age range in which their labor force participation will likely drop off sharply as many workers in these cohorts retire. More specifically, we estimate that the underlying trend in the participation rate has fallen from a little more than 66\1/2\ percent of the civilian working-age population in 2001 to about 66\1/4\ percent this year. Because the participation rate in recent months has averaged just over 66 percent, we estimate that the implied cyclical shortfall in participation equates to a few tenths of a percentage point on the unemployment rate. Our estimates are broadly similar to those of the Congressional Budget Office. Differences between our estimates and those reported in the Boston Fed study that we discussed at my hearing primarily reflect different views about the evolution of trends in participation for various demographic groups and different ways to measure the size of the current participation shortfall. In particular, the Boston Fed study examines a range of alternative trajectories for participation rates for women and older workers and calibrates the size of the estimated current shortfall as a percentage of the labor force. Of course, all such estimates are subject to considerable uncertainty, and our understanding of the relationship between labor force participation and labor market slack will undoubtedly benefit from additional research on this topic. CHRG-111hhrg63105--236 The Chairman," Thank you very much. And we do appreciate your coming. Our purpose today was to try to shed a little daylight on what is going on at this moment, the importance it is to our economy and all that goes on in the different markets. I think it has been a good day. We have learned and got the insight of the Chairman and all the Commissioners and some of the needs that you have. And we want to invite you to continue to be in contact with us, and I am sure you will. So with that, I thank you again. I wish you a great holiday and we look forward to seeing you, if not before, at least next year. Thank you so much. Under the rules of the Committee, the record of today's hearing will remain open for 10 calendar days to receive additional materials and supplementary written response from a witness to any questions posed by a Member. The hearing of the Subcommittee on General Farm Commodities and Risk Management is adjourned. [Whereupon, at 12:20 p.m., the Subcommittee was adjourned.] " CHRG-109shrg30354--92 Chairman Bernanke," I think certainly an important part of what has happened has been the increases in energy and commodity prices. That has directly added to total inflation, and now we are seeing it passing through, to some extent, to core inflation. I think if energy prices were $40, I think things would be much better. I would say that. Whether policy has been optimal or not, I really cannot judge. Certainly, along with fiscal stimulus and other measures we did succeed in getting the economy back on a strong growth track in the middle of 2003. And we have seen 3 years of strong growth. It took a while for jobs to come back but eventually the labor market also began to improve. Senator Sununu. When you say I cannot judge, is that because you are not technically suited to do that evaluation? Or because you do not think it would be productive in your current occupation? " CHRG-110shrg50416--96 Mr. Montgomery," Well, that is one of ten things that wake us all up in the middle of the night. The reason why FHA didn't take part in the boom, there are a lot of them. One is we did not lower our underwriting criteria. We had this crazy notion that people should verify their income. They should produce tax returns. They needed to have atleast 2 years with their current employer. And we have not lowered those standards. And our ratios, our front-end ratios, our back-end ratios exist for a reason. I think because of that, I think you will see FHA continue to perform admirably over here on the long term. If I could just interject one thing here real quick, sir, on the servicing, FHA, and I referenced this number before, the last 3 years, we have saved 300,000 FHA borrowers from foreclosure, 300,000. That is a number you have not read anywhere. You don't see that, and it is because our loss mitigation program, which Congress put into place 10 years ago, is working, and the main reason it works is because we require it. Lenders and servicers know this. The borrowers know this. The investors know this. They are required to do loss mitigation. If they don't do that, they face treble damages from FHA and I think that is one of the keys to why this has been successful. You have not read about those borrowers going to foreclosure because they have not been. Senator Corker. Thank you, and if I could just--we have all traveled a long ways to be here and we thank you for having this hearing. Mr. Kashkari, I have to tell you that the concern about the--first of all, thank you for what you are doing and I appreciate the conversations that we have had. I do think the concern about the loans is somewhat unfounded. I mean, at the end of the day, people are paying 5 percent for this money. I know it raises at some point to 9 percent. At some point, the banks have to make a profit. I mean, they can't just hoard cash. I mean, it is pretty self-evident, is it not, that the way that money is going to be made is lending that money, and while there may be an initial hoarding, at some point, this money has to go out. Otherwise, these enterprises are not making money. I mean, that is just sort of self-evident. I wonder if you could just take maybe 10 seconds to address that issue. It concerns me. Obviously, I supported this measure and was involved in it. One of the things in the back of my mind was, once the camel nose goes under the tent and you get a bunch of Senators and a bunch of House members involved in the business of banking, all of a sudden, we are telling the banks what to do, which, let us face it, part of our problem with Fannie and Freddie, and I don't want to go into that now, we will deal with it after the election, but was that very thing, OK. And so I am very concerned about us making prescriptive arrangements with these banks. I don't think you are going to get many participants in that regard, but we are going to destroy our banking system if we do that. I appreciate the balance you are trying to create, but is it not self-evident that with paying for these through dividends--it is basically a loan, let us face it, that they can show as equity--they have got to make loans to make money and be in business. Is that a yes or no answer? " CHRG-109hhrg31539--125 Mr. Bernanke," Well, Congressman, as you point out, there is uncertainty. We have a baseline forecast which assumes that energy prices don't do another big increase, that expectations remain contained, as they appear to be currently. We have talked about the cost side of labor costs, which seem not at this point to be a problem from a cost perspective. So from all that perspective, again, we have the baseline forecast that the inflation will gradually decline over the next couple of years. At the same time, we talk about risks, and we think there are some risks. The risk that I talk about in my testimony is that, given the tightening of markets, product markets in particular, that some firms may be better able to pass through those energy and commodity prices that you mention, and that that might become possibly embedded in the expectations of the public. So we do see some upside risks, and we have to take that into account as we make policy. " CHRG-111hhrg52397--54 Mr. Pickel," I would also reference back to this whole discussion about legal certainty. The Act passed by Congress, the Commodity Futures Modernization Act in 2000, provided that legal certainty and Secretary Geithner's letter makes it very clear, and you have heard from the panelists today, that we should not tinker with that legal certainty. In that situation, if the wrong decision had been made, the business would have almost by necessity had to move elsewhere. Here we are talking about aspects of regulation, it may on the margin increase the cost, it may in some cases decrease the costs. That will be a calculation in the decision as to where a transaction might be traded or booked, but we are not talking about undermining the fundamental enforceability. " FOMC20080430meeting--75 73,MR. STOCKTON.," Your intuition on that last point is correct. Obviously, in that simulation we have inflation expectations deteriorate a little more from where we think they have deteriorated already over the past year or so. Again, this is really hard to pin down, but we think there has probably been an increase of maybe � percentage point in longer-term inflation expectations over the last couple of years in the context of this step-up in headline inflation and the higher commodity prices that are associated with that increase. So in the simulation, we're basically assuming that the process continues: If you have another year or two of high headline inflation, you may get additional deterioration of inflation expectations on the order of � percentage point. You're right that, if expectations truly became unhinged and people began to view the entire inflation process as generating some greater upward momentum, it would have implications both for inflation and-- " FinancialCrisisReport--305 Moody’s staff, however, had raised concerns about personnel shortages impacting their work quality as early as 2002. A 2002 survey of the Structured Finance Group staff reported, for example: “[T]here is some concern about workload and its impact on operating effectiveness. … Most acknowledge that Moody’s intends to run lean, but there is some question of whether effectiveness is compromised by the current deployment of staff.” 1182 Similar concerns were expressed three years later in a 2005 employee survey: “We are over worked. Too many demands are placed on us for admin[istrative] tasks ... and are detracting from primary workflow .... We need better technology to meet the demand of running increasingly sophisticated models.” 1183 In 2006, Moody’s analyst Richard Michalek worried that investment bankers were taking advantage of the fact that analysts did not have the time to understand complex deals. He wrote: “I am worried that we are not able to give these complicated deals the attention they really deserve, and that they (CS) [Credit Suisse] are taking advantage of the ‘light’ review and the growing sense of ‘precedent’.” 1184 Moody’s managers and analysts interviewed by the Subcommittee stated that staff shortages impacted how much time could be spent analyzing a transaction. One analyst responsible for rating CDOs told the Subcommittee that, during the height of the boom, Moody’s analysts didn’t have time to understand the complex deals being rated and had to set priorities on what issues would be examined: “When I joined the [CDO] Group in 1999 there were seven lawyers and the Group rated something on the order of 40 – 60 transactions annually. In 2006, the Group rated over 600 transactions, using the resources of approximately 12 lawyers. The hyper-growth years from the second half of 2004 through 2006 represented a steady and constant adjustment to the amount of time that could be allotted to any particular deal’s analysis, and with that adjustment, a constant re-ordering of the priority assigned to the issues to be raised at rating Committees.” 1185 1181 Id. at 97. 1182 5/2/2002 “Moody’s SFG 2002 Associate Survey: Highlights of Focus Groups and Interviews,” Hearing Exhibit 4/23-92a at 6. 1183 4/7/2006 “Moody’s Investor Service, BES-2005: Presentation to Derivatives Team,” Hearing Exhibit 4/23-92b. 1184 5/1/2006 email from Richard Michalek to Yuri Yoshizawa, Hearing Exhibit 4/23-19. 1185 Prepared statement of Richard Michalek at 20, April 23, 2010 Subcommittee hearing. FOMC20080130meeting--278 276,MR. PLOSSER.," Thank you, Mr. Chairman. Since September, this Committee has lowered the federal funds rate 175 basis points. My estimate is that the real funds rate before any action today is 1 percent or slightly below that, and that is very low by historical standards. The slowdown in growth suggests that the equilibrium real rate really has fallen, and the Committee has appropriately allowed the nominal funds rate to fall as well. Do nominal rates need to go lower and, if so, about how much? Part of this depends on what you think the equilibrium real rate of the economy is now. The Bluebook indicates that estimates of r* vary considerably by the model and the process they use to calculate them. The 70 percent confidence interval around them is 3 percentage points. Moreover, the estimates of r*, as we talked a bit about yesterday, can be quite volatile. It troubles me that the estimate of r* consistent with the Greenbook has changed by 140 basis points from December to today. I am uncomfortable using an estimate that is so variable and so sensitive to stock markets as a guide to setting policy. I also want to note that the Bluebook indicates that the appropriate funds rate, based on a range of Taylor rule specifications, is anywhere from 40 to 120 basis points above where we currently are today. That includes forecast-based versions of the rule that rely on the weak forecast found in the Greenbook. While I don't want to suggest that such guidelines are definitive, they do suggest that the current level of the fed funds rate is clearly accommodative and that we have taken out insurance against downside risk. When do we stop taking out more insurance? If we do cut 50 basis points today, which is the amount the market is expecting, it would bring, to my mind, the real funds rate down to below � percent. That is based on expectations of about 2� percent inflation, which in fact may be conservative. To my way of thinking, that is a very accommodative policy by any standard. Moreover, I don't believe that enough time has elapsed for us to realize the full effect of the cuts that we have already put in place. I share President Hoenig's concern that only the market can solve many of the problems that we see out there, and we must give the market time and patience to do so. The last time real rates were this low was in 2003-04, when the real rate was in fact apparently negative. But that was different. Inflation was running around 1 percent or less, and our concern was possible deflation. Today, we are not worried about deflation in the near term. We are worried about inflation; inflation has been moving up. Lowering rates too aggressively in today's situation would seem to me a risky strategy, fueling inflation; possibly setting up the next boom-bust cycle, which I worry about; and delaying the recognition of losses on bank's balance sheets but not eliminating them. The main effect of the rate cut will be after the first half of the year, if the economy begins to recover. I think we need to be very cautious not to get carried away in our insurance strategies with lowering rates too much. In my view, we are on the verge of overshooting, and I worry about the broad range of consequences for our credibility and the expectations of our future actions such behavior may have. That is closely related to President Lacker's comments about what people interpret that behavior to mean about what we may do in future episodes. But two things are even more important, in my mind, about what we may do and what we do today. First, we need to be very careful about our communications and not to excessively reinforce the market's expectation that further rate cuts are coming. In particular, I would feel much more comfortable with supporting a moderate 25 or 50 basis point cut if the statement language today were more agnostic about the balance of risks, as I suggested in my memo before the meeting. The market interprets our saying that there are downside risks to growth as that we are planning to cut rates again. I do not think we should encourage those beliefs. I worry that the balance of risks portion of our statements has come to be a code for predicting the path of our federal funds rate. I think that is not a good position for us to be in, nor should we condone it. Given the Greenbook forecast, I don't believe that negative real rates are called for, and signaling further cuts clearly sends the message that negative real rates are on the way, if not already here. When our forecasts are released, the public will get our assessments of the risks in our outlook. We don't need to say anything more about it in the statement. That, of course, does not preclude us from cutting rates again if our forecast deteriorates further. But until it does, I am reluctant to encourage the perception that more rate cuts are forthcoming. Second, as I said in the last go-round, we need to be able to better understand how we are going to unwind these cuts that we have implemented as insurance against the macroeconomic effects and financial disruptions. Of course, this was the theme of the discussion we had before the go-round. Unwinding those cuts too slowly not only risks our credibility on inflation but also risks setting up the next boom�bust cycle. Hindsight, of course, is always 20/20, but as we discussed in Monday's videoconference, the Fed's being slow to raise rates back up after the deflationary scare was over in 2003 may indeed have contributed to the conditions we are facing today. Thus, it is crucially important, to my mind, that we do have a plan for unwinding the significant cuts we have implemented as insurance against the financial turmoil. If the market turmoil subsides, I believe this Committee needs to have clear signals as to what we are going to look at and what has to happen before we start to remove the accommodation. I believe that the Committee must undo the accommodation as aggressively as we put it in play. We need to determine what indicators we will be looking at to determine when that process should begin. When we know ourselves, we want to help the markets and public understand what our process will be as well. I strongly believe that we must be both credible and committed policymakers, and our communications must signal not a particular funds rate path but articulate and focus on the contingent nature of that path and help the public understand and appreciate the systematic part of our policies and our policy decisions. Thank you, Mr. Chairman. " CHRG-111hhrg51698--305 Mr. Taylor," Thank you. Thank you, Chairman Peterson, Ranking Member Lucas, and Members of the Committee. I am Gary Taylor, CEO of Cargill Cotton in Memphis, Tennessee; and I appear today here representing the members of the National Cotton Council, the American Cotton Shippers and AMCOT, which is a trade association of marketing cooperatives. In the past year, the cotton industry has undergone severe financial strain due to the unpredictable risk caused by a dysfunctional futures market. The March 2008, debacle and the ICE No. 2 Cotton Contract forced a number of first handlers into bankruptcy, while others have announced orderly closures. Traditional merchandising relationships have ceased, because price risks are too great for hedging purposes. Growers continue to be concerned about the financial viability of marketing entities with whom they have previously contracted. To ensure the survival of our marketing structure, the cotton futures market must be returned to its historical function of price discovery and risk management relative to real market conditions. As the cotton industry informed this Committee in 2008, investment funds and over-the-counter operatives flooded our futures markets with record amounts of cash. In our opinion, their presence distorted both the futures and physical markets. We believe the legislation before the Committee, the Derivatives Markets Transparency and Accountability Act of 2009, addresses these concerns raised by our industry and the agriculture sector and restores confidence of the commercial trade and lending institutions. It will facilitate market fundamentals, not speculative activity, resulting in accurate price discovery. The cotton industry acknowledges the importance of market liquidity and the essential function speculative interests perform in our commodity markets. In our view, by requiring full transparency and accountability of speculative trades, the proposed legislation would not discourage speculative participation in the commodity contracts. Market liquidity is essential, but it must be tempered and monitored, and it should not dictate the direction of the market. In the current regulatory structure, Congress's CFTC has imposed speculative position limits in our futures contracts to reduce the potential for market disruption or manipulation. Such limits are no longer effective for three reasons: first, hedge exemptions granted to investment funds allowed them to exceed the limit; second, large traders using swaps exemptions operate outside the regulatory framework altogether; and third, nontraditional trader's speculative limits are only imposed as these contracts go into convergence. The other significant area of concern is the exempt status afforded swaps transactions that are executed off-exchange with each party mutually agreeing to satisfy each other's credit standards, and to remit margins to one another as the underlying market fluctuates. Such transactions pose problems when one of the parties has a hedge exemption that exempts his or her on-exchange futures trading from position size limits. These arrangements, along with billions of dollars invested in index funds, has brought so much cash into our markets that the traditional speculators could not take a short position to match the institutional longs. This left it up to the commercials to offset these positions. But, lacking the necessary capital to meet the huge margin requirements, they could not do so. The result is a market with no economic purpose for the commercial traders. Simply put, the investment funds have negated the real purpose of our futures markets. In order to restore the integrity of the markets, and to ensure they fulfill the basic roles of price discovery risk management and hedging, the cotton industry has developed a number of recommendations that are incorporated into the legislation before the Committee. First, establish trading limits to prevent excessive speculation; second, subject all contract and over-the-counter market participants to speculative position limits; third, subject speculative entities to the same weekly reporting requirements as the trade; and finally, limit hedge exemptions and limit eligibility for hedge margin levels to those actually involved in the physical handling of our commodities. The cotton industry also believes that the lack of transparency and disparate reporting requirements by market participants is appropriately addressed by legislation requiring the CFTC to disaggregate index funds, and publish the number of positions and total value of the index funds and other passive, long-only, short-only investors and data on speculative positions relative to their bona fide physical hedges. And also to establish reporting requirements for index traders and swap traders in designated market contracts, derivative transaction execution facilities and all other trading areas. In addition to these necessary changes, the cotton industry feels strongly that the CFTC should require the IntercontinentalExchange and its clearinghouse members to adhere to the practice of margining futures to futures settlements and options to options settlements. Also, the cotton industry has an important caveat for both the Committee and the CFTC. We submit that no action should be taken to discourage over-the-counter transactions with legitimate commercial purposes, transactions that are transparent and have proven to be beneficial risk management tools. It is essential that we encourage commercial innovation for those producing, merchandising or using physical commodities traded in the futures market. In closing, I would like to stress restoring confidence in the futures markets is of the utmost importance, and we thank you for considering our views. [The prepared statement of Mr. Taylor follows:] Prepared Statement of Gary W. Taylor, CEO, Cargill Cotton Company, Cordova, TN; on Behalf of National Cotton Council; American Cotton Shippers Association; and AMCOT Chairman Peterson, Ranking Member Lucas, and Members of the Committee, I am Gary Taylor, CEO of Cargill Cotton Company in Cordova, Tennessee. Cargill Cotton is a division of Cargill, Incorporated, an international provider of food, agricultural and risk management products and services. We service growers, ginners, buyers and textile mills worldwide through our network of buying, selling and shipping offices and our cotton gins and warehouses. I appear today representing the members of the National Cotton Council, the American Cotton Shippers Association, and AMCOT, a trade association of marketing cooperatives. We appreciate your scheduling this week's hearing and the outstanding leadership you have provided this past year on this subject critical to farmers, marketers, processors and consumers of agricultural and energy products. The involvement of the Committee this past year exemplifies its interest and its willingness to effectively oversee the commodity futures markets and to address issues vitally important to the functioning of the U.S. economy.Impact of Futures Markets on Cotton Industry The sound and effective regulation of a transparent futures market would provide significant benefits to the cotton industry, which is concentrated in 17 cotton-producing states, stretching from Virginia to California with the downstream manufacturers of cotton apparel and home furnishings located in virtually every state. The industry and its suppliers, together with the cotton product manufacturers, account for more than 230,000 jobs in the U.S. The annual economic activity generated by cotton and its products in the U.S. is estimated to be in excess of $100 billion. In the past year, the cotton industry has undergone severe financial strain due to the uncertainty and unpredictable risk caused by a dysfunctional futures market. Coming to light is the damage of the March 2008 debacle in the ICE No. 2 Upland Cotton Contract as a number of first handlers have been forced into bankruptcy, several have announced orderly closures, and most have seen their assets dwindle to a critical level. Traditional merchandising relationships between growers and buyers have ceased because price risks are too great for short hedging purposes. Growers continue to be concerned about the financial viability of marketing entities with whom they have previously contracted crop sales. The inability of merchandisers to hedge their risks translates into a weaker basis and lower prices offered to the cotton producer. Each penny reduction in the price of cotton means that U.S. cotton farmers lose $85 million in revenue. Therefore, to insure the survival of our marketing structure, the cotton futures market must be returned to its historical function of price discovery and risk management relative to real market conditions.The Lesson Learned As the cotton industry and the agricultural complex informed this Committee in 2008, investment funds and over-the-counter (OTC) operatives flooded the futures markets with record amounts of cash, throwing the trading fundamentals out of balance, resulting in a widened basis, and thereby making these markets illiquid for those for whom Congress created these markets. The presence of large speculative funds and index funds in the energy and agricultural futures contracts distorted the futures and the physical or cash markets of these commodities. The abundance of unregulated cash allowed these funds to overwhelm these markets negating their primary purposes. Long before others in the Congress or the regulatory agencies recognized the problem or began to take action, the House Agriculture Committee had hearings underway and appropriate legislation before the Congress. Now, the leaders of the developed and developing world are calling for the U.S. to effectively regulate the commodity markets. We commend the Committee for that bipartisan foresight and believe that the legislation before the Committee, The Derivatives Markets Transparency and Accountability Act of 2009, would address the concerns raised by the cotton industry and the agricultural sector and restore the confidence of the commercial trade and the lending institutions. Above all, it will facilitate market fundamentals, not speculative activity, resulting in accurate price discovery in the futures markets.The Importance of Market Liquidity The cotton industry acknowledges the importance of market liquidity and the essential function the speculative interests perform in the commodity markets. We welcome that participation and do not wish to discourage it. In our view, the legislation before the Committee by requiring full transparency and accountability of speculative trades would not discourage speculative participation in the commodity contracts. Market liquidity is essential, but it must be tempered and monitored--it should not dictate the direction of the market.Speculative Position Limits and the Swaps Exemption In the current regulatory structure of the futures markets, Congress, through the CFTC, has imposed speculative positions limits in the futures contracts to reduce the potential for market disruption or manipulation. But such limits are no longer effective for three reasons: 1. The CFTC has granted Hedge Exemptions to the investment funds allowing them to exceed the limits; 2. Large traders were permitted by Congress, through the Swaps Exemption, to operate outside the regulatory framework altogether; and 3. Non-traditional traders speculative limits are only imposed as contracts go into convergence. The other significant area of concern is the exempt status afforded Swaps transactions that are executed off-exchange with each party mutually agreeing to satisfy each other's credit standards and to remit margins to one another as the underlying market fluctuates. Such transactions, however, pose problems when one of the parties to the Swap has a ``Hedge Exemption'' that exempts his or her on-exchange futures trading from position-size limits.\1\--------------------------------------------------------------------------- \1\ In such situations, the Swaps dealer would take an equal and opposite position in the futures market to the Swaps trade. For example, should a pension fund desire to purchase $20 million in long exposure in a commodity, it can purchase this exposure from a Swaps dealer. The dealer, now short the price of that commodity via the Swap, enters the futures market to hedge his position by buying futures in that commodity. Given that he is a ``hedger,'' the CFTC allows him to trade futures in excess of the normal speculative position-size limits. This has created a situation where such large investors can trade in any contract in any size they desire without regard to position limits. They are not limited by the CFTC. Only a Swaps dealer can limit such trades, and it is unlikely that a Swaps dealer would turn a deaf ear to a financial entity awash in cash.--------------------------------------------------------------------------- These arrangements, along with the billions of dollars invested in index funds, brought so much cash into the market that the traditional speculators could not take a short position to match the institutional longs. This left it up to the commercials to offset these positions. But lacking the necessary capital to meet the huge margin requirements, they could not do so. That has been the situation this past year as the funds continued to purchase futures. Unwilling to assume such margin risks in such a volatile futures market, the commercial traders were forced to remain passive not only in the futures, but in the physical markets as well. The result: markets with no economic purpose for the commercials. Therefore, no business was done. Producers, lacking a price, could not properly plan and processors had to buy hand to mouth. Simply put, the investment funds have negated the real purpose of the futures markets, causing severe disruptions in the marketing process.Cotton Industry Recommendations In order to restore the integrity of the futures and derivatives markets and to ensure that such markets function properly by providing price discovery and hedging thereby allowing producers and manufacturers to lock in prices and merchants and cooperatives to offer forward prices to producers and manufacturers, the U.S. cotton industry has developed a number of recommendations that are incorporated in The Derivatives Markets Transparency and Accountability Act of 2009. Congress should: Establish trading limits to prevent excessive speculation, Subject all contract and over-the-counter market participants to speculative position limits, Subject speculative entities to the same weekly reporting requirements as the trade, and Limit hedge exemptions and limit eligibility for hedge margin levels to those actually involved in the physical handling of the agricultural commodity. The cotton industry also believes that the lack of transparency and disparate reporting requirements by market participants is appropriately addressed by the legislation by requiring the CFTC to: Disaggregate index funds and publish the number of positions and total value of the index funds and other passive, long-only and short-only investors, and data on speculative positions relative to their bona fide physical hedges, and Establish reporting requirements for index traders and swap dealers in designated contract markets (exchanges), derivative transaction execution facilities and all other trading areas. In addition to these necessary changes, the cotton industry feels strongly that the CFTC should require the IntercontinentalExchange and its clearing house members to adhere to the practice of margining futures to futures settlements and options to options settlements. Also, the cotton industry has an important caveat for both the Committee and the CFTC. We submit that no action should be taken to discourage over-the-counter transactions with legitimate commercial purposes--transactions that are transparent and have proven to be beneficial risk management tools utilized by producers, merchants, and manufacturers. It is essential that we encourage commercial innovation for those producing, merchandising, manufacturing, or using the physical commodity traded in the futures markets. In closing, I would like to stress that restoring confidence in the futures market is of the utmost importance to our industry. Thank you for considering our views and recommendations during the development and consideration of this vitally important legislation. " FOMC20080805meeting--132 130,MR. KOHN.," Thank you, Mr. Chairman. Like others around the table, I made only small revisions to the central tendency of my forecast going forward as a result of the developments of the intermeeting period, maybe a slight reduction in the path of output and a quicker decline in headline inflation owing to the oil prices. But I think more important than any shift in central tendencies is the sense that the information tends to reinforce--to reduce the uncertainties around--the basic contours of a projection in which the economy operates with a wider output gap and a lower inflation rate on balance over the next 18 months or so than it has over recent quarters. About the output gap, the incoming information strongly suggests that we are on a trajectory that at least for some time will have the economy growing appreciably below the growth rate of its potential. The most obvious evidence is the persistence of a soft labor market--continuing declines in employment and no sign of near-term strengthening in the initial claims data. I agree that the declines in employment, as several of you have pointed out, are not consistent with a recession, but they're certainly not consistent with the economy growing close to its potential. You need another 150,000 or 200,000 jobs rather than minus 60,000, which is where we are now. So I think the economy is likely to grow below potential for some time. Even on the spending side, the decline in consumption in June, when rebate checks were continuing to hit bank accounts, and a further sharp drop in auto sales in July might be early signs that households are beginning to pull back under pressure from higher energy prices, job worries, declining house values, and reduced credit availability. To be sure, one month's consumption data along with auto sales, which are subject to all kinds of idiosyncratic influences, are not enough to justify a major change in outlook. But as President Lacker noted, household spending has for some time been a source of downside risk to the forecast. At some point, household spending could begin to reflect attitudes, and this information at a minimum seems to underline those risks as well as to point to sluggish growth of spending in the third quarter. Soggy economic news has extended to our trading partners, where actual activity and expected activity also have been marked down. The tone of news from abroad has been decidedly downbeat, as those economies feel the effect of weaker purchases from the United States, continuing financial strain, softening housing markets, and higher energy prices. Much as in the United States, attitudes abroad seem weaker than the data; but the euro area did report a record decline in retail sales in June this morning, and my sense is that our trading partners are facing larger downside risks to growth as well as a markdown of central tendencies. The dollar hasn't changed much on balance for four or five months now. With a stable dollar and weaker demand abroad, production in the United States will be getting a lot less cushion from net exports over the next few quarters than it did in the first half of the year. Finally, despite the downward movement in Treasury interest rates and in the expected federal funds rate path, financial conditions for households and businesses have tightened since the last FOMC meeting. Savers and intermediaries have become even more cautious amid concerns about deepening losses spreading beyond subprime mortgages, about the safety of uninsured deposits at regional banks, high volatility in markets, and the possible weakening of the underlying macro situation. Lenders are hunkering down to endure a long period of rising credit problems and great uncertainty. I don't think we need to rely on anecdotes here. Mortgage interest rates have actually risen on balance, as have corporate bond yields across many risk categories; and in many of these cases, the nominal interest rates are at least as high as or in some cases much higher than they were last August when the federal funds rate was at 5�. Banks continue to tighten terms and standards for nearly all categories of loans. Equity prices have fallen, adding to the downward pressure on wealth