[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
TOO BIG TO FAIL: THE ROLE FOR BANKRUPTCY AND ANTITRUST LAW IN FINANCIAL
REGULATION REFORM (PART II)
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON COURTS AND
COMPETITION POLICY
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 17, 2009
__________
Serial No. 111-106
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Printed for the use of the Committee on the Judiciary
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Available via the World Wide Web: http://judiciary.house.gov
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COMMITTEE ON THE JUDICIARY
JOHN CONYERS, Jr., Michigan, Chairman
HOWARD L. BERMAN, California LAMAR SMITH, Texas
RICK BOUCHER, Virginia F. JAMES SENSENBRENNER, Jr.,
JERROLD NADLER, New York Wisconsin
ROBERT C. ``BOBBY'' SCOTT, Virginia HOWARD COBLE, North Carolina
MELVIN L. WATT, North Carolina ELTON GALLEGLY, California
ZOE LOFGREN, California BOB GOODLATTE, Virginia
SHEILA JACKSON LEE, Texas DANIEL E. LUNGREN, California
MAXINE WATERS, California DARRELL E. ISSA, California
WILLIAM D. DELAHUNT, Massachusetts J. RANDY FORBES, Virginia
ROBERT WEXLER, Florida STEVE KING, Iowa
STEVE COHEN, Tennessee TRENT FRANKS, Arizona
HENRY C. ``HANK'' JOHNSON, Jr., LOUIE GOHMERT, Texas
Georgia JIM JORDAN, Ohio
PEDRO PIERLUISI, Puerto Rico TED POE, Texas
MIKE QUIGLEY, Illinois JASON CHAFFETZ, Utah
JUDY CHU, California TOM ROONEY, Florida
LUIS V. GUTIERREZ, Illinois GREGG HARPER, Mississippi
TAMMY BALDWIN, Wisconsin
CHARLES A. GONZALEZ, Texas
ANTHONY D. WEINER, New York
ADAM B. SCHIFF, California
LINDA T. SANCHEZ, California
DEBBIE WASSERMAN SCHULTZ, Florida
DANIEL MAFFEI, New York
Perry Apelbaum, Majority Staff Director and Chief Counsel
Sean McLaughlin, Minority Chief of Staff and General Counsel
------
Subcommittee on Courts and Competition Policy
HENRY C. ``HANK'' JOHNSON, Jr., Georgia, Chairman
JOHN CONYERS, Jr., Michigan HOWARD COBLE, North Carolina
RICK BOUCHER, Virginia JASON CHAFFETZ, Utah
ROBERT WEXLER, Florida BOB GOODLATTE, Virginia
CHARLES A. GONZALEZ, Texas F. JAMES SENSENBRENNER, Jr.,
SHEILA JACKSON LEE, Texas Wisconsin
MELVIN L. WATT, North Carolina DARRELL ISSA, California
MIKE QUIGLEY, Illinois GREGG HARPER, Mississippi
DANIEL MAFFEI, New York
Christal Sheppard, Chief Counsel
Blaine Merritt, Minority Counsel
C O N T E N T S
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NOVEMBER 17, 2009
Page
OPENING STATEMENTS
The Honorable Henry C. ``Hank'' Johnson, Jr., a Representative in
Congress from the State of Georgia, and Chairman, Subcommittee
on Courts and Competition Policy............................... 1
The Honorable Howard Coble, a Representative in Congress from the
State of North Carolina, and Ranking Member, Subcommittee on
Courts and Competition Policy.................................. 2
The Honorable John Conyers, Jr., a Representative in Congress
from the State of Michigan, Chairman, Committee on the
Judiciary, and Ranking Member, Subcommittee on Courts and
Competition Policy............................................. 3
The Honorable Jason Chaffetz, a Representative in Congress from
the State of Utah, and Member, Subcommittee on Courts and
Competition Policy............................................. 6
WITNESSES
Mr. Christopher L. Sagers, Associate Professor of Law, Cleveland-
Marshall College of Law, Cleveland, OH
Oral Testimony................................................. 8
Prepared Statement............................................. 10
Mr. Edwin E. Smith, Bingham McCutchen, LLP, on behalf of the
National Bankruptcy Conference, Fairfax, VA
Oral Testimony................................................. 47
Prepared Statement............................................. 49
Mr. Michael A. Rosenthal, Gibson, Dunn & Crutcher, LLP, New York,
NY
Oral Testimony................................................. 58
Prepared Statement............................................. 60
Mr. Charles W. Calomiris, Henry Kaufman Professor of Financial
Institutions, Columbia Business School, New York, NY
Oral Testimony................................................. 105
Prepared Statement............................................. 108
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Prepared Statement of the Honorable John Conyers, Jr., a
Representative in Congress from the State of Michigan,
Chairman, Committee on the Judiciary, and Member, Subcommittee
on Courts and Competition Policy............................... 4
Prepared Statement of the Honorable Steve Cohen, a Representative
in Congress from the State of Tennessee, and Chairman,
Subcommittee on Commercial and Administrative Law.............. 7
Prepared Statement of the Honorable Lamar Smith, a Representative
in Congress from the State of Texas, and Ranking Member,
Committee on the Judiciary..................................... 123
TOO BIG TO FAIL: THE ROLE FOR BANKRUPTCY AND ANTITRUST LAW IN FINANCIAL
REGULATION REFORM (PART II)
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TUESDAY, NOVEMBER 17, 2009
House of Representatives,
Subcommittee on Courts and
Competition Policy
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to notice, at 1:02 p.m., in
room 2237, Rayburn House Office Building, the Honorable Henry
C. ``Hank'' Johnson, Jr. (Chairman of the Subcommittee)
presiding.
Present: Representatives Johnson, Conyers, Coble, Chaffetz,
and Goodlatte.
Staff present: (Majority) Christal Sheppard, Subcommittee
Chief Counsel; Anant Raut, Counsel; Elisabeth Stein, Counsel;
Rosalind Jackson, Professional Staff Member; and (Minority)
Stewart Jeffries, Counsel.
Mr. Johnson. This hearing on the Committee on the
Judiciary, Subcommittee on Courts and Competition Policy will
now come to order.
Without objection, the Chair is authorized to declare a
recess.
Today the Subcommittee holds its second hearing examining
the implications of companies that are ``Too big to Fail.''
During our first hearing in April, we asked two questions: Are
there such things as institutions that are too big to fail? And
if so, do they represent a failure of the antitrust laws?
At the time, our panel of experts concluded that yes, there
are companies whose size makes them systematically significant
in our economy. However, the antitrust laws don't need to be
changed on account of these companies.
If anything, these companies merit greater enforcement of
the antitrust laws that currently exist.
Our country remains in the grip of a grim economic
downturn. Since the collapse of Lehman Brothers in September of
2008, the unemployment rate in my home State of Georgia has
climbed from 6.6 percent to 10.2 percent today. The
metropolitan Atlanta area has lost more than 124,000 jobs
during that time.
Today we have before us several pieces of legislation
proposed by the Treasury to systematically unwind these large
companies once they are on the verge of failure.
The Administration points to the collapse of companies like
Lehman Brothers and warns that this new authority is vital to
preventing another big company from bringing down the economy
as it goes under.
I, for one, am skeptical. The legislation proposed by the
Treasury raises a number of troubling issues under this
Subcommittee's jurisdiction.
The resolution authority would, in some instances, sidestep
antitrust oversight entirely.
Decisions about which competitor gets a failing company's
assets could be made without the input of the antitrust
enforcement agencies, creating a new generation of too big to
fail companies requiring another multibillion-dollar bailout
down the road.
Courts which have traditionally played a pivotal role in
the normal bankruptcy process would also have their oversight
diminished.
Decisions about the distribution of assets could be made
without a judge watching over the process to make sure that the
shareholders and the general public are treated fairly.
In the wake of great crises, whether financial or national
security in nature, it is tempting for new Administrations to
dismiss existing law as inadequate and claim that new
approaches and new powers are necessary for a new kind of
threat.
But what we have learned is that agencies empowered with
emergency authority can't be solely responsible for determining
when and how it gets used. Checks and balances are a necessary
restraint on the powers granted by Congress.
I hope that our discussion today will help us better
understand what protections need to be built into this proposed
resolution authority to ensure that it is used sparingly and in
the best interests of the American public.
I now recognize my colleague Howard Coble, the
distinguished Ranking Member of the Subcommittee, for his
opening remarks.
Mr. Coble. I thank you, Mr. Chairman.
And good to have the panelists with us today.
Mr. Chairman, thank you for calling today's hearing, which
is the second that this Subcommittee has held on the role of
antitrust in correcting the current economic crisis.
Last April, you will recall we heard from former acting
assistant attorney general Deb Garza that antitrust laws did
not create the current economic crisis, and the antitrust
division was capable of conducting antitrust review of proposed
asset sales under the TARP plan. That is the Troubled Asset
Relief Program.
Last month I attended a Commercial and Administrative Law
Subcommittee hearing on the role of the bankruptcy law and
antitrust in resolving the existing financial crisis.
At that hearing, under direct questioning from Chairman
Conyers, representatives of the Treasury Department and the
Federal Deposit Insurance Commission told the Subcommittee that
the Administration's bill did not alter antitrust review of any
proposed sale of assets in a government takeover of a failing
financial entity.
However, it appears from a subsequent markup by the
Financial Services Committee and through written statements of
at least some of the witnesses here today that this proposal
does alter antitrust review.
