will continue to to deal with this and we are pleased to have the president you're working group before us i think as i read the testimony we have a kind of  here but neither is there any obvious thing we ought to be doing this is a matter for concern and interesting issue in that it's a challenge to our regulatory system both within the u s and internationally i mean the fact that we have a wide range of activities here we have  independent we have the treasury and the federal reserve or with pieces of this we have obviously a very important interface with the international community and i i know that people don't generally believe this but it is the case that sometimes i don't often knowledge but sometimes congressional committees have hearings because they want to know things it's not the norm but it is today this is a subject of great importance considerable uncertainty is obvious value to the activity of these entities the market is not irrational people profit because they are doing things that are totally beneficial but there are also potential dangers in particular from this  small investors there's one exception to that there is a great deal of concern about the potential for pension funds to get involved beyond what they should be doing and i've talked to the chairman of the committee on education and labor mr mellow if you're sticking there we are going to be one of the things we have to address is whether or not there should be some special rules but beyond that the question is just emigrate the question is whether given the proliferation of forms of investment that have high leverage whether or not if there is a rapid change in the basic financial environment people will be able to deal with the consequences so far there's been some good signs that the amaranth situation was a problem for people for whom we could have been a problem but it did not have brought a systemic problems it does not appear now  that the best surgeons issue is going to be something that causes a lot of problems but those have happened within a stable financial context the question i guess is what happens if the current financial context regarding international quality and interest  rates were to change and i don't think anyone thinks that that's going to remain forever in both context so what we are talking about is are we ready to deal with a potential problem and if so what should we be able to do about it and how do we  do that without causing some damage as i said i regard this as a study that i'm going and i'm glad to say that it's been a collaborative one between the congress and the and the various regulators and chairman said we're unsure about what to do and we're not confident about any action that we might take at this time so that is a clear indication that we ought to be listening we ought to be learning but we than we do we're really fortunate to have with our four witnesses today they're distinguished representatives of the president's working group on financial markets and the president working group collapse might be a better word made up chaired by the treasury secretary and it's made up of the chairman of the federal reserve securities exchange commission and the commodity futures trading on regulation that relies primarily on market pressures and incentives to contain risk to the group concluded correctly in my opinion that market discipline together with statutory limits  government regulation i believe that the president's working group struck the right balance regulating and overseeing the activities of these highly innovative investment vehicles  private equity funds have in recent years we all know become convenient targets for those favoring higher taxes and more government intervention in our capital markets while this is certainly worth having to the sometimes excessive enthusiasm of long term investors perhaps more importantly they often provide valuable liquidity to financial markets both in normal market conditions and especially during periods  ordinary ordinarily perform these functions more effectively than other types of financial intermediaries because investors often have a greater appreciation for risk and because they're largely free from regulatory constraints hearings like the one we're having today are important because they allow members of congress to better understand and markets we over see if congress attempts to regulate or tax any specific sector of the financial services industries without a thorough understanding of the role it plays in our financial system the risk of unintended unnecessary burdensome and harmful regulation is real the last thing we want to do is drive investment whether it's hedge funds or private equity fund and their capital offshore so i again commend chairman frank for his attention to this issue and welcome our have four minutes but thank you mr chairman thank you ranking member for the time i have some significant questions about where we stand with this matter from the president's working group recommendations of april ninety nine there were at that point in financial history some observations i think worthy of reviewing the working group recommendations at that moment emphasize the promotion of sound risk management management practices by all market participants and to allow individual market participants therefore to make more informed investment and credit decisions so the message in ninety nine was to the market get your act together so people can make decisions i think some assessment of what has taken place from ninety nine till now on the market side of the fence might be instructive for the committee to hear in light of the fact of market factors that have changed rather dramatically since one thousand ninety nine there was legislation that was filed pursuant to the ninety nine report h r twenty nine twenty four implementing the working group recommendations requiring interesting lee enough the largest unregulated funds to disclose purton certain public information which was non for terry including a new meaningful measurement of risk i also note that the internationally generally accepted at face a regime does require the larger funds to make such disclosure of non proprietary information to enable governmental regulators to assess not only leverage but the potential for systemic risk event consistent with the ninety nine working group twenty nine twenty four did not call and make make this any more clear or direct regulation but instead provides for enhanced public disclosure by only those funds that if a large enough if one were to fail that failure could potentially pose systemic risk to those innocent third parties that set of findings and comments were made by mr sachs who was then the assistant secretary for financial markets department of the treasury mr patrick parkinsons comments who was a associate director division of research for the federal reserve went on to say that there was strong support for the ninety nine working group recommendations and that the very largest funds should be required to publicly disclose information about their financial activities the only modification to twenty nine twenty four suggested by the fed at that time was that the disclosure should be made to the s e c rather than the federal reserve board because of the broader responsibilities in the field of public disclosure my point is that from one thousand nine hundred ninety and now it is not only the explosive growth