from declining house prices, and I think these developments underscore the very slow recovery likely in financial markets and the possible downside risks relative to even that very gradual improvement that many of us were expecting. The tightening of conditions is damping credit growth broadly defined and will constrain, at least to some extent, spending going forward, delaying the return to trend or above-trend growth. Thus although uncertainties remain quite elevated, I think we can be a little more confident that the economy will be subject to further quarters of below-trend growth and declining resource utilization. Furthermore, with housing prices still falling fast, inventories of homes still high, and financial markets quite skittish, the downside risks even to a slightly lower central tendency forecast remain high. Greater confidence that output will grow below potential for a time contributes to a little more optimism on my part that inflation will, indeed, come down substantially over the coming quarters. An environment of rising unemployment and declining capacity utilization is not one in which businesses or labor will find it easy to restore real incomes or raise profit margins after the increase in energy prices. With regard to that increase in energy and other commodity prices and how it affects headline inflation, I like to differentiate pass-through from spillover. I think we can expect passthrough. Pass-through to consumer prices of the higher energy and commodity prices is part of the adjustment process by which demand gets damped and by which consumers realize, unfortunately, the lower real income that they get from the adverse terms of trade. So the fact that businesses are able to pass through higher commodity prices and higher petroleum prices I don't find all that worrisome, provided that they're passing through a one-time increase in prices rather than a continuing rise. I think we have some further evidence that at least to date--things could change, I admit--what we are seeing is a pass-through of a one-time rise rather than some continuing increases. For one thing, commodity prices, as shown in Bill's chart, have flattened out or actually declined in the past few months. So presumably that pass-through is a one-time jump, if that's what they're doing, passing through those prices. Second, I think we saw in the GDP chain-type price indexes that the price of domestic value added increased at an annual rate of only 1.1 percent in the second quarter--which suggests to me that, at least through the second quarter, there was very little spillover from these higher commodity and energy prices to the stuff we produce here at home. Also, labor compensation growth, which could be a lagging indicator, at least to date hasn't increased. If anything, it has slowed a little further, which along with relatively robust productivity growth is holding down unit labor costs. Headline inflation--the goods and services that people purchase--has been high. Energy prices are being passed through, but I think to date there's no evidence or very little evidence that it's spilling over into other prices in the economy. So this is about the adjustment to relative prices. Obviously the decline in oil prices, if it holds, will be helpful on the inflation front, both in its direct effect on headline inflation and its indirect effect on inflation expectations. We finally have evidence of two-way risk in oil prices, and that should make us more comfortable with an assumption of stable prices as a reasonable basis for forecasting. Other recent contributors to higher price levels have also become less averse. As I mentioned, other industrial commodity prices have leveled out or declined, and the dollar has been relatively stable in recent months. Although I feel a little more confident about the expectation of lower inflation going forward, I agree that upside risks still prevail. Core inflation has ticked up. Headline inflation will be high for some time and could threaten to spill over through increases in inflation expectations. Oil and commodity price declines are largely an endogenous response to perceptions of weak growth, and if those perceptions turn around, so will those prices. Longer-term inflation expectations remain elevated by some measures and are probably less well anchored than they were a couple of years ago, before oil and commodity prices rose so much. In sum, I see upside risks to both the inflation gaps and the output gaps as having diminished over the intermeeting period, and we'll get to the implications of that for policy in the next part of the meeting. " CHRG-111hhrg63105--52 Mr. Chilton," There shouldn't be any exemptions from commercial. People that have an underlying interest in the physical commodity, whether or not it is a Swift or Cargill or just a normal farmer or independent petroleum producer, they should have exemptions. Other than that, there shouldn't be exemptions. Whether or not there should be different levels, you might be right, sir. It may be more appropriate to have a little more granular view of it, because--and we can address this if you look at what their net position is. It is one thing if people have a large position, but the added benefit of what we are going to be doing in the future is we are going to be looking at this swaps data to find out where they really are. So we can't just base things on whether or not they have a percentage on ICE or a percentage on CME, you have to look at where they are net, and we will be able to do that with this new rule, I think. " CHRG-111hhrg53246--55 Mr. Gensler," I would agree with that. I think that we are in agreement. And the products, the interest rate, currency, and commodity products, the CFTC would take the lead on. On the narrow-based, the SEC would take the lead. This is broad-based product area. Currently, there are over 150 broad-based futures contracts. There are five or six that trade actively that are regulated by the CFTC. There are about 60 options on those futures, again, regulated by us. So broad-based implicate those. But there is a second category that I should mention. I do think we can go in and harmonize for the trading platforms. And working with Congress and working together we can do that, but we haven't yet, between our agencies, been able to get to that level of detail. But I think that would be important. " CHRG-111shrg54675--59 Mr. Hopkins," We have adequate dollars available for ag-operating loans, and for the most part, most of our ag producers have done quite well. We are in a heavy crop area and the corn and soybean prices have been quite good. The problem we are seeing with some of our operators is the input costs over the last 12 to 24 months have increased dramatically. We feel at some point the commodity prices will come down more. We are seeing some real pressure on our livestock producers. Those are the people that I think we are seeing some real pressure on right now and I think it will be more so going forward over the next 12 to 24 months. Senator Tester. Do you have much dairy in your region? " CHRG-111hhrg48868--284 Chairman Kanjorski," The gentlelady from California for 2 minutes. Ms. Speier. Thank you, Mr. Chairman. I think that it is very important for us today to realize that Congress has a lot of finger pointing to do at itself. When the Commodities and Futures Trading Commission Chairman said, ``Credit default swaps should be regulated,'' came up here, testified to that fact, she lost her job, and subsequently, credit default swaps were unregulated specifically by legislation that passed the Congress. We had the Glass-Steagall Act that was on the books for over 60 years, it worked, and then the financial services industry wanted the Gramm-Leach-Bliley Act, which allowed for this financial supermarket to happen, and what did Congress do? It passed it. So I believe that part of the responsibility falls with us. One last question to Mr. Clark. You rated AIG at an A or A minus through most of 2008, is that not correct? " fcic_final_report_full--432 Commission focused thousands of staff hours on investigation, and not nearly enough on analyzing these critical economic questions. The investigations were in many cases productive and informative, but there should have been more balance be- tween investigation and analysis. Conclusions: • The credit bubble was an essential cause of the financial crisis. • Global capital flows lowered the price of capital in the United States and much of Europe. • Over time, investors lowered the return they required for risky investments. Their preferences may have changed, they may have adopted an irrational bub- ble mentality, or they may have mistakenly assumed that the world had become safer. This inflated prices for risky assets. • U.S. monetary policy may have contributed to the credit bubble but did not cause it. THE HOUSING BUBBLE The housing bubble had two components: the actual homes and the mortgages that financed them. We look briefly at each component and its possible causes. There was a housing bubble in the United States—the price of U.S. housing in- creased by more than could be explained by market developments. This included both a national housing bubble and more concentrated regional bubbles in four “Sand States”: California, Nevada, Arizona, and Florida. Conventional wisdom is that a bubble is hard to spot while you’re in one, and painfully obvious after it has burst. Even after the U.S. housing bubble burst, there is no consensus on what caused it. While we still don’t know the relative importance of the possible causes of the housing bubble, we can at least identify some of the most important hypotheses: • Population growth. Arizona, Florida, Nevada, and parts of California all expe- rienced population growth that far exceeded the national average. More people fueled more demand for houses. • Land use restrictions. In some areas, local zoning rules and other land use re- strictions, as well as natural barriers to building, made it hard to build new houses to meet increased demand resulting from population growth. When supply is constrained and demand increases, prices go up. • Over-optimism. Even absent market fundamentals driving up prices, shared expectations of future price increases can generate booms. This is the classic explanation of a bubble. • Easy financing. Nontraditional (and higher risk) mortgages made it easier for potential homebuyers to borrow enough to buy more expensive homes. This doesn’t mean they could afford those homes or future mortgage payments in the long run, but only that someone was willing to provide the initial loan. Mortgage originators often had insufficient incentive to encourage borrowers to get sustainable mortgages. CHRG-111shrg51395--274 RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM DAMON A. SILVERSQ.1. Do you all agree with Federal Reserve Board Chairman Bernanke's remarks today about the four key elements that should guide regulatory reform? First, we must address the problem of financial institutions that are deemed too big--or perhaps too interconnected--to fail. Second, we must strengthen what I will call the financial infrastructure--the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets--to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality--that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.A.1. I would cover some of the same ground that Chairman Bernanke did in a different way. I think regulatory reform must: 1. LProtect the public by creating an independent consumer protection agency for financial services, which would, among other duties, ensure mortgage markets are properly regulated 2. LReregulate the shadow markets-in particular, derivatives, hedge funds, private equity funds, and off-balance sheet vehicles, so that it is no longer possible for market actors to choose to conduct activities like bond insurance or money management either in a regulated or an unregulated manner. As President Obama said in 2008 at Cooper Union, financial activity should be regulated for its content, not its form. 3. LProvide for systemic risk regulation by a fully public entity, including the creation of a resolution mechanism applicable to any financial firm that would be the potential subject of government support. The Federal Reserve System under its current governance structure, which includes significant bank involvement at the Reserve Banks, is too self-regulatory to be a proper systemic risk regulator. Either the Federal Reserve System needs to be fully public, or the systemic risk regulatory function needs to reside elsewhere, perhaps in a committee that would include the Fed Chairman in its leadership. The issue of procyclicality is complex. I think anticyclicality in capital requirements may be a good idea. I have become very skeptical of the changes that have been made to GAAP that have had the effect, in my opinion, of making financial institutions' balance sheets and income statements less transparent and reliable. See the August, 2009, report of the Congressional Oversight Panel. Most importantly, moves that appear to be anticyclical may be procyclical, by allowing banks not to write down assets that are in fact impaired, these measures may be a disincentive, for example, for banks to restructure mortgages in ways that allow homeowners to stay in their homes.Q.2. Would a merger or rationalization of the roles of the SEC and CFTC be a valuable reform, and how should that be accomplished?A.2. A merger of the SEC and the CFTC would be a valuable reform. Alternatively, jurisdiction over financial futures and derivatives could be transferred from the CFTC to the SEC so that there is no possibility of regulatory arbitrage between securities on the one hand and financial futures and derivatives on the other. Recent efforts by both agencies to harmonize their approaches to financial regulation, while productive, have highlighted the degree to which they are regulating the same market, and the extent of the continuing threat of regulatory arbitrage created by having separate agencies. If there were to be a merger, it must be based on adopting the SEC's greater anti-fraud and market oversight powers. The worst idea that has surfaced in the entire regulatory reform debate, going back to 2006, was the proposal in the Paulson Treasury blueprint to use an SEC-CFTC merger to gut the investor protection and enforcement powers of the SEC. For more details on these issues, the Committee should review the transcript of the second day of the joint SEC-CFTC roundtable on coordination issues held on September 3, 2009. I have attached my written statement to that roundtable. [See, Joint Hearing Testimony, below.]Q.3. How is it that AIG was able to take such large positions that it became a threat to the entire financial system? Was it a failure of regulation, a failure of a product, a failure of risk management, or some combination?A.3. AIG took advantage of three regulatory loopholes that should be closed. Their London-based derivatives office was part of a thrift bank, regulated by the OTS, an agency which during the period in question advertised itself to potential ``customers'' as a compliant regulator. This ability to play regulators off against each other needs to end. Second, the Basel II capital standards for banks allowed banks with AAA ratings not to have to set capital aside to back up derivatives commitments. Third, thanks to the Commodities Futures Modernization Act, there was no ability of any agency to regulate derivatives as products, or to require capital to be set aside to back derivative positions. Within AIG, the large positions taken by the London affiliate represent a colossal managerial and governance failure. It is a managerial failure in that monitoring capital at risk and leverage is a central managerial function in a financial institution. It is a governance failure in that the scale of the London operation, and its apparent contribution to AIG's profits in the runup to the collapse, was such that the oversight of the operation should have been of some importance to the board. The question now is, what sort of accountability has there really been for these failures?Q.4. How should we update our rules and guidelines to address the potential failure of a systematically critical firm?A.4. We need to make the following changes to our financial regulatory system to address the need to protect the financial system against systemic risk: 1. LWe need to give the FDIC and a systemic risk regulator the power to resolve any financial institution, much as that power is now given to the FDIC to resolve insured depositary institutions, if that financial institution represents a systemic threat. 2. LCapital requirements and deposit insurance premiums need to increase as a percentage of assets as the size of the firm increases. The Obama Administration has proposed a two tier approach to this idea. More of a continuous curve would be better for a number of reasons--in particular it would not tie the hands of policy makers when a firm fails in the way a two tier system would. If we have a two tier system, the names of the firm in the top tier must be made public. These measures both operate as a deterrent to bigness, and compensate the government for the increased likelihood that we will have to rescue larger institutions. 3. LBank supervisory regulators need to pay much closer attention to executive compensation structures in financial institutions to ensure they are built around the proper time horizons and the proper orientation around risk. This is not just true for the CEO and other top executives--it is particularly relevant for key middle management employees in areas like trading desks and internal audit. Fire alarms should go off if internal audit is getting incentive pay based on stock price. 4. LWe need to close regulatory loopholes in the shadow markets so that all financial activity has adequate capital behind it and so regulators have adequate line of site into the entire market landscape. This means regulating derivatives, hedge funds, private equity and off-balance sheet vehicles based on the economic content of what they are doing, not based on what they are called. 5. LWe need to end regulatory arbitrage, among bank regulators; between the SEC and the CFTC, and to the extent possible, internationally by creating a global financial regulatory floor. 6. LWe need to adopt the recommendation of the Group of Thirty, chaired by Paul Volcker, to once again separate proprietary securities and derivatives trading from the management of insured deposits. AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS Joint Hearing of the CFTC and the SEC--Harmonization of Regulation September 3, 2009 Good morning Chairman Schapiro and Chairman Gensler. My name is Damon Silvers, I am an Associate General Counsel of the AFL-CIO, and I am the Deputy Chair of the Congressional Oversight Panel created under the Emergency Economic Stabilization Act of 2008 to oversee the TARP. My testimony reflects my views and the views of the AFL-CIO unless otherwise noted, and is not on behalf of the Panel, its staff or its chair, Elizabeth Warren. I should however note that a number of the points I am making in this testimony were also made in the Congressional Oversight Panel's Report on Financial Regulatory Reform's section on reregulating the shadow capital markets, and I commend that report to you. \1\--------------------------------------------------------------------------- \1\ Congressional Oversight Panel, Special Report on Regulatory Reform, at 22-24 (Jan. 29, 2009), available at http://cop.senate.gov/documents/cop-012909-report-regulatoryreform.pdf--------------------------------------------------------------------------- Thank you for the opportunity to share my views with you today on how to best harmonize regulation by the SEC and the CFTC. Before I begin, I would like to thank you both for bringing new life to securities and commodities regulation in this country. Your dedication to and enforcement of the laws that ensure fair dealing in the financial and commodities markets has never been more important than it is today. Derivatives are a classic shadow market. To say a financial instrument is a derivative says nothing about its economic content. Derivative contracts can be used to synthesize any sort of insurance contract, including most prominently credit insurance. Derivatives can synthesize debt or equity securities, indexes, futures and options. Thus the exclusion of derivatives from regulation by any federal agency in the Commodity Futures Modernization Act ensured that derivatives could be used to sidestep thoughtful necessary regulations in place throughout our financial system. \2\ The deregulation of derivatives was a key step in creating the Swiss cheese regulatory system we have today, a system that has proven to be vulnerable to shocks and threatening to the underpinnings of the real economy. The result--incalculable harm throughout the world, and harm in particular to working people and their benefit funds who were not invited to the party and in too many cases have turned out to be paying for the cleanup.--------------------------------------------------------------------------- \2\ Commodity Futures Modernization Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763 (2000).--------------------------------------------------------------------------- There are three basic principles that the AFL-CIO believes are essential to the successful harmonization of SEC and CFTC regulation and enforcement, and to the restoration of effective regulation across our financial system: 1. Regulators must have broad, flexible jurisdiction over the derivatives markets that prevents regulatory arbitrage or the creation of new shadow markets under the guise of innovation. 2. So long as the SEC and the CFTC remain separate agencies, the SEC should have authority to regulate all financial markets activities, including derivatives that reference financial products. The CFTC should have authority to regulate physical commodities markets and all derivatives that reference such commodities. 3. Anti-fraud and market conduct rules for derivatives must be no less robust than the rules for the underlying assets the derivatives reference. The Administration's recently proposed Over-the-Counter Derivatives Markets Act of 2009 (``Proposed OTC Act'') will help to close many, but not all, of the loopholes that make it difficult for the SEC and the CFTC to police the derivatives markets. It will also make it even more important that the SEC and the CFTC work together to ensure that regulation is comprehensive and effective.Regulators Must Have Broad, Flexible Jurisdiction Over the Entire Derivatives Market Derivatives as a general matter should be traded on fully regulated, publicly transparent exchanges. The relevant regulatory agencies should ensure that the exchanges impose tough capital adequacy and margin requirements that reflect the risks inherent in contracts. Any entity that markets derivatives products must be required to register with the relevant federal regulators and be subject to business conduct rules, comprehensive recordkeeping requirements, and strict capital adequacy standards. The Proposed OTC Act addresses many of the AFL-CIO's concerns about the current lack of regulation in the derivatives markets. If enacted, the Proposed OTC Act would ensure that all derivatives and all dealers face increased transparency, capital adequacy, and business conduct requirements. \3\ It would also require heightened regulation and collateral and margin requirements for OTC derivatives.--------------------------------------------------------------------------- \3\ Available at http://www.financialstability.gov/docs/regulatoryreform/titleVII.pdf--------------------------------------------------------------------------- The Proposed OTC Act would also require the SEC and CFTC to develop joint rules to define the distinction between ``standardized'' and ``customized'' derivatives. \4\ This would make SEC/CFTC harmonization necessary to the establishment of effective derivatives regulation.--------------------------------------------------------------------------- \4\ Proposed OTC Act 713(a)(2) (proposing revisions to the Commodity Exchange Act, 7 U.S.C. 2(j)(3)(A)).--------------------------------------------------------------------------- The AFL-CIO believes that the definition of a customized contract should be very narrowly tailored. Derivatives should not be permitted to trade over-the-counter simply because the counterparties have made minor tweaks to a standard contract. If counter-parties are genuinely on opposite sides of some unique risk event that exchange-trading could not accommodate, then they should be required to show that that is the case through a unique contract. The presence or absence of significant arms-length bargaining will be indicative of whether such uniqueness is genuine, or artificial. In a recent letter to Senators Harkin and Chambliss, Chairman Gensler flagged several areas of the Proposed OTC Act that he believes should be improved. \5\ The AFL-CIO strongly supports Chairman Gensler's recommendation that Congress revise the Proposed OTC Act to eliminate exemptions for foreign exchange swaps and forwards. We also strongly agree with Chairman Gensler that mandatory clearing and exchange trading of standardized swaps must be universally applicable and there should not be an exemption for counterparties that are not swap dealers or ``major swap participants.''--------------------------------------------------------------------------- \5\ Letter from Gary Gensler, Chairman of the Commodity Futures Trading Commission, to The Honorable Tom Harkin and The Honorable Saxby Chambliss, August 17, 2009, page 4, available at http://tradeobservatory.org/library.cfm?refid=106665---------------------------------------------------------------------------The SEC Should Regulate Financial Markets and the CFTC Should Regulate Commodities Markets The SEC was created in 1934, due to Congress' realization that ``national emergencies . . . are precipitated, intensified, and prolonged by manipulation and sudden and unreasonable fluctuations of security prices and by excessive speculation on such exchanges and markets, and to meet such emergencies the Federal Government is put to such great expense as to burden the national credit.'' \6\ As a result of the impact instability in the financial markets had on the broader economy during the Great Depression, Congress gave the SEC broad authority to regulate financial markets activities and individuals that participate in the financial markets in a meaningful way. \7\--------------------------------------------------------------------------- \6\ 15 U.S.C. 78b. \7\ See generally The Securities Act of 1933 (15 USC 77a et seq.); The Securities Exchange Act of 1934 (15 USC 78a et seq.); The Investment Company Act of 1940 (15 USC 80a-1 et seq.); The Investment Advisers Act of 1940 (15 USC 80b-1 et seq.).--------------------------------------------------------------------------- As presently constituted, the CFTC has oversight not only for commodities such as agricultural products, metals, energy products, but also has come to regulate--through court and agency interpretation of the CEA--financial instruments, such as currency, futures on U.S. government debt, and security indexes. \8\--------------------------------------------------------------------------- \8\ 7 U.S.C. 1a(4) provides the CFTC with jurisdiction over agricultural products, metals, energy products, etc. See Commodity Futures Trading Com'n v. International Foreign Currency, Inc., 334 F.Supp.2d 305 (E.D.N.Y. 2004), Commodity Futures Trading Com'n v. American Bd. of Trade, Inc., 803 F.2d 1242 (2d Cir 1986) discussing the CFTC's authorities with regard to currency derivatives. Since 1975, the CFTC has determined that all futures based on short-term and long-term U.S. government debt qualifies as a commodity under the CEA. See CFTC History, available at http://www.cftc.gov/aboutthecftc/historyofthecftc/history--1970s.html. Other financial products regulated by the CFTC include security indexes, Mallen v. Merrill Lynch., 605 F.Supp. 1105 (N.D.Ga.1985).--------------------------------------------------------------------------- So long as two agencies continue to regulate the same or similar financial instruments, there will be opportunities for market participants to engage in regulatory arbitrage. As we have seen on the banking regulatory side and with respect to credit default swaps, such arbitrage can have devastating results. As long as the SEC and the CFTC are separate, the SEC should regulate all financial instruments including stocks, bonds, mutual funds, hedge funds, securities, securities-based swaps, securities indexes, and swaps that reference currencies, U.S. government debt, interest rates, etc. The CFTC should have authority to regulate all physical commodities and commodities-based derivatives. We recognize that the proposed Act does not in all cases follow the principles laid out above. To the extent financial derivatives remain under the jurisdiction of the CFTC, it is critical that the CFTC and the SEC seek the necessary statutory changes to bring the CFTC's power to police fraud and market manipulation in line with the SEC's powers. In this respect, we are heartened by the efforts by the CFTC under Chairman Gensler's leadership to address possible gaps in the Administration's proposed statutory language. A vigorous and coordinated approach to enforcement by both agencies can in some respects correct for flaws in jurisdictional design. They cannot correct for lack of jurisdiction or weak substantive standards of market conduct. In his letter to Senators Harkin and Chambliss, Chairman Gensler raised concerns about the Administration's proposal for the regulation of ``mixed swaps,'' or swaps whose value is based on a combination of assets including securities and commodities. Because the underlying asset will include those regulated by both the SEC and the CFTC, the Administration proposes that both agencies separately regulate these swaps in a form of ``dual regulation.'' Chairman Gensler expresses concern that such dual regulation will be unnecessarily confusing, and suggests instead that each mixed swap be assigned to one agency or the other, but not both. In that proposed system, the mixed swap would be ``primarily'' deriving its economic identity from either a security or a commodity. \9\ Under the Chairman's view, only one agency would regulate any given mixed swap, depending on whether the swap was ``primarily'' a security- or a commodity-based swap.--------------------------------------------------------------------------- \9\ Id.--------------------------------------------------------------------------- Chairman Gensler's proposal certainly has a great deal of appeal--it's simpler, and eliminates the concern that duplicative regulation becomes either unnecessarily burdensome, or worse, completely ineffective. One could imagine a situation where each agency defers to the other, leaving mixed swaps dealers with free reign to develop their market as they see fit. But a proposal that focuses on the boundary between an SEC mixed swap and a CFTC mixed swap will run into a clear problem. There are swaps that are not primarily either security- or commodity-based: in fact, by design, they are swaps that, at the time of contract, are exactly 50/50, where the economic value of the SEC-type asset is equivalent to the economic value of the CFTC based asset. 50/50 swaps aren't that unusual, and Chairman Gensler's approach does not address what to do in those instances. These kinds of boundary issues become inevitable when we decide not to merge the two agencies. In order to prevent these problems from becoming loopholes, a solution must either eliminate the boundary--e.g., the Administration's dual regulation proposal--or it must adequately police that boundary. One potential alternative would be to form a staff-level joint task force between the CFTC and the SEC to ensure that these 50/50 swaps--those that are neither obviously SEC-swaps nor CFTC-swaps--would be regulated comprehensively, and consistently, across the system.Anti-Fraud and Market Conduct Rules In considering enforcement issues for derivatives, it is critical to consider the appropriate level of regulation of the underlying assets from which these derivatives flow. Some of the strongest tools in the agencies' toolboxes are anti-fraud and market conduct enforcement. Derivatives must be held at a minimum to the same standards as the underlying assets. The Administration's Proposed OTC Derivatives Act makes important steps in this direction. However, there will be a continuing problem if the rules governing the underlying assets are too weak. Here the CFTC's current statutory framework is substantially weaker in terms of both investor protection and market oversight than the SEC. The Commodities Exchange Act (CEA) does not recognize insider trading as a violation of the law. This is a serious weakness in the context of mixed derivatives and both financial futures and derivatives based on financial futures. It also appears to be an obstacle to meaningful oversight of the commodities markets themselves in the light of allegations of market manipulation in the context of the recent oil price bubble. Similarly, the CEA has an intentionality standard for market manipulation, while the SEC operates under a statutory framework where the standard in general is recklessness. Intentionality as a standard for financial misconduct tends to require that the agency be able to read minds to enforce the law. Recklessness is the proper common standard.Rules Versus Principles The Treasury Department's White Paper on Financial Regulatory Reform suggests there should be a harmonization between the SEC's more rules-based approach to market regulation and the CFTC's more principles-based approach. \10\ Any effective system of financial regulation requires both rules and principles. A system of principles alone gives no real guidance to market actors and provides too much leeway that can be exploited by the politically well connected. A system of rules alone is always gameable.--------------------------------------------------------------------------- \10\ Financial Regulatory Reform: A New Foundation. Department of the Treasury (June 17, 2009). See also http://www.financialstability.gov/docs/regs/FinalReport_web.pdf--------------------------------------------------------------------------- Unfortunately, in the years prior to the financial crisis that began in 2007 the term ``principles based regulation'' became a code word for weak regulation. Perhaps the most dangerous manifestation of this effort was the Paulson Treasury Department's call in its financial reform blueprint for the weakening of the SEC's enforcement regime in the name of principles based regulation by requiring a merged SEC and CFTC to adopt the CEA's approach across the entire securities market. \11\--------------------------------------------------------------------------- \11\ http://www.treas.gov/press/releases/reports/Blueprint.pdf--------------------------------------------------------------------------- The SEC and the CFTC should build a strong uniform set of regulations for derivatives markets that blend principles and rules. These rules should not be built with the goal of facilitating speedy marketing of innovative financial products regardless of the risks to market participants or the system as a whole. In particular, the provisions of the Commodities Exchange Act that place the burden on the CFTC to show an exchange or clearing facilities operations are not in compliance with the Act's principles under a ``substantial evidence'' test are unacceptably weak, and if adopted in the area of derivatives would make effective policing of derivatives' exchanges and/or clearinghouses extremely difficult. It remains a mystery to us why ``innovation'' in finance is uncritically accepted as a good thing when so much of the innovation of the last decade turned out to be so destructive, and when so many commentators have pointed out that the ``innovations'' in question, like naked credit default swaps with no capital behind them, were well known to financial practitioners down through the ages and had been banned in our markets for good reason, in some cases during the New Deal and in some cases earlier. This approach is not a call for splitting the difference between strong and weak regulation. It is a call for building strong, consistent regulation that recognizes that the promotion of weak regulation under the guise of ``principles based regulation'' was a major contributor to the general failure of the financial regulatory system.Conclusion The last 2 years have shown us the destructive consequences of the present system--destructive not only to our overall economy, but also to the lives and livelihoods of the men, women, and families least positioned to weather these storms. We have seen firsthand how regulatory arbitrage in the financial markets create tremendous systemic risks that can threaten the stability of the global economy. Derivatives are a primary example of how jurisdictional battles among regulators can result in unregulated and unstable financial markets. We urge you to work together to create a system that will ensure that nothing falls through the cracks when the SEC and the CFTC are no longer under your collective leadership. CHRG-111hhrg53021Oth--135 Secretary Geithner," I share that skepticism and concern, and I think you are right in seeing it that way. I think what the CFTC Chairman proposed the other day, and what is an appropriate approach to think about policy in this area, is to look for ways to limit volatility. And it is very hard to not look at the last 2 years of pattern in the global energy markets, even though there has been such enormous shifts in confidence about the strength and weakness of the global economy, and not to believe we have seen a level of volatility that has been damaging, fundamentally, to the capacity of businesses to manage risk and damaging to confidence. And so it is worth trying to see whether you can, through better disclosure, limit that risk. Hard to do. Lots of people have tried it unsuccessfully. But, you are also right that, if you are going to do that effectively, you have to try and do it in a common approach where oil and other commodities are traded globally. " CHRG-111hhrg53021--135 Secretary Geithner," I share that skepticism and concern, and I think you are right in seeing it that way. I think what the CFTC Chairman proposed the other day, and what is an appropriate approach to think about policy in this area, is to look for ways to limit volatility. And it is very hard to not look at the last 2 years of pattern in the global energy markets, even though there has been such enormous shifts in confidence about the strength and weakness of the global economy, and not to believe we have seen a level of volatility that has been damaging, fundamentally, to the capacity of businesses to manage risk and damaging to confidence. And so it is worth trying to see whether you can, through better disclosure, limit that risk. Hard to do. Lots of people have tried it unsuccessfully. But, you are also right that, if you are going to do that effectively, you have to try and do it in a common approach where oil and other commodities are traded globally. " fcic_final_report_full--155 AIG also bestowed the imprimatur of its pristine credit rating on commercial pa- per programs by providing liquidity puts, similar to the ones that Citigroup’s bank wrote for many of its own deals, guaranteeing it would buy commercial paper if no one else wanted it. It entered this business in ; by , it had written more than  billion of liquidity puts on commercial paper issued by CDOs. AIG also wrote more than  billion in CDS to protect Société Générale against the risks on liquidity puts that the French bank itself wrote on commercial paper issued by CDOs.  “What we would always try to do is to structure a transaction where the transaction was vir- tually riskless, and get paid a small premium,” Gene Park, who was a managing direc- tor at AIG Financial Products, told the FCIC. “And we’re one of the few guys who can do that. Because if you think about it, no one wants to buy disaster protection from someone who is not going to be around. . . . That was AIGFP’s sales pitch to the Street or to banks.”  AIG’s business of offering credit protection on assets of many sorts, including mortgage-backed securities and CDOs, grew from  billion in  to  billion in  and  billion in .  This business was a small part of the AIG Finan- cial Services business unit, which included AIG Financial Products; AIG Financial Services generated operating income of . billion in , or  of AIG’s total. AIG did not post any collateral when it wrote these contracts; but unlike mono- line insurers, AIG Financial Products agreed to post collateral if the value of the un- derlying securities dropped, or if the rating agencies downgraded AIG’s long-term debt ratings. Its competitors, the monoline financial guarantors—insurance compa- nies such as MBIA and Ambac that focused on guaranteeing financial contracts— were forbidden under insurance regulations from paying out until actual losses occurred. The collateral posting terms in AIG’s credit default swap contracts would have an enormous impact on the crisis about to unfold. But during the boom, these terms didn’t matter. The investors got their triple-A- rated protection, AIG got its fees for providing that insurance—about . of the notional amount of the swap per year  —and the managers got their bonuses. In the case of the London subsidiary that ran the operation, the bonus pool was  of new earnings.  Financial Products CEO Joseph J. Cassano made the allocations at the end of the year.  Between  and , the least amount Cassano paid himself in a year was  million. In the later years, his compensation was sometimes double that of the parent company’s CEO.  In the spring of , disaster struck: AIG lost its triple-A rating when auditors discovered that it had manipulated earnings. By November , the company had reduced its reported earnings over the five-year period by . billion.  The board forced out Maurice “Hank” Greenberg, who had been CEO for  years. New York Attorney General Eliot Spitzer prepared to bring fraud charges against him. Greenberg told the FCIC, “When the AAA credit rating disappeared in spring , it would have been logical for AIG to have exited or reduced its business of writing credit default swaps.”  But that didn’t happen. Instead, AIG Financial Prod- ucts wrote another  billion in credit default swaps on super-senior tranches of CHRG-111hhrg63105--64 Mr. Chilton," The Chairman probably wants to comment further, and I know you only have a little bit of time. While everybody says we to need to get all this data that Mr. Marshall and people talked about, ``Let's get it all, let's not make a haphazard decision,'' I agree. The spot month we could do right now even in the swaps area. This is the currently unregulated area. This is the one that you have given us the authority to look at. And the reason we can set that limit now is because you base the limit on the deliverable supply of whatever the commodity is. So you don't need to see all-months. You don't need to see the aggregate. We could do the spot month right now, which would in part get us to where Congress instructed us to go. The Chairman wanted to add? " FOMC20080916meeting--120 118,MS. YELLEN.," Thank you, Mr. Chairman. During the past several weeks, my head office and Branch directors have become decidedly more pessimistic about the economic outlook. My own assessment of incoming data coincides with theirs. My contacts also report that their businesses are still raising prices in response to past increases in commodity and import prices that boosted their costs. I expect as a consequence that core inflation will remain uncomfortably high for a while longer, but the marked decline in commodity prices since June reinforces my conviction that there is light at the end of this inflation tunnel. With respect to growth, our forecast is similar to the Greenbook's, with a little more weakness in the second half of this year and a little more strength in 2009. I think the risks to this forecast are decidedly skewed to the downside. I agree with the Greenbook's assessment that the strength we saw in the upwardly revised real GDP growth in the second quarter will not hold up. Despite the tax rebates, real personal consumption expenditures declined in both June and July, and retail sales were down in August. My contacts report that cutbacks in spending are widespread, especially for discretionary items. For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter] Reservations are no longer necessary at many high-end restaurants. And the Silicon Valley Country Club, with a $250,000 entrance fee and seven-to-eight-year waiting list, has seen the number of would-be new members shrink to a mere thirteen. [Laughter] Exports were a huge source of strength in the second quarter, but I am concerned that we cannot count on very large contributions to growth from exports going forward, now that the dollar has begun to rise and economic growth abroad has slowed, even turning negative in some important trade partners. Indeed, the growing weakness of the global outlook appears to be an important explanation for the reversion in commodity prices, and this adds a dimension of gloom to what would otherwise be a decided plus for both inflation and demand. Recent data also suggest that labor markets are weakening across the board--a development that will cast a pall on household income and spending. The interaction of higher unemployment with the housing and financial markets raises the potential for even worse news--namely, an intensification of the adverse feedback loop we have long worried about and are now experiencing. Indeed, delinquencies have risen substantially across the spectrum of consumer loans, and credit availability continues to decline. One ray of hope is that the changes at Fannie and Freddie have caused a notable drop in mortgage rates. Another is that the decline in home prices has become somewhat less steep, and we have seen an outright improvement in home inventories relative to sales. But my contacts are very pessimistic about the prospects for nonresidential construction. They note that construction is continuing on projects in the pipeline with committed funding, but new projects are all but impossible to finance. Turning to inflation, I have long anticipated and still expect that inflation will fall to more-reasonable levels in 2009. However, developments since our August meeting diminish the upside risks to this projection. The drop in oil and other commodity prices, along with the appreciation of the dollar, should work to moderate the current inflation bulge and diminish the potential for a wage�price spiral to develop. Import inflation has already begun to ease. Furthermore, we have seen a remarkable decline in inflation compensation for the next five years in the TIPS market. I would not rely heavily on this decline to support my view, but I do have to say that the decline is a lot more reassuring than the alternative. I was also encouraged by the 30 basis point drop in long-term inflation expectations in the most recent Michigan survey. I anticipate that the recent jump in the unemployment rate will place some additional downward pressure on growth in labor compensation, which has been quite low, and in core inflation. Although the jump in the unemployment rate probably partly reflects the extension of unemployment insurance coverage, a back-of-the-envelope calculation suggests that the upper bound on this effect is just a few tenths of a percent. I would agree with the Greenbook estimates. We have also examined the possibility that the increase in unemployment reflects a rise in the NAIRU due to sectoral employment shifts out of construction and finance and into other industries. Ned Phelps has argued that the sectoral shift story implies a sizable dispersion of employment growth across industries and states. But we looked at these data and found no significant increase, so I don't find this Phelps argument particularly convincing. Considering all of these factors, I expect both headline and core PCE price inflation to fall to about 2 percent for 2009 as a whole, and I see the risks to this projection as roughly balanced. With respect to policy, I would be inclined to keep the funds rate target at 2 percent today. For now, it seems to me that the additional liquidity measures that have been put in place are an appropriate response to the turmoil. I am fine with the wording of alternative B and would support President Lockhart's suggestion for change. That would seem fine to me, too. In view of the intensified financial stress and the potential for more turmoil, obviously I think we will need to be flexible in setting policy going forward, and I am very concerned about downside risks to the real economy and think that inflation risk is diminished. " CHRG-111shrg54589--30 Mr. Gensler," I believe, sir, that that should be reported to all the regulators and certainly aggregated in the aggregate positions by underlying commodity. In that way, jet fuel derivatives should be reported to the public. I think working together, we have to think through whether that should also be part of this consolidated tape or whether there are some that would be so unique that the commercial attributes of, as you said, Delta Airlines might be put at risk. But they, I believe, should be---- Senator Bunning. I think---- " Mr. Gensler," ----aggregated in part, seen clearly by the regulators, and possibly be part of the consolidated tape. Senator Bunning. I can't see how Delta Airlines would be put at risk if they are smart enough to hedge against the market's advance in future oils or future jet fuel or whatever it might be---- " CHRG-110shrg50369--125 Chairman Dodd," Let me, if I can, Mr. Chairman, I want to raise a couple of questions, if I can for you, and some of them have been touched on. I do not want to take a long time here with you, but I am just intrigued by the correlation of some of these issues. Sometimes we cite a bunch of statistics and wonder what the correlations are between them. There are two factors that I want your thoughts on, if I can, that contribute to this huge run-up in commodity prices that we heard Senator Tester talk about and others. Oil is the first thing I think about, but obviously, if you are a farmer or a baker in Rhode Island, it can be the cost of wheat and others. The first is the increase in the demand for these goods. That is obviously one set of issues. The second is that these goods are priced in dollar terms. Sometimes we pass over that idea, but we talked about the price of oil a barrel, it is in dollar terms. And to what extent is the decline in the value of the dollar driving this? And beyond that concern, is that decline in the dollar--does that decline represent a decrease in confidence in the U.S. financial system? As the Fed report indicates--and I mentioned this at the outset--there was a net sale of U.S. securities by private foreign investors in the third quarter of 2007, the first quarterly net sale in more than 15 years. And I wonder how is that loss of confidence in the U.S. by foreign investors leading into a decline in the dollar, which leads to the rising commodity prices. I am trying to connect these questions, if at all. I was talking to a friend of mine in Europe this morning who is involved in the financial services sector--a totally different matter--and I told him I was going to be having the hearing this morning with you. And he was saying that one of the problems we have got is the fact that Europe is not cutting its interest rates at all, and so you are getting that comparison as well, which probably exacerbates this problem to some extent, at least in that market. And I was curious, because we have had a lot of questions of you--and I will come back to this in a minute--on the sovereign wealth funds, and I was trying to get some sense of proportionality about private investment versus sovereign wealth funds. And I do not minimize the importance of the sovereign wealth funds issues, but I asked staff to give me some sense of the proportionality of numbers. And out of the estimated $150 trillion in global capital stock, $2.2 trillion is held by sovereign wealth funds. And while sovereign wealth funds are about double the size of hedge fund assets, they represent less than 5 percent of global assets. And while China's sovereign wealth fund hold is about $200 billion in assets, the size of China's foreign exchange reserves is about $1.3 trillion. And so you have got--putting aside that for a second, the private investment sector here is an important one, and maybe I--am I making too much of this bar graph I saw in the Monetary Report Fund where you see for the first time that looks like a selling off here? And I noticed in your response to one of the--I forget who it was raised the question earlier. At least I thought I heard you say this was not as--that foreign investment is still coming in and that is a source of some confidence here. Anyway, could you try and connect those things for me? Is it a false connection? But I am curious how that relates to the decline in the dollar, the rise in commodity prices, and whether or not there is some connection here. " FOMC20080430meeting--67 65,MR. STOCKTON.," I think that is a fair characterization. You know, one thing that we're struggling with--and I assume you are as well in giving your own views about the uncertainty and the skewness around your forecast--is whether things have changed. Is the skew large enough for us to argue that, in fact, the risks look unbalanced? We thought about that and about the potential upside and downside risks. Clearly, as I indicated, upside risks would be associated with ongoing increases in underlying prices for oil and other commodities that would probably feed through indirectly into core inflation over time. On the downside, we have been struck with how little upward pressure there has been on labor compensation and labor costs. Now, if you pinned me down and said draw a fine line on this, I'd probably say that, given the pattern of the past few years, it would look to me as though there's probably a little more upside risk than downside risk, but I don't see that skewness as being material in the forecast. " fcic_final_report_full--564 Washington, D.C., May 14, 1998, p. 8. 19. Federal Housing Finance Agency, Report to Congress, 2008 (2009), tables 3, 4, 12, and 13. 20. Lawrence Lindsey, interview by FCIC, September 20, 2010. 21. Jim Callahan, interview by FCIC, October 18, 2010. 22. Securities Industry and Financial Markets Association (SIFMA), US ABS Outstanding. 23. Scott Patterson, interview by FCIC, August 12, 2010. 24. Gillian Tett, Fool’s Gold: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe (New York: Free Press, 2009), pp. 32–33, 49, 70, 115. 25. Emmanuel Derman, interview by FCIC, May 12, 2010. 26. Volcker, interview. 27. Vincent Reinhart, interview by FCIC, September 10, 2010. 28. Lindsey, interview. 29. A futures contract is a bilateral contract in which one party, the long position, is compensated if the price or index or rate underlying the contract rises while the other party, the short position, is com- pensated if it goes down. An options contract grants the right but not the obligation to purchase or sell a commodity or financial instrument at a particular price in the future; the option holder derives a benefit if the price moves in his or her favor. In a swaps contract, the two parties exchange streams of payments based on different benchmarks. 30. Securities options are regulated by the SEC. 31. Commodity Futures Trading Commission, Exemption for Certain Swap Agreements, Final Rule, Federal Registrar 58 (January 22, 1993): 5587. 32. Brooksley Born, chairperson, Commodity Futures Trading Commission, “Concerning the Over- the-Counter Derivatives Market,” prepared testimony before the House Committee on Banking and Fi- nancial Services, 105th Cong., 2nd sess., July 24, 1998. 33. GAO, “Financial Derivatives: Actions Needed to Protect the Financial System,” GGD-94-133 (Re- port to Congressional Requesters), May 18, 1994. 34. Commodity Futures Trading Commission, “Division of Enforcement” (www.cftc.gov/anr/an- renf98.htm). 35. “Joint Statement by Treasury Secretary Robert E. Rubin, Federal Reserve Board Chairman Alan Greenspan, and Securities and Exchange Commission Chairman Arthur Levitt,” Treasury Department press release, May 7, 1998. 36. Fed Chairman Alan Greenspan, “The Regulation of OTC Derivatives,” prepared testimony before the House Committee on Banking and Financial Services, 105th Cong., 2nd sess., July 24, 1998. 37. GAO, “Long-Term Capital Management: Regulators Need to Focus Greater Attention on Systemic Risk,” GAO/GGD-00-3 (Report to Congressional Requesters), October 1999, pp. 7, 18, 39–40. The no- tional amount of OTC derivatives contracts is a standard measure used in reporting the outstanding vol- ume of such contracts. Its calculation is based on the value of the underlying instrument, commodity, index, or rate that the swap is based on. It therefore may be of limited use in measuring the potential ex- posure of the parties to the contracts. For example, an interest rate swap based on changes in interest rate on a $100 million loan would likely involve only a small percentage of the $100 million notional amount. On the other hand, price changes on an oil swap based on $100 million worth of oil could be even more than the notional amount, depending on the volatility in oil prices. For credit default swaps, which are discussed in more detail later in this volume, the notional amount is usually a close measure of the poten- tial financial exposure of the issuer or seller of the swap. 561 38. Fed Chairman Alan Greenspan, “Private-sector Refinancing of the Large Hedge Fund, Long-Term Capital Management,” prepared testimony before the House Committee on Banking and Financial Serv- ices, 105th Cong., 2nd sess., October 1, 1998. 39. Fed Chairman Alan Greenspan, “Financial Derivatives,” remarks before the Futures Industry As- sociation, Boca Raton, Florida, March 19, 1999. 40. “Over-the-Counter Derivatives Markets and the Commodity Exchange Act,” report of the Presi- dent’s Working Group on Financial Markets, November 1999. 41. Gross market value is the current price at which the outstanding swaps contract can be sold or re- placed on the market. As such, that amount reflects the current amount owing on a contract but does not reflect the possible future exposure on these generally long-term instruments. 42. Bank for International Settlements, data on semiannual OTC derivatives statistics. 43. Alan Greenspan, testimony before the FCIC, Hearing on Subprime Lending and Securitization and Government-Sponsored Entities (GSEs), day 1, session 1: The Federal Reserve, April 1, 2010, tran- script, pp. 88–89. 44. Robert Rubin, testimony before the FCIC, FCIC Hearing on Subprime Lending and Securitization and Government-Sponsored Entities (GSEs), day 2, session 1: Citigroup Senior Management, April 8, 2010, transcript, pp. 108–10, 123–24. 45. Lawrence Summers, interview by FCIC, May 28, 2010. 46. Daniel K. Tarullo, Banking on Basel: The Future of International Financial Regulation (Washington, CHRG-111hhrg74855--355 Mr. Shelk," So under the version that you have suggested essentially the tier one bank wouldn't post the collateral, we would have to post the collateral as the counterparty to the tier one institution and as I indicated earlier, the problem with that is it would tie-up, and the examples we have come up with about an average a quarter of the capital of the end user so we fully agree with your comments that the electric utilities and other generators didn't cause the problem. We think the way to get to your transparency goal which we share because we are in the market too, is to have a data repository so that information on these trades would be available to the CFTC and others, and the problem with electricity is it is very customized. These products are traded over hundreds of different nodes around the country so it doesn't really lend itself, the CFTC doesn't lend itself to the corn example, and the T-bill example and kinds of commodities that the chairman indicated. " CHRG-111hhrg49968--24 Mr. Bernanke," Mr. Plosser does, as well. He is simply saying we shouldn't put too much weight because it is very difficult to measure them. But what I am saying is that, currently, there is not much doubt that there is an output gap, and that, therefore, there would be a downward effect on inflation. That being said, there are other factors as well, including the currency, including commodity prices and so on, and we watch those very carefully. I think I would note that, if you look around for evidence of inflation, inflation expectations, you are not going to find very much. If you look, for example, at surveys of consumers, if you look at the forecast of professional forecasters, if you look at the spreads between indexed and nonindexed bonds, all of those things are quite consistent with inflation remaining stable and well within the bounds that the Federal Reserve believes is consistent with price stability. " FinancialCrisisInquiry--196 CHAIRMAN ANGELIDES : You refer to “animal spirits,” in the context of your remarks today. To what extent do the animal spirits extend beyond the housing market? In other words, as we look at causes, perhaps—I don’t want to characterize it—it was certainly a large fire burning, but what were the other fires burning—what were the other areas of excess within the economy in the last few years, in your judgment? If any? ZANDI: I think the... CHAIRMAN ANGELIDES: And by proportion? (LAUGHTER) ZANDI: I think the hubris in the financial system was widespread. I think it was clearest and most evident in the residential mortgage market, thus the focus on that. But I think it extends well beyond that, and, as we can see to this day, into commercial real estate lending, which many small banks are now struggling with, to corporate lending, all various kinds of—of corporate lending. It was evident more broadly in financial markets, in the derivatives market, stock prices, obviously in commodity markets at certain points in time. So I think the hubris among investors, global investors, was extraordinarily widespread and cut across lots of different markets, a whole range of markets. In fact, it would be more difficult to identify the markets that weren’t affected at the height of this by that hubris. CHAIRMAN ANGELIDES: Is there any way of measuring proportionality? FinancialCrisisInquiry--610 ZANDI: I think the hubris in the financial system was widespread. I think it was clearest and most evident in the residential mortgage market, thus the focus on that. But I think it extends well beyond that, and, as we can see to this day, into commercial real estate lending, which many small banks are now struggling with, to corporate lending, all various kinds of—of corporate lending. It was evident more broadly in financial markets, in the derivatives market, stock prices, obviously in commodity markets at certain points in time. So I think the hubris among investors, global investors, was extraordinarily widespread and cut across lots of different markets, a whole range of markets. In fact, it would be more difficult to identify the markets that weren’t affected at the height of this by that hubris. FOMC20060808meeting--41 39,MS. JOHNSON.," I would say in a kind of notional sense that most especially China, for example, has not slowed to the degree that we and everybody else had been expecting. There was a significant positive surprise in the Q2 numbers for China. At the time we saw what we called the “volatility” of May-June, when it looked as though some commodity prices were coming off and the stories that they had been held up by speculators and so forth seemed true, and it looked as though those prices might actually adjust downward and stay down. Well, that perception was very short lived: The fundamental demand for some of these products seems to have reasserted itself, and many of those prices are back up where they once were. So based on those kinds of indirect signals, I would say that the strength of the global economy is at least what it was three months ago and perhaps a tiny bit stronger." CHRG-111hhrg52397--103 Mrs. Biggert," Okay. No one else? Well, then if it has been a concern that some of the OTC derivative products are not safe for retail investors, should we simply restrict participation in these markets? We heard long ago that these were not for the people who were in pensions or whatever but for those who had the ability to take a loss on a large amount of money and somehow it seemed to have slipped from that. Is there any concern that we would go back to that? Mr. Don Thompson. Well, I think it is fair to say the over-the-counter derivatives market is already an institutional market. The eligible contract participant requirement in the Commodity Exchange Act restricts it from retail investors. Now, I guess one can quibble about whether that has been set high enough, low enough or whatever, but it is not, and has never been, a retail market, unlike the exchange traded markets. " CHRG-111hhrg51698--332 Mr. Pickel," We focus on the trading limits and the hedge exemption provisions. Keep in mind that we represent the bilateral, privately negotiated derivatives business. In that role, parties, whether we are talking about interest rates or other types of commodities, would typically be entering into bilateral contracts that are tailored to the particular needs of the counterparties. The dealer in that situation hedges its risk in various ways. If it can find an offsetting position with another bilateral trade it will do that, but often it looks to manage that risk via the futures markets. That is the root of the hedging exemption that is provided for, is to recognize that ability for the dealer to hedge its position that it takes on the bilateral trade it may wish to access the futures market and, therefore, that is the appropriate role for that exemption. " CHRG-111hhrg63105--84 Mr. Marshall," Thank you, Mr. Kissell. Just sort of following up where I was when I stopped, you clearly have the statutory authority not to move forward unless it is appropriate to do so. That is why that language was stuck in there. And that if you move forward without understanding precisely what the problem is, then it seems to me that you are not moving forward appropriately. And if your staff hasn't identified what the problem is, then how do you actually come up with a regulation to solve that problem. You don't even know what it is. It is sort of too broad a brush. But back to this classes of traders. We intentionally stuck that language in there to give you the discretion to distinguish among the speculators and, if you chose to do so, I don't know whether there is a massive passive problem here. I just don't have the expertise. And there are, as Mr. Kissell points out, people on both sides of that. So I leave it to you and your staff and your economists and whatnot to figure it out. But if it is massive passive that is the problem, then the solution should focus specifically on that, and one-size-fits-all position limits don't do that. And you just use ratios. Assume you have 20 traders in the market, five of them are passive. You put a position limit in that is designed to maintain their percentage at no more than 25 percent. And then let us say a whole bunch of additional passives show up. Let us say 20 additional passives show up. Now I have 40 traders in the market and 60 percent of it is passive money. So you really do need to at least consider distinguishing among the classes of traders if you conclude that that is a problem. I associate myself with the questioning of Mr. Conaway in many different respects, and he has observed there is a fiduciary duty here. And I guess a final question. Let us assume that you impose position limits and that there is a large market demand out there that is now sort of stymied. It doesn't have an opportunity to just come into these markets because you are aggregate. You are across all of the markets. Where does that money go? How do people who want to take a position in commodities to do whatever, hedge or because they want that in their portfolio or whatnot and they can't do it in these vehicles, where do they go? Do they go to Europe? Do they start hoarding commodities? I mean, what do they do? " fcic_final_report_full--32 Maker told the board that she feared an “enormous economic impact” could re- sult from a confluence of financial events: flat or declining incomes, a housing bub- ble, and fraudulent loans with overstated values.  In an interview with the FCIC, Maker said that Fed officials seemed impervious to what the consumer advocates were saying. The Fed governors politely listened and said little, she recalled. “They had their economic models, and their economic mod- els did not see this coming,” she said. “We kept getting back, ‘This is all anecdotal.’”  Soon nontraditional mortgages were crowding other kinds of products out of the market in many parts of the country. More mortgage borrowers nationwide took out interest-only loans, and the trend was far more pronounced on the West and East Coasts.  Because of their easy credit terms, nontraditional loans enabled borrowers to buy more expensive homes and ratchet up the prices in bidding wars. The loans were also riskier, however, and a pattern of higher foreclosure rates frequently ap- peared soon after. As home prices shot up in much of the country, many observers began to wonder if the country was witnessing a housing bubble. On June , , the Economist magazine’s cover story posited that the day of reckoning was at hand, with the head- line “House Prices: After the Fall.” The illustration depicted a brick plummeting out of the sky. “It is not going to be pretty,” the article declared. “How the current housing boom ends could decide the course of the entire world economy over the next few years.”  That same month, Fed Chairman Greenspan acknowledged the issue, telling the Joint Economic Committee of the U.S. Congress that “the apparent froth in housing markets may have spilled over into the mortgage markets.”  For years, he had warned that Fannie Mae and Freddie Mac, bolstered by investors’ belief that these in- stitutions had the backing of the U.S. government, were growing so large, with so lit- tle oversight, that they were creating systemic risks for the financial system. Still, he reassured legislators that the U.S. economy was on a “reasonably firm footing” and that the financial system would be resilient if the housing market turned sour. “The dramatic increase in the prevalence of interest-only loans, as well as the in- troduction of other relatively exotic forms of adjustable rate mortgages, are develop- ments of particular concern,” he testified in June. To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is be- ginning to add to the pressures in the marketplace. . . . Although we certainly cannot rule out home price declines, espe- cially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications. Nationwide banking and widespread securitization of mortgages makes it less likely that financial intermediation would be impaired than was the case in prior episodes of regional house price corrections.  CHRG-111hhrg51698--5 Mr. Lucas," Thank you, Chairman Peterson, for calling today's hearing. We appreciate the opportunity to examine your draft legislation that addresses concerns with the derivatives industry and its impact on the U.S. economy. During the past several months, the Committee has spent a great deal of time monitoring the issue of trading activity in the futures market, as well as exploring the role credit default swaps have played in our current financial crisis. The draft legislation we are considering would impact a wide array of financial instruments, and what the ultimate effect will be in the marketplace is unknown. My main concern is how the legislation will impact risk management for agricultural producers. How far will this legislation go beyond credit default swaps and derivatives in general? I support greater transparency and accountability in respect to the over-the-counter transactions. However, I also believe any legislation to regulate financial markets has to strike a delicate balance between protecting the economic workings of this country and creating opportunities for economic growth, business expansion, risk management for our agricultural producers. To that end, I believe this Committee must work to ensure that the Commodity Futures Trading Commission, the CFTC, plays a leading role in appropriately regulating the derivative and commodity markets once the Committee decides what level of additional regulations are needed. We should also work to ensure that the CFTC has the tools it needs, human resources, technical resources, economic resources to effectively carry out its statutory mandate. It must be noted that the CFTC has a proven track record in clearing futures contracts, and to date has not lost a single dollar of a single customer's money due to failure of a clearinghouse. Finally, I would like to thank the participants of our two panels today. We appreciate your time and your commitment to the public policy process, and we look forward to your testimony and answers to our questions. Thank you, Mr. Chairman. " FOMC20080805meeting--143 141,CHAIRMAN BERNANKE.," You want it before 2:15, though. All right. Well, I spent a lot of time through the meeting and during the break working up a crystalline summary of the discussion. [Laughter] But I am a bit concerned about getting to lunch and avoiding the 2:15 hard deadline; so if you would excuse me, this time I will just go directly to a few comments of my own, and then we can go to the policy round. We saw growth of about 2 percent in the second quarter, which suggests a campaign slogan for the Republicans, ""The Economy: It Could Be Worse."" [Laughter] The question, though, is whether this higher-than-expected growth rate in the second quarter implies that we are actually looking forward to a better-than-expected remainder of the year or whether this was in some sense a last hurrah of borrowing from the future. I feel that I am very strongly in the latter camp, unfortunately. I do think that, for reasons people have talked about, the remainder of the year and into next year are likely to be quite weak. I don't know how weak, but if you look at each component of spending or component of production, you see mostly very negative indicators. We have talked about consumption. We know about all the fundamental issues that are affecting consumers, and we have seen recently, I think both anecdotally and in terms of the data, some softness, particularly in the auto area. In the labor market, several people have noted that the loss of payroll jobs has not been as rapid as, for example, in 2001. The unemployment rate, though, has risen as quickly as in previous episodes, and any look at the unemployment rate would suggest that this is something close to a normal recession dynamic. Housing, of course, remains very uncertain. We don't really know when the bottom will be, although I would add, a point that I think Bill Dudley made, that there seems to be a growing confidence that when we have reached the bottom in housing, whenever that may be, we will see a very quick improvement, both in the financial markets and then, presumably, in the economy as well. In other areas, such as nonresidential construction, architectural billings and other factors suggest slowing there. We see slowing in the other industrial countries, although some strength is still in the emerging markets. So just looking at the traditional indicators of growth and production, I think the best guess is for a slow second half, a slow beginning of 2009, and an unemployment rate that continues to rise from here. I do believe that the financial stress and its implications for credit availability are important in this whole dynamic. I guess President Lacker and I keep talking past each other, but I don't think that the federal funds rate is an adequate description of the stance of monetary policy. To give another example, in the past we have used money growth as an indicator of monetary policy. If we used that indicator, it would look quite different. I think the appropriate indicators are the rates and terms that are being faced by the people making decisions to spend in the economy. You can go through the entire list, and in every case, as Governor Kohn suggested, the actual rates being faced in the data by borrowers are as high as or higher than they were last summer. Mortgages, which are a particularly sensitive area, are of course critical here. Despite the decline in the federal funds rate, the spread between mortgage-backed securities and duration-matched Treasuries is now about 260 basis points compared with 120 basis points last summer. In addition, for the spread between jumbo loans and conforming loans, which in the past has normally been between 25 and 50 basis points, the offer rate is about 120 basis points. So there seems little doubt--and we can check with Governor Duke about this--that, despite the lower rate on overnight bank lending, the rates that matter for economic activity are largely higher than they were a year ago. Therefore, I don't think it is evident at all that we are in a financial situation that is conducive to rapid, excessive growth and inflationary increases a priori. Now, going forward, of course, a lot of what happens in the economy is going to depend on bank balance sheets. I won't spend much time. In April, I