So my question to all the witnesses is does this bill alter
antitrust review and, if so, how is it altered, and does it
protect consumers?
The proposed resolution authority that is before this
Congress does not change my mind about the wisdom or lack
thereof of governmental bailouts. The Constitution gives
Congress the authority to establish bankruptcy laws and
procedures, and in my estimation the bankruptcy system has many
more public checks and balances.
It is my understanding, Mr. Chairman that many of our
colleagues on the Financial Services Committee and on the
Judiciary Committee have suggested some changes to the
bankruptcy laws to address this kind of large-scale financial
crisis that we faced last year.
Personally, I am far more comfortable with that approach to
this issue, because it is non-biased. It is proven and
reliable. And it provides a solid foundation from which
businesses can recover.
In any event, I would like to thank you, Mr. Chairman, and
Chairman Johnson for protecting the Committee's jurisdiction
with respect to bankruptcy and antitrust laws.
These well-established laws have been the bulwark of
America's capitalist system and any financial services reform
should stem from their well-accepted principles.
And, Mr. Chairman, I am going to have to depart imminently
because I am scheduled to handle two bills on the floor, but
the distinguished gentleman from Utah has promised to stand in
for me, if that is okay. And I yield back.
Mr. Johnson. I thank the gentleman for his statement.
And I now recognize John Conyers, a distinguished Member of
the Subcommittee and also the Chairman of the Committee on
Judiciary.
Mr. Conyers. Thank you very much, Chairman Johnson.
And to my colleagues here, this is a hearing that is part
of the larger financial regulatory reform package that we have
jurisdiction over. That is, as I have explained, Title 7,
improvements to regulation of over-the-counter derivatives, and
Title 12, enhanced resolution authority.
And I am grateful for the four witnesses that are here.
Now, to me, our jurisdiction has been delineated. The
Chairman of Finance Committee, Chairman Frank, has assured us
that our determinations in these two titles will be adhered to.
At the same time, we have the larger issue, and I don't
know how we go about taking both of these things into
consideration. I think it is a mistake for us to think only
narrowly in terms of our two titles in the bill, because
ultimately we will all be collectively voting on the larger
bill.
And we have had hearings. I have two folders of hearings of
the Committee. Some have been in your Committee. I think one
has been in Chairman Cohen's Committee.
And we have circling overhead--and I would encourage the
witnesses to feel free to go beyond the titles that we have
actual jurisdiction. But I have got a notebook that tries to
lay out the larger positions on this financial regulatory
reform, which is coming now after more than a trillion dollars
has already been expended.
I mean, somebody needs to help me understand how we just
thought about regulatory reform and the horse is out of the
barn.
Now, Chris Dodd and Barney Frank have two seriously
different views about this thing. And Charles Schumer has yet
another position on this. And the gentleman, I think, from
Alabama, Shelby, has a position on this. The Nobel economist
Joseph Stiglitz has a very distinct view about this.
And so to me, Chairman Johnson and my colleagues, what
becomes important here is that we try to understand the
relationship between what is in our jurisdiction and what
everybody else is thinking and doing both in the other body and
in the House--the Finance Committee, the Committees on the--in
the Senate.
And of course, the Administration has its team that is sort
of omnipresent in this whole situation.
So I am going to submit an opening statement and look
forward to the testimony from our witnesses. Thank you.
[The prepared statement of Mr. Conyers follows:]
Prepared Statement of the Honorable John Conyers, Jr., a Representative
in Congress from the State of Michigan, Chairman, Committee on the
Judiciary, and Member, Subcommittee on Courts and Competition Policy
The financial regulatory reform package incubated in the Treasury
Department and hatched in the Financial Services Committee appears to
be in ailing health.
The effort to regulate financial derivatives, the complex and
highly speculative instruments at the heart of the meltdown last year,
and the effort to create a new Consumer Financial Protection Agency to
protect Americans from abusive, deceptive, and predatory lending, are
both being targeted by lobbyists intent on weakening them.
If the lobbyists succeed--and right now they appear to be gaining--
this important effort will be squandered, and the resulting legislation
won't be worth supporting.
Turning to the proposed new special resolution authority for the
FDIC to take over failing financial institutions that are so
interconnected to the wider financial system that their failure puts
the wider system at undue risk, there is another danger--that if we are
not careful, we will end up throwing some fundamental American values
overboard. We need to make sure that doesn't happen.
We must ensure that the rights of innocent citizens who get caught
up in the tangents of a giant financial institution's far-flung
activities are not cast aside, while favored interests are allowed to
jump to the head of the line and grab the lion's share.
We must preserve full-strength antitrust authority against
anticompetitive mergers, so we don't wake up with just a handful of
financial institutions that are even more gargantuan than the ones we
started with.
To ensure these values are protected, we can't just turn everything
over to a government liquidator and stand back.
We need to preserve the role of bankruptcy law in providing fair
treatment for all who have claims against the financial institution,
not just the favored few.
And we need to preserve the role of the antitrust laws, in all of
their vitality.
If extraordinary powers are needed to respond to a systemic
financial emergency, we should make sure that those powers are
triggered only when there truly is such an emergency. We should make
sure that those powers are limited in scope and duration--that they
displace the important American values reflected in the bankruptcy and
antitrust laws, if at all, only to the limited extent, and only for the
limited duration, that is necessary for responding effectively to the
emergency.
And we should make sure that any harm to those values that results
from the exercise of those powers should be reversible once the
emergency has subsided.
We need to keep in mind that this is not about bailing out Wall
Street.
It is not about helping the institutions that brought us this
crisis pay their brokers billions of dollars in new bonuses. It is not
about funneling money to those institutions as counterparties in
derivative contracts, as a just-released report by the TARP Inspector
General indicates Secretary Geithner was instrumental in doing last
year when he was head of the Federal Reserve Bank in New York.
It is not about excusing those institutions from giving struggling
homeowners a chance at reasonable mortgage terms that avoid needless
foreclosures.
I for one am not comforted by Goldman Sachs Chairman and CEO Lloyd
Blankfein's recent statement insisting that he is just a banker ``doing
God's work'' and that his mammoth company is fulfilling ``a social
purpose.''
Resurgent Wall Street profits and bonuses clearly are not trickling
down to Main Street, or Woodward Avenue.
In Detroit, the unemployment rate is nearly 28 percent. 195 homes
there are being taken into the foreclosure process each day. One in
three people in my district are at or below the poverty line.
Let's not forget the lessons of the Gramm-Leach-Bliley Act of 1999
and the Glass-Steagall Act of 1933. Ten years ago, Gramm-Leach-Bliley
repealed the firewall set up in Glass-Steagle between the casino on
Wall Street and the private investment engines of Main Street. The
repeal allowed for the creation of giant financial supermarkets that
could own investment banks, commercial banks, and insurance firms,
thereby clearing the way for consolidation into companies too big and
intertwined to fail.
It also led to deregulation that helped cause the current economic
crisis.
I support the efforts in the Financial Services Committee to build
the regulatory infrastructure needed to protect our economy against
ever again being held hostage to fears that irresponsible financial
giants are too big to fail.
Our job in the Judiciary Committee is to ensure that this is
accomplished in an effective and responsible manner that respects these
other important American values.
So I am pleased that the Courts and Competition Subcommittee is
continuing our examination into these issues. I hope our witnesses
today can shed light on three issues in the legislation to establish
special resolution authority for financial institutions that pose undue
systemic risk.
First, are there adequate antitrust safeguards? We don't want our
response to a financial crisis to lead to even larger and more
concentrated institutions, with less competition, and higher prices for
consumers.
FDIC Special Advisor for Policy Michael Krimminger's statement
before our Committee last month that ``in a systemic context, there can
be cases in which there is an override of the anti-competitive
consequences'' was troubling to those who care about our economic
freedoms.
Those considerations need to be carefully reconciled, not set
against each other. I hope our witnesses can address how to maintain
meaningful antitrust values under the new resolution mechanism.
Second, are there fair and balanced protections for those affected
by the insolvency?
The standard should be the protections set out carefully in our
Bankruptcy Code. Any departures from those Bankruptcy Code protections
should be few, and justified, and each carefully limited in scope and
duration to what is necessary to avert the systemic financial crisis.
The Financial Services Committee bill is modeled on the authority
given to the FDIC when a bank with FDIC-insured deposits fails.
But the powers and priorities that are appropriate when FDIC-
insured deposits are a dominant factor may not be appropriate when
there is a greater variety of competing claims and claimants--labor
contracts, pensions, and garden variety business debts, to name just a
few.
So while a receiver should have the power to act quickly to
conserve systemically critical assets and liabilities, that power
should be exercised in a manner that respects the rights of other
innocent parties.
I hope our witnesses today can address how to fairly protect these
rights in the context of the need for quick action in a financial
emergency, and create a measure of predictability that will enhance
stability.
Third, is there appropriate judicial review to guard against
arbitrary and unfair government action?
Under the Bankruptcy Code, it is a court that appoints a trustee to
act as conservator or liquidator, oversees the trustee, and ultimately
reviews and approves the process by which the business is reorganized
or liquidated and claims are resolved.
Under the Financial Services Committee bill, once the failure of
the business is deemed to be a systemic risk to the financial system,
the new conservator or receiver takes over.
Any bankruptcy proceedings are abruptly terminated, and new
bankruptcy proceedings are precluded.
Instead of an open process, under uniform rules, with direct court
oversight, we have an opaque process, under procedures that give the
conservator or receiver broad discretion.
I hope our witnesses can address how to make the resolution process
more transparent and predictable, under appropriate judicial review.
Clearly, the status quo, where too-big-to-fail institutions have
privatized gains and received taxpayer-subsidized losses, is not
acceptable.
We need a workable mechanism to allow large, complex,
interconnected, global financial companies to fail when they should,
while managing the ripple effects.
But we need to ensure that due process, fairness, transparency, and
pro-competition principles are core ingredients of that mechanism.
I commend the collaboration between Courts and Competition Policy
Subcommittee Chairman Hank Johnson and Commercial and Administrative
Law Subcommittee Chairman Steve Cohen in putting together this third in
a series of important and thought-provoking hearings on the too-big-to-
fail issue, and I look forward to the testimony.
__________
Mr. Johnson. Thank you, Mr. Chairman.
I now recognize the gentleman from Utah, Mr. Chaffetz, for
his statement.
Mr. Chaffetz. Well, thank you. Thank you, Mr. Chairman.
And thank you, Chairman Conyers and Ranking Member Coble.
And I appreciate the witnesses being here today. This is a
very, very important subject and topic. I want to do more
hearing than making a statement.
I just wish to wholeheartedly support the verbal comments
Chairman Conyers made and some of the deep concerns about the
various approaches to this.
I, too, have some concerns I would appreciate being
addressed and I am sure you share many of these as well. I want
to make sure we are staying within the constitutional duties
and bounds that we are--have been given in our Constitution.
I worry about our troubled firms getting even bigger. You
know, one of the amazing statistics through all this is we talk
about too big to fail--is if you actually go back and analyze
these firms, we have less firms and they are even bigger than
ever, and so have--through our public policy actually made the
situation more vulnerable as opposed to actually solving it.
Obviously, we want to ensure the American people that we
are doing--be good stewards of their money. I have serious
troubles and concerns with the TARP, and the bailouts, and the
so-called stimulus, and things that have gone on in the past.
I want to make sure that we are maximizing transparency. I
think one of the benefits that--through going through
bankruptcy, as painful and as derogatory as that term might be,
there are certainly benefits in terms of exposure in going
through a process.
We have seen companies, large companies, very successfully
go through the bankruptcy process and then go on to thrive.
And I want to make sure that we don't--aren't injecting
politics into it. I think to the degree we can have an even
hand and that public policy is not driven by political
maneuvering, the better the system will be.
So again, thank you, Chairman, for calling this hearing. I
look forward to the interaction and appreciate you all being
here today. Thank you. Yield back.
Mr. Johnson. I thank the gentleman for his opening
statement.
All Members' opening statements will be included in the
record.
And I would like to enter into the record a statement from
our esteemed colleague, the Chairman of the Commercial and
Administrative Law Subcommittee, Mr. Steve Cohen of Tennessee.
[The prepared statement of Mr. Cohen follows:]
Prepared Statement of the Honorable Steve Cohen, a Representative in
Congress from the State of Tennessee, and Chairman, Subcommittee on
Commercial and Administrative Law
I applaud Chairman Hank Johnson and the Subcommittee on Courts and
Competition Policy for continuing the House Judiciary Committee's
inquiry into the Administration's proposal for enhanced resolution
authority to wind-down failing, systemically important non-bank
financial institutions. Several weeks ago, I presided over Part I of
this hearing series before the Subcommittee on Commercial and
Administrative Law. During that hearing, my Subcommittee posed some
tough questions to Administration officials concerning the need for
resolution authority for such nonbank institutions as well as the
numerous bankruptcy, administrative law, and antitrust concerns raised
by the Administration's proposal. We also heard from several bankruptcy
and antitrust experts who further elaborated on these concerns.
The Administration's resolution authority proposal would create an
alternative to the bankruptcy system for dealing with failing non-bank
financial institutions that are so interconnected with the Nation's
financial system that their disorderly failure would destabilize the
national and global financial systems. The ordinary bankruptcy process,
it is said, would be too slow to deal with the imminent collapse of
such institutions and would create too much uncertainty in the
financial markets. The proposed resolution authority would be modeled
on the authority of the Federal Deposit Insurance Corporation to wind-
down failing commercial banks.
While I understand the Administration's desire for the authority to
act quickly to stave off dangerous shocks to the Nation's financial
system, I am concerned that its proposed resolution process lacks the
transparency and due process safeguards of the bankruptcy process. I am
not unsympathetic to the argument that some type of authority for the
executive branch to act quickly in the face of the impending failure of
a systemically important nonbank financial institution is important.
What I am not yet convinced of is that an alternative to bankruptcy is
needed with respect to the claims resolution process--that is, the
process that occurs after a failing firm has been stabilized and its
core assets have been sold to a third party or transferred to a bridge
holding company. I am particularly concerned about the effect of the
Administration's proposal with respect to claims for employee and
retiree compensation and benefits.
I am also deeply concerned about the creation of the Financial
Services Oversight Council, which, under the legislation, would not be
an ``agency'' for purposes of any State or Federal law and, therefore,
not subject to the Administrative Procedure Act and other restrictions
on agency power. As I have said before in other contexts, as a
legislator for more than 30 years, such vast expansions of unfettered
executive power trouble me greatly. The formation of the Council should
be reconsidered. Even if not eliminated, there should be far greater
Congressional oversight authority over the Council's activities.
__________
Mr. Johnson. With his oversight over the bankruptcy laws,
Chairman Cohen shares our interest and concerns regarding the
proposed reform legislation. And without objection, I will so
include his statement.
Now, I am now pleased to introduce the witnesses for
today's hearing. Our first witness is Professor Chris Sagers.
Professor Chris Sagers is an Associate Professor of Law at the
Cleveland Marshall College of Law in Cleveland, Ohio. He is an
expert in the fields of antitrust and corporate law.
Welcome, Professor Sagers.
Our next witness is Mr. Edwin Smith. Mr. Smith is a Partner
at the law firm of Bingham McCutchen LLP. He is here today
testifying on behalf of the National Bankruptcy Conference.
Welcome, Mr. Smith.
Next we have Mr. Michael A. Rosenthal, who is a partner at
the law firm of Gibson Dunn & Crutcher LLP. Mr. Rosenthal is
co-chair of the firm's business restructuring and
reorganization practice group.
Welcome, Mr. Rosenthal.
And finally, we have Professor Charles Calomiris. Professor
Calomiris is the Henry Kaufman Professor of Financial
Institutions at Columbia Business School.
Welcome, Professor Calomiris.
Thank you all for your willingness to participate in
today's hearing. Without objection, your written statements
will be placed into the record, and we would ask that you limit
your oral remarks to 5 minutes.
You will note that we have a lighting system that starts
with a green light. At 4 minutes, it turns yellow and then red
at 5 minutes.
After each witness has presented his or her testimony,
Subcommittee Members will be permitted to ask questions subject
to the 5-minute rule limit.
Professor Sagers, please begin your testimony.
STATEMENT CHRISTOPHER L. SAGERS, ASSOCIATE PROFESSOR OF LAW,
CLEVELAND-MARSHALL COLLEGE OF LAW, CLEVELAND, OH
Mr. Sagers. Thank you, Mr. Chairman and Members of the
Committee. It is, again, my pleasure and privilege to be here.
I am glad that the larger question has been asked about
what is an appropriate approach to this problem overall, rather
than the specific antitrust questions that I was asked to talk
about.
I wish I was competent to give some plenary answer to that
question and I am not. But I can answer one big question that
is relevant to it. And I have to begin by disagreeing with
something that Ms. Garza said. Her comment was quoted again
here today.
I am not sure this is a very widely held view or a very
popular one, but Ms. Garza, again, was acting assistant
attorney general for antitrust in the Justice Department.
She was also chair of the Antitrust Modernization
Commission a couple years ago. She is an eminent figure in
antitrust and I am sure that many, many people share her view.
I happen to think that she is wrong in that she said
antitrust didn't cause this problem. I would be the last person
to say that antitrust is the only explanation for this problem,
but let me say one thing.
We have thousands and thousands of Federal statutes and
regulations, and we have precisely one that is designed to deal
with the size and power of private entities, and that is
Clayton Act Section 7.
Clayton Act Section 7 nominally has applied to all the many
mergers and acquisitions that gave rise to TBF--excuse me, TBTF
firms. It has never been applied in a way that has taken into
consideration systemic risk.
Many people right now would say it is impossible for that
to be done. It shouldn't be done. My basic point here today is
that that being the case, we don't have any law anywhere to
deal with this problem.
Dealing with that problem is a much bigger question, I
suppose, than I could really talk about in 5 minutes. It is not
addressed in my written testimony, so I won't pursue it.
But for what it is worth, that issue is not on the table
right now anywhere. And I personally think it is a serious
problem with the overall approach to financial regulatory
reform.
Having said all that, I only have a couple of minutes left
to summarize the rest of my testimony. So let me say, rather
than digging into the details of what is quite a complicated
issue, I think that everything I had to say in what I--my
written submission and anything I would have to say today in
person basically addresses one big issue.
And that is that there is an attitude that has become quite
common, especially among the courts and, first among them, the
Supreme Court that antitrust, however venerable and useful it
might be in some circumstances, is generally a bit of a tedious
problem. It is costly, it is clumsy and it is to be avoided
whenever it can.