talked about the staff's estimates of losses going forward. That has been updated. Nellie Liang is working with people in New York. The numbers are not too encouraging under the baseline scenario, forgetting about the more severe scenarios. The staff now projects about $228 billion in losses for U.S. banks and thrifts in '08 and '09. That excludes investment banks. That excludes write-downs. If that occurs, it would be about a 2 percent loss rate over the next two years, which would be above the peak of 1991 and 1992. Of course, if the economy does worse, it would be even higher. Relative to that $228 billion in losses, there are so far loan-loss provisions of about $68 billion. So it looks as though we still have a long way to go in terms of bank losses and write-downs. In addition, some of the biggest banks will take very significant hits. This is very preliminary, and I don't want to make too much of it, but the preliminary analysis shows that for five of the very biggest banks, under a baseline scenario and looking at the composition of their asset holdings, their current tier 1 capital ratios will be reduced between 30 percent and 50 percent over the next two years. So there is a real concern about the availability of credit and about the cost of credit. I could go on and talk about a variety of other areas, including the Senior Loan Officer Opinion Survey, which suggests that credit will be a concern going forward. President Lacker and I have, I hope, respect--I respect him, and I hope he respects me. But we disagree also about President Bullard on systemic risk. I take his criticism to be that it works in practice, but can it work in theory? Systemic risk is an old phenomenon. There are literally dozens and dozens of historical episodes that are suggestive of that phenomenon. There is also an enormous theoretical literature. Maybe it is not entirely satisfactory, but certainly many people have thought about that issue. I, myself, have obviously worked in this area. Clearly, it is not something that we can tightly explain in all aspects, but I do think it is a concern. We need to remain concerned about it. Although it is true, as President Bullard points out, that there is an accommodation and a basis for anticipating crises as we go forward, it is also the case, as I think Governor Mishkin noted, that after a year we are also facing a situation of greater fragility, of much lower capital, and fewer shock absorbers. Those things will make any crisis that much more severe, should it occur. So overall I think there is still significant downside risk to growth. I think the baseline of slow growth is right. I am hopeful that we will see growth restored early next year, but I think it is very uncertain at this point. On inflation, I do have concerns, as everyone else does. I think that the commodity price movements we have seen are good news. They have been quite significant. Besides oil prices down about 10 percent and natural gas prices down about 32 percent, since the last meeting corn is off 27 percent; soybeans, 17 percent; and wheat, 16 percent. Those are not small changes. Now, obviously, the level of prices is still very high. It has risen considerably over the past year. We will continue to see that high level of prices being passed through into the core, as Governor Kohn noted, but I would argue that if--and this is a very big ""if""--commodity prices do begin to stabilize within the general range of what we see now, I think that the inflation concerns will moderate over time because they will have lost essentially their driving force. We don't really have the conditions to turn the commodity price increases into persistent inflation, absent continued pressure on that front and absent changes in inflation expectations, of which there is only limited evidence at this point. So I want to be very clear: I think that containing inflation is enormously important, and I think it is our first responsibility. We need to watch this very carefully. I think there will be continued pressures even if commodity prices don't rise, but I do think there is also a chance that we will see a moderation of this problem going forward. What else? I guess there has been a lot of discussion about the appropriate withdrawal of stimulus. Again, I don't think I accept the idea that we are currently in an extremely stimulative situation. However, if financial markets were to normalize, for example, that would lead to a more stimulative situation. I would like to say just a word about that. That is to say that the speed at which we remove the accommodation--and I think it is clear we do have to do that relatively soon--should depend to some extent on how inflation evolves. Under the more benign scenario that I have just described--if inflation does decline significantly because of commodity prices--I think that we obviously have more time. I would just note for comparison past episodes. In 1994, for example, the pause lasted 17 months, and the first increase in rates came two years after payrolls began growing again. In 2001, again, it was more than a year after unemployment rates started coming down, and payrolls began growing before the rates started going up. Now, I think there is a view, which is a reasonable one, that maybe in at least the second of those two episodes we waited too long to begin to normalize. That is entirely possible. But, again, it would be extraordinary if we were to begin raising rates without an immediate inflation problem with the economy still in a declining or extremely weakened situation. If inflation does in fact become the problem that many around the table think it is, particularly if commodity prices begin to go up again or if the dollar begins to weaken, then I will be the first here to support responding to that. I do think it is incredibly important to keep inflation expectations well anchored, particularly to the extent that movements of commodity prices and the dollar seem to be derived from monetary policy as opposed to things like geopolitical risk. Then, I think we can't treat them as truly exogenous. We would have to respond to those things. So I welcome the ongoing discussion we should have about the pace of withdrawal of accommodation. I do think it depends very much on how things evolve, and I do think that our strategy should be to watch carefully and to make the right decisions as we see the data come in. Let me stop there and turn to the last round and ask Brian, please, to introduce the policy discussion. " CHRG-111hhrg48867--114 Mr. Silvers," Well, you certainly mentioned one which is Gramm-Leach-Bliley. The second was the Commodities Act--and I can't recall the formal title--which deprived the CFDC of the ability to regulate financial futures--financial derivatives and other derivatives. A third was not Congress, at least Congress didn't act formally. It was the court decision that took away from the SEC the ability to regulate hedge funds. Congress then failed to act in response to that. Fourth was--here is an instance where Congress acted responsibly but the regulators didn't act, where Congress gave the Fed the ability to regulate mortgages comprehensively, and the Fed didn't use it. The fifth is somewhat older, which is--and I think goes to the-- " CHRG-111hhrg51698--289 The Chairman," All right. I thank the panel. I thank the Committee Members. The Committee stands adjourned subject to the call of the chair. [Whereupon, at 4:10 p.m., the Committee was adjourned.] [Material submitted for inclusion in the record follows:] Submitted Statement by American Public Gas Association Chairman Peterson, Ranking Member Lucas and Members of the Committee, the American Public Gas Association (APGA) appreciates this opportunity to submit testimony to you today. We also commend the Committee for calling this hearing on the important subject of derivative trading. APGA would also like to commend Chairman Peterson and the House Agriculture Committee for its ongoing focus on market transparency and oversight. APGA is the national association for publicly-owned natural gas distribution systems. There are approximately 1,000 public gas systems in 36 states and over 700 of these systems are APGA members. Publicly-owned gas systems are not-for-profit, retail distribution entities owned by, and accountable to, the citizens they serve. They include municipal gas distribution systems, public utility districts, county districts, and other public agencies that have natural gas distribution facilities. APGA's number one priority is the safe and reliable delivery of affordable natural gas. To bring natural gas prices back to a long-term affordable level, we ultimately need to increase the supply of natural gas. However, equally critical is to restore public confidence in the pricing of natural gas. This requires a level of transparency in natural gas markets which assures consumers that market prices are a result of fundamental supply and demand forces and not the result of manipulation, excessive speculation or other abusive market conduct. We, along with other consumer groups, have watched with alarm over the last several years certain pricing anomalies in the markets for natural gas. More recently, we have noted much greater volatility in the price of energy and other physical commodities. APGA has strongly supported an increase in the level of transparency with respect to trading activity in these markets from that which currently exists. We believe that additional steps are needed in order to restore our current lack of confidence in the natural gas marketplace and to provide sufficient transparency to enable the CFTC, and market users, to form a reasoned response to the critically important questions that have been raised before this Committee during the course of these hearings. APGA believes that the increased regulatory, reporting and self-regulatory provisions relating to the unregulated energy trading platforms contained in legislation that reauthorizes the Commodity Futures Trading Commission (``CFTC'') is a critically important first step in addressing our concerns. Those provisions are contained in Title XIII of the farm bill which has become law. We commend this Committee for its work on this important legislation. The market transparency language that was included in the farm bill will help shed light on whether market prices in significant price discovery energy contracts are responding to legitimate forces of supply and demand or to other, non-bona fide market forces. However, APGA believes that more can, and should, be done to further increase transparency of trading in the energy markets. Many of these steps would likely also be useful in better understanding the current pricing trends in the markets for other physical commodities as well. Although the additional authorities which have been provided to the CFTC under Title XIII of the 2008 Farm Bill will provide the CFTC with significant additional tools to respond to the issues raised by this hearing (at least with respect to the energy markets), we nevertheless believe that it may be necessary for Congress to provide the CFTC with additional statutory authorities. We are doubtful that the initial steps taken by the reauthorization legislation are, or will be, sufficient to fully respond to the concerns that we have raised regarding the need for increased transparency. In this regard, we believe that additional transparency measures with respect to transactions in the Over-the-Counter markets are needed to enable CFTC to assemble a more complete picture of a trader's position and thereby understand a large trader's potential impact on the market. We further believe, that in light of the critical importance of this issue to consumers, that this Committee should maintain active and vigilant oversight of the CFTC's market surveillance and enforcement efforts, that Congress should be prepared to take additional legislative action to further improve transparency with respect to trading in energy contracts and, should the case be made, to make additional amendments to the Commodity Exchange Act, 7 U.S.C. 1 et seq. (``Act''), that allows for reasonable speculative position limits in order to ensure the integrity of the energy markets.Speculators' Effect on the Natural Gas Market As hedgers that use both the regulated futures markets and the OTC energy markets, we value the role of speculators in the markets. We also value the different needs served by the regulated futures markets and the more tailored OTC markets. As hedgers, we depend upon liquid and deep markets in which to lay off our risk. Speculators are the grease that provides liquidity and depth to the markets. However, speculative trading strategies may not always have a benign effect on the markets. For example, the 2006 blow-up of Amaranth Advisors LLC and the impact it had upon prices exemplifies the impact that speculative trading interests can have on natural gas supply contracts for local distribution companies (``LDCs''). Amaranth Advisors LLC was a hedge fund based in Greenwich, Connecticut, with over $9.2 billion under management. Although Amaranth classified itself as a diversified multi-strategy fund, the majority of its market exposure and risk was held by a single Amaranth trader in the OTC derivatives market for natural gas. Amaranth reportedly accumulated excessively large long positions and complex spread strategies far into the future. Amaranth's speculative trading wagered that the relative relationship in the price of natural gas between summer and winter months would change as a result of shortages which might develop in the future and a limited amount of storage capacity. Because natural gas cannot be readily transported about the globe to offset local shortages, the way for example oil can be, the market for natural gas is particularly susceptible to localized supply and demand imbalances. Amaranth's strategy was reportedly based upon a presumption that hurricanes during the summer of 2006 would make natural gas more expensive in 2007, similar to the impact that Hurricanes Katrina and Rita had had on prices the previous year. As reported in the press, Amaranth held open positions to buy or sell tens of billions of dollars of natural gas. As the hurricane season proceeded with very little activity, the price of natural gas declined, and Amaranth lost approximately $6 billion, most of it during a single week in September 2006. The unwinding of these excessively large positions and that of another previously failed $430 million hedge fund--MotherRock--further contributed to the extreme volatility in the price of natural gas. The Report by the Senate Permanent Subcommittee on Investigations affirmed that ``Amaranth's massive trading distorted natural gas prices and increased price volatility.'' \1\--------------------------------------------------------------------------- \1\ See ``Excessive Speculation in the Natural Gas Market,'' Report of the U.S. Senate Permanent Subcommittee on Investigations (June 25, 2007) (``PSI Report'') at p. 119.--------------------------------------------------------------------------- Many natural gas distributors locked-in prices prior to the period Amaranth collapsed at prices that were elevated due to the accumulation of Amaranth's positions. They did so because of their hedging procedures which require that they hedge part of their winter natural gas in the spring and summer. Accordingly, even though natural gas prices were high at that time, it would have been irresponsible (and contrary to their hedging policies) to not hedge a portion of their winter gas in the hope that prices would eventually drop. Thus, the elevated prices which were a result of the excess speculation in the market by Amaranth and others had a significant impact on the price these APGA members, and ultimately their customers, paid for natural gas. The lack of transparency with respect to this trading activity, much of which took place in the OTC markets, and the extreme price swings surrounding the collapse of Amaranth have caused bona fide hedgers to become reluctant to participate in the markets for fear of locking-in prices that may be artificial. Recently, additional concerns have been raised with respect to the size of positions related to, and the role of, passively managed long-only index funds. In this instance, the concern is not whether the positions are being taken in order to intentionally drive the price higher, but rather whether the unintended effect of the cumulative size of these positions has been to push market prices higher than the fundamental supply and demand situation would justify. The additional concern has been raised that recent increased amounts of speculative investment in the futures markets generally have resulted in excessively large speculative positions being taken that due merely to their size, and not based on any intent of the traders, are putting upward pressure on prices. The argument made is that these additional inflows of speculative capital are creating greater demand then the market can absorb, thereby increasing buy-side pressure which results in advancing prices. Some have responded to these concerns by reasoning that new futures contracts are capable of being created without the limitation of having to have the commodity physically available for delivery. This explains why, although the open-interest of futures markets can exceed the size of the deliverable supply of the physical commodity underlying the contract, the price of the contract could nevertheless reflect the forces of supply and demand. As we noted above, as hedgers we rely on speculative traders to provide liquidity and depth to the markets. Thus, we do not wish to see steps taken that would discourage speculators from participating in these markets using bona fide trading strategies. But more importantly, APGA's members rely upon the prices generated by the futures to accurately reflect the true value of natural gas. Accordingly, APGA would support additional regulatory controls, such as stronger speculative position limits, if a reasoned judgment can be made based on currently available, or additional forthcoming market data and facts, that such controls are necessary to address the unintended consequences arising from certain speculative trading strategies or to reign in excessively large speculative positions. To the extent that speculative investment may be increasing the price of natural gas or causing pricing aberrations, we strongly encourage Congress to take quick action to expand market transparency in order to be able to responsibly address this issue and protect consumers from additional cost burdens. Consumers should not be forced to pay a ``speculative premium.''The Markets in Natural Gas Contracts The market for natural gas financial contracts is composed of a number of segments. Contracts for the future delivery of natural gas are traded on NYMEX, a designated contract market regulated by the CFTC. Contracts for natural gas are also traded in the OTC markets. OTC contracts may be traded on multi-lateral electronic trading facilities which are exempt from regulation as exchanges, such as the IntercontinentalExchange (``ICE''). ICE also operates an electronic trading platform for trading non-cleared (bilateral) OTC contracts. They may also be traded in direct, bilateral transactions between counterparties, through voice brokers or on electronic platforms. OTC contracts may be settled financially or through physical delivery. Financially-settled OTC contracts often are settled based upon NYMEX settlement prices and physically delivered OTC contracts may draw upon the same deliverable supplies as NYMEX contracts, thus linking the various financial natural gas market segments economically. Increasingly, the price of natural gas in many supply contracts between suppliers and local distribution companies, including APGA members, is determined based upon monthly price indexes closely tied to the monthly settlement of the NYMEX futures contract. Accordingly, the futures market serves as the centralized price discovery mechanism used in pricing these natural gas supply contracts. Generally, futures markets are recognized as providing an efficient and transparent means for discovering commodity prices.\2\ However, any failure of the futures price to reflect fundamental supply and demand conditions results in prices for natural gas that are distorted and do not reflect its true value.\3\ This has a direct affect on consumers all over the U.S., who as a result of such price distortions, will not pay a price for the natural gas that reflects bona fide demand and supply conditions. If the futures price is manipulated or distorted, then the price consumers pay for the fuel needed to heat their homes and cook their meals will be similarly manipulated or distorted.--------------------------------------------------------------------------- \2\ See the Congressional findings in section 3 of the Commodity Exchange Act, 7 U.S.C. 1 et seq. (``Act''). Section 3 of the Act provides that, ``The transactions that are subject to this Act are entered into regularly in interstate and international commerce and are affected with a national public interest by providing a means for . . . discovering prices, or disseminating pricing information through trading in liquid, fair and financially secure trading facilities.'' A further question with respect to whether other speculative strategies, or excessively large speculative positions is also distorting market prices by pushing prices higher than they otherwise would be. \3\ The effect of Amarath's trading resulted in such price distortions. See generally PSI Report. The PSI Report on page 3 concluded that ``Traders use the natural gas contract on NYMEX, called a futures contract, in the same way they use the natural gas contract on ICE, called a swap. . . . The data show that prices on one exchange affect the prices on the other.''--------------------------------------------------------------------------- Today, the CFTC provides generally effective oversight of futures exchanges and the CFTC and the exchanges provide a significant level of transparency. And under the provisions of the Title XIII of the farm bill, the CFTC has been given additional regulatory authority with respect to significant price discovery contracts traded on exempt commercial markets, such as ICE. This is indeed a major step toward greater market transparency. However, even with this additional level of transparency, a large part of the market remains opaque to regulatory scrutiny. The OTC markets lack such price transparency. This lack of transparency in a very large and rapidly growing segment of the natural gas market leaves open the potential for a participant to engage in manipulative or other abusive trading strategies with little risk of early detection; and for problems of potential market congestion to go undetected by the CFTC until after the damage has been done to the market. Equally significant, even where the trading is not intended to be abusive, the lack of transparency for the over-all energy markets leaves regulators unable to answer questions regarding speculators' possible impacts on the market. For example, do we know who the largest traders are in the over-all market, looking at regulated futures contracts, significant price discovery contracts and bilateral OTC transactions? Without being able to see a large trader's entire position, it is possible that the effect of a large OTC trader on the regulated markets is masked, particularly when that trader is counterparty to a number of swaps dealers that in turn take positions in the futures market to hedge these OTC exposures as their own.Regulatory Oversight NYMEX, as a designated contract market, is subject to oversight by the CFTC. The primary tool used by the CFTC to detect and deter possible manipulative activity in the regulated futures markets is its large trader reporting system. Using that regulatory framework, the CFTC collects information regarding the positions of large traders who buy, sell or clear natural gas contracts on NYMEX. The CFTC in turn makes available to the public aggregate information concerning the size of the market, the number of reportable positions, the composition of traders (commercial/noncommercial) and their concentration in the market, including the percentage of the total positions held by each category of trader (commercial/noncommercial). The CFTC also relies on the information from its large trader reporting system in its surveillance of the NYMEX market. In conducting surveillance of the NYMEX natural gas market, the CFTC considers whether the size of positions held by the largest contract purchasers are greater than deliverable supplies not already owned by the trader, the likelihood of long traders demanding delivery, the extent to which contract sellers are able to make delivery, whether the futures price is reflective of the cash market value of the commodity and whether the relationship between the expiring future and the next delivery month is reflective of the underlying supply and demand conditions in the cash market.\4\--------------------------------------------------------------------------- \4\ See letter to the Honorable Jeff Bingaman from the Honorable Reuben Jeffery III, dated February 22, 2007.--------------------------------------------------------------------------- Title XIII of the 2008 Farm Bill, empowered the CFTC to collect large trader information with respect to ``significant price discovery contracts'' traded on the ICE trading platform. However, there remain significant gaps in transparency with respect to trading of OTC energy contracts, including many forms of contracts traded on ICE. Despite the links between prices for the NYMEX futures contract and the OTC markets in natural gas contracts, this lack of transparency in a very large and rapidly growing segment of the natural gas market leaves open the potential for participants to engage in manipulative or other abusive trading strategies with little risk of early detection and for problems of potential market congestion to go undetected by the CFTC until after the damage has been done to the market, ultimately costing the consumers or producers of natural gas. More profoundly, it leaves the regulator unable to assemble a true picture of the over-all size of a speculator's position in a particular commodity.Greater Transparency Needed Our members, and the customers served by them, believe that although Title XIII of the 2008 Farm Bill goes a long way to addressing the issue, there is not yet an adequate level of market transparency under the current system. This lack of transparency has led to a growing lack of confidence in the natural gas marketplace. Although the CFTC operates a large trader reporting system to enable it to conduct surveillance of the futures markets, it cannot effectively monitor trading if it receives information concerning positions taken in only one, or two, segments of the total market. Without comprehensive large trader position reporting, the government will remain handicapped in its ability to detect and deter market misconduct or to understand the ramifications for the market arising from unintended consequences associated with excessive large positions or with certain speculative strategies. If a large trader acting alone, or in concert with others, amasses a position in excess of deliverable supplies and demands delivery on its position and/or is in a position to control a high percentage of the deliverable supplies, the potential for market congestion and price manipulation exists. Similarly, we simply do not have the information to analyze the over-all effect on the markets from the current practices of speculative traders. Over the last several years, APGA has pushed for a level of market transparency in financial contracts in natural gas that would routinely, and prospectively, permit the CFTC to assemble a complete picture of the overall size and potential impact of a trader's position irrespective of whether the positions are entered into on NYMEX, on an OTC multi-lateral electronic trading facility which is exempt from regulation or through bilateral OTC transactions, which can be conducted over the telephone, through voice-brokers or via electronic platforms. APGA is optimistic that the enhanced authorities provided to the CFTC in the provisions of the CFTC reauthorization bill will help address the concerns that we have raised, but recognizes that more needs to be done to address this issue comprehensively.Additional Potential Enhancements in Transparency In supporting the CFTC reauthorization bill, we previously noted that only a comprehensive large trader reporting system would enable the CFTC, while a scheme is unfolding, to determine whether a trader, such as Amaranth, is using the OTC natural gas markets to corner deliverable supplies and manipulate the price in the futures market.\5\ A comprehensive large trader reporting system would also enable the CFTC to better detect and deter other types of market abuses, including for example, a company making misleading statements to the public or providing false price reporting information designed to advantage its natural gas trading positions, or a company engaging in wash trading by taking large offsetting positions with the intent to send misleading signals of supply or demand to the market. Such activities are more likely to be detected or deterred when the government is receiving information with respect to a large trader's overall positions, and not just those taken in the regulated futures market. It would also enable the CFTC to better understand the overall size of speculative positions in the market as well as the impact of certain speculative investor practices or strategies on the future's markets ability to accurately reflect fundamental supply and demand conditions.--------------------------------------------------------------------------- \5\ See e.g. U.S. Commodity Futures Trading Commission v. BP Products North America, Inc., Civil Action No. 06C 3503 (N.D. Ill.) filed June 28, 2006.--------------------------------------------------------------------------- Accordingly, APGA supports proposals to further increase and enhance transparency in the energy markets, generally, and in the markets for natural gas, specifically. APGA supports greater transparency with respect to positions in natural gas financial contracts acquired through bilateral transactions. Because bilateral trading can in fact be conducted on an all-electronic venue, and can impact prices on the exchanges even if conducted in a non-electronic environment, it is APGA's position that transparency in the bilateral markets is critical to ensure an appropriate level of consumer protection.Electronic Bilateral trading One example of the conduct of bilateral trading on an all-electronic trading platform was ``Enron On-line.'' Enron, using its popular electronic trading platform, offered to buy or sell contracts as the universal counterparty to all other traders using this electronic trading system. This one-to-many model constitutes a dealer's market and is a form of bilateral trading. This stands in contrast to a many-to-many model which is recognized as a multi-lateral trading venue. This understanding is reflected in section 1a(33) of the Commodity Exchange Act, which defines ``Trading Facility'' as a ``group of persons that . . . provides a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts or transactions by accepting bids and offers made by other participants that are open to multiple participants in the facility or system.'' On the Enron On-line trading platform, only one participant--Enron--had the ability to accept bids and offers of the multiple participants--its customers--on the trading platform. Section 1a(3) continues by providing that, ``the term 'trading facility' does not include (i) a person or group of persons solely because the person or group of persons constitutes, maintains, or provides an electronic facility or system that enables participants to negotiate the terms of and enter into bilateral transactions as a result of communications exchanged by the parties and not from interaction of multiple bids and multiple offers within a predetermined, nondiscretionary automated trade matching and execution algorithm . . . .'' This means that it is also possible to design an electronic platform for bilateral trading whereby multiple parties display their bids and offers which are open to acceptance by multiple parties, so long as the consummation of the transaction is not made automatically by a matching engine. Both of these examples of bilateral electronic trading platforms might very well qualify for exemption under the current language of sections 2(g) and 2(h)(1) of the Commodity Exchange Act. To the extent that these examples of electronic bilateral trading platforms were considered by traders to be a superior means of conducting bilateral trading over voice brokerage or the telephonic call-around markets, or will not fall within the significant price discovery contract requirements, their use as a substitute for a more-regulated exempt commercial market under section 2(h)(3) of the Act should not be readily discounted.Non-Electronic Bilateral Trading Moreover, even if bilateral transactions are not effected on an electronic trading platform, it is nonetheless possible for such direct or voice-brokered trading to affect prices in the natural gas markets. For example, a large hedge fund may trade bilaterally with a number of counterparty/dealers using standard ISDA documentation. By using multiple counterparties over an extended period of time, it would be possible for the hedge fund to establish very large positions with each of the dealer/counterparties. Each dealer in turn would enter into transactions on NYMEX to offset the risk arising from the bilateral transactions into which it has entered with the hedge fund. In this way, the hedge fund's total position would come to be reflected in the futures market. Thus, a prolonged wave of buying by a hedge fund, even through bilateral direct or voice-brokered OTC transactions, can be translated into upward price pressure on the futures exchange. As NYMEX settlement approaches, the hedge fund's bilateral purchases with multiple dealer/counterparties would maintain or increase upward pressure on prices. By spreading its trading through multiple counterparties, the hedge fund's purchases would attract little attention and escape detection by either NYMEX or the CFTC. In the absence of routine large-trader reporting of bilateral transactions, the CFTC will only see the various dealers' exchange positions and have no way of tying them back to purchases by a single hedge fund. Given that the various segments of the financial markets that price natural gas are linked economically, it is critical to achieving market transparency that traders holding large positions entered into through bilateral transactions be included in any large-trader reporting requirement. As explained above, by trading through multiple dealers, a large hedge fund would be able to exert pressure on exchange prices similar to the pressure that it could exert by holding those positions directly. Only a comprehensive large-trader reporting system that includes positions entered into in the OTC bilateral markets would enable the CFTC to see the entire picture and trace such positions back to a single source. If large trader reporting requirements apply only to positions acquired on multi-lateral electronic trading platforms, traders in order to avoid those reporting requirements may very well move more transactions to electronic bilateral markets or increase their direct bilateral trading. This would certainly run counter to efforts by Congress to increase transparency. APGA remains convinced that all segments of the natural gas marketplace should be treated equally in terms of reporting requirements. To do otherwise leaves open the possibility that dark markets on which potential market abuses could go undetected would persist and that our current lack of sufficient information to fully understand the impact of large speculative traders and certain trading strategies on the markets will continue, thereby continuing to place consumers at risk.Derivatives Markets Transparency and Accountability Act of 2009 As stated previously, APGA supports proposals to further increase and enhance transparency in the energy markets, generally, and in the markets for natural gas, specifically. APGA commends Chairman Peterson for drafting the Derivatives Markets Transparency and Accountability Act of 2009. This legislation would significantly enhance market transparency and would provide the CFTC with additional needed resources to help ensure that the ``cop on the beat'' has the tools needed to do its job. Specifically, this legislation would provide greater transparency with respect to the activities of the Index Funds by requiring them to be separately accounted for in the CFTC's Commitment of Traders Reports. APGA strongly supports provisions in the legislation that would provide greater transparency to the CFTC with respect to bilateral swap contracts. Another provision in the bill that APGA strongly supports is the requirement that the CFTC appoint at least 100 new full time employees. The CFTC plays a critical role in protecting consumers, and the market as a whole, from fraud, manipulation and market abuses that create distortion. It is essential that the CFTC have the necessary resources, both in terms of employees but also in terms of information technology, to monitor markets and protect consumers from attempts to manipulate the market. This is critical given the additional oversight responsibilities the CFTC will have through the market transparency language included in the 2008 Farm Bill and the additional transparency requirements that APGA is proposing to the Committee. Over the last several years, trading volumes have doubled while CFTC staffing levels have decreased. In fact, while we are experiencing record trading volumes, employee levels at the CFTC are at their lowest since the agency was created. Further, more complex and comprehensive monitoring practices from the CFTC will require the latest technology. It is critical that CFTC have the necessary tools to catch abuses before they occur. APGA is concerned that if funding for the CFTC is inadequate, so may be the level of protection.Conclusion Experience tells us that there is never a shortage of individuals or interests who believe they can, and will attempt to, affect the market or manipulate price movements to favor their market position. The fact that the CFTC has assessed over $300 million in penalties, and has assessed over $2 billion overall in government settlements relating to abuse of these markets affirms this. These efforts to punish those that manipulate or abuse markets or to address those that might innocently distort markets are important. But it must be borne in mind that catching and punishing those that manipulate markets after a manipulation has occurred is not an indication that the system is working. To the contrary, by the time these cases are discovered using the tools currently available to government regulators, our members, and their customers, have already suffered the consequences of those abuses in terms of higher natural gas prices. Greater transparency with respect to traders' large positions, whether entered into on a regulated exchange or in the OTC markets in natural gas will provide the CFTC with the tools to answer that question and to detect and deter potential manipulative or market distorting activity before our members and their customers suffer harm. The Committee's ongoing focus on energy markets has raised issues that are vital to APGA's members and their customers. We do not yet have the tools in place to say with confidence the extent to which the pricing mechanisms in the natural gas market today are reflecting market fundamentals or the possible market effects of various speculative trading strategies. However, we know that the confidence that our members once had in the pricing integrity of the markets has been badly shaken. In order to protect consumers the CFTC must be able to (1) detect a problem before harm has been done to the public through market manipulation or price distortions; (2) protect the public interest; and (3) ensure the price integrity of the markets. Accordingly, APGA and its over 700 public gas system members applaud your continued oversight of the CFTC's surveillance of the natural gas markets. We look forward to working with the Committee towards the passage of legislation that would provide further enhancements to help restore consumer confidence in the integrity of the price discovery mechanism. ______ Statment Submitted by Steve Suppan, Senior Policy Analyst, Institute for Agriculture and Trade Policy The Institute for Agriculture and Trade Policy (IATP) is a 501(c)(3) organization headquartered in Minneapolis, MN with an office in Geneva, Switzerland. IATP, founded over 20 years ago, works locally and globally to ensure fair and sustainable food, farm and trade systems. IATP is grateful for the opportunity to comment on a bill that is crucial for ensuring that commodities exchange activities contribute to the orderly functioning of markets that enable food and energy security. In November, IATP published ``Commodity Market Speculation: Risk to Food Security and Agriculture'' (http://www.iatp.org/iatp/publications.cfm?accountID=451&refID=104414). The study found that commodity index fund speculation in U.S. commodity exchanges distorted prices and induced extreme price volatility that made the futures and options market unusable for commercial traders. For example, one market consultant estimated that index fund trading accounted for about 30 percent of the nearly $8 a bushel price of corn on the Chicago Board of Trade at the height of the commodities bubble in late June. Until the bubble burst, many country elevators, unable to assess their risk in such volatile markets, had stopped forward contracting, endangering the cash flows and operations of many U.S. farms. The spike in developing country food import bills and increasing food insecurity, both in the United States and around the world, is partly due to the financial damage of deregulated speculation. While researching this study, I monitored the Committee hearings that contributed to H.R. 6604, ``Commodity Exchange Transparency and Accountability Act of 2008.'' IATP congratulates the Committee for the intense and expedited schedule of hearings and legislative drafting that resulted in the passage of H.R. 6604 and revisions to it in the draft ``Derivatives Markets Transparency and Accountability Act of 2009'' (hereafter ``the Act''). Due to the complexity of the legislation, our comments will only concern a small portion of the Act's provisions.Section 3. Speculative limits and transparency of off-shore trading and Section 6. Trading limits to prevent excessive speculation U.S. commodity exchanges have a dominant international influence over both cash and futures prices for many commodities. Because of the affects of that influence on food security and agriculture around the world, it is crucial that U.S. regulation and oversight of commodity exchanges be exemplary for the regulation of other markets. However, incidents of off-shore noncommercial traders benefiting from U.S. commodity exchanges while claiming to be beyond the jurisdiction of the Commodity Exchange Act (CEA) have resulted in the need for the prudent measures of section 3. The Committee and its staff are to be congratulated for the work undertaken since the passage of H.R. 6604 on September 18 to improve the bill. Particularly noteworthy are the visits of Chairman Peterson and Committee staff to regulatory authorities in London and Brussels both to explain H.R. 6604 and to learn how it might be improved. Section 3 would do by statute what the Commodities Futures Trading Commission's (hereafter ``the Commission'') memoranda of understanding with other regulatory authorities have failed to do: to ensure that foreign traders of futures, options and other derivatives cannot trade on U.S. exchanges unless they submit completely to the authorities of the CEA. Section 6 is so drafted as to avoid the possibility of a trade dispute ruling against the United States for ``discrimination'' against foreign firms in the peculiar trade and investment policy sense of that term. However, the World Trade Organization negotiations seek to further liberalize and deregulate financial services, particularly through the Working Party on Domestic Regulation of the General Agreement on Trade in Services (GATS).