With respect, I happen to believe that that is incorrect.
And as a peripheral observer of this Committee's process during
the last couple of months, I am very pleased to say my
impression is that that sense is shared by at least some
Members of the Committee, and my impression is, then, that that
is shared by Members of both parties, at least from what I have
been able to observe, and that makes me very happy.
The problem is I happen to think that that attitude is
reflected in this bill in many ways. It is not anywhere
explicitly stated in any of the Administration's bills, but--
and it may not have been deliberate, but my impression
generally is that throughout most of the Administration's
financial regulatory reform package, the attitude has been ``we
should avoid or limit antitrust wherever possible because it
will get in the way of other regulatory objectives.''
My sense, again, is that that is unfortunate both because I
think that the difficulty that is said to be associated with
antitrust in these markets is overstated, and maybe more
importantly, because competition issues, issues of
concentration and collusion in financial markets, are actually
pretty serious, and not only in the--with respect to the sort
of systemic risk problems I began with.
They are also serious in more traditional--the more
traditional sense that those problems limit allocational
efficiency in these markets in serious ways.
[The prepared statement of Mr. Sagers follows:]
Prepared Statement of Christopher L. Sagers
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Johnson. Thank you, Professor Sagers.
Mr. Smith, would you proceed, please?
TESTIMONY OF EDWIN E. SMITH, BINGHAM McCUTCHEN, LLP, ON BEHALF
OF THE NATIONAL BANKRUPTCY CONFERENCE, FAIRFAX, VA
Mr. Smith. Thank you.
Mr. Johnson. I think we have an elementary school student
handling our audiovisual, so give us just a second.
Mr. Smith. Can you hear me on this microphone? Why don't I
proceed, then? Thank you.
Can you hear me now? Okay. Thank you, Mr. Chairman and
Members of the Committee, and my name is Edwin Smith. I am here
on behalf of the National Bankruptcy Conference.
For those of you who don't know, the National Bankruptcy
Conference is a nonprofit, nonpartisan self-supporting
organization of about 60 lawyers, academicians and judges.
We have historically advised Congress on bankruptcy issues,
and so we are before you today to talk about the resolution
authority issues that are under discussion in the current bill.
Part of our concern as a member of the National Bankruptcy
Conference relates to, of all things, avoiding bankruptcy. What
we have noticed is that where you start devising back-end rules
like you are talking about with the resolution authority, that
tends to affect the availability and cost of credit.
To the extent that rules are not transparent, to the extent
that they are uncertain, to the extent that they are unfair,
what that does is it tends to make lenders more reticent about
extending credit or doing so, if they do so at all, at much
higher prices.
And we have seen many, many companies avoid bankruptcy
because they were able to get credit. They were able to get
credit at affordable rates. They were able to address short-
term needs. They were able to reorganize.
And one of the things that we really would hate to see in a
resolution authority bill are rules that tend to discourage the
availability of credit or to increase the price of credit
because we are afraid that what that might do is to increase
the systemic risk that you are all trying to avoid.
Now, what is it about the resolution authority discussions
today that raise these issues as transparency, certainty and
fairness? One is if there is going to be a system where there
are too-big-to-fail companies that get identified, that should
be transparent.
It should be apparent for extenders of credit to know in
advance when they are thinking of extending credit whether
someone is going to be on the list and, if so, whether they are
going to be subject to this entire scheme.
To the extent that they don't know that, then they are
going to have to make their credit decisions based on that lack
of transparency, and that is going to increase the cost of
credit or probably decrease its availability.
We also are looking at certainty. How can these rules
create certainty? And one of the things that is of concern is
what happens when the Federal agency comes in and it rescues an
organization that is too big to fail. It might find a buyer. It
might create some sort of a bridge entity.
But it would take the core systemic risk assets, as we
understand them, and put them somewhere else--in a buyer, in a
bridge entity. And then there would need to be at that
particular point some claims resolution process. There would
have to be a way of dealing with the assets that are left
behind and the unassumed liabilities.
And those rules are going to have to be very certain. And
we think that the bankruptcy rules are actually in much better
shape right now to deal with the assets that are left behind
than the proposed FDIC rules, which we don't think are as well
known, or as developed or as detailed as what you see in
bankruptcy.
And then we think the process has to be a fair process. If
creditors are concerned that the process is unfair, once again
they are going to be reluctant to extend credit or to do so--if
they do so, they would do so at a higher price.
We think, once again, the bankruptcy rules for dealing with
the assets and unassumed liabilities that are left behind are
much fairer to deal with that, not only just because they are
more well known and well developed and more detailed, but also
there are open proceedings. People get judicial review. The
standards for review are much tighter than would be in the case
of an administrative proceeding.
And then as a matter of fairness, we have a rule in the
bankruptcy code that says where you have a Chapter 11 plan and
one creditor would be worse off under the plan than it would be
on liquidation, that plan cannot be confirmed. And that was
done out of fairness, with constitutional implications.
There should be a similar rule here. If a creditor would
get less under these rules that you are devising now--the
creditor should be no worse off than it would be if the entity
were liquidated, as a matter of fairness.
Thank you, gentlemen.
[The prepared statement of Mr. Smith follows:]
Prepared Statement of Edwin E. Smith
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Johnson. Thank you, Mr. Smith.
Now we will hear from Mr. Rosenthal.
TESTIMONY OF MICHAEL A. ROSENTHAL,
GIBSON, DUNN & CRUTCHER, LLP, NEW YORK, NY
Mr. Rosenthal. I will try to use--let me try to use this
microphone. It seems to be better.
Chairman Johnson, other Members of the Subcommittee, thank
you for inviting me to testify today. I have spent 30 years in
my legal career focusing on representation of financially
distressed debtors and their creditors in a wide variety of
industries.
I believe that in addition to crafting a resolution regime
that assures that there is no institution that is too big to
fail, there should be two overarching goals of the legislation.
The first relates to flexibility. We need to give the
government the ability to act quickly to construct solutions to
problems with these companies.
The second, though, relates to predictability. Market
stability requires predictable results. And if creditors are
unable to rely on the predictability of expected returns, they
may either restrict credit extensions, as Mr. Smith said, or
extract excessively high risk premiums.
While reform is clearly complicated, I firmly believe the
foundation for reform should be the simple principle that
absent compelling public policy reasons to the contrary, we
should base a new system as much as possible on what market
participants know, understand and have relied on.
The new system must accomplish the goal of managing or
restoring market stability, but do so in a way that does as
little violence as possible to creditor expectations.
Congress essentially has two existing regimes to choose
from, the FDIA, which is used to resolve bank failures, and the
bankruptcy code, which is used to resolve virtually all other
business failures.
The proposed legislation draws primarily from the FDIA but,
in my view, could benefit significantly from the adoption of
more features of the bankruptcy code.
In part, this is because the bankruptcy code's concepts,
including those that govern the judicial review of creditor
claims, work better in the face of a system-shaking failure of
a non-bank entity.
And in part, this is because creditors of these companies
understand and have structured and priced their transactions on
their expectations about the application and the predictability
of the bankruptcy code.
The revisions to the legislation that I have proposed,
taken together, create a hybrid between the FDIA and the
bankruptcy code. They marry the bankruptcy code's basic
creditor protections, including judicial review, transparency,
predictability, with the FDIA's flexibility to address quickly
the systemic repercussions of the failure of a significant
financial entity.
There are two distinct phases of a covered financial
company's collapse which must be addressed by the legislation.
The first is the initial phase, which is the crisis, where the
FDIC must be given flexibility and discretion to act quickly
and decisively to avert the crisis.
We have proposed that during this 30-or-so-day-period,
short period, the FDIC could act without contemporaneous
oversight by a court. But after the financial crisis has been
averted, a second phase of the process begins. During this
second phase, the FDIC must administer the underlying
liquidation of the failed entity, including resolution of any
disputes with creditors.
We have proposed that the FDIC's actions during this second
phase would be subject to the oversight of the bankruptcy
court. The bankruptcy court would apply the same procedures,
precedents and adjudicative process that it employs every
single day and that market participants already know,
understand, rely on and expect.
Time doesn't permit a discussion of the other specific
changes that I have recommended, but they are summarized in my
testimony and its--and its attachments.
These changes include incorporation of the bankruptcy
code's concepts regarding claim determinations, preference in
fraudulent conveyances, contract rejections, reporting,
valuation and treatment of secured claims.
While you might ultimately enact a resolution system that
is more administrative in nature than I have outlined, I
encourage you even then to implement as many of the
recommendations as possible to minimize the disruption to
creditors' expectations.
I commend the Committee for taking the time to consider
this important topic and, again, appreciate the opportunity to
speak with you today.
[The prepared statement of Mr. Rosenthal follows:]
Prepared Statement of Michael A. Rosenthal
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
ATTACHMENT 1
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
ATTACHMENT 2
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Johnson. Thank you, Mr. Rosenthal.
And last, but not least, Professor Calomiris?
TESTIMONY OF CHARLES W. CALOMIRIS, HENRY KAUFMAN PROFESSOR OF
FINANCIAL INSTITUTIONS, COLUMBIA BUSINESS SCHOOL, NEW YORK, NY
Mr. Calomiris. Thank you, Mr. Chairman, distinguished
Members. It is a pleasure to appear here today.
I am going to address briefly in my oral comments two
issues--the best way to reform laws and regulations governing
the resolution of large, complex, non-bank financial
institutions, and secondly, some antitrust issues related to
the approval of bank mergers.
With respect to the first, I want to focus a bit on the
decision-making process in reality that produces bailouts.
Experience has shown that political risk aversion favors
bailouts even when they are not necessary and is too generous
in the bailouts when they are performed.
Which regulator will be willing to risk a systemic meltdown
on their watch and face the potential political backlash that
would accompany it if they have ready-made taxpayer funds that
they can pay out instead?
Creditors of failing non-bank financial institutions are
aware of policy-makers' risk aversion, demonstrated by the
series of bailouts beginning in 1984, with what is now widely
regarded as a political and regulatory overreaction to the
failure of Continental Bank, the first example of the
application of the too-big-to-fail doctrine.
Creditors use that risk aversion to exaggerate their own
vulnerability to shocks and to obtain more generous protection
from taxpayers.
A Washington Post article that came out today, written
after my testimony, has the following quote in it in discussing
the AIG bailout and why creditors received no haircuts in the
AIG bailout.
Quote--this is a quote from the New York Fed's general
counsel, who was part of the negotiation--"In its negotiations
with its counterparties, AIG just didn't have the same
bargaining power that it did with the Federal Reserve standing
in the background. The only sensible outcome was to give them
what they were legally entitled to.'' In other words, zero
haircuts.
I would be happy to talk with you more about that. But what
the general counsel of the New York Fed is saying is when the
Fed is involved, we are just not tough negotiators. And I think
that is exactly what happened in the AIG bailout.
Bailouts, as most recently illustrated by AIG's experience,
keep counterparties and creditors whole because there is no
way, short of bankruptcy, under current law to force them to
bear a loss.
In other words, the game of chicken between government
agencies and creditors is one that the government is likely to
lose, as they did with AIG's creditors, when trying to convince
creditors to share in losses, which means taxpayers end up
bearing all the loss.
Now, there is broad consensus that this status quo is not
acceptable, and we all understand it is not going to be changed
just by bold statements. Reform must create a means to transfer
the control of assets and operations of a failed institution in
an orderly way while ensuring that shareholders and creditors
of the failing firm suffer large losses.
Those outcomes are essential if the resolution of failure
is to avoid significant disruptions to third parties and also
avoid bailout costs to taxpayers accompanying the--the bailout.
Two approaches have been suggested--one, bankruptcy
reforms, and two, the creation of an administrative resolution
authority.
Critics of creating an administrative resolution authority
rightly argue that placing discretionary authority over
resolution in a regulator is likely to institutionalize
generous, too-big-to-fail protection, just as I have argued it
would.
But despite the arguments that I believe favor bankruptcy
reform as an approach, it is not clear whether the government
can credibly pursue a pure bankruptcy approach even if doing so
were economically desirable.
The problem is a political one. An economically defensible
tough-love bankruptcy system might encourage, for reasons
associated with political risk aversion, ad-hoc resolutions to
occur outside the reform bankruptcy process, just like AIG.
And for that reason, I believe it would be desirable to
establish a hybrid bankruptcy resolution approach which
predefines and thereby constrains the way administrative
resolution would occur.
I am part of a bipartisan task force put together by the
Pew Trusts, which is about to release a report, a large part of
which has to do with how to structure such a bipartisan
compromise that would create this hybrid resolution. And I will
be happy to discuss it more. It is referenced a bit in my
testimony.
I know I am running out of time. I want to focus briefly on
what to do about antitrust. In my testimony, I describe my own
experience as an advisor to the attorneys general of
Massachusetts and Connecticut and the problem there with the
politicization of the antitrust process in the case of the
Fleet-BankBoston merger.
My conclusion from that is that we need to have undivided
authority vested in the Justice Department Antitrust Division,
and it needs to have budgetary autonomy. The Fed needs to get
out of the process, and we need to make sure that the Justice
Department is politically protected. Thank you very much.
[The prepared statement of Mr. Calomiris follows:]
Prepared Statement of Charles W. Calomiris
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Johnson. Thank you.
Professor Sagers, proponents of the bill have argued that
this bill has essentially the same limitations on antitrust as
the FDIA, and wanted to ask you, since we are now in the
questioning period and all Members will abide by the 5-minute
rule, is that accurate?
Mr. Sagers. Yes, in one important respect it is incorrect.
As I explain in my written statement, it is a very complicated
question, but a simple answer is that the claim that the bill
does not modify current antitrust review--that claim is
incorrect for the simple reason that under current law
transfers of banking assets--"banking assets"--are subject to a
special regime of antitrust review which is undertaken by both
the banking agencies and the Justice Department jointly.
And in some respects it is a little bit different than the
more familiar merger review process under the Hart-Scott-Rodino
Act and sometimes it can be made to go a little bit faster than
HSR review.
However, where non-banking assets are transferred in almost
all cases, including some securities and insurance businesses,
other financial businesses--when those transactions occur, the
ordinary Hart-Scott-Rodino process applies.
And importantly, when the Justice Department or the Federal
Trade Commission reviews a transaction, reviews a transfer of
non-banking assets, they have a lot of power. They have a lot
of essentially civil discovery power to force the merging
parties to disclose information. They can also request
information from third parties.
And I believe, most importantly, they can essentially force
the merger--force the transaction to slow down so that they can
take the time they feel they need to address anticompetitive
concerns. Okay.
So that is the piece that would be changed under bill under
the resolution authority where FDIC causes the sale of some
non-banking asset that is owned by a failing financial company
in receivership.
That transaction would be subject to HSR, except that the
agencies would not be permitted to make the so-called second
request for more information, which has the result of both
giving them more information and slowing the process down.
As I explained, I happen to think that is really a pretty
big deal. It is a pretty big change, because in effect the
agencies are going to be forced to review what could be very
large mergers or acquisitions in 30 calendar days, with
probably quite limited information.
Mr. Johnson. Thank you.
I would like to ask everyone on the panel to respond to
this question, starting with Professor Calomiris. Does the
resolution authority have the effect of institutionalizing too-
big-to-fail companies as part of the economy? And is this a
problem?
Mr. Calomiris. It all depends, Mr. Chairman, on how it is
structured. If it is a backstop protection, as I am proposing,
and, crucially, if there is a requirement of minimal haircuts
to creditors and, furthermore, if triggering the use of the
resolution authority has to be approved by Congress and,
finally, if the large financial institutions that presumably
benefit from this protection have to pay for it after the
protections applied, so it is not the taxpayers paying for it
but the financial system, then I think we can say it doesn't
institutionalize too big to fail.
But if you don't add all those caveats, you will
institutionalize too big to fail.
Mr. Johnson. Thank you.
Mr. Rosenthal?
Mr. Rosenthal. Yes. I believe it does not institutionalize
too big to fail but, again, subject to the statements that I
made before, that we need to layer onto what is already--what
has already been proposed bankruptcy code concepts that impose
judicial restraint in some instances, that impose factors that
limit the ability of the regulator to go too far and that
subject companies to restrictions that they and their creditors
agree to.
Mr. Smith. Let me try this one. Thank you, Mr. Chairman. I
also agree that this should not institutionalize too big to
fail, especially if creditors and shareholders will be
suffering a loss as part of the process.
The only caveat I have relates to what happens when you
have a business that, at its core, relates to systemic risk and
where it may be necessary to transfer the assets of that
business with certain liabilities being assumed.
Now, if you are one of the creditors who is extending
credit to one of the businesses that does not fall into that
category, you know that you are going to suffer a loss even if
the business is too big to fail.
But if you are one of those creditors who is extending
credit to the part of the business that is a core systemic risk
asset, I think there needs to be a lot of thought given as to
whether that creditor's claim is going to be assumed in its
entirety as part of the rescue process and, if so, whether
there is an element of institutionalizing the too big to fail
scheme for that creditor that needs to be taken into account.
So I would suggest caution in that area. But as a general
matter, this is legislation that one hopes would never be
invoked in the future.
Mr. Johnson. Yes. Thank you, Mr. Smith.
And, Professor Sagers?
Mr. Sagers. Thank you. I really would just repeat what
Professor Calomiris said. It seems to me the question really
depends on how the act is administered.
The act seems to me to give one agency an extraordinary
amount of flexibility and its administration, it seems to me,
is going to be subject to some degree to changing political
forces, depending on changes in Administrations.
I would add that I think that problem, like other problems,
could be improved under this act if it is--if it strengthens
antitrust review under Hart-Scott-Rodino Act.
Mr. Johnson. All right. Thank you, gentlemen. My time has
expired.
I will now proceed to Mr. Chaffetz for questions.
Mr. Chaffetz. Thank you, Chairman.
I would ask, actually, unanimous consent to insert into the
record, if I could, a statement from the Ranking Member of the
overall Judiciary Committee, Member Lamar Smith. If I could
insert those into the record----
Mr. Johnson. Without objection.
[The prepared statement of Mr. Smith follows:]
Prepared Statement of the Honorable Lamar Smith, a Representative in
Congress from the State of Texas, and Ranking Member, Committee on the
Judiciary
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Chaffetz. Thank you, Mr. Chairman.
I want to go back to you, Mr.--Professor Calomiris--am I
pronouncing your name properly? I hope so. Okay.
Mr. Calomiris. Calomiris, yes.