\1\ The members of the Financial Leaders Group that has lobbied effectively for GATS and U.S. deregulation (and particular regulatory exemptions for their firms) are major recipients of taxpayer bailouts through the Troubled Asset Relief Program.--------------------------------------------------------------------------- \1\ Ellen Gould. ``Financial Instability and the GATS Negotiations.'' Canadian Centre for Policy Alternatives. July 2008. http://www.tradeobservatory.org/library.cfm?refID=103596. --------------------------------------------------------------------------- The Committee should invite testimony from the Office of the U.S. Trade Representative (USTR) concerning U.S. GATS commitments, to ensure that those commitments and/or USTR positions advocated at the GATS negotiations not conflict with sections 3 and 6 or leave them vulnerable to WTO challenge. Furnished with that testimony and documents relevant to it, legislative drafting may be tightened to avoid the possibility of a WTO challenge. As the Committee is well-aware, the number of contracts held by noncommercial speculators far outweighs those of bona fide physical hedgers. The overwhelming dominance of purely financial speculation has induced price volatility that can be neither explained nor justified in terms of physical supply and demand, bona fide hedging by commercial traders and/or the amount of purely financial speculation required to clear trades. For example, in May, The Brock Report stated, ``no [commercial] speculator today can have a combined contract position in corn that exceeds 11 million bushels. Yet, the two biggest index funds [Standard and Poors/Goldman Sachs and Dow Jones/American Insurance Group] control a combined 1.5 billion bushels!'' \2\--------------------------------------------------------------------------- \2\ ``A Big Move Lies Ahead.'' The Brock Report. May 23, 2008.--------------------------------------------------------------------------- Section 3 of the Act seeks to close the regulatory exemption granted to Wall Street banks that enabled this massive imbalance between bona fide hedging on physical commodities and contracts held purely for financial speculation. However, closing that loophole will not suffice to begin to repair the damage wrought by the speculative position exemption. In 2004, the Security Exchange Commission granted for just a half dozen investment banks an exemption to prudential reserve requirements to cover losses, thus freeing up billions of dollars of speculative capital and handing the chosen banks a huge competitive advantage.\3\ These two regulatory exemptions enabled the asset price bubbles that began to burst in July, with dire consequences for the entire financial system and the global economy. The Act should authorize the Commission to work with the SEC to close all exemptions to prudential capital reserve requirements.--------------------------------------------------------------------------- \3\ Stephen LaBaton. ``Agency's `04 Rule Let Banks Pile Up New Debt, and Risk.'' The New York Times. October 3, 2008.--------------------------------------------------------------------------- Despite the commodities price collapse, Goldman Sachs, whose then CEO Henry Paulson lead the successful campaign to exempt his firm and other paragons of risk management from prudential capital reserve requirements, is estimated to have made $3 billion in net revenue in 2008 from its commodities division alone. The average bonus for a commodities trading managing director is estimated to be $3-$4 million in 2008, down 25 percent from 2007.\4\ Hence, there is little trader disincentive to exceed whatever speculative position limits that are agreed as a result of the deliberations of the Position Limit Agricultural and Energy Advisory Groups (stipulated by section 6. 4a). The Act provides for no advisory group for base and precious metals, which suggests that those components of the index funds may continue without speculative limits. The Act can readily be amended to provide for a Position Limit Metals Advisory Group. Given the financial service industry incentives structure, there is much to be done in the Act to provide strong disincentives for firms and individual traders to exceed the agreed speculative position limits.--------------------------------------------------------------------------- \4\ Ann Davis. ``Top Traders Still Expect the Cash.'' The Wall Street Journal. November 19, 2008.--------------------------------------------------------------------------- One of the responsibilities of the advisory groups is to submit to the Commission a recommendation about whether the exchanges themselves or the Commission should administer the position limit requirements ``with enforcement by both the registered entity and the Commission'' (lines 10-12, p. 15). While IATP agrees that the exchanges may have a role to play in administering the position limits requirement, we fail to understand why enforcement is not exclusively the Commission's prerogative. We urge the Committee to modify this provision to remove any suggestion of exchange enforcement authority.Section 4. Detailed Reporting and Disaggregation of Market Data and Section 5. Transparency and Record Keeping Authorities The provisions in these sections will help regulators monitor the size, number and value of contracts during the reporting period ``to the extent such information is available'' (Sec. 4(g)(2)). It is this qualifying last clause that worries IATP, since the Commission's ability to carry out its statutory obligations depends on complete and timely reporting of index fund data that disaggregates the agricultural, energy, base metal and precious metal contract components of these funds. The duration of agricultural futures contracts are typically 90 days, while energy and metals futures are for 6 months to a year. Both sections should stipulate that disaggregation not only concern contract positions held by traders with a bona fide commercial interest in the commodity hedged versus contracts held by financial speculators. Disaggregated and detailed reporting requirements should also stipulate reporting data from all component commodities contracts of the index funds, taking into account the differences in typical contract duration. Furthermore, the Act should authorize the Commission to stipulate that the reporting period for the disaggregated and detailed data be consistent with the duration of the index funds' component contracts, rather than with the reporting period of the index fund itself. The Act should further stipulate that the privilege to trade may be revoked or otherwise qualified if that trader's reporting does not provide sufficient information for the Commission to determine whether the trader is complying with the CEA as amended. Section 5 anticipates that traders will exceed the speculative position limits set by the Commission and provides for the terms of a special call by the Commission for trading data to determine whether the violation of the position limit has lead to price manipulation or excessive speculation, as defined in the CEA. Although IATP finds these provisions necessary for prudential regulation, we believe that the Act should stipulate how the Commission should seek to obtain the documents requested in the special call, when the trading facilities are located outside the United States. The Act wisely provides a ``Notice and Comment'' provision concerning the implementation of the reporting requirements for deals that exceed the speculative position limits. We anticipate that this ``Notice and Comment'' period will be used and guide the Commission's implementation of section 5 reporting requirements.Section 7. CFTC Administration IATP believes that the increase in Commission staff, above that called for in H.R. 6604, is well warranted. The Committee should consider adding to this section a provision for a public ombudsman who could take under consideration evidence of misuse or abuse of the Act's authorities by Commission employees and evidence of damage to market integrity that may result from non-implementation or non-enforcement of the Act's provisions.Section 9. Review of Over-the-Counter Markets Because of the prevalence of over-the-counter trades in commodities markets, and the damage to market integrity caused by lack of regulation of OTC trades, the need for speculative position limits on those trades seems all but self-evident. However, the Committee is wise to mandate the Commission's study of the OTC market given the heterogeneity, as well as the sheer volume of OTC contracts. We would suggest, however, that the study not be limited to transactions involving agricultural and energy commodities, but should also include base and precious metals.Section 10. Study Relating to International Regulation of Energy Commodity Markets IATP is very disappointed that section 10 has dropped the study of agricultural commodity markets called for in H.R. 6604. The Commission will be better able to carry out its responsibilities if it understands how agricultural commodities are regulated or not on exchanges outside of the United States. While U.S. exchanges are dominant in determining futures and cash prices for many agricultural commodities, there are other influential exchanges for certain commodities. The Commission should study these exchanges to find out whether there are best practices from which U.S. exchanges could benefit. IATP urges the Committee to restore the provision for a study of the international regulation of agricultural commodity markets to section 10.Section 13. Certain Exclusions and Exemptions Available Only for Certain Transactions Settled and Cleared Through Registered Derivatives Clearing Organizations We confess to not understanding these amendments to the CEA and to skepticism about the need for the exclusions, exemptions and waivers, in light of the exclusions, exemptions, and waivers whose abuse has helped bankrupt both financial institutions and individual investors. IATP suggests that the Committee add a ``Notice and Comment'' provision to this section, so that the public has an opportunity to argue for or against individual provisions of this section.Section 14. Treatment of Emission Allowances and Off-Set Credits This addition to H.R. 6604 may be premature, as the efficacy of emissions trading for actual reduction of global greenhouse gas emissions is under debate in the negotiations for a new United Nations Framework Convention on Climate Change. IATP believes that the Committee should await the results of the Framework Convention negotiations in December in Copenhagen before deciding whether to add this amendment to the CEA. If the Committee decides to retain this section, it should consider whether the current amendment should be limited to carbon sequestration or whether it should cover other green house gas emissions. Again, I thank the Committee for the opportunity to submit testimony. I congratulate the Committee on moving forward on this important work. I'm available to answer any questions concerning this testimony. FOMC20080916meeting--158 156,CHAIRMAN BERNANKE.," Thank you very much, and thanks, everyone, for very helpful comments. Let me try to summarize, and I will just make some comments, and then we can turn to the statement and policy. The group indicated, of course, that economic growth has slowed and looks to be quite sluggish in the second half. I didn't hear a great deal of change in the general profile, with most people still viewing growth as being slow in the near term but perhaps recovering somewhat in 2009. But obviously there is a lot of uncertainty surrounding that judgment. The ongoing problems in housing and the financial system are, of course, the downside risks to growth. Another factor, which is becoming more relevant, is the slowing global economy, which together with the stronger dollar may mean that U.S. export growth will be somewhat less. Despite the tax rebate, consumer spending seems likely to be weak in the near term, reflecting a variety of factors that we noted before, including housing and equity wealth, credit conditions, and particularly perhaps the ongoing weakness in the labor market. The labor market is deteriorating, with unemployment up, although UI programs may play some role in the unemployment rate. It is somewhat difficult to predict the peak of the unemployment rate, given the upward momentum we are seeing. Declines in energy prices, however, will improve real incomes and help consumer sentiment--so that is a potentially positive factor. The housing sector continues to be the central concern in the economy, in both the real and the financial sides. There are no clear signs of stabilization, although obviously regional conditions vary considerably. The government action regarding the GSEs has lowered mortgage rates and may be of some assistance. Credit conditions have tightened, though, in other areas as well, including nonresidential construction. Firms are continuing to struggle with weaker demand, higher uncertainty, and high costs. Manufacturing has been relatively stable to weaker, but we had at least one report of a survey that in the medium term the outlook is looking a little better. Inventories appear to be relatively well managed. Credit conditions for business vary, but there are indications that some firms are finding it very difficult to attract capital. Financial markets received a lot of attention around the table. Conditions clearly have worsened recently, despite the rescue of the GSEs, the latest stressor being the bankruptcy of Lehman Brothers and other factors such as AIG. Almost all major financial institutions are facing significant stress, particularly difficulties in raising capital, and credit quality is problematic, particularly in residential-related areas. One member noted that it is not evident that markets are clearly differentiating between weaker and stronger firms at this point. Deleveraging is continuing, and securitization markets are moribund. Credit terms and conditions are quite tight and may be a significant drag on the economy. However, the mediumterm implications of the recent increases in financial stress for the economy are difficult to assess. We may have to wait for some time to get greater clarity on the implications of the last week or so. On the inflation front, recent core and headline numbers have been high, reflecting earlier increases in the prices of energy and raw materials. There are positive factors, including the significant intermeeting declines in the prices of oil and other commodities, which, if maintained, would bring headline inflation down rather notably by the end of the year or next year. The dollar has also strengthened. Generally speaking, inflation expectations, though noisy, have improved. We have seen a decline in TIPS breakevens and some decline in survey expectations as well. But it was noted that the five-by-five TIPS breakeven remains above a level consistent with long-term price stability. Nominal wage growth has remained subdued so far, slack is increasing, productivity has been strong, and therefore, unit labor costs are well controlled. Again, all of these factors are positive in terms of a better inflation picture going forward. On the other hand, recent declines notwithstanding, the cumulative increases in commodity prices over the past year or so do remain large, and there is some evidence that these cost increases are being passed through into core prices. Commodity prices are extremely volatile, which makes inflation very difficult to forecast and makes the inflation outlook, therefore, quite uncertain. Wages could also begin to rise more quickly as the economy strengthens. For all these reasons, inflation risks are still in play and remain a concern for the Committee. Some participants reiterated their concern that maintaining rates too low for too long risks compromising our credibility and stimulating inflation over the medium run. That is a very quick survey of the comments. Are there any comments or questions? If not, let me just make a few comments. Personally, I see the prospects for economic growth in the foreseeable future as quite weak, notwithstanding the second quarter's strength. I think what we saw in the recent labor reports removes any real doubt that we are in a period that will be designated as an official NBER recession. Unemployment rose 1.1 percentage points in four months, which is a relatively rapid rate of increase. The significance of that for our deliberations is, again, that there does seem to be some evidence that, in recession regimes, the dynamics are somewhat more powerful and we tend to see more negative and correlated innovations in spending equations. So I think that we are in for a period of quite slow growth. That is confirmed by what we are seeing in consumption, which probably would be quite negative if it weren't for the remainder of the fiscal stimulus package. Other components of demand are, likewise, quite weak. We are all familiar with the housing situation. Some other factors that were supportive in Q2 are weakening--a number of people have noted the export growth. Actually, it is net exports--which is important--not just exports, and we are seeing both slowing growth in exports and some forecast of increased growth in imports. A factor that we haven't talked about much is the fiscal side. That has been supportive and may be less supportive going forward. Generally speaking, though, I do think--and I have said this for a long time--that the credit effects will be important. They operate with a lag. It is very difficult to judge the lag. But my strong sense is that they are still some distance from their peak; that they will begin to be felt outside of housing, in nonresidential construction, for example, in consumer spending, and in investment; and that this is going to be independent of last week's financial developments. I think that is going to be a major drag, probably well into next year. There are a few positives, which give some hope of some improvement next year. We have talked about energy and commodity prices as they relate to inflation, but of course, the decline in energy and commodity prices is also a plus for consumers and raises real incomes and would be supportive of sentiment, as we have already seen. There are a few positive indications here and there on the housing market, a few glimmers of stability, particularly in some regions. I think that the GSE stabilization is going to be very important. It has already lowered mortgage rates. It suggests that there will be a market for securitized mortgages, and I think that is positive. So if I wanted to outline an optimistic scenario, it would involve stronger indications of stabilization in housing, which in turn would feed into more confidence in the financial sector and would lead over time to improvement in the broader economy. I do think that financial conditions are a major concern. The situation right now is very uncertain, and we are not by any means away from significant systemic risk. Even if we avoid a major systemic event, the increase in risk aversion, the pullback from all counterparties, the deleveraging, the sale of assets--all of these things are going to continue for some time and are going to make the financial sector very stressed, which obviously will have effects on the economy. I have been grappling with the question I raised for President Lacker, and I would be very interested in hearing other views either now or some other time. The ideal way to deal with moral hazard is to have in place before the crisis begins a well-developed structure that gives clear indications in what circumstances and on what terms the government will intervene with respect to a systemically important institution. We have found ourselves, though, in this episode in a situation in which events are happening quickly, and we don't have those things in place. We don't have a set of criteria, we don't have fiscal backstops, and we don't have clear congressional intent. So in each event, in each instance, even though there is this sort of unavoidable ad hoc character to it, we are trying to make a judgment about the costs--from a fiscal perspective, from a moral hazard perspective, and so on--of taking action versus the real possibility in some cases that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action. Frankly, I am decidedly confused and very muddled about this. I think it is very difficult to make strong, bright lines given that we don't have a structure that has been well communicated and well established for how to deal with these conditions. I do think there is some chance--it is not yet large, but still some chance--that we will in fact see a much bigger intervention at the fiscal level. One is tempted to argue that by doing more earlier you can avoid even more later, but of course that is all contingent and uncertain. So we will collectively do our best to deal with these very stressful financial conditions, which I don't think will be calm for some time. With respect to inflation, I accept the many caveats around the table. I have to say that I think, on net, inflation pressures are less worrisome now. The last two meetings have been very positive in that respect. The declines in energy and commodity prices are quite substantial. Natural gas, for example, has reversed all of its gains of the year. Steel scrap is down 40 percent in two months. We are seeing many other indications that commodity prices really have come down quite a bit. The dollar's increase is also quite striking, and we have talked about wages, TIPS, and other factors. So I think overall I see at least the near-term inflation risk as considerably reduced. I do agree, though, with the points that were made that we may well see pressure on core inflation for a while longer, despite this morning's reasonably benign number. The increases in commodity costs, although they have been partially reversed, have not been entirely reversed. Certainly over the last year to year and a half there is still a net substantial increase, which will show up as firms begin to pass through those costs. It is also the case, of course, that we have seen a very, very sharp movement in commodity prices and the dollar. Therefore, there is no logical reason why that couldn't be reversed. Clearly, one problem we face is that the uncertainty about forecasting commodity prices is so large that it makes our forecasting exercises extraordinarily uncertain and means that we need to be somewhat more careful than we otherwise would be if we were back in the days of the Texas Railroad Commission, when we knew the price of oil six months in advance. We don't have that privilege anymore. So I think core inflation may be elevated for a while. It may take a while for inflation to moderate. Everything I say is contingent on the dollar and commodity trends not being strongly reversed. But if those things are not reversed, I think we will see some improvement in inflation in the near term. I also agree with those who say that, when the time comes, we do need to be prompt at removing accommodation. It is just as much a mistake to move too late and allow inflation, and perhaps even financial imbalances, to grow as it is to move too early and be premature in terms of assuming a recovery. I think that is a very difficult challenge for us going forward, and I acknowledge the importance of that, which a number of people have noted. So that is a quick summary of my views. Let me just turn briefly, then, to policy. Do we have the statement? Let me just preview. I talked with Governor Warsh, and he gave me now during the break some of those suggestions he made. As they fit closely with other things that people said around the table, we have made a version here that incorporates them. I'll discuss that in just a minute. 3 First, as a number of people have said, let me just say that I thought the memo that the staff prepared over the intermeeting period was extraordinarily helpful. We have been debating around the table for quite a while what the right indicator of monetary policy is. Is it the federal funds rate? Is it some measure of financial stress? Or what is it? I think the only answer is that the right measure is contingent on a model. As President Lacker and President Plosser pointed out, you have to have a model and a forecasting mechanism to think about where the interest rate is that best achieves your objectives. It was a very useful exercise to find out, at least to some 3 The statement referred to here is appended to this transcript (appendix 3). extent, how the decline in the funds rate that we have put into place is motivated. In particular, the financial conditions do appear to be important both directly and indirectly--directly via the spreads and other observables that were put into the model and indirectly in terms of negative residuals in spending equations and the like. The recession dynamics were also a big part of the story. I hope that what this memo does for us--again, I think it's extraordinarily helpful--is to focus our debate better. As President Plosser pointed out, we really shouldn't argue about the level of the funds rate or the level of the spreads. We should think about the forecast and whether our policy path is consistent with achieving our objectives over the forecast period. I am sympathetic to the general view taken by the staff, which argues that those recession dynamics and financial restraints are important, that we are looking at slow growth going forward, and that inflation is likely to moderate. Based on those assumptions, I think that our policy is looking actually pretty good. To my mind, our quick move early this year, which was obviously very controversial and uncertain, was appropriate. Their analysis also suggests that the amount of insurance that we have is perhaps limited, given that they take a risk-neutral kind of modeling approach. Having said that, I think they have also clearly set out the conditions and the framework in which we can debate going forward exactly where we should be going. To the extent that those around the table disagree with the model or with the projection, then that is the appropriate way, it seems to me, to address our policy situation. So, again, I do very much appreciate that. It helped me think about the policy situation. As I said, I think our aggressive approach earlier in the year is looking pretty good, particularly as inflation pressures have seemed to moderate. Overall I believe that our current funds rate setting is appropriate, and I don't really see any reason to change. On the one hand, I think it would be inappropriate to increase rates at this point. It is simply premature. We don't have enough information. There is not enough pressure on inflation at this juncture to do that. On the other hand, cutting rates would be a very big step that would send a very strong signal about our views on the economy and about our intentions going forward, and I think we should view that step as a very discrete thing rather than as a 25 basis point kind of thing. We should be very certain about that change before we undertake it because I would be concerned, for example, about the implications for the dollar, commodity prices, and the like. So it is a step we should take only if we are very confident that that is the direction in which we want to go. Therefore my recommendation to the Committee--and I will open it up for comment in a moment--is to keep the funds rate at its current level. I listened very carefully to the conversation around the table in terms of the statement. I think it was President Lockhart, President Stern, and Governor Warsh, among others, who talked about strengthening the language on financial markets. So the draft statement that you have in front of you is an attempt to make that change. It has two changes relative to existing alternative B. First, as Governor Warsh suggested, it reverses the first two sentences and so focuses in the first sentence on ""Strains in financial markets have increased significantly and labor markets have weakened further,"" and then the rest of it is basically the same as it was. The other change, which is in the last paragraph in the risk assessment, is pretty small, but it is probably worth considering. The word ""closely"" has been added to suggest, obviously, that we understand that the situation is changing rapidly and that we are carefully following conditions as they evolve. Kevin, we took your word ""market"" there--what was the rationale for it? " FOMC20060629meeting--19 17,MR. KAMIN.," In contrast to the mixed news on economic activity coming out of the United States and despite the international financial volatility that Dino described, readings on foreign economic activity have been generally positive. Importantly, some of the areas of the global economy that had been weak in previous years are showing signs of strength. As indicated by the blue line in the top left panel of exhibit 11, euro-area industrial production has been moving up on balance in recent months, buoyed by solid manufacturing orders. The consumer had been the laggard in the euro zone’s recovery; but retail sales have edged up, and the first-quarter data on German consumption (not shown) were quite encouraging. In Japan, the middle panel, the rapid expansion that kicked in last year appears to be continuing: As in the euro area, manufacturing orders and output have been quite strong. And after generally disappointing growth for the past several years, Mexico’s economy, shown on the right, has accelerated on the back of strong manufacturing production, destined in large part for the United States. These indications support our estimate that total foreign growth (line 1 in the middle panel) registered a healthy and broad-based 3½ percent in the current quarter. To be sure, this represents a step-down from the exceptionally strong performance in the first quarter. The deceleration was mainly in emerging market economies (line 7), particularly China and Mexico. The Chinese government has taken several additional measures in recent months to slow investment, including restricting investment in certain sectors, raising down payments for real estate purchases, and tightening lending guidelines; we anticipate that these measures will finally bring overall growth down to a more sustainable pace. Mexican GDP, having surged more than 6 percent in the first quarter, likely has cooled to a still-robust 3½ percent rate in the second. Second-quarter growth in the industrial economies (line 2) is estimated to have shown a more muted decline from its first-quarter pace. Canadian growth likely slowed along with the U.S. economy, but Japanese growth is estimated to have stayed strong while activity in the euro area and the United Kingdom accelerated. Beyond the current quarter, we see growth in the emerging market economies holding steady while that of industrial economies moderates a bit further. Lower U.S. economic growth will restrain demand. Additionally, foreign economic activity will be responding to previous and prospective increases in interest rates. As shown in the bottom left panel, which presents our projections for key foreign policy rates, although we believe the tightening cycle is winding down in Canada, it still has a way to go in the euro area, and it has yet to begin in Japan. Finally, the recent sharp declines in global stock markets (the black and purple lines on the right) as well as the increase in emerging market credit spreads (the red line) will likely weigh on spending in both industrial and emerging market economies. Were downdrafts in international financial markets to continue and to intensify, they could lead to sharp falloffs in activity. For now, however, financial markets appear to be stabilizing with equity prices having reversed only a small part of previous steep run-ups and EMBI spreads remaining at historically low levels. A few economies—especially Turkey, South Africa, and Hungary—remain under pressure, but this likely reflects their particular vulnerabilities rather than more generalized turmoil in emerging markets. Accordingly, returning to the top line of the middle panel, total foreign growth is projected to make a smooth landing to its estimated trend rate of roughly 3¼ percent. This “goldilocks” projection for the foreign economies hinges on our assessment that inflation will remain contained despite continued high commodity prices and diminishing slack. As shown on the top left panel of exhibit 12, average inflation in the industrial economies is projected to move up a bit further in the current quarter but to then ease as the pass-through of higher energy and other commodity prices into consumer prices is completed. In the emerging economies, government policies tend to slow the response of domestic energy prices to those set in world markets; accordingly, inflation for these economies is not projected to peak until later this year, after which it also moves down. As shown on the right, our projection, based on quotes from futures markets, is that prices of both West Texas intermediate crude oil and non-energy commodities will flatten out but stay elevated. Oil prices have increased considerably faster than our import-weighted aggregate of non-energy commodity prices; but some non- energy