Mr. Chaffetz. Yes. Are you familiar with H.R. 3310 and what
that uses as the foundation for reform in the bankruptcy code?
Could you talk specifically to that and your impression of
that?
Mr. Calomiris. Yes. I have reviewed it. I couldn't recite
every part of it to you from memory, but I liked it. But I
don't think it goes far enough. I mentioned three things in my
testimony that I think would be additional reforms to the
bankruptcy process, especially as applied to a new--let's call
it Chapter 14--applied to non-bank financial institutions.
And so I could go over those. One of them has to do with
dealing with voting problems that have emerged in the recent
CIT bankruptcy case.
So we have to worry now about creditors who have offsetting
hedged positions or maybe even over-hedged positions so that
they have an incentive in disrupting the bankruptcy process. So
you might want to change the law so that your net position
determines your voting power, not your gross position as a
creditor.
That is just one example, and that is not just for
financial institutions. We need to be worrying about that more
broadly.
We also have to worry about the problem of international
coordination. And it is not good enough just to say let's worry
about it. We actually have to figure out a way over a short
period of time that we can figure out where assets are going to
reside.
A big problem in the Lehman bankruptcy was that a lot of
assets came back overnight. Nobody knew, are they part of the
New York jurisdiction or are they going back to other
countries?
You have to have as part of the living will that is being
proposed--and I support that idea--cooperation, pre-agreement
among regulators in advance, as to how they are going to figure
out where assets and liabilities reside if the bankruptcy
happens.
And I had another point, but I will stop there talking.
Mr. Chaffetz. Okay.
Mr. Rosenthal, I want to give you a moment here to expand
on this idea of flexibility but predictability and how those
two are able to balance in such a way to achieve what we are
trying to achieve. Can you----
Mr. Rosenthal. Yes, and actually, interestingly, the way we
have tried to come up with the hybrid approach could be
implemented through a new regime, or it could also be
implemented through a revision to the bankruptcy code.
What we have envisioned here to get flexibility is have a
period of time--call it an exclusive period, a crisis period--
where the FDIC--whatever the regulatory agency is--takes over
the business, does what it has to do in terms of selling it
to--or transferring it, or capitalizing it to avert a financial
crisis, without supervision of a court, which enables the
action to be taken quicker, doesn't require all of the notice
of the bankruptcy proceeding. That is the flexibility.
But then you come to the point of how is the rest of the
case going to continue, and is there any judicial supervision
or oversight, even on an after-the-fact basis, of the actions
that were taken during the exclusive period.
So the way that we have built in the predictability is to
say that all of the things that would occur after this initial
period are effectively managed and run and supervised the same
way they would be under the bankruptcy code--bankruptcy court
is there, bankruptcy court looks at the thing.
And even the actions that were taken during that initial
period could be brought forward later before the bankruptcy
court if a creditor was able to demonstrate that as a result of
the actions that were taken it is in a worse position down the
road than it was in on day one if the actions had not been
taken.
Mr. Chaffetz. Okay. Thank you.
Sorry, time is so short. Going back to Mr. Calomiris, if I
could, please, let's talk a little bit about the case study
that is first and foremost on a lot of people's mind, which is
AIG.
I just want to give you a moment to further expand on that
thought, and know that we probably have less than a minute here
before my time expires.
Mr. Calomiris. Well, I think the really important lesson
from the combination of AIG and Lehman was, first of all, that
a big part of the problem with Lehman, which was related to--
they all happened simultaneously--was the anticipation of
protection.
And Lehman would have gone to the market in March of 2008
and raised capital after the Bear Stearns failure if it didn't
expect to be protected. That is the big lesson. We don't want
to have that expectation.
And then AIG proved it. Even though Lehman didn't get
protected, that was a mistake that--you know, many people
regard as a mistake. I don't, but the problem is now people do
regard that as a mistake, and the solution to it is going to
look--unless we have very hard language that prevents it, it is
going to look a lot like AIG.
AIG's UBS counterparty was willing to take a 2 percent
haircut. That was very, very big of them--willing to take a 2
percent haircut on their positions. Nobody else was.
And the Fed spent, as far as I can tell, about 30 seconds
negotiating with them and then decided to tell UBS they didn't
even have to take the 2 percent haircut they offered because
they decided it was simpler for them just to make a one-size-
fits-all, nobody takes a haircut.
That sent a hugely bad message to creditors in the future.
It was unnecessary. But what I want to emphasize is not that,
you know, Tim Geithner was a bad guy because he did that. What
I want to emphasize is he wasn't playing with his money. He was
playing with mine and yours.
And he is not a very tough negotiator because as a
regulator his incentives will always be to do that. That is
what we need to be worried about if we empower discretionary
authority outside of bankruptcy.
Now, some people on the panel here have talked about the
need to protect creditors' rights. I understand that, and I
favor reform of the bankruptcy code as the dominant way to do
this.
But I also worry about protecting taxpayers' rights.
Mr. Chaffetz. Thank you.
Thank you, Mr. Chairman. I appreciate your indulgence in
allowing us to go over time a little bit. Thank you.
Mr. Johnson. Certainly. Thank you, Mr. Chaffetz.
Now I recognize the esteemed gentleman from Michigan, the
Chair of the Judiciary Committee, the honorable John Conyers.
Mr. Conyers. Thank you.
One of the problems is that the Finance Committee is
marking up their bill right now, and I keep thinking about the
barn door syndrome here. And I am trying to figure out what
this Committee--this part of Judiciary can do about it and
what--when I meet with Chairman Frank that we want to keep
working on.
So at the same time that I am omitting the fact that we
should have really held this part of the hearing before them so
that they got an idea--their frame of reference is fixed. All
this good testimony they may look at some day after it.
I see that bankruptcy is being minimized in this regulatory
finance package. I see that we are going to have a situation
where we may be sorry about not being strong enough.
I am impressed with the witnesses here who I hear telling
me that it is more than about patching up the system, it is
the--it is to put in safeguards so that this won't happen
again.
You can patch it up--and this isn't the first time we have
been to the brink either. All of you know better than we--we
can create a remedy, a regulatory remedy, that still makes the
same thing that doesn't limit the possibility of this happening
again.
So the question that I have for you four is what more can
we do, and of course, I don't ever stop--we are not going to
stop just because they are marking up their bill. There is
going to be lots of negotiations. Only heaven knows what the
other body is going to produce.
There will be a rules committee where lights frequently go
out. There will be a conference committee. So I want you to
tell me what we ought to do, because we haven't mentioned
Glass-Steagall and the little sorry Bliley effort that
succeeded it.
I mean, I am not comfortable about this, and I want you to
give me not only your best advice here today, but I would like
the honor of us being in touch as this moves down the road.
This isn't going to happen before next year. I know there
is great intentions for moving with swiftness.
Sagers and Calomiris, why don't you start off this
discussion?
I ask unanimous consent for a little more time, Mr.
Chairman.
Mr. Johnson. Without objection.
Mr. Sagers. Yes. Thank you, Mr. Chairman. I hate to be a
one-trick pony, and I also sort of hate to say this, because I
really don't know how controversial this sort of thing might be
to say.
I take heart that if I understand him, Professor Calomiris
said something similar. I personally think that the regime of
bank merger law we have right now needs to be reopened, and I
would favor getting rid of it.
To the extent that it ever had a justification, it is now a
very strained justification that I think many people don't find
very persuasive, and bank mergers could take place under the
ordinary Hart-Scott-Rodino Act.
That leaves open the large problem, though, that as the
Justice Department and the banking agencies have interpreted
their duties under bank merger law--that is, as they have
understood their substantive job in reviewing bank mergers,
which undoubtedly would--they would carry over.
I mean, if you do away with bank merger law and say
everything is subject to Hart-Scott-Rodino, the same
theoretical approach that has been applied under bank merger
law would continue to be applied under Hart-Scott-Rodino,
unless Congress were to take some action to correct that.
And the problem is traditionally both the banking
regulators and the Justice Department for a long time have
believed--and in their defense, they believe it on the basis of
a fair amount of empirical evidence--they believe that, by and
large, competition issues relevant to Section 7 just aren't
very serious in these markets.
That is, the only cases in which we have serious
competition issues are in local markets serving consumers,
mainly, the sort of retail lending needs of consumers and small
businesses. Everything else we can take to be presumptively
highly competitive and therefore those mergers don't raise any
concerns.
I am not really prepared to offer ideas on how that should
be corrected, but I think that it is mistaken even in the
traditional respect--that is, it is mistaken even in its
assumptions about whether particular banking markets are
competitive.
But also, let me just reemphasize--this is a bit of a pie
in the sky sort of argument that academics get to make and
nobody else does because they are difficult, I guess. But we
don't have any laws, really, that directly deal with the
problem of systemic risk being increased by mergers and
acquisitions.
When companies get together and get bigger, thereby
increasing systemic risk, to my knowledge there is no really
effective regime other than Clayton Act Section 7 to address
that, and Clayton Act Section 7 hasn't been used in that way.
Mr. Conyers. But banks are exempted under Hart.
Mr. Sagers. That is true.
Mr. Conyers. You haven't mentioned that. I mean, you keep
relying on it, but they have got a hole as big as a tank to
drive through Hart-Scott-Rodino.
Mr. Sagers. Yes, and my suggestion would be issue number
one ought to be closing that loophole. Technically, bank
mergers are subject to this--a substantive standard, a legal
substantive standard very similar to the one that is applied
under Clayton Act Section 7.