prices, especially those of metals such as copper, have indeed moved up sharply over a short period of time. The quarterly data plotted in the chart obscure the fact that, most recently, prices of metals and other commodities have moved back down, in part because of the same concerns about future monetary policies and growth that have weighed on financial markets. The middle left panel shows spot prices for copper and zinc; although these have declined sharply, they remain extremely elevated. Increases in demand have been an important driver of the overall rise in commodity prices in the past few years. Some observers have taken this rise to be a signal that the global economy is overheating. Indeed, as shown on the right, world GDP growth (the red dashed line) has been brisk in the past two years, and this growth does appear to be correlated with the rate of change of oil and other commodity prices. Yet rising commodity prices are probably not so much a symptom of generalized global overheating as a reflection of rapid industrial development in Asia, particularly China. As indicated in line 2 of the bottom left panel, China, by itself, has contributed 1½ percentage points to global economic growth in the past three years; moreover, of the total increase in world oil consumption (shown in line 3), increases in Chinese consumption (shown in line 4) accounted for more than one-quarter. China’s contributions to global output growth appear to have been supported by corresponding increases in capacity. CPI inflation excluding food, the solid line in the panel on the right, has remained quite low at around 1 percent recently. Data on overall industrial capacity are not available, but we do have data for specific sectors. The red cross-hatched bars in the panel indicate Chinese steel-making capacity, and the solid bars represent actual production. China’s steel production has soared to 31 percent of total global output, but by dint of extraordinary levels of investment, capacity has risen even more. Thus, rising commodity prices likely reflect sectoral bottlenecks in the midst of rapid Asian development rather than a more-generalized global overheating. The top left panel of exhibit 13 focuses on resource utilization in the foreign industrial economies. The solid black line represents the staff estimate of the output gap—that is, the excess of actual over potential GDP; it suggests that actual output in the industrial economies is now near but not significantly above potential. The message that the industrial economies are not overheating is also supported by measures of capacity utilization rates in manufacturing, expressed as deviations from their ten-year averages; aside from Japan, capacity utilization rates in the major foreign industrial economies are close to historical levels. It is not possible to construct reliable measures of potential output and of the output gap for the developing economies because the requisite data on stocks of labor and especially capital are not available. Moreover, as these economies are undergoing rapid structural change, conventional output gap calculations would be doubly tenuous. Measures of manufacturing capacity utilization are available for some developing economies, as shown on the right, and they point to declining levels of resource slack. Whether overall GDP in these economies has moved up beyond potential, however, is difficult to say. The middle panels present a mixed picture of recent inflation trends in three of our important trading partners. In the euro area, twelve-month headline inflation (the solid black line) has edged up in recent months; however, both core inflation (the dotted red line) and wage growth (the blue dashed line) have stayed subdued. In Canada, headline, core, and wage inflation have all been creeping up, although core inflation remains at only 2 percent. In Mexico, notwithstanding rising global energy prices and accelerating wages, both headline inflation and core inflation have been trending down. The bottom left panel shows unit labor costs. Recent cost growth has been coming down from high levels in Canada and the United Kingdom, has been reasonably contained in France, and remains negative in Germany. Finally, the right panel indicates that long-term inflation expectations in the foreign industrial economies excluding Japan—whether measured by bond market breakeven rates (the black line) or semiannual surveys (the red line) have remained around 2½ percent or below. To sum up this lengthy discussion, although there is some risk of more-severe upward pressures on foreign inflation, the data in hand appear to support the more benign scenario we have built into our outlook. A second key risk to the outlook centers on the dollar. As indicated in the top left panel of exhibit 14, the U.S. current account deficit reached nearly 2 percent of world GDP last year, balanced primarily by surpluses in Japan, emerging Asia, and especially the oil-exporting countries. As shown on the right, the U.S. trade balance, while having recovered a bit from its plunge in the wake of Hurricane Katrina last fall, nevertheless remains on a deteriorating trend. Market focus on external imbalances likely explains much of the decline in the broad dollar (the black line in the middle left panel) in April and early May. However, the market’s attention to global external imbalances appeared to fade by mid-May, and the dollar has moved up since then. Neither the dollar’s decline nor its subsequent rebound could be explained by the differential between U.S. bond yields and foreign bond yields, shown on the right, which has moved little this year. The markets also apparently took no signal from the mid-June announcement of U.S. balance-of-payments data, shown in the bottom panel. As shown in line 1, the current account deficit narrowed in the first quarter, reflecting a smaller nominal trade deficit, reduced transfers abroad, and an improved balance on investment income. As for the financing of the deficit, private foreign purchases of U.S. securities, line 4, slowed sharply in April. However, neither the good news about the deficit nor the potentially bad news about its financing had much of an effect on the dollar. In projecting the future path of the dollar, we have wrestled with the usual tension between the need for the dollar to fall over the longer term to restore current account sustainability and the fact that in the shorter term the dollar can do pretty much whatever it wants. Accordingly, as indicated by the black line in the top left panel of exhibit 15, in our Greenbook projection the broad real dollar depreciates only about 2 percent annually. However, we are keenly aware that a refocusing of investor attention on sustainability could lead to a much steeper decline in the dollar. This exhibit compares our baseline projection of the external sector with a simulation of the staff’s FRB/Global model in which the dollar declines an additional 15 percent over the next year and a half; this is the same simulation summarized in the International Developments section of the Greenbook. As shown on the right, our baseline projection is for the trade balance to continue to deteriorate for the remainder of this year but to flatten out a bit next year as oil prices top out and the slowing of U.S. growth takes effect. Because of J-curve effects, the path of the nominal trade balance is roughly similar under the alternative simulation, at least during the forecast period. However, the additional depreciation leads to declines in real imports and increases in real exports. Accordingly, as shown in the next row, the contribution of net exports to real GDP growth, which is negative for most of next year in the baseline, becomes positive under the alternative simulation. A more-rapid depreciation of the dollar would affect prices as well as output. As shown on the right, in our baseline projection, core import price inflation—which we project will rise to 4 percent in the third quarter because of rising commodity prices— decelerates to 1 percent by the end of next year as commodity prices flatten out. The additional dollar depreciation in the alternative simulation adds 2 to 3 percentage points to core import inflation over the forecast period. As shown in the next row, core PCE inflation rises about ¼ percentage point, reflecting both the higher import prices and brisker economic activity. Accordingly, the Taylor rule in the model leads the federal funds rate to rise above 6 percent by the end of next year. This squeezes domestic consumption and investment somewhat and, as a result, real GDP growth in the alternative simulation rises a bit less than does the contribution of net exports to GDP. Notably, foreign growth declines a bit less than U.S. growth rises. In sum, we view a sharp decline in the dollar as unpredictable but entirely possible. Such an event likely would lead to more U.S. growth but also more inflation and a need for tighter monetary policy than currently incorporated into the Greenbook forecast." CHRG-111hhrg51698--210 Mr. Slocum," I am Tyson Slocum. I direct the Energy Program at Public Citizen. Public Citizen is one of America's largest consumer advocacy groups. We primarily get our funding from the 100,000 Americans across the country that pay dues to support our organization's work. My particular area of focus is on energy policy, and we have heard from our members and from Americans all over the country about the incredibly harmful impacts the volatility in energy prices have had on working people across the country. There is no question that this volatility is the direct result of rampant speculation, speculation made possible due to unregulated or under-regulated energy futures markets. I think that it is not a coincidence that the speculative bubble burst in crude oil at the same time that the Wall Street credit crisis occurred. These speculators were speculating on highly leveraged bets; and once the credit seized up, their ability to continue speculating also evaporated. So the huge drop in prices from $147 a barrel in just 5 months to $40 a barrel was a direct result of the ability of the speculators to continue evaporating. So the draft legislation that has been put together by Chairman Peterson does an excellent job as a first step to addressing the need to increase transparency and regulation over these futures markets. By bringing foreign exchanges under CFTC jurisdiction, by requiring mandatory clearing for OTC markets--although there is this big exemption that I am concerned about--requiring more detailed data from index traders and swaps dealers, requiring a review of all past CFTC decisions, which I believe undermined the transparency of the market, all of these are excellent things. The need to re-regulate these markets is all the more important because of the enormous consolidation that we have seen among the speculators. In response to the Wall Street crash, there has been a number of mergers between entities that had significant energy trading portfolios. There were no hearings when any of these mergers were approved; and so you had a lot of these very powerful entities become even larger and more powerful, with little or no public scrutiny over the impacts on the future of energy trading markets. So improving transparency, as the draft Derivatives Markets Transparency and Accountability Act, is an excellent start. There is an area that the legislation doesn't address that I would like to touch on for the rest of my opening statement. And that is dealing with what Public Citizen identifies as a serious matter of concern regarding the intersection of speculators like Wall Street investment banks and their ownership or control over physical energy infrastructure assets such as storage facilities, pipelines, oil refineries, and other physical energy infrastructure assets. There has been an explosion just over the last couple of years of Wall Street investment banks taking over pipeline systems and other energy infrastructure with, I believe, the sole purpose to provide them with added ability to enhance their speculative activities in the futures market. It is the only reason that I could figure why a company like Goldman Sachs would acquire 40,000 miles of petroleum product pipeline in North America through its 2006 acquisition of Kinder Morgan. Owning pipelines is a relatively low return business. With pipeline operations, their profits are heavily regulated. But owning and controlling pipeline systems gives an investment bank that has a large speculative division an insider's peek into the movement of information, of product that enhances their ability to make large speculative trades. The fact that Morgan Stanley, when I was reviewing their most recent annual report, boasted that they were going to be spending half a billion dollars in 2009 leasing petroleum storage facilities in the United States and, as Morgan Stanley said--I am quoting from their annual report--in connection with its commodities business, Morgan Stanley enters into operating leases for both crude oil and refined product storage for vessel charters. These operating leases are integral parts of the company's commodities risk management business. Just a month ago, Bloomberg reported that investment banks and other financial firms had 80 million barrels of oil stored offshore in oil tankers that were not being shipped to deliver into markets, to deliver oil and other needed products to consumers, but simply to use them to enhance their speculative hedging tactics. So, that it would be great if the Committee could examine a study by the CFTC or another appropriate entity to determine whether or not the intersection of ownership and control over physical energy assets with energy market speculative activities requires additional levels of scrutiny. Thank you very much for your time, and I look forward to your questions. [The prepared statement of Mr. Slocum follows:] Prepared Statement of Tyson Slocum, Director, Energy Program, Public Citizen, Washington, D.C.Protecting Families From Another Energy Price Shock: Restoring Transparency and Regulation to Futures Markets To Keep the Speculators Honest Thank you, Mr. Chairman and Members of Committee on Agriculture for the opportunity to testify on the issue of energy futures regulation. My name is Tyson Slocum and I am Director of Public Citizen's Energy Program. Public Citizen is a 38 year old public interest organization with over 100,000 members nationwide. We represent the needs of households by promoting affordable, reliable and clean energy. The extraordinary volatility in energy prices, particularly crude oil--which soared from $27/barrel in September 2003 to a high of $147/barrel in July 2008 before plummeting to its current price of $40/barrel--wreaked havoc with the economy while making speculators rich. The spectacular 75% decline in oil prices in just 5 months cannot be explained purely by supply and demand; rather, a speculative bubble burst, triggered by the Wall Street financial crisis. Strapped of their credit that had been fueling their highly leveraged trading operations, the credit crisis ended the speculators' ability to continue driving up prices far beyond the supply demand fundamentals. This speculation was made possible by legislative and regulatory actions that deregulated these energy futures markets. Although energy prices are no longer at record highs, it must be assumed that it is a matter of when, not if, a return to high prices will occur. Absent reregulation of the energy futures markets, aggressive government efforts to restore liquidity and unfreeze the credit markets will give new life to the Wall Street financial speculators, ushering a return to an energy commodity speculative bubble. Restoring transparency to futures markets is all the more urgent given the wave of consolidation that has occurred among the financial firms that were leading the speculative frenzy. Several major energy trading firms merged their operations in response the credit crisis: In 2007, ABN Amro was purchased by the Dutch National Government, the Royal Bank of Scotland and Spain's Banco Santander. In April 2008, J.P.Morgan Chase acquired Bear Stearns and its trading operations. In September 2008, Bank of America acquired Merrill Lynch. In October 2008, Wells Fargo and Wachovia agreed to merge. Electricite de France arranged to purchase all of Lehman Bros. energy trading operations in October 2008. Wells Fargo agreed to buy Wachovia in October 2008. In January 2009, UBS sold its energy trading operations to Barclays. Congress can take two broad actions to provide relief: providing incentives to households to give them better access to alternatives to our dependence on oil, and restoring transparency to the futures markets where energy prices are set. The former option is of course an effective long-term investment, as providing incentives to help families afford the purchase of super fuel efficient hybrid or alternative fuel vehicles, solar panel installation, energy efficient improvements to the home and greater access to mass transit would all empower households to avoid the brunt of high energy prices. The second option-restoring transparency to the futures markets where energy prices are actually set--is equally important. Stronger regulations over energy trading markets would reduce the level of speculation and limit the ability of commodity traders to engage in anti-competitive behavior that is contributing the record high prices Americans face. And as Congress considers market-based climate change legislation that would create a pollution futures trading market, the priority of establishing strong regulatory oversight over all energy- and pollution-related futures trading is the only way to effectively combat climate change, in order to ensure price transparency. Of course, supply and demand played a role in the recent rise and decline in oil prices. Gasoline demand in America is down, with Americans driving 112 billion less miles from November 2007 to November 2008,\1\ and global demand--even in emerging economies like China, India and oil exporting nations in the Middle East--has slackened in response to the global economic downturn, thereby offsetting the fact that mature, productive and easily-accessible oil fields are in decline. Claims of Saudi spare capacity are questioned due to the Kingdom's refusal to allow independent verification of the country's oil reserve claims. Simply put, oil is a finite resource with which the world--until recently--has embarked on unprecedented increased demand.--------------------------------------------------------------------------- \1\ www.fhwa.dot.gov/ohim/tvtw/tvtpage.htm.--------------------------------------------------------------------------- But there is no question that speculators and unregulated energy traders have pushed prices beyond the supply-demand fundamentals and into an era of a speculative bubble in oil markets. While some speculation plays a legitimate function for hedging and providing liquidity to the market, the exponential rise in market participants who have no physical delivery commitments has skyrocketed, from 37 percent of the open interest on the NYMEX West Texas Intermediate (WTI) contract in January 2000 to 71 percent in April 2008.\2\--------------------------------------------------------------------------- \2\ http://energycommerce.house.gov/Investigations/EnergySpeculationBinder_062308/15.pdf.--------------------------------------------------------------------------- Rather than demonize speculation generally, the goal is to address problems associated with recent Congressional and regulatory actions that deregulated energy trading markets that has opened the door to these harmful levels of speculation. Removing regulations has opened the door too wide for speculators and powerful financial interests to engage in anti-competitive or harmful speculative behavior that results in prices being higher than they would otherwise be. When oil was at $145/barrel, many estimated that at least $30 of that price was pure speculation, unrelated to supply and demand. While the Commodity Futures Trading Commission (CFTC) and Congress have taken recent small steps in the right direction, more must be done to protect consumers. While the CFTC has been disparaged by consumer advocates as being too deferential to energy traders, it has responded to recent criticism by ordering the United Kingdom to set limits on speculative trading of WTI contracts, proposing stronger disclosure for index traders and swap dealers, spearheading an interagency task force to more closely monitor energy markets and strengthening disclosure requirements in its amended Dubai Mercantile Exchange No Action letter. But these actions are hardly enough to rein in the harmful levels of speculation and anti-competitive behavior that are causing energy prices to rise. A new CFTC Chairman presents important opportunities for the agency to take a more assertive role in policing these markets. Recent Congressional action, too, has been beneficial to consumers, but the legislation has not gone nearly far enough. Title XIII of H.R. 6124 (the ``farm bill'') that became law in June 2008, closed some elements of the so-called ``Enron Loophole,'' which provided broad exemptions from oversight for electronic exchanges like ICE. But the farm bill only provides limited protections from market manipulation, as it allows the CFTC, ``at its discretion,'' to decide on a contract-by-contract basis that an individual energy contract should be regulated only if the CFTC can prove that the contract will ``serve a significant price discovery function'' in order to stop anti-competitive behavior. In December 2007, H.R. 6 was signed into law. Sections 811 through 815 of that act empower the Federal Trade Commission to develop rules to crack down on petroleum market manipulation.\3\ If these rules are promulgated effectively, this could prove to be an important first step in addressing certain anti-competitive practices in the industry.--------------------------------------------------------------------------- \3\ http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_public_laws&docid=f:publ140.110.pdf.--------------------------------------------------------------------------- Public Citizen recommends four broad reforms to rein in speculators and help ensure that energy traders do not engage in anti-competitive behavior: [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Require foreign-based exchanges that trade U.S. energy products to be subjected to full U.S. regulatory oversight. Impose legally-binding firewalls to limit energy traders from speculating on information gleaned from the company's energy infrastructure affiliates or other such insider information, while at the same time allowing legitimate hedging operations. Congress must authorize the FTC and DOJ to place greater emphasis on evaluating anti-competitive practices that arise out of the nexus between control over hard assets like energy infrastructure and a firm's energy trading operations. Legislation introduced by U.S. Representative Collin C. Peterson, ``The Derivatives Markets Transparency and Accountability Act of 2009,'' \4\ does a great job addressing most of Public Citizen's recommendations. There are two areas, however, upon which the legislation could be improved. First, the bill should immediately subject OTC markets to the same regulatory oversight to which regulated exchanges like NYMEX must adhere. Second, the legislation should impose aggregate speculation limits over all markets to limit the ability of traders to engage in harmful speculation.--------------------------------------------------------------------------- \4\ http://agriculture.house.gov/inside/Legislation/111/PETEMN_001_xml.pdf.---------------------------------------------------------------------------Energy Trading Abuses Require Stronger OversightBackground Two regulatory lapses are enabling anti-competitive practices in energy trading markets where prices of energy are set. First, oil companies, investment banks and hedge funds are exploiting recently deregulated energy trading markets to manipulate energy prices. Second, energy traders are speculating on information gleaned from their own company's energy infrastructure affiliates, a type of legal ``insider trading.'' These regulatory loopholes were born of inappropriate contacts between public officials and powerful energy companies and have resulted in more volatile and higher prices for consumers. Contrary to some public opinion, oil prices are not set by the Organization of Petroleum Exporting Countries (OPEC); rather, they are determined by the actions of energy traders in markets. Historically, most crude oil has been purchased through either fixed-term contracts or on the ``spot'' market. There have been long-standing futures markets for crude oil, led by the New York Mercantile Exchange and London's International Petroleum Exchange (which was acquired in 2001 by an Atlanta-based unregulated electronic exchange, ICE). NYMEX is a floor exchange regulated by the U.S. Commodity Futures Trading Commission (CFTC). The futures market has historically served to hedge risks against price volatility and for price discovery. Only a tiny fraction of futures trades result in the physical delivery of crude oil. The CFTC enforces the Commodity Exchange Act, which gives the Commission authority to investigate and prosecute market manipulation.\5\ But after a series of deregulation moves by the CFTC and Congress, the futures markets have been increasingly driven by the unregulated over-the-counter (OTC) market over the last few years. These OTC and electronic markets (like ICE) have been serving more as pure speculative markets, rather than traditional volatility hedging or price discovery. And, importantly, this new speculative activity is occurring outside the regulatory jurisdiction of the CFTC.--------------------------------------------------------------------------- \5\ 7 U.S.C. 9, 13b and 13(a)(2).--------------------------------------------------------------------------- Energy trading markets were deregulated in two steps. First, in response to a petition by nine energy and financial companies, led by Enron,\6\ on November 16, 1992, then-CFTC Chairwoman Wendy Gramm supported a rule change--later known as Rule 35--exempting certain energy trading contracts from the requirement that they be traded on a regulated exchange like NYMEX, thereby allowing companies like Enron and Goldman Sachs to begin trading energy futures between themselves outside regulated exchanges. Importantly, the new rule also exempted energy contracts from the anti-fraud provisions of the Commodity Exchange Act.\7\ At the same time, Gramm initiated a proposed order granting a similar exemption to large commercial participants in various energy contracts that was later approved in April 2003.\8\--------------------------------------------------------------------------- \6\ The other eight companies were: BP, Coastal Corp. (now El Paso Corp.) Conoco and Phillips (now ConocoPhillips), Goldman Sachs' J. Aron & Co., Koch Industries, Mobil (now ExxonMobil) and Phibro Energy (now a subsidiary of CitiGroup). \7\ 17 CFR Ch. 1, available at www.access.gpo.gov/nara/cfr/waisidx_06/17cfr35_06.html. \8\ ``Exemption for Certain Contracts Involving Energy Products,'' 58 Fed. Reg. 6250 (1993).--------------------------------------------------------------------------- Enron had close ties to Wendy Gramm's husband, then-Texas Senator Phil Gramm. Of the nine companies writing letters of support for the rule change, Enron made by far the largest contributions to Phil Gramm's campaign fund at that time, giving $34,100.\9\--------------------------------------------------------------------------- \9\ Charles Lewis, ``The Buying of the President 1996,'' pg. 153. The Center for Public Integrity.--------------------------------------------------------------------------- Wendy Gramm's decision was controversial. Then-Chairman of a House Agriculture Subcommittee with jurisdiction over the CFTC, Rep. Glen English, protested that Wendy Gramm's action prevented the CFTC from intervening in basic energy futures contracts disputes, even in cases of fraud, noting that that ``in my 18 years in Congress [Gramm's motion to deregulate] is the most irresponsible decision I have come across.'' Sheila Bair, the CFTC Commissioner casting the lone dissenting vote, argued that deregulation of energy futures contracts ``sets a dangerous precedent.'' \10\ A U.S. General Accounting Office report issued a year later urged Congress to increase regulatory oversight over derivative contracts,\11\ and a Congressional inquiry found that CFTC staff analysts and economists believed Gramm's hasty move prevented adequate policy review.\12\--------------------------------------------------------------------------- \10\ ``Derivatives Trading Forward-Contract Fraud Exemption May be Reversed,'' Inside FERC's Gas Market Report, May 7, 1993. \11\ ``Financial Derivatives: Actions Needed to Protect the Financial System,'' GGD-94-133, May 18, 1994, available at http://archive.gao.gov/t2pbat3/151647.pdf. \12\ Brent Walth and Jim Barnett, ``A Web of Influence,'' Portland Oregonian, December 8, 1996.--------------------------------------------------------------------------- Five weeks after pushing through the ``Enron loophole,'' Wendy Gramm was asked by Kenneth Lay to serve on Enron's Board of Directors. When asked to comment about Gramm's nearly immediate retention by Enron, Lay called it ``convoluted'' to question the propriety of naming her to the Board.\13\--------------------------------------------------------------------------- \13\ Jerry Knight, ``Energy Firm Finds Ally, Director, in CFTC Ex-Chief,'' Washington Post, April 17, 1993.--------------------------------------------------------------------------- Congress followed Wendy Gramm's lead in deregulating energy trading contracts and moved to deregulate energy trading exchanges by exempting electronic exchanges, like those quickly set up by Enron, from regulatory oversight (as opposed to a traditional trading floor like NYMEX that remained regulated). Congress took this action during last-minute legislative maneuvering on behalf of Enron by former Texas GOP Senator Phil Gramm in the lame-duck Congress 2 days after the Supreme Court ruled in Bush v. Gore, buried in 712 pages of unrelated legislation.\14\ As Public Citizen pointed out back in 2001,\15\ this law deregulated OTC derivatives energy trading by ``exempting'' them from the Commodity Exchange Act, removing anti-fraud and anti-manipulation regulation over these derivatives markets and exempting ``electronic'' exchanges from CFTC regulatory oversight.--------------------------------------------------------------------------- \14\ H.R. 5660, an amendment to H.R. 4577, which became Appendix E of P.L. 106-554 available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=106_cong_public_laws&docid=f:publ554.106.pdf. \15\ Blind Faith: How Deregulation and Enron's Influence Over Government Looted Billions from Americans, available at www.citizen.org/documents/Blind_Faith.pdf.--------------------------------------------------------------------------- This deregulation law was passed against the explicit recommendations of a multi-agency review of derivatives markets. The November 1999 release of a report by the President's Working Group on Financial Markets--a multi-agency policy group with permanent standing composed at the time of Lawrence Summers, Secretary of the Treasury; Alan Greenspan, Chairman of the Federal Reserve; Arthur Levitt, Chairman of the Securities and Exchange Commission; and William Rainer, Chairman of the CFTC--concluded that energy trading must not be deregulated. The Group reasoned that ``due to the characteristics of markets for nonfinancial commodities with finite supplies . . . the Working Group is unanimously recommending that the [regulatory] exclusion not be extended to agreements involving such commodities.'' \16\ In its 1999 lobbying disclosure form, Enron indicated that the ``President's Working Group'' was among its lobbying targets.\17\--------------------------------------------------------------------------- \16\ ``Over-the-Counter Derivatives Markets and the Commodity Exchange Act,'' Report of The President's Working Group on Financial Markets, pg. 16. www.ustreas.gov/press/releases/docs/otcact.pdf. \17\ Senate Office of Public Records Lobbying Disclosure Database, available at http://sopr.senate.gov/cgi-win/opr_gifviewer.exe?/1999/01/000/309/00030933130, page 7.--------------------------------------------------------------------------- As a result of the Commodity Futures Modernization Act, trading in lightly-regulated exchanges like NYMEX is declining as more capital flees to the unregulated OTC markets and electronic exchanges such as those run by the IntercontinentalExchange (ICE). Trading on the ICE has skyrocketed, with the 138 million contracts traded in 2007 representing a 230 percent increase from 2005.\18\ This explosion in unregulated and under regulated trading volume means that more trading is done behind closed doors out of reach of Federal regulators, increasing the chances of oil companies and financial firms to engage in anti-competitive practices. The founding members of ICE include Goldman Sachs, BP, Shell and TotalfinaElf. In November 2005, ICE became a publicly traded corporation.--------------------------------------------------------------------------- \18\ Available at www.theice.com/exchange_volumes_2005.jhtml.---------------------------------------------------------------------------The Players Goldman Sachs' trading unit, J. Aron, is one of the largest and most powerful energy traders in the United States, and commodities trading represents a significant source of revenue for the company. Goldman Sachs' most recent 10-k filed with the U.S. Securities and Exchange Commission show that Fixed Income, Currency and Commodities (which includes energy trading) generated 17 percent of Goldman's $22 billion in revenue for 2008.\19\ That share, however, masks the role that energy trading plays in Goldman's revenue as the company lumps under-performing activities such as securitized mortgage debt, thereby dragging down revenues for the entire segment. Indeed, Goldman touted the performance of its commodity trading activities in 2008, noting that it ``produced particularly strong results and net revenues were higher compared with 2007.''--------------------------------------------------------------------------- \19\ http://idea.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm.--------------------------------------------------------------------------- In 2005, Goldman Sachs and Morgan Stanley--the two companies are widely regarded as the largest energy traders in America--each reportedly earned about $1.5 billion in net revenue from energy trading. One of Goldman's star energy traders, John Bertuzzi, made as much as $20 million in 2005.\20\--------------------------------------------------------------------------- \20\ http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee--prints&docid=f:28640.pdf, pages 24 and 26.--------------------------------------------------------------------------- In the summer of 2006, Goldman Sachs, which at the time operated the largest commodity index, GSCI, announced it was radically changing the index's weighting of gasoline futures, selling about $6 billion worth. As a direct result of this weighting change, Goldman Sachs unilaterally caused gasoline futures prices to fall nearly 10 percent.\21\--------------------------------------------------------------------------- \21\ Heather Timmons, ``Change in Goldman Index Played Role in Gasoline Price Drop,'' The New York Times, September 30, 2006.--------------------------------------------------------------------------- Morgan Stanley held $18.7 billion in assets in commodity forwards, options and swaps at November 30, 2008. As the company noted in its annual report: ``Fiscal 2008 results reflected . . . record revenues from commodities . . . Commodity revenues increased 62%, primarily due to higher revenues from oil liquids and electricity and natural gas products.'' A deregulation action by the Federal Reserve in 2003--at the request of Citigroup and UBS--allows commercial banks to engage in energy commodity trading.\22\ Since then commercial banks have become big players in the speculation market. The total value of commodity derivative contracts held by the Citigroup's Phibro trading division increased 384 percent from 2004 through 2008, rising from $44.4 billion to $214.5 billion.\23\ Bank of America held $58.6 billion worth of commodity derivatives contracts as of September 2008.\24\ Merrill Lynch, which BoA acquired in September 2008, experienced ``strong net revenues for the [third] quarter [2008] generated from our . . . commodities businesses.'' \25\--------------------------------------------------------------------------- \22\ Regulation Y; Docket No. R-1146, www.federalreserve.gov/boarddocs/press/bcreg/2003/20030630/attachment.pdf. \23\ http://idea.sec.gov/Archives/edgar/data/831001/000104746908011506/a2188770z10-q.htm. \24\ http://idea.sec.gov/Archives/edgar/data/70858/000119312508228086/d10q.htm. \25\ http://idea.sec.gov/Archives/edgar/data/65100/000095012308014369/y72170e10vq.htm.--------------------------------------------------------------------------- Just a year after Enron's collapse, the Commodity Futures Trading Commission finalized rules allowing hedge funds to engage in energy trading without registering with the CFTC, opening the door to firms like Citadel and D.E. Shaw.\26\--------------------------------------------------------------------------- \26\ 17 CFR Part 4, RIN 3038-AB97, ``Additional Registration and Other Regulatory Relief for Commodity Pool Operators and Commodity Trading Advisors,'' final rule issued August 1, 2003.---------------------------------------------------------------------------The Consequences of Deregulation A recent bipartisan U.S. Senate investigation summed up the negative impacts on oil prices with this shift towards unregulated energy trading speculation: Over the last few years, large financial institutions, hedge funds, pension funds, and other investment funds have been pouring billions of dollars into the energy commodity markets-- perhaps as much as $60 billion in the regulated U.S. oil futures market alone . . . The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the spot market . . . Several analysts have estimated that speculative purchases of oil futures have added as much as $20-$25 per barrel to the current price of crude oil . . . large speculative buying or selling of futures contracts can distort the market signals regarding supply and demand in the physical market or lead to excessive price volatility, either of which can cause a cascade of consequences detrimental to the overall economy . . . At the same time that there has been a huge influx of speculative dollars in energy commodities, the CFTC's ability to monitor the nature, extent, and effect of this speculation has been diminishing. Most significantly, there has been an explosion of trading of U.S. energy commodities on exchanges that are not regulated by the CFTC . . . in contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversights. In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (``open interest'') at the end of each day.\27\--------------------------------------------------------------------------- \27\ The Role Of Market Speculation In Rising Oil And Gas Prices: A Need To Put The Cop Back On The Beat, Staff Report prepared by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs of the U.S. Senate, June 27, 2006, available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf. Thanks to the Commodity Futures Modernization Act, participants in these newly-deregulated energy trading markets are not required to file so-called Large Trader Reports, the records of all trades that NYMEX traders are required to report to the CFTC, along with daily price and volume information. These Large Trader Reports, together with the price and volume data, are the primary tools of the CFTC's regulatory regime: ``The Commission's Large Trader information system is one of the cornerstones of our surveillance program and enables detection of concentrated and coordinated positions that might be used by one or more traders to attempt manipulation.'' \28\ So the deregulation of OTC markets, by allowing traders to escape such basic information reporting, leave Federal regulators with no tools to routinely determine whether market manipulation is occurring in energy trading markets.--------------------------------------------------------------------------- \28\ Letter from Reuben Jeffrey III, Chairman, CFTC, to Michigan Governor Jennifer Granholm, August 22, 2005.--------------------------------------------------------------------------- One result of the lack of transparency is the fact that even some traders don't know what's going on. A recent article described how: Oil markets were rocked by a massive, almost instant surge in after-hours electronic trading one day last month, when prices for closely watched futures contracts jumped 8% . . . this spike stands out because it was unclear at the time what drove it. Two weeks later, it is still unclear. What is clear is that a rapid shift in the bulk of crude trading from the raucous trading floor of the New York Mercantile Exchange to anonymous computer screens is making it harder to nail down the cause of price moves . . . The initial jump ``triggered more orders already set into the system, and with prices rising, people thought somebody must know something,'' Tom Bentz, an analyst and broker at BNP Paribas Futures in New York who was watching the screen at the time, said the day after the spike. ``The more prices rose, the more it seemed somebody knew something.'' \29\--------------------------------------------------------------------------- \29\ Matt Chambers, ``Rise in Electronic Trading Adds Uncertainty to Oil,'' The Wall Street Journal, April 10, 2007. Oil companies, investment banks and hedge funds are exploiting the lack of government oversight to price-gouge consumers and make billions of dollars in profits. These energy traders boast how they're price-gouging Americans, as a recent Dow Jones article makes clear: energy ``traders who profited enormously on the supply crunch following Hurricane Katrina cashed out of the market ahead of the long weekend. `There are traders who made so much money this week, they won't have to punch another ticket for the rest of this year,' said Addison Armstrong, manager of exchange-traded markets for TFS Energy Futures.'' \30\--------------------------------------------------------------------------- \30\ Leah McGrath Goodman, ``Oil Futures, Gasoline In NY End Sharply Lower,'' September 2, 2005.--------------------------------------------------------------------------- The ability of Federal regulators to investigate market manipulation allegations even on the lightly-regulated exchanges like NYMEX is difficult, let alone the unregulated OTC market. For example, as of August 2006, the Department of Justice is still investigating allegations of gasoline futures manipulation that occurred on a single day in 2002.\31\ If it takes the DOJ 4 years to investigate a single day's worth of market manipulation, clearly energy traders intent on price-gouging the public don't have much to fear.--------------------------------------------------------------------------- \31\ John R. Wilke, Ann Davis and Chip Cummins, ``BP Woes Deepen with New Probe,'' The Wall Street Journal, August 29, 2006.--------------------------------------------------------------------------- That said, there have been some settlements for manipulation by large oil companies. In January 2006, the CFTC issued a civil penalty against Shell Oil for ``non-competitive transactions'' in U.S. crude oil futures markets.\32\ In March 2005, a Shell subsidiary agreed to pay $4 million to settle allegations it provided false information during a Federal investigation into market manipulation.\33\ In August 2004, a Shell Oil subsidiary agreed to pay $7.8 million to settle allegations of energy market manipulation.\34\ In July 2004, Shell agreed to pay $30 million to settle allegations it manipulated natural gas prices.\35\ In October 2007, BP agreed to pay $303 million to settle allegations the company manipulated the propane market.\36\ In September 2003, BP agreed to pay NYMEX $2.5 million to settle allegations the company engaged in improper crude oil trading, and in July 2003, BP agreed to pay $3 million to settle allegations it manipulated energy markets.\37\--------------------------------------------------------------------------- \32\ ``U.S. Commodity Futures Trading Commission Assesses Penalties of $300,000 Against Shell-Related Companies and Trader in Settling Charges of Prearranging Crude Oil Trades'' available at www.cftc.gov/newsroom/enforcementpressreleases/2006/pr5150-06.html. \33\ ``Commission Accepts Settlement Resolving Investigation Of Coral Energy Resources,'' available at www.ferc.gov/news/news-releases/2005/2005-1/03-03-05.asp. \34\ ``Order Approving Contested Settlement,'' available at www.ferc.gov/whats-new/comm-meet/072804/E-60.pdf. \35\ ``Coral Energy Pays $30 Million to Settle U.S. Commodity Futures Trading Commission Charges of Attempted Manipulation and False Reporting,'' available at www.cftc.gov/opa/enf04/opa4964-04.htm. \36\ www.cftc.gov/newsroom/enforcementpressreleases/2007/pr5405-07.html. \37\ ``Order Approving Stipulation and Consent Agreement,'' 104 FERC 61,089, available at http://elibrary.ferc.gov/idmws/common/opennat.asp?fileID=10414789.--------------------------------------------------------------------------- In August 2007, Oil giant BP admitted in a filing to the Securities and Exchange Commission that ``The U.S. Commodity Futures Trading Commission and the U.S. Department of Justice are currently investigating various aspects of BP's commodity trading activities, including crude oil trading and storage activities, in the U.S. since 1999, and have made various formal and informal requests for information.'' \38\--------------------------------------------------------------------------- \38\ www.sec.gov/Archives/edgar/data/313807/000115697307001223/u53342-6k.htm.--------------------------------------------------------------------------- In August 2007, Marathon Oil agreed to pay $1 million to settle allegations the company manipulated the price of West Texas Intermediate crude oil.\39\--------------------------------------------------------------------------- \39\ www.cftc.gov/newsroom/enforcementpressreleases/2007/pr5366-07.html.--------------------------------------------------------------------------- There is near-unanimous agreement among industry analysts that speculation is driving up oil and natural gas prices. Representative of these analyses is a May 2006 Citigroup report on the monthly average value of speculative positions in American commodity markets, which found that the value of speculative positions in oil and natural gas stood at $60 billion, forcing Citigroup to conclude that ``we believe the hike in speculative positions has been a key driver for the latest surge in commodity prices.'' \40\--------------------------------------------------------------------------- \40\ The Role Of Market Speculation In Rising Oil And Gas Prices: A Need To Put The Cop Back On The Beat, Staff Report prepared by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs of the U.S. Senate, June 27, 2006, available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf.--------------------------------------------------------------------------- Natural gas markets are also victimized by these unregulated trading markets. Public Citizen has testified before Congress on this issue,\41\ and a March 2006 report by four State Attorneys General concludes that ``natural gas commodity markets have exhibited erratic behavior and a massive increase in trading that contributes to both volatility and the upward trend in prices.'' \42\--------------------------------------------------------------------------- \41\ ``The Need for Stronger Regulation of U.S. Natural Gas Markets,'' available at www.citizen.org/documents/Natural%20Gas%20Testimony.pdf. \42\ The Role of Supply, Demand and Financial Commodity Markets in the Natural Gas Price Spiral, available at www.ago.mo.gov/pdf/NaturalGasReport.pdf.--------------------------------------------------------------------------- The Industrial Energy Consumers of America wrote a January 2005 letter to the Securities and Exchange Commission ``alarmed at the significant increase in unregulated hedge funds trading on the NYMEX and OTC natural-gas markets.'' \43\ In November 2004 the group wrote Congress, asking them to ``increase energy market oversight by the Commodity Futures Trading Commission.'' \44\--------------------------------------------------------------------------- \43\ www.ieca-us.com/downloads/natgas/SECletter013105.doc. \44\ www.ieca-us.com/downloads/natgas/111704LettertoCongr%23AAC2.doc.--------------------------------------------------------------------------- While most industry analysts agree that the rise in speculation is fueling higher prices, there is one notable outlier: the Federal Government. In a widely dismissed report, the CFTC recently concluded that there was ``no evidence of a link between price changes and MMT [managed money trader] positions'' in the natural gas markets and ``a significantly negative relationship between MMT positions and prices changes . . . in the crude oil market.'' \45\--------------------------------------------------------------------------- \45\ Michael S. Haigh, Jana Hranaiova and James A. Overdahl, ``Price Dynamics, Price Discovery and Large Futures Trader Interactions in the Energy Complex,'' available at www.cftc.gov/files/opa/press05/opacftc-managed-money-trader-study.pdf.--------------------------------------------------------------------------- The CFTC study (and similar one performed by NYMEX) is flawed for numerous reasons, including the fact that the role of hedge funds and other speculators on long-term trading was not included in the analysis. The New York Times reported that ``many traders have scoffed at the studies, saying that they focused only on certain months, missing price run-ups.'' \46\--------------------------------------------------------------------------- \46\ Alexei Barrionuevo and Simon Romero, ``Energy Trading, Without a Certain `E','' January 15, 2006.---------------------------------------------------------------------------Latest Trading Trick: Energy Infrastructure Affiliate Abuses Energy traders like Goldman Sachs are investing and acquiring energy infrastructure assets because controlling pipelines and storage facilities affords their energy trading affiliates an ``insider's peek'' into the physical movements of energy products unavailable to other energy traders. Armed with this non-public data, a company like Goldman Sachs most certainly will open lines of communication between the affiliates operating pipelines and the affiliates making large bets on energy futures markets. Without strong firewalls prohibiting such communications, consumers would be susceptible to price-gouging by energy trading affiliates. For example, In January 2007, Highbridge Capital Management, a hedge fund controlled by J.P.Morgan Chase, bought a stake in an energy unit of Louis Dreyfus Group to expand its oil and natural gas trading. Glenn Dubin, co-founder of Highbridge, said that owning physical energy assets like pipelines and storage facilities was crucial to investing in the business: ``That gives you a very important information advantage. You're not just screen-trading financial products.'' \47\--------------------------------------------------------------------------- \47\ Saijel Kishan and Jenny Strasburg, ``Highbridge Capital Buys Stake in Louis Dreyfus Unit,'' Bloomberg, January 8, 2007, www.bloomberg.com/apps/news?pid=20601014&sid=aBnQy1botdFo. --------------------------------------------------------------------------- Indeed, such an ``information advantage'' played a key role in allowing BP's energy traders to manipulate the entire U.S. propane market. In October 2007, the company paid $303 million to settle allegations that the company's energy trading affiliate used the company's huge control over transportation and storage to allow the energy trading affiliate to exploit information about energy moving through BP's infrastructure to manipulate the market. BP's energy trading division, North America Gas & Power (NAGP), was actively communicating with the company's Natural Gas Liquids Business Unit (NGLBU), which handled the physical production, pipeline transportation and retail sales of propane. A PowerPoint exhibit to the civil complaint against BP details how the two divisions coordinated their manipulation strategy, which includes ``assurance that [the] trading team has access to all information and optionality within [all ofBP] . . . that can be used to increase chance of success [of market manipulation] . . . Implement weekly meetings with Marketing & Logistics to review trading positions and share opportunities.'' \48\--------------------------------------------------------------------------- \48\ www.cftc.gov/files/enf/06orders/opa-bp-lessons-learned.pdf.--------------------------------------------------------------------------- And in August 2007, BP acknowledged that the Federal Government was investigating similar gaming techniques in the crude oil markets. BP is not alone. A Morgan Stanley energy trader, Olav Refvik, ``a key part of one of the most profitable energy-trading operations in the world . . . helped the bank dominate the heating oil market by locking up New Jersey storage tank farms adjacent to New York Harbor.'' \49\ As of November 2008, Morgan Stanley committed $452 million to lease petroleum storage facilities for 2009. As the company notes: ``In connection with its commodities business, the Company enters into operating leases for both crude oil and refined products storage and for vessel charters. These operating leases are integral parts of the Company's commodities risk management business.'' \50\ In 2003, Morgan Stanley teamed up with Apache Corp. to buy 26 oil and gas fields from Shell for $500 million, of which Morgan Stanley put up $300 million in exchange for a portion of the production over the next 4 years, which it used to supplement its energy trading desk.\51\ Again, control over physical infrastructure assets plays a key role in helping energy traders game the market.--------------------------------------------------------------------------- \49\ http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_senate_committee_prints&docid=f:28640.pdf, page 26. \50\ http://idea.sec.gov/Archives/edgar/data/895421/000119312509013429/d10k.htm. \51\ Paul Merolli, ``Two Morgan Stanley M&A deals show bullish stance on gas,'' Natural Gas Week, Volume 19; Issue 28, July 14, 2003.--------------------------------------------------------------------------- The Wall Street Journal suggested that the bankruptcy of a single firm, SemGroup, served as the initial trigger of crude oil's price collapse this summer. The company operated 1,200 miles of oil pipelines and held 15 million barrels of crude storage capacity, but was misleading regulators and its own investors on the extent of its hedging practices. Data suggests that SemGroup was taking out positions far in excess of its physical delivery commitments, becoming a pure speculator. When its bets turned sour, the company was forced to declare bankruptcy.\52\--------------------------------------------------------------------------- \52\ Brian Baskin, ``SemGroup Loses Bets on Oil; Hedging Tactics Coincide With Ebb In Price of Crude,'' July 24, 2008, Page C14.--------------------------------------------------------------------------- This shows that the energy traders were actively engaging the physical infrastructure affiliates in an effort to glean information helpful for market manipulation strategies. And it is important to note that BP's market manipulation strategy was extremely aggressive and blatant, and regulators were tipped off to it by an internal whistleblower. A more subtle manipulation effort could easily evade detection by Federal regulators, making it all the more important to establish firewalls between energy assets affiliates and energy trading affiliates to prevent any undue communication between the units. Financial firms like hedge funds and investment banks that normally wouldn't bother purchasing low-profit investments like oil and gasoline storage have been snapping up ownership and/or leasing rights to these facilities mainly for the wealth of information that controlling energy infrastructure assets provides to help one's energy traders manipulate trading markets. The Wall Street Journal reported that financial speculators were snapping up leasing rights in Cushing, Ok.\53\--------------------------------------------------------------------------- \53\ Ann Davis, ``Where Has All The Oil Gone?'' October 6, 2007, Page A1.--------------------------------------------------------------------------- In August 2006, Goldman Sachs, AIG and Carlyle/Riverstone announced the $22 billion acquisition of Kinder Morgan, Inc., which controls 43,000 miles of crude oil, refined products and natural gas pipelines, in addition to 150 storage terminals. Prior to this huge purchase, Goldman Sachs had already assembled a long list of oil and gas investments. In 2005, Goldman Sachs and private equity firm Kelso & Co. bought a 112,000 barrels/day oil refinery in Kansas operated by CVR Energy, and entered into an oil supply agreement with J. Aron, Goldman`s energy trading subsidiary. Goldman's Scott L. Lebovitz & Kenneth A. Pontarelli and Kelso's George E. Matelich & Stanley de J. Osborne all serve on CVR Energy's Board of Directors. In May 2004, Goldman spent $413 million to acquire royalty rights to more than 1,600 natural gas wells in Pennsylvania, West Virginia, Texas, Oklahoma and offshore Louisiana from Dominion Resources. Goldman Sachs owns a six percent stake in the 375 mile Iroquois natural gas pipeline, which runs from Northern New York through Connecticut to Long Island. In December 2005, Goldman and Carlyle/Riverstone together are investing $500 million in Cobalt International Energy, a new oil exploration firm run by former Unocal executives.Conclusion This era of high energy prices isn't a simple case of supply and demand, as the evidence suggests that weak or non-existent regulatory oversight of energy trading markets provides opportunity for energy companies and financial institutions to price-gouge Americans. Forcing consumers suffering from inelastic demand to continue to pay high prices--in part fueled by uncompetitive actions--not only hurts consumers economically, but environmentally as well, as the oil companies and energy traders enjoying record profits are not investing those earnings into sustainable energy or alternatives to our addiction to oil. Reforms to strengthen regulatory oversight over America's energy trading markets are needed to restore true competition to America's oil and gas markets.Solutions Re-regulate energy trading markets by subjecting OTC exchanges--including foreign-based exchanges trading U.S. energy products--to full compliance under the Commodity Exchange Act and mandate that all OTC energy trades adhere to the CFTC's Large Trader reporting requirements. In addition, regulations must be strengthened over existing lightly- regulated exchanges like NYMEX. Impose legally-binding firewalls to limit energy traders from speculating on information gleaned from the company's energy infrastructure affiliates or other such insider information, while at the same time allowing legitimate hedging operations. Congress must authorize the FTC and DOJ to place greater emphasis on evaluating anti-competitive practices that arise out of the nexus between control over hard assets like energy infrastructure and a firm's energy trading operations. Incorporating energy trading operations into anti-trust analysis must become standard practice for Federal regulatory and enforcement agencies to force more divestiture of assets in order to protect consumers from abuses. Raise margin requirements so market participants will have to put up more of their own capital in order to trade energy contracts, and impose aggregate position limits on noncommercial trading to reduce speculation. Currently, margin requirements are too low, which encourages speculators to more easily enter the market by borrowing, or leveraging, against their positions. And aggregated limits over all markets--not just select ones--would preclude an energy trader from dipping their hands in multiple futures market cookie jars with the intent to speculate. " fcic_final_report_full--151 CDOs, and leverage, Cioffi’s funds earned healthy returns for a time: the High-Grade fund had returns of  in ,  in , and  in  after fees.  Cioffi and Tannin made millions before the hedge funds collapsed in . Cioffi was rewarded with total compensation worth more than  million from  to . In , the year the two hedge funds filed for bankruptcy, Cioffi made more than . mil- lion in total compensation. Matt Tannin, his lead manager, was awarded compensa- tion of more than . million from  to .  Both managers invested some of their own money in the funds, and used this as a selling point when pitching the funds to others.  But when house prices fell and investors started to question the value of mort- gage-backed securities in , the same short-term leverage that had inflated Cioffi’s returns would amplify losses and quickly put his two hedge funds out of business. CITIGROUP ’S LIQUIDITY PUTS: “A POTENTIAL CONFLICT OF INTEREST ” By the middle of the decade, Citigroup was a market leader in selling CDOs, often using its depositor-based commercial bank to provide liquidity support. For much of this period, the company was in various types of trouble with its regulators, and then-CEO Charles Prince told the FCIC that dealing with those troubles took up more than half his time.  After paying the  million fine related to subprime mort- gage lending, Citigroup again got into trouble, charged with helping Enron—before that company filed for bankruptcy in —use structured finance transactions to manipulate its financial statements. In July , Citigroup agreed to pay the SEC  million to settle these allegations and also agreed, under formal enforcement actions by the Federal Reserve and Office of the Comptroller of the Currency, to overhaul its risk management practices.  By March , the Fed had seen enough: it banned Citigroup from making any more major acquisitions until it improved its governance and legal compliance. Ac- cording to Prince, he had already decided to turn “the company’s focus from an ac- quisition-driven strategy to more of a balanced strategy involving organic growth.”  Robert Rubin, a former treasury secretary and former Goldman Sachs co-CEO who was at that time chairman of the Executive Committee of Citigroup’s board of direc- tors, recommended that Citigroup increase its risk taking—assuming, he told the FCIC, that the firm managed those risks properly.  Citigroup’s investment bank subsidiary was a natural area for growth after the Fed and then Congress had done away with restrictions on activities that could be pur- sued by investment banks affiliated with commercial banks. One opportunity among many was the CDO business, which was just then taking off amid the booming mort- gage market. In , Citi’s CDO desk was a tiny unit in the company’s investment banking arm, “eight guys and a Bloomberg” terminal, in the words of Nestor Dominguez, then co-head of the desk.  Nevertheless, this tiny operation under the command of FOMC20080625meeting--84 82,MS. PIANALTO.," Thank you, Mr. Chairman. The last two months have brought an interesting shift in my conversations with my business contacts. Their concerns have shifted from problems in financial markets to the rapid increase in input prices. Energy prices are the focus nationwide, but steel prices are also capturing the attention of the business people in my District. Several manufacturers and builders noted that the price they pay for steel has almost doubled since the beginning of this year. Clearly, businesses are worried about signs of growing price pressures, but their reactions to these price shocks tell a more complicated story. Many manufacturers have not been able to pass on price increases, resulting in a clear loss to profit margins. These businesses often report cost-containment or efficiency programs that will affect their hiring and capital decisions for months to come. Interestingly, the consumer price data show a similar dichotomy. My staff noted that our primary measures of core inflation are not providing a consistent story about the path of underlying inflation. In the May CPI report, roughly one-third of the weighted price changes increased at rates above 5 percent, and roughly one-third of prices changed by rates less than 1 percent. For example, while energy costs were up strongly and prices for a number of general service components have been drifting higher, large declines in apparel and vehicle expenses are imparting significant offsets. The 16 percent trimmed mean indicator showed an alarming 4 percent rise in prices, while the median rose just at 2.2 percent. The weight of price changes in the 1 percent to 5 percent range was unusually small, making it difficult to estimate the central tendency of the price change distribution with much confidence. So this makes it difficult to get a good read on where future prices are headed. My District business contacts remain pessimistic about growth prospects. District retail reports focused extensively on the likely effects of gasoline and food prices on the purchasing decisions of consumers. Many manufacturers, builders, and distributors are facing complicated output and investment decisions in the context of input price growth and weaker markets. Overall, most of the business people that I talk with are still quite cautious about their business plans, despite the fact that most of them have found sources of credit and terms that are not too elevated from what they have seen in previous years. In the economic projections that I submitted for this meeting, I raised my near-term forecast for output growth slightly and for headline inflation slightly more. Over the medium term, my outlook continues to be for modest growth because the housing market, in my forecast, recovers slowly, actually more slowly than in the Greenbook. My staff estimated a model for national housing starts that takes into account what has happened in the past in states that have seen major increases in foreclosures. The real estate difficulties that these states faced were much more persistent than anything that we have yet seen in the national data. The bottom line of this analysis is that, if the patterns of past housing cycles from the states that experienced the boom�bust cycles are repeated at the national level, then housing starts should remain relatively weak over the next couple of years. Supporting this analysis, three of the large regional banking organizations in my District are increasing their loan-loss provisions significantly in the second quarter based on the continued deterioration in the housing sector. Based on current projections, these institutions are projecting housing sector credit losses to accelerate in the second half of 2008 and to continue into 2009. Currently, the weak output growth contributes to my forecast of declining inflation rates, especially the core rate, but I also see evidence supporting that view in the ""less worker bargaining power"" scenario that is in the Greenbook. My contacts see very little price pressures coming from labor costs now or in the near future. Finally, implicit in my forecast for output growth and inflation is a fed funds rate path that includes increases later this year and into next year. Although additional risks to growth remain, the primary risk to my forecast concerns input prices and inflation expectations. If commodity prices continue to accelerate, they are going to put upward pressure on both headline and core inflation and downward pressure on output. That environment could lead to a highly undesirable increase in inflation expectations. On the positive side of risk to the outlook, I think that the fed funds rate actions that we have taken, in conjunction with the actions that we took in August to bolster market liquidity, have improved confidence, and I have substantially lowered the odds I had placed on financial market meltdown and on a severe recession. In that sense, since our meeting in April the downside risks to my outlook for economic growth have lessened somewhat, and the risks to my inflation outlook have moved up somewhat. Regarding the issue of providing longer-term forecasts, I have long supported efforts to clarify the underlying objectives of FOMC participants by providing our longer-term economic projections. Of the proposals that were offered by the Subcommittee on Communications, I favor reporting the average values for output growth, unemployment, and total inflation expected over a five-to-ten-year period--option 3. The features of these five-to-ten-year projections that I find attractive are that they indicate where the economy might converge and don't imply too much knowledge of the path to the long run. Thank you, Mr. Chairman. " FOMC20081007confcall--81 79,MS. DANKER.," Yes. The vote will encompass both the directive and the policy statement that were distributed earlier today, with the exception of the final sentence in the second paragraph of the draft policy statement, which says, ""Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation."" Chairman Bernanke Vice Chairman Geithner Governor Duke President Fisher Governor Kohn Governor Kroszner President Pianalto President Plosser President Stern Governor Warsh Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes " fcic_final_report_full--23 Many people chose poorly. Some people wanted to live beyond their means, and by mid-, nearly one-quarter of all borrowers nationwide were taking out interest- only loans that allowed them to defer the payment of principal.  Some borrowers opted for nontraditional mortgages because that was the only way they could get a foothold in areas such as the sky-high California housing market.  Some speculators saw the chance to snatch up investment properties and flip them for profit—and Florida and Georgia became a particular target for investors who used these loans to acquire real estate.  Some were misled by salespeople who came to their homes and persuaded them to sign loan documents on their kitchen tables. Some borrowers naively trusted mortgage brokers who earned more money placing them in risky loans than in safe ones.  With these loans, buyers were able to bid up the prices of houses even if they didn’t have enough income to qualify for traditional loans. Some of these exotic loans had existed in the past, used by high-income, finan- cially secure people as a cash-management tool. Some had been targeted to borrow- ers with impaired credit, offering them the opportunity to build a stronger payment history before they refinanced. But the instruments began to deluge the larger market in  and . The changed occurred “almost overnight,” Faith Schwartz, then an executive at the subprime lender Option One and later the executive director of Hope Now, a lending-industry foreclosure relief group, told the Federal Reserve’s Con- sumer Advisory Council. “I would suggest most every lender in the country is in it, one way or another.”  At first not a lot of people really understood the potential hazards of these new loans. They were new, they were different, and the consequences were uncertain. But it soon became apparent that what had looked like newfound wealth was a mirage based on borrowed money. Overall mortgage indebtedness in the United States climbed from . trillion in  to . trillion in . The mortgage debt of American households rose almost as much in the six years from  to  as it had over the course of the country’s more than -year history. The amount of mortgage debt per household rose from , in  to , in .  