Mr. Conyers. Well, technically, but it doesn't happen in
real time.
Professor Calomiris?
Mr. Calomiris. Yes. I agree with you about the loophole.
The way I experienced it, which I described in my testimony,
was that I was working for the attorneys general of
Massachusetts and Connecticut.
And I showed them in my study--I predicted that if they
allowed Fleet and BankBoston to merge, middle market borrowers,
meaning the backbone firms, small businesses and middle-market
businesses in the U.S.--would experience an increase of a full
1 percent on their loans' cost if they did, and that that is
who was complaining about the merger.
It wasn't hidden. Those were the people complaining, and
those were the people who were going to suffer. After the
merger happened, it went up exactly 1 percent. So it wasn't
rocket science. It wasn't difficult to see.
What was lacking was the political will, because the
problem is mergers create a lot of cookies, and people like
cookies, and they come, frankly, to Congress and they ask
people to help them get some of the cookies.
And then in this case the Antitrust Division of the Justice
Department was leaned on by a Member of Congress, who said,
``If you guys fight this, it is going to hurt you in your
budget for antitrust.''
And it was a very embarrassing thing for the Antitrust
Division, because I am on the phone with them 1 day, and they
are ready, gung-ho, an the next day they say, ``We are not
gung-ho anymore.'' And that is why I emphasize--I am not a
lawyer but I am an economist, so I emphasize budgetary
independence. If you are serious about this, that is what it is
going to take, because that is where--what I saw.
Now, I want to say another----
Mr. Conyers. Now, what is this piece of history--how does
this tie into the regulatory reform act that is being--is on
the stove being cooked up right now?
Mr. Calomiris. It should be added in, and I don't see it.
Mr. Conyers. What should be added in?
Mr. Calomiris. The kind of reform that, in my view, would
take away from the Fed and place in the Antitrust Division
undivided authority and budgetary autonomy to strengthen
protection for all the various consumers, including businesses
and small businesses.
And I think, really, the biggest concern right now--I think
Professor Sagers agreed with me, or someone did--is these
middle-sized businesses which in many parts of the country are
not getting served. You need to have a couple, at least, or
three or four large banks in every location to be able to have
real competition for middle market lending, and we don't have
that.
Mr. Conyers. Mr. Rosenthal, how do you weigh in on this
discussion?
Mr. Rosenthal. Mr. Chairman, first, I think this issue is
not going to go away. If you are lucky enough that it
disappears in the rules committee, maybe, but I think we have a
problem that needs a resolution.
We have the bankruptcy code that deals with the rights of
creditors. We have the FDIA that deals with the rights of
depositors. Neither one of those deal with systemic risk.
So I think if you want to be--if you want to be productive
and you do not think that you can overcome the majority with
respect to a bill that takes power out of the bankruptcy code
and creates a new resolution authority, then you have to make
proposals that build in the protections that we have been
talking about.
So for example, we have--and we would love to talk to you
about it further--I have done some summaries of changes that
would be inserted into this bill that would, in fact, provide
the protections--a number of the protections that Mr. Smith and
I at least talked about in terms of judicial----
Mr. Conyers. For example?
Mr. Rosenthal [continuing]. Review, claims determination.
For example, a provision that would require judicial review,
that would, in effect, make the bankruptcy court the arbiter of
decisions from--you know, after this exclusive period that I
was talking about.
A provision that would require that claims determinations
first be the subject of a negotiation between the FDIC, but if
they could not reach a resolution then you would do what we do
in the bankruptcy code--court all the time. You would go to the
bankruptcy court and you would say, ``Bankruptcy court, decide
how this--decide this claim. What is the amount of the claim?"
Issues about valuation--clearly, secured creditors bargain
for collateral to support their obligations.
The bill deals somewhat with the rights of secured
creditors, but it doesn't say how you would value their claims.
We would build in--we think you should build in provisions that
if you can't agree with the regulatory authority about the
value of the secured claim, you go to the bankruptcy court.
Mr. Conyers. Can the rest of our witnesses buy into that
modification?
Mr. Smith. I certainly can. This was, indeed, part of my
testimony on behalf of the National Bankruptcy Conference. But
I do want to add something in terms of the broader perspective
that you are raising, Mr. Conyers. You were saying how can this
legislation be devised so that what happened doesn't happen
again.
And looking at this purely from the bankruptcy standpoint
is almost like asking an undertaker what he could have done to
have prevented the death of the deceased. The bankruptcy is the
back-end side of things.
And there is an important element that Mr. Rosenthal has
mentioned, which is you want to have transparent, clear, fair
rules for creditors to ensure predictability so that the market
starts to adjust for true credit risk and does not take into
account the fact that there are no consequences for creditors
who make bad credit decisions, as Professor Calomiris had
mentioned.
But even beyond that, part of this bill has to be
prudential regulation at the outset, maybe in the area of
antitrust that was just discussed, but maybe broader regulation
as well, so that there are limits on some of the risk-taking
that can be made in this economy. Thank you.
Mr. Calomiris. I want to give a hopeful note here and tell
you that in about 2 days the Pew Trusts bipartisan task force
on financial reform is going to release a report. I am a member
of that.
It is a bipartisan group. Democrats who are members of that
include Alice Rivlin, former vice governor of the Fed; Alan
Blinder, also former vice governor of the Fed; Bob Litan;
Rodgin Cohen, Sullivan & Cromwell; Morris Goldstein.
We have about a dozen people, and we have reached
consensus. We have a platform. It is not identical to the Frank
bill. It is not identical to the Dodd bill. It does share a lot
in common with them. There are good ideas in those bills. But
the details are not often very good.
Intellectually, what you are seeing here today, I think, is
a lot of consensus across the aisle, and what is really
interesting is I have lived through that for the past 6 months
in the Pew task force.
I think if Congress would just slow down on both sides of--
both houses, and just listen to that bipartisan consensus, you
could do a lot better than either of those bills. And I think
the problem is the devil is in the details, and he really is in
those details right now. We need to fix those.
Mr. Conyers. Yes, we will be looking forward to the Pew
report.
And I thank you for the time, Mr. Chairman. Could I just
close with one--let me just ask you, we have got some strong
personalities involved in this legislation--Dodd, Frank,
Shelby--and I wish Stiglitz could have been here to join you to
make it five instead of four.
How do you separate out what we have been talking about
from what they seem to be advocating?
Mr. Calomiris. I am willing to take a crack at it. I think
that there are good things, as I said, in--I have talked to
people on both sides of the aisle, and I am actually very
hopeful. I think people can come together on a bipartisan
consensus. I really do.
I don't think that any of the positions and the differences
are insurmountable. I think I don't want to speak out of school
and mention particular lawmakers that I have talked to, but I
am actually confident of it.
I think the key, though, is don't rush it through. Give it
a little bit of time. Instead of trying to get a bill done by
February that is going to have to be done on an egotistical or
partisan basis, give it till March or--and you will have a
bipartisan one.
Mr. Rosenthal. I would agree with that, and I will just
point to one provision of the bill. If you look at the
proposal--and this is in a number of the proposals--frankly,
all of the proposals that have been introduced--you see one
provision that says claim determinations are not subject to
judicial review, and you see another proposal that says claim
determinations are subject to judicial review.
I think that highlights what Professor Calomiris has been
saying, that you need to take the time to go through this
legislation and, one, make it consistent and, two, make sure
that it embodies characteristics that both guard against
systemic risk, which I think everybody would agree is a
problem, and that protect creditors' interests as well.
Mr. Conyers. Well, look, the Chairman on the--in the other
body has a seriously different view from the Chairman in this
body. I am glad to have words of hope. And I mentioned Mr.
Shelby. I know he doesn't--I don't say I know--I think he
doesn't agree with either one of them.
So let's work through this a little bit. None of them are
saying what you have been saying about bankruptcy and how we we
resolve--how we make Hart-Scott-Rodino more effective. Glass-
Steagall--that is like something out of the past. I am not sure
how far memory goes back on these subjects.
So I don't know where the optimism seems to be coming from.
I just hope you are right, but it is not at all clear to me.
So I thank you, Mr. Chairman, for your indulgence.
Mr. Johnson. Thank you, Mr. Chairman.
There is a call to have a second round of questions, so I
will begin that second round with Mr. Chaffetz.
Mr. Chaffetz. Thank you. I appreciate it, Mr. Chairman--
such an important subject.
I want to just offer one kind of two-part question, and
then if you can just kind of go down the line and--and address
it, do you think that an extended period of legal uncertainty
could actually undermine the availability of credit to
businesses as we try to emerge from the current recession?
And the second part of that is if you think that another
meltdown hits before the legal uncertainty is cleared up, the
legal uncertainty could actually impair our ability to control
such a meltdown?
I would appreciate your perspective on that. Just kind of
left from right.
Mr. Sagers. You know, thank you. I guess my immediate
reaction is in studying this bill, and in studying a lot of
related legal topics, that is precisely the kind of concern
that is consistently--I am not saying it is true in this case,
but it is consistently overstated with rhetorical purposes in
mind--that is, with achieving certain consequences.
I gather a person stating such an argument, at least during
a period like this one, when policy reform is on the table,
would be making that claim with the point of urging haste.
I think that would be a mistake in this case, and I just
want to sort of incorporate something Professor Calomiris said
on this before. I think he said it well, and he is much more
expert in it than I am. Thank you.
Mr. Smith. Thank you. I come at this from a long history of
law reform where I was advised very early on that one of the
primary goals of law reform is to do no harm. And it is very
easy to try to address a specific problem and find out that you
are creating other problems that are totally unforeseen.
I think there is a greater risk here in haste. It is true
that a period of uncertainty will affect the availability of
credit and will affect the cost of credit, but that problem
could be compounded if the wrong legislation were enacted.
Mr. Rosenthal. I would agree with that. I think that there
is more problem--yes, I think there is--it is worse and you
compound the problem to rush to judgment and implement
legislation which itself may be very uncertain than whatever
legal uncertainty currently exists.
We have a system that does work to some extent. It may have
some problems, but we know the system. We understand the
system. Creditors understand the system. Businesses understand
the system. Courts understand the system.
Courts worked through Lehman, even though they had to work,
you know, all night, day and night, for weeks. They worked
through Lehman. They worked through G.M. They worked through
Chrysler. And they did it quickly.
So to me, you would delay a decision and come to a more
reasoned decision than rush something through.
Mr. Calomiris. I agree with what has been said by the other
three. I would just point to a couple of things.
When we had the clarification after September 2008 by FASB
of how they--the regulations in terms of mark to market would
be applied--that clarification was extremely helpful to the
markets, because it told people that they didn't have to go
into a death spiral of valuation based on some existing market
price. That resolved a very big legal uncertainty about the
appropriate way to apply that, and it was very helpful.
I would also say that the stress tests resolved a
regulatory enforcement uncertainty. More than they provided
information about the condition of the banks, they really told
us how the regulators were planning to behave toward the banks,
and that was hugely beneficial.
So what we know from just looking at the recent crisis is
moments of regulatory enforcement uncertainty or rules
uncertainty can be devastating.
And I also agree with Mr. Rosenthal that actually aside
from the issues associated with international coordination of
which assets belong where, the Lehman bankruptcy actually gives
us a fairly good feeling about the ability of the bankruptcy
code to deal with things.
So I look at it as we have workable problems. We have
problems that we could actually deal with but that we need to
focus on.
Mr. Chaffetz. Yes, I yield to Mr. Goodlatte.
Mr. Goodlatte. Yes, I wanted to follow up. Do you think
that if they had made that clarification much earlier in this
process that it would have had that same settling beneficial
effect that you noted that it had when they finally got around
to doing that late last fall?
I mean, we here in the Congress struggled with this all
through this crisis, and the votes we had on bailout bills and
so on, saying that market to market was a significant
contributor to the uncertainty and that addressing that early
and quickly would have had a very salutary effect?
Mr. Calomiris. Yes, I do.
Mr. Goodlatte. Thank you.
Mr. Chaffetz. And let me just say, Mr. Chairman, as I wrap
up, I appreciate the kind of what I perceive as unanimous
conclusion that it is most important to get it right rather
than get it done fast, that there are unintended consequences
of overreacting and reacting too quickly without understanding
all of the ramifications.
I think that is precisely the point that I would like to
make, that there is a system that, by and large, works, that no
doubt there needs to be reform, and we are trying to address
that.
But, Mr. Chairman, we ought to be understanding--thoroughly
understanding each and every act and consequence so that we
don't misstep and create unintended consequences that we will
suffer from for years to come. So thank you for your time.
Mr. Johnson. Thank you, Congressman.
I have got a couple of questions. In the case of a non-bank
entity that is too big to fail, who--how would the process work
under the bill that is being marked up now in Financial
Services? How would this work?
And I will say that when a bank is teetering on the brink
of insolvency you would have, you know, some notices that would
have gone out to the bank saying you need to do this, or you
need to do that, and then after a period of time then the
regulators would swoop in, I guess without notice, and take
over the bank, and then find some entity that would purchase
the bank.
What would be the process of determining what entity is too
big to fail, why--who would make that assessment, and--I will
rest with that. And anyone who wants to answer that question is
certainly welcome to.
Mr. Smith. I will start off by saying that my understanding
of how the too-big-to-fail institution would be identified
would be--we will know it when we see it, if I understand it,
that there are a number of different agencies that need to
collaborate in the form of a council that would make that
judgment, and the bill spells out the factors that need to be
taken into consideration.
But in the end of the day I would be curious whether the
other panelists see things differently--it is a pure judgment
made by the best authorities who could view the problem.
Mr. Rosenthal. And, Mr. Chairman, if you--some of the
attachments to my testimony reflect an overview of--and a
comparative summary of how that decision gets made under the
current bill.
It is basically a recommendation by the FDIC, approved by
the Secretary of the Treasury, in consultation with the
President, and they have to make certain findings about that
collapse would be--you know, would cause a systemic difficulty.
That is the technical things that happen.
The practical things that happen I think are a little
different. We know how bank failures occur because we have a
whole--a number of years of precedent about how banks are taken
over. It is a little bit unclear how, as a practical matter,
this would occur.
But you would expect that it wouldn't be swooping in, you
know, in--at midnight for companies that are this large and
this significant, that there would be significant discussions
between the FDIC or the Fed or--and others----
Mr. Johnson. Including the target?
Mr. Rosenthal. I would think so, because just as there was
with Lehman, you know, just as there undoubtedly was with Bear,
just as there has been with AIG, I think there would be
discussions with the target company to see if there were ways
to avert the problem short of declaring the company to be a
systemically significant company and subjecting it to this
resolution authority.
But ultimately, if there were no other--there were no other
solution, or if management of the company, for example, were
unwilling to implement other solutions, then I could see these
recommendations being made.
Remember that in a bankruptcy, the way you get into
bankruptcy is that the--either your creditors put you in
through the filing of an involuntary or the company voluntarily
files a bankruptcy case. There isn't a provision, at least in
current law, for the FDIC or the Treasury or the United States
to put a company into bankruptcy.
What this new regime would do is say that there would be
discussions--if the company wouldn't take the action that the
government wanted, or there wasn't an action short of--you
know, short of using this authority, that you could use this
authority to resolve these companies and essentially depose
management.
Mr. Calomiris. Under what I think is going to be reported
on Friday by the Pew task force, it would work the following
way--similar in some ways to the resolution authority in the
two different bills right now, but I think the details are kind
of important.
First of all, let's say that on a particular day, Friday, a
non--a large non-bank financial institution looks like it is in
trouble, it is having problems. How do we know that? What would
happen is it would have trouble finding counterparties to deal
with it in the market.
And then I would expect the President, in consultation with
the Secretary of the Treasury, would decide whether he wanted
to appeal to Congress to make this firm exempted from the
bankruptcy. So now we can go in one of two ways.
If the President decides not to, then what happens in
bankruptcy? Under the Chapter 14 as I would see it reformed,
the Fed would be able to do debtor-in-possession financing
during a--some period of time while the bankruptcy court was
able to take charge of the process.
There are already QFCs. Certain contracts are exempted from
a bankruptcy stay. It might make sense to change the rules a
little bit to allow people who are willing--short-term
contracts that are maturing to take large haircuts in exchange
for also being exempted as QFCs are.
There are lots of interesting details, because we don't
want the financial system to freeze up because of the
networking of claims that have to be traded. So there may be
some reforms for the bankruptcy process--I didn't get through
all of them--that are helpful in that.
Then, or if we are not going to go in that direction, if
the President thinks we need to have a resolution authority, it
is going to now proceed in a way where the creditors know that
by law they cannot be made whole because, for example, under
the Dodd bill--the Dodd bill now says there has to be a minimal
haircut.
Unfortunately, it gives a loophole that says that unless
the FDIC decides there is a systemic problem they can waive
that. So there are lots of problems. I don't support that
loophole.
But if they did proceed that way, creditors would know that
either way they are going to have a loss. That would be very
beneficial. And I would predict that the resolution authority--
the regulator--would end up imposing the legally mandated
minimum loss. They are not going to be aggressive enough.
And so it is--if you put in that minimum loss, then they
will be imposed. And if you don't put it in, it won't be
imposed.
Mr. Johnson. Let me ask this question. Assuming a target
has been in negotiations with the resolution authority, but
then decides that it is in its best interest to file a Chapter
11 petition, which I suppose has an automatic stay feature--
okay--would the resolution authority under the current bills
being considered have authority to trump the bankruptcy court?
Mr. Rosenthal. Yes. What happens is that the--if resolution
authority is exercised, then that company becomes ineligible to
be a debtor in a Chapter 11 case. So it effectively trumps the
bankruptcy code.
Mr. Johnson. All right. I have no further questions.
Next, Mr. Chairman, anything further?
I will say that the--we may as well bring this to a close.
I do appreciate you all's appearance before us today and I
would like to thank you for your testimony.
Without objection, Members will have 5 legislative days to
submit any additional written questions which we will forward
to the witnesses and ask that you answer as promptly as you
can, to be made a part of the record.
Without objection, the record will be kept open for 5
legislative days for the submission of any other--any
additional materials.
Today's hearing raised a number of important issues and
certainly there--I don't know if February or March or April
would be sufficient time to iron out all of the details.
But as we consider this proposed legislation, we would do
well to consider whether the absence of sufficient antitrust
and judicial protections in emergency situations creates larger
problems that it--than it seeks to solve.
And with that, this hearing of the Subcommittee on Courts
and Competition Policy is adjourned.
[Whereupon, at 2:34 p.m., the Subcommittee was adjourned.]