With a simple flourish of a pen on paper, millions of Americans traded away decades of eq- uity tucked away in their homes. Under the radar, the lending and the financial services industry had mutated. In the past, lenders had avoided making unsound loans because they would be stuck with them in their loan portfolios. But because of the growth of securitization, it wasn’t even clear anymore who the lender was. The mortgages would be packaged, sliced, repackaged, insured, and sold as incomprehensibly complicated debt securities to an assortment of hungry investors. Now even the worst loans could find a buyer. More loan sales meant higher profits for everyone in the chain. Business boomed for Christopher Cruise, a Maryland-based corporate educator who trained loan offi- cers for companies that were expanding mortgage originations. He crisscrossed the nation, coaching about , loan originators a year in auditoriums and classrooms. CHRG-111hhrg51698--269 Mr. Boswell," Thank you, Mr. Chairman. I had to step out. I apologize. If this has been asked, just stop me. But, to Mr. Roth, I guess we will get better acquainted as I take on the new responsibility with commodities and risk management that the Chairman has seen so fit to give me, but we will talk more as time goes on. But I am concerned. There is a lot of blame for hastening the downward spiral for the naked credit default swaps. Would you just comment some more on that? That is done through, some say, bad actors; to short a company and then drive the company down by sending market signs through the CDS market, decreases the company's ability to borrow or raise capital, while other companies require higher margin capital requirements. How would you propose Congress weighs a systemic risk to the market without lending legitimate risk mitigation strategy? " CHRG-111shrg55117--132 RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM BEN S. BERNANKEQ.1. Back in March, Secretary Geithner, who was FOMC Vice-Chair under you and Chairman Greenspan, said he now thinks easy money policies by central banks were a cause of the housing bubble and financial crisis. Do you agree with him?A.1. I do not believe that money policies by central banks in advanced economies were a significant cause of the recent boom and bust in the U.S. housing sector and the associated financial crisis. The accommodative stance of monetary policy in the United States was necessary and appropriate to address the economic weakness and deflationary pressures earlier in this decade. As I have noted previously, I believe that an important part of the crisis was caused by global saving imbalances. Those global saving imbalances increased the availability of credit to the U.S. housing sector and to other sectors of the U.S. economy, leading to a boom in housing construction and an associated credit boom. The role of global savings imbalances in the credit and housing boom and bust was amplified by a number of other factors, including inadequate mortgage underwriting, inadequate risk management practices by investors, regulatory loopholes that allowed some key financial institutions to assume very large risk positions without adequate supervision, and inaccurate assessments of risks by credit ratings agencies.Q.2. You said you think you can stop the expansion of the money supply from being inflationary. Does that mean you think the expansion of the money supply is permanent?A.2. Broad measures of the money supply, such as M2, have not grown particularly rapidly over the course of the financial crisis. By contrast, narrower measures, such as the monetary base, have grown significantly more rapidly. That growth can be attributed to the rapid expansion of bank reserves that has resulted from the liquidity programs that the Federal Reserve has implemented in order to stabilize financial markets and support economic activity. Nearly all of the increase in reserve is excess reserves--that is, reserves held by banks in addition to the level that they must hold to meet their reserve requirements. As long as banks are willing to hold those excess reserves, they will not contribute to more rapid expansion of the money supply. Moreover, as the Federal Reserve's acquisition of assets slows, growth of reserves will also slow. When economic conditions improve sufficiently, the Federal Reserve will begin to normalize the stance of monetary policy; those actions will involve a reduction in the quantity of excess reserves and an increase in short-term market rates, which will likely result in a reduction in some narrow measures of the money supply, such as the monetary base, and will keep the growth of the broad money aggregates to rates consistent with sustainable growth and price stability. As a result of appropriate monetary policy actions, the above-trend expansion of narrow measures of money supply will not be permanent and will not lead to inflation pressures.Q.3. Do you think a permanent expansion of the money supply, even if done in a noninflationary matter, is monetization of Federal debt?A.3. As noted above, growth of broad measures of the money supply, such as M2, has not been particularly rapid, and any above-trend growth of the money stock will not be permanent. Monetization of the debt generally is taken to mean a purchase of Government debt for the purpose of making deficit finance possible or to reduce the cost of Government finance. The Federal Reserve's liquidity programs, including its purchases of Treasury securities, were not designed for such purposes; indeed, it is worth noting that even with the expansion of the Federal Reserve's balance sheet, the Federal Reserve's holdings of Treasury securities are lower now than in 2007 before the onset of the crisis. The Federal Reserve's liquidity programs are intended to support growth of private spending and thus overall economic activity by fostering the extension of credit to households and firms.Q.4. Do you believe forward-looking signs like the dollar, commodity prices, and bond yields are the best signs of coming inflation?A.4. We use a variety of indicators, including those that you mention, to help gauge the likely direction of inflation. A rise in commodity prices can add to firms' costs and so create pressure for higher prices; this is especially the case for energy prices, which are an important component of costs for firms in a wide variety of industries. Similarly, a fall in the value of the dollar exerts upward pressure on prices of both imported goods and the domestic goods that compete with them. A central element in the dynamics of inflation, however, is the role played by inflation expectations. Even if firms were to pass higher costs from commodity prices or changes in the exchange rate into domestic prices, unless any such price increases become built into expectations of inflation and so into future wage and price decisions, those price increases would likely be a one-time event rather than the start of a higher ongoing rate of inflation. In this regard, it should be noted that survey measures of long-run inflation expectations have thus far remained relatively stable, pointing to neither a rise in inflation nor a decline in inflation to unwanted levels. A rise in bond yields--the third indicator you mention--could itself be evidence of an upward movement in expected inflation. More specifically, a rise in yields on nominal Treasury securities that is not matched by a rise in yields on inflation-indexed securities (TIPS) could reflect higher expected inflation. Indeed, such movements in yields have occurred so far this year. However, the rise in nominal Treasury yields started from an exceptionally low level that likely reflected heightened demand for the liquidity of these securities and other special factors associated with the functioning of Treasury markets. Those factors influencing nominal Treasury yields have made it particularly difficult recently to draw inferences about expected inflation from the TIPS market. The FOMC will remain alert to these and other indicators of inflation as we gauge our future policy actions in pursuit of our dual mandate at maximum employment and price stability.Q.5.a. Other central banks that pay interest on reserves set their policy rate using that tool. Now that you have the power to pay interest on excess reserves, are you going to change the method of setting the target rate?A.5.a. At least for the foreseeable future, the Federal Reserve expects to continue to set a target (or a target range) for the Federal funds rate as part of its procedures for conducting monetary policy. The authority to pay interest on reserves gives the Federal Reserve an additional tool for hitting its target and thus affords the Federal Reserve the ability to modify its operating procedures in ways that could make the implementation of policy more efficient and effective. Also, the Federal Reserve is in the process of designing various tools for reserve management that could be helpful in the removal of policy accommodation at the appropriate time and that use the authority to pay interest on reserves. However, the Federal Reserve has made no decisions at this time on possible changes to its framework for monetary policy implementation.Q.5.b. Assuming you were to make such a change, would that lead to a permanent expansion of the money supply?A.5.b. No. These tools are designed to implement monetary policy more efficiently and effectively. Their use would have no significant effect on broad measures of the money supply. It is possible that such a change could involve a permanently higher level of reserves in the banking system. However, the level of reserves under any such regime would still likely be much lower than at present and, in any case, would be fully consistent with banks' demand for reserves at the FOMC's target rate. As a result, the higher level of reserves in such a system would not have any implication for broad measures of money.Q.5.c. Would such an expansion essentially mean you have accomplished a one-time monetization of the Federal debt?A.5.c. No. If the Federal Reserve were to change its operating procedures in a way that involved a permanently higher level of banking system reserves, it is possible that the corresponding change on the asset side of the Federal Reserve's balance sheet would be a permanently higher level of Treasury securities, but the change could also be accounted for by a higher level of other assets--for example, repurchase agreements conducted with the private sector. The purpose of any permanent increase in the level of the Federal Reserve's holdings of Treasury securities would be to accommodate a higher level of reserves in the banking system rather than to facilitate the Treasury's debt management.Q.6. Is the Government's refusal to rescue CIT a sign that the bailouts are over and there is no more ``too-big-to-fail'' problem?A.6. The Federal Reserve does not comment on the condition of individual financial institutions such as CIT.Q.7. Do you plan to hold the Treasury and GSE securities on your books to maturity?A.7. The evolution of the economy, the financial system, and inflation pressures remain subject to considerable uncertainty. Reflecting this uncertainty, the way in which various monetary policy tools will be used in the future by the Federal Reserve has not yet been determined. In particular, the Federal Reserve has not developed specific plans for its holdings of Treasury and GSE securities.Q.8. Which 13(3) facilities do you think are monetary policy and not rescue programs?A.8. The Federal Reserve developed all of the facilities that are available to multiple institutions as a means of supporting the availability of credit to firms and households and thus buoying economic growth. Because supporting economic growth when the economy has been adversely affected by various types of shocks is a key function of monetary policy, all of the facilities that are available to multiple institutions can be considered part of the Federal Reserve's monetary policy response to the crisis. In contrast, the facilities that the Federal Reserve established for single and specific institutions would ordinarily not be considered part of monetary policy.Q.9. Given the central role the President of the New York Fed has played in all the bailout actions by the Fed, why shouldn't that job be subject to Senate confirmation in the future?A.9. Federal Reserve policy makers are highly accountable and answerable to the Government of the United States and to the American people. The seven members of the Board of Governors of the Federal Reserve System are appointed by the President and confirmed by the Senate after a thorough process of public examination. The key positions of Chairman and Vice Chairman are subject to presidential and congressional review every four years, a separate and shorter schedule than the 14-year terms of Board members. The members of the Board of Governors account for seven seats on the FOMC. By statute, the other five members of the FOMC are drawn from the presidents of the 12 Federal Reserve Banks. District presidents are appointed through a process involving a broad search of qualified individuals by local boards of directors; the choice must then be approved by the Board of Governors. In creating the Federal Reserve System, the Congress combined a Washington-based Board with strong regional representation to carefully balance the variety of interests of a diverse Nation. The Federal Reserve Banks strengthen our policy deliberations by bringing real-time information about the economy from their district contacts and by their diverse perspectives.Q.10. The current structure of the regional Federal Reserve Banks gives the banks that own the regional Feds governance powers, and thus regulatory powers over themselves. And with investment banks now under Fed regulation, it gives them power over their competitors. Don't you think that is conflict of interest that we should address?A.10. Congress established the makeup of the boards of directors of the Federal Reserve Banks. The potential for conflicts of interest that might arise from the ownership of the shares of a Federal Reserve Bank by banking organizations in that Bank's district are addressed in several statutory and policy provisions. Section 4 of the Federal Reserve Act provides that the board of directors of Reserve Banks ``shall administer the affairs of said bank fairly and impartially and without discrimination in favor of or against any member bank or banks.'' 12 U.S.C. 301. Reserve Bank directors are explicitly included among officials subject to the Federal conflict of interest statute, 18 U.S.C. 208. That statute imposes criminal penalties on Reserve Bank directors who participate personally and substantially as a director in any particular matter which, to the director's knowledge, will affect the director's financial interests or those of his or her spouse, minor children, or partner, or any firm or person of which the director is an officer, director, trustee, general partner, or employee, or any other firm or person with whom the director is negotiating for employment. Reserve Banks routinely provide training for their new directors that includes specific training on section 208, and Reserve Bank corporate secretaries are trained to respond to inquiries regarding possible conflicts in order to assist directors in complying with the statute. The Board also has adopted a policy specifically prohibiting Reserve Bank directors from, among other things, using their position for private gain or giving unwarranted preferential treatment to any organization. Reserve Bank directors are not permitted to be involved in matters relating to the supervision of particular banks or bank holding companies nor are they consulted regarding bank examination ratings, potential enforcement actions, or similar supervisory issues. In addition, while the Board of Governors' rules delegate to the Reserve Banks certain authorities for approval of specific types of applications and notices, Reserve Bank directors are not involved with oversight of those functions. Moreover, in order to avoid even the appearance of impropriety, the Board of Governors' delegation rules withdraw the Reserve Banks' authority where a senior officer or director of an involved party is also a director of a Reserve Bank or branch. Directors are also not involved in decisions regarding discount window lending to any financial institution. Finally, directors are not involved in awarding most contracts by the Reserve Banks. In the rare case where a contract requires director approval, directors who might have a conflict as a result of affiliation or stock ownership routinely recuse themselves or resign from the Reserve Bank board, and any involvement they would have in such a contract would be subject to the prohibitions in section 208 discussed above.Q.11. Do you think access to the discount window should be opened to nonbanks by Congress?A.11. The current episode has illustrated that nonbank financial institutions can occasionally experience severe liquidity needs that can pose significant systemic risks. In many cases, the Federal Reserve's 13(3) authority may be sufficient to address these situations, which should arise relatively infrequently. However, a case could be made that certain types of nonbank institutions, such as primary dealers, should have ongoing access to the discount window; any such increased access would need to be coupled with more stringent regulation and supervision. The Federal Reserve also believes that the smooth functioning of various types of regulated payment, clearing, and settlement utilities, some of which are organized as nonbanks, is critical to financial stability; a case could also be made that such organizations should be granted ongoing access to discount window credit.Q.12. Do you think any of the 13(3) facilities should be made permanent by Congress?A.12. As noted above, the issue of appropriate access to central bank credit by certain types of nonbank financial institutions deserves careful consideration by policy makers. The financial crisis has illustrated that various types of nonbank financial institutions can experience severe liquidity strains that pose risks to the entire financial system. However, whether access to the discount window should be granted to such institutions depends on a wide range of considerations and any decision would need to be based on careful study of all of the relevant issues.Q.13. For several reasons, I am doubtful that the Fed or anyone else can effectively regulate systemic risk. A better approach may be to limit the size and scope of firms so that future failures will not pose a danger to the system. Do you think that is a better way to go?A.13. I believe that it is important to improve the U.S. financial regulatory system so as to contain systemic risk and to address the related problem of ``too-big-to-fail'' financial institutions. The Federal Reserve and the Administration have proposed a number of ways to limit systemic risk and the problem of ``too-big-to-fail'' financial institutions. Imposing artificial limits on the size of scope of individual firms will not necessarily reduce systemic risk and could reduce competitiveness. A challenge of this approach would be to address the financial institutions that already are large and complex. Such institutions enjoy certain competitive benefits including global access to credit. At any point in time, the systemic importance of an individual firm depends on a wide range of factors. Size is only one relevant consideration. The impact of a firm's financial distress depends also on the degree to which it is interconnected, either receiving funding from, or providing funding to, other potentially systemically important firms, as well as on whether it performs crucial services that cannot easily or quickly be executed by other financial institutions. In addition, the impact varies over time: the more fragile the overall financial backdrop and the condition of other financial institutions, the more likely a given firm is to be judged systemically important. If the ability of the financial system to absorb adverse shocks is low, the threshold for systemic importance will more easily be reached. Judging whether a financial firm is systemically important is thus not a straightforward task, especially because a determination must be based on an assessment of whether the firm's failure would likely have systemic effects during a future stress event, the precise parameters of which cannot be fully known. I am confident that the Federal Reserve is well positioned both to identify systemically important firms and to supervise them. We look forward to working with Congress and the Administration to enact meaningful regulatory reform that will strengthen the financial system and reduce both the probability and severity of future crises.Q.14. Given your concerns about opening monetary policy to GAO review, what monetary policy information, specifically, do you not want in the hands of the public?A.14. The Federal Reserve believes that a substantial degree of transparency in monetary policymaking is appropriate and has initiated numerous measures to increase its transparency. In addition to a policy announcement made at the conclusion of each FOMC meeting, the Federal Reserve releases detailed minutes of each FOMC meeting 3 weeks after the conclusion of the meeting. These minutes provide a great deal of information about the range of topics discussed and the views of meeting participants at each FOMC meeting. Regarding its liquidity programs, the Federal Reserve has provided a great deal of information regarding these programs on its public Web site at http://www.federalreserve.gov/monetarypolicy/bst.htm. In addition, the Federal Reserve has initiated a monthly report to Congress providing detailed information on the operations of its programs, types, and amounts of collateral accepted, and quarterly updates on Federal Reserve income and valuations of the Maiden Lane facilities. This information is also available on the Web site at http://www.federalreserve.gov/monetarypolicy/bst_reportsresources.htm. The Federal Reserve believes that it should be as transparent as possible consistent with the effective conduct of the responsibilities with which it has been charged by the Congress. The Federal Reserve has noted its effectiveness in conducting monetary policy depends critically on the confidentiality of its policy deliberations. It has also noted that the effectiveness of its tools to provide liquidity to the financial system and the economy depends importantly on the willingness of banks and other entities in sound financial condition to use the Federal Reserve's credit facilities when appropriate. That willingness is supported by assuring borrowers that their usage of credit facilities will be treated as confidential by the Federal Reserve. As a result of these considerations, the Federal Reserve believes that the release of detailed information regarding monetary policy deliberations or the names of firms borrowing from Federal Reserve facilities would not be in the public interest. ------ CHRG-111hhrg63105--5 Mr. Moran," Mr. Chairman, thank you very much. I appreciate the friendship that you and I have encountered now for a long time in the House of Representatives, and I appreciate the leadership that you provide on this Subcommittee and our full House Agriculture Committee. The House Agriculture Committee has really been my home during my time as a Member of the House of Representatives, and this is a significant part of what I enjoy the most about serving in Congress. In regard to today's hearing, Mr. Chairman, I certainly believe that Congressional oversight is a good thing. And while I will not be here in the new year to chair this Subcommittee, I believe that my successor, and the incoming full Committee Chairman, Mr. Lucas, will readily exercise the House Agriculture Committee's oversight authority over the Commodity Futures Trading Commission. In regard to the topic of position limits under the Dodd-Frank Act, however, I believe it is premature to hold an oversight hearing, because the CFTC has yet to release a proposed rule. Thus we are left to hold a hearing based on hearsay, a few exchanges between CFTC's Commissioners during a hearing on another issue, and a speech and an opinion editorial released to the press by Commissioner Chilton. Having said that, I am concerned about where the Commission's position on position limits discussion is going. First, I would like to note that early on in the legislative process, both I as Ranking Member, and the Ranking Member, Mr. Lucas, of the full Committee, and other Members of the House Agriculture Committee, introduced amendments to place limits on the authority of the CFTC to impose position limits. During that debate, we were clear that the commodity futures market needed greater transparency, and we were in favor of creating mandatory reporting requirements. We were hesitant, however, to give the CFTC broader powers to impose position limits until we had adequate information about the over-the-counter markets. We felt that Congress needed to know who was trading on the OTC market, the size of the OTC market, and whether the OTC market was or was not having an adverse effect on exchange-traded markets before bestowing greater position limit authority on the Commission. Unfortunately, those amendments did not pass, and we now have a situation where a regulator may be contemplating imposing position limits without having access to the information necessary to determine the appropriate position limits, or to enforce such position limits once they are set. Despite what some believe is a mandate for the Commission to set position limits within a definite period of time, the Dodd-Frank legislation actually qualifies CFTC's position limit authority. Section 737 of the Dodd-Frank Act amends the Commodity Exchange Act so that section 4a(a)(2)(A) states: ``The Commission shall by rule . . . establish limits on the amount of positions as appro-priate . . . .'' The Act then states in subparagraph (B) for exempt commodities, the limit required under subparagraph (A) shall be established within 180 days after the date of enactment of this paragraph. When subparagraphs (A) and (B) are read in conjunction, the Act states that when position limits are required under subparagraph (A), the Commission shall set elements within 180 days under paragraph (B). Subparagraph (A) says the position limit rule should be only prescribed when appropriate. Therefore, the 180 day timetable is only triggered if position limits are appropriate. In regard to the word appropriate, the Commission has three distinct problems. First, the Commission has never made an affirmative finding that position limits are appropriate to curtail excessive speculation. In fact, to date the only reports issued by the Commission or its staff failed to identify a connection between market trends and excessive speculation. This is not to say that there is no connection, but it does say the Commission does not have enough information to draw an affirmative conclusion. The second and third issues related to the appropriateness of position limits are related to adequacy of information about OTC markets. On December 8, 2010, the Commission published a proposed rule on Swap data record-keeping and reporting requirements. This proposed rule is open for comment until February 7, 2011, and the rule is not expected to be final and effective until summer at the earliest. Furthermore, the Commission has yet to issue a proposed rulemaking about Swap data repositories. Until a Swap data repository is set up and running, it is difficult to see how it would be appropriate for the Commission to set position limits. Without additional information about trades in the OTC market, the Commission could neither have enough information to adequately determine the appropriate position limits, or have the information necessary to enforce position limits, assuming the appropriate formula could be determined without full access to OTC market information. In conclusion, I would again caution that my remarks are based on hearsay and not on an actual proposed rule. It is hard to be critical of something that does not yet exist. I hope that Chairman Gensler in his testimony today will inform the Subcommittee that the Commission is aware of the challenges surrounding the current imposition of position limits, and that the Commission hearing tomorrow will not consider enacting position limits before adequate information is obtained. I would also caution the Chairman and the other Commissioners, however, that if the Commission moves forward with a proposed position limit rule before information from the OTC markets are made available, they should be prepared for more hearings on this topic next year. Mr. Chairman, that is a longer opening statement than my usual, which suggests I am leaving the House of Representatives for someplace else. But I am grateful for the opportunity to express my opinion today. I am delighted to be with you, and I thank you, Mr. Chairman, for recognizing me, and I look forward to our continued close working relationship. [The prepared statement of Mr. Moran follows:] Prepared Statement of Hon. Jerry Moran, a Representative in Congress from Kansas Thank you, Mr. Chairman. I believe Congressional oversight is a good thing. While I will not be here to chair this Subcommittee next year, I believe my successor, and the incoming full Committee Chairman, Mr. Lucas, will readily exercise the House Agriculture Committee's oversight authority over the Commodity Futures Trading Commission (CFTC). In regard to the topic of position limits under the Dodd-Frank Act, however, I believe it is premature to hold an oversight hearing because the CFTC has yet to release a proposed rule. Thus, we are left to hold a hearing based on hearsay, a few exchanges between CFTC Commissioners during a hearing on another issue, and a speech and opinion editorial released to the press by Commissioner Chilton. Having said that, I am concerned about where the Commission's position limit discussion is going. First, I would note that early on in the legislative process, both myself, Ranking Member Lucas, and other Members of the Agriculture Committee introduced amendments to place limits on the authority of the CFTC to impose position limits. During that debate, we were clear that the commodity futures markets needed greater transparency and we were in favor of creating mandatory reporting requirements. We were hesitant, however, to give CFTC broader powers to impose position limits until we had adequate information about the over-the-counter (OTC) markets. We felt the Congress needed to know who was trading in the OTC market, the size of the OTC market, and whether the OTC market was or was not having an adverse affect on exchange-traded markets before bestowing greater position limit authority on the Commission. Unfortunately, those amendments did not pass, and we now have a situation where a regulator may be contemplating imposing position limits without having access to the information necessary to determine the appropriate position limits or to enforce such position limits once they are set. Despite what some believe is a mandate for the Commission to set position limits within a definite time period, the Dodd-Frank legislation actually qualifies CFTC's position limit authority. Section 737 of the Dodd-Frank Act amends the Commodity Exchange Act (CEA) so that Section 4a(a)(2)(A) states: ``the Commission shall by rule . . . establish limits on the amount of positions, as appropriate . . . .'' The Act then states in subparagraph (B): ``For exempt commodities, the limits required under subparagraph (A) shall be established within 180 days after the date of the enactment of this paragraph.'' When subparagraphs (A) and (B) are read in conjunction, the Act states that when position limits are required under subparagraph (A), the Commission shall set the limits within 180 days under subparagraph (B). Subparagraph (A) says position limit rules should only be prescribed when ``appropriate.'' Therefore, the 180-day timetable is only triggered if position limits are appropriate. In regard to the word ``appropriate,'' the Commission has three distinct problems. First, the Commission has never made an affirmative finding that position limits are appropriate to curtail excessive speculation. In fact, to date, the only reports issued by the Commission or its staff fail to identify a connection between market trends and excessive speculation. This is not to say that there is no connection, but it does say the Commission does not have enough information to draw an affirmative conclusion. The second and third issues related to the appropriateness of position limits are related to adequacy of information about the OTC markets. On December 8, 2010, the Commission published a proposed rule on ``Swap Data Recordkeeping and Reporting Requirements.'' This proposed rule is open for comment until February 7, 2011, and the rule is not expected to be final and effective until this coming summer at the earliest. Furthermore, the Commission has yet to issue a proposed rulemaking about swap data repositories. Until a swap data repository is up and running, it is difficult to see how it would be appropriate for the Commission to set position limits. Without additional information about trades in the OTC market, the Commission could neither have enough information to adequately determine the appropriation position limit or have the information necessary to enforce position limits, assuming an appropriate formula could be determined without full access to OTC market information. To conclude, I would again caution that my remarks are based on hearsay and not an actual proposed rule. It is hard to be critical of something that does not yet exist. I hope that Chairman Gensler, in his testimony today, will inform the Subcommittee that the Commission is aware of the challenges surrounding the current imposition of position limits and at the Commission's hearing tomorrow, he will not consider enacting position limits before adequate information is known. I would caution the Chairman and other Commissioners, however, that if the Commission moves forward with a proposed position limit rule before information from the OTC markets are made available, they should be prepared for more hearings on this topic next year. Again, thank you for recognizing me Mr. Chairman and I look forward to the testimony of today's witnesses. " fcic_final_report_full--238 Overall, of the delinquent loans and loans in foreclosure sampled by Freddie,  were put back. In  and , Freddie put back significant loan volumes to the following lenders: Countrywide, . billion; Wells Fargo, . billion; Chase Home Financial, . billion; Bank of America,  million; and Ally Financial,  mil- lion.  Using a method similar to Freddie’s to test for loan eligibility, Fannie reviewed be- tween  and  of the mortgages originated since —sampling at the higher rates for delinquent loans. From  through , Fannie put back loans to the fol- lowing large lenders: Bank of America, . billion; Wells Fargo, . billion; JP Mor- gan Chase, . billion; Citigroup, . billion; SunTrust Bank,  million; and Ally Financial,  million.  In early January , Bank of America reached a deal with Fannie and Freddie, settling the GSEs’ claims with a payment of more than . billion.  Like Fannie and Freddie, private mortgage insurance (PMI) companies have been finding significant deficiencies in mortgages. They are refusing to pay claims on some insured mortgages that have gone into default. This insurance protects the holder of the mortgage if a homeowner defaults on a loan, even though the responsibility for the premiums generally lies with the homeowner. By the end of , PMI compa- nies had insured a total of  billion in potential mortgage losses.  As defaults and losses on the insured mortgages have been increasing, the PMI companies have seen a spike in claims. As of October , the seven largest PMI companies, which share  of the market, had rejected about  of the claims (or  billion of  billion) brought to them, because of violations of origination guidelines, improper employment and income reporting, and issues with property valuation.  Separate from their purchase and guarantee of mortgages, over the course of the housing boom the GSEs purchased  billion of subprime and Alt-A private-label securities.  The GSEs have recorded  billion in charges on securities from Janu- ary ,  to September , .  Frustrated with the lack of information from the securities’ servicers and trustees, in many cases large banks, on July , , the GSEs through their regulator, the Federal Housing Finance Agency, issued  sub- poenas to various trustees and servicers in transactions in which the GSEs lost money.  Where they find that the nonperforming loans in the pools have violations, the GSEs intend to demand that the trustees recognize their rights (including any rights to put loans back to the originator or wholesaler).  While this strategy being followed by the GSEs is based in contract law, other in- vestors are relying on securities law to file lawsuits, claiming that they were misled by inaccurate or incomplete prospectuses; and, in a number of cases, they are winning. As of mid-, court actions embroiled almost all major loan originators and underwriters—there were more than  lawsuits related to breaches of representa- tions and warranties, by one estimate.  These lawsuits filed in the wake of the finan- cial crisis include those alleging “untrue statements of material fact” or “material misrepresentations” in the registration statements and prospectuses provided to in- vestors who purchased securities. They generally allege violations of the Securities Exchange Act of  and the Securities Act of . CHRG-110hhrg41184--56 Mr. Neugebauer," Thank you, Mr. Chairman. I want to turn my attention a little bit. You mentioned in your testimony a little bit about the dollar and the fact it has increased our exports, because American goods are more competitive. But, at the same time, it swings the other way in the fact that it raises prices. It has an inflationary impact on the American consumer. I believe one of the reasons that oil is $100 a barrel today is because of our declining dollar. People settled oil in dollars and I think a lot of them have obviously just increased the price of the commodity. And so I really have two questions. One is, what do you believe the continuing decline of the dollar is? What kind of inflationary impact do you think that is going to have? And then secondly, as this dollar declines, one of the things that I begin to get concerned with is all of these people who have all of these dollars have taken a pretty big hickey over the last year or so and continue to do that. At what point in time do people say, you know, we want to trade in dollars and other currencies, and what implication do you think then that has on the capital markets in the United States? " FOMC20060629meeting--116 114,CHAIRMAN BERNANKE.," Thank you. If I could try your patience for a few more minutes at the end of a long afternoon, I’d like to summarize what I’ve heard today and then just add a few comments of my own. While I’m doing that, Brian, would you distribute table 1? Table 1 in the Bluebook shows the three alternative suggestions for the statement. Since the Bluebook, we have received some suggestions, and we’ve done some wordsmithing—we’ve actually responded to a few things we heard today. The general tone of the three statements is the same, but we wanted you to see where it was today, so that you could think about it overnight and so that it would help you for your discussion tomorrow. That’s going to be coming around. Let me just briefly summarize what I heard. Certainly, a central theme of the speakers today was the increase of uncertainty and risk in the environment. It’s getting more and more difficult to forecast, and there are certainly risks both to the upside and to the downside. The central tendencies with respect to output seem to be that output is slowing to something close to potential. Some felt growth would be stronger than the Greenbook suggested; others, like the Greenbook, thought it would be falling somewhat below potential. A few people saw downside risks from previous tightening. There was some disagreement on the extent to which financial conditions are supportive of the economy, and some disagreement on consumption, although there was a view that lower-income consumers were going to do worse than higher-income consumers. Housing is certainly slowing. Some took the view that it was slowing more or less as expected, whereas some thought the slowing was somewhat worse than expected—certainly that’s a source of downside risk. The view of the labor market is that it remains reasonably healthy, that it’s difficult to find skilled workers, but there are still few signs of wage pressures in the economy. The business-sector evaluations were much more upbeat, with ongoing expansion, good sentiment, and capital investment. Finally, there seems to be considerable unease about recent inflation developments. Everyone considered these recent developments to be unwelcome. Some felt that the recent increase in inflation might be temporary. Others saw it as more persistent. But there certainly was a sense that it’s a risk to the economy. Let me add just a few thoughts about the situation. The situation is, I think, exceptionally complicated because at least three different things are going on. First of all, there’s a cyclical transition from a period of above-trend growth to what we would hope would be a period of trend growth, the normal soft-landing problem. Second, we essentially have a supply shock. It’s not exactly a supply shock because it has complicated elements to it, but oil prices and commodity prices are rising significantly, and that is creating a worsened tradeoff. Third, we are having a housing cycle that has a certain autonomous component to it because it’s like any other asset-price correction taking place on its own schedule, so to speak, and it is interacting with the other two forces. So given these three things occurring at the same time, the situation is obviously very complicated. Now, the ideal situation would be for us to move to a steady, sustainable pace without inflation. Right now, the biggest risk to that steady pace seems to be the pickup that we’ve seen recently in inflation. The main point I want to make about inflation—many points have already been made—is that it really is quite broad-based. I think there are good reasons to downweight, to some extent, owners’ equivalent rent. It is arguably a cost of living; however, the effects of monetary policy on this kind of cost of living are somewhat ambiguous. So we could get ourselves into a bad situation if we focus on it too much. But having said that, if you slice, say, core PCE in any other way—if you look, for example, at core PCE prices excluding OER, at core goods, at core PCE services excluding OER, at market-based core PCE less OER, at any of these ways of slicing inflation—you get a similar pattern in terms of the three-month, six-month, and twelve-month averages, which suggests a broad-based acceleration and one that I think we should be concerned about. We should also note that the three-month total PCE inflation rate is 5.2, which is significant because it influences inflation expectations overall. Now, a concern that we all have—and many people expressed—is that we don’t fully understand why this sudden acceleration is taking place. Some of the possibilities are, first, the supply-shock increases of energy prices; second, the tight product markets; and third, changes in inflation psychology, perhaps related to headline inflation. I guess I would just raise the possibility that these three things are interacting. Perhaps with tighter product markets it’s easier to pass through your energy costs or your commodity costs. That pass-through interacts with higher inflation psychology, and there’s maybe a vicious cycle there. The thing we should be concerned about is whether those higher prices then lead to higher wage pressures in an inverse kind of spiral. So I do have concerns about inflation, although I don’t want to exaggerate. I think we’re still looking at numbers that are historically not extremely high. The other big issue is the housing cycle. I’m going to give us a bit of perspective. It is a good thing that housing is cooling. If we could wave a magic wand and reinsta