in the number of funds but the enormity of growth in the individual funds the advent of the fund of funds which enables the twenty five thousand dollar investor to take on risk that i do not believe were intended for sophisticated qualified investors and that pension funds now as a matter of practice routinely invest in funds for which i do not fund managers necessarily are adequately equipped to assess the risk for which the third parties they represent are undertaking i foresee a circumstance in which an amaranth matter might lead to significant people in state pension funds of some region i can think of several in my own state that have displayed significant inadequate  governance capabilities that would then lead to a schoolteacher or fireman or policeman to find their reserves retirement dissipated because the fund manager did not fully understand the counterparty risk that the hedge fund investment really represented i don't have a remedy for this problem but i have an observation about what the recommendations may mean if not fully heeded by the market if the zero seven working group recommendations are not in that message is not fully received and i have concerns because the message was sent in one thousand nine hundred ninety and i don't know that market discipline has yielded any regulatory constraints in market practice that should we have one of those undesirable events i read from the ninety nine working group report page twenty six generally government regulations becomes necessary because of the market failure of the failure pricing mechanisms to be out to account for all social cost government regulation of markets is largely achieve by regulating financial intermediaries that have access to the federal safety net the banks that play a central dealer role or that raise funds from the general public any resort to governmental regulation should have a clear purpose and be carefully evaluated  in order to avoid unintended consequences i think here my cautionary note is if self regulation in the market does not work and we have an untoward event the resulting actions of this congress will be very unhelpful to the market at large to get some information get some enlightenment from my perspective i look forward to hearing a real definition of hedge fund so i understand you all have defined it today and will be clearly understand the not worried about protecting individual high net worth or their right to invest and participate and perhaps help the marketplace in leveling the field and providing the liquidity out there on the other risk to the system i think we're going to rely on the testimony of this group today to see where we're headed and what the congress should do in response to some of the  don't hear a hue and cry that we've overregulated because the congress will be called upon to move in very swiftly and very deeply into a control situation we hope that is look forward to the working group report to the congress and the combined assets of the hundred largest hedge funds represent about sixty five percent of the total industry secretary still further explain the best amount of trading volume hedge funds are generating expected they may represent up to fifty percent of trading in particular instances  which is something to think about how the group also discussed how institutional vassar's like pension funds more than half of investments in hedge funds pension funds placing more their money in hedge funds american workers retirees and other average investors may unknowingly be exposed to hedge fund losses the president's working group recommended that investors and hedge funds gather necessary information regarding the fund strategies turns conditions and risk management to make informed investment decisions and perform due diligence yet he not required to disclose this information i am concerned with the lack of transparency because a manager of a pension fund cannot fulfill their fiduciary duty or duty and may not understand the risk of their investments perform due diligence before committing funds a lack of required to disclose information about their financial activities including meaningful and comprehensive measures of market risk the working group now concludes that no government needs any information about hedge fund activities and that we can rely on  protect the markets from systemic risk is unclear to me why the treasury now appears a lot less cautious and they were nine hundred ninety nine has grown considerably more recently the new york federal reserve has repeatedly warned that hedge funds pose the largest risk world and private equity pools in the u s and global markets indeed this is a timely hearing because the time what they did by hedge funds and their dramatic growth over the last several years the estimates suggest but answer this question because in the past two months it has been revealed that a number of page funds are heavily invested in mortgage backed securities related to prime loans according to the new york times the bear stearns company and investment bank pledged  three point two billion to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages it is the biggest rescue of the hedge fund since one thousand nine hundred eight when more than a dozen lenders provided three point six billion to save long term capital management is nicely this type of investment activity that raises concerns in the marketplace i'm sure that we have just seen the tip of the iceberg as relates the prime lending two point two million people according to some estimates by next year interesting some hedge fund strategies are designed to capitalize on these negative conditions in the market so what are the cost funds which results in additional liquidity has helped the u s financial markets become the deepest and most liquid markets in the world today the ability of hedge funds to target price between market has also proven to be a useful tool that has resulted also in more efficient markets furthermore their ability to transfer and distribute risk allows market participants to more easily manage the level of risk  while the broader financial system is gain from the presence of hedge funds and inherent risk will always accompany those private pools of capital that we call hedge funds banks and other depository institutions that choose to extend credit or choose to be counterparts to hedge funds must make well informed sound business decisions regulators with authority over banking system should focus their attention on preventing the institutions which they oversee from taking on excessive risk if market discipline and prudent risk management is practiced the likelihood of a shock will be greatly reduced again mr investigations in this particular area which raises a concern that he must have and i want to share that concern and what best practices advice you give us today i thank you for your work and your who losses and at what cost are all to all who are who are involved and what i'm really concerned about is that no one really knows including the funds lenders what it's exotic portfolio risk mortgage derivatives is really worth and finally as hedge funds are purchasing all sorts of illiquid hard to value assets are we worried aren't necessarily what the assets would be in the open market very serious questions no decision made whether we and what type of regulation but it is very very his district you know if we just we could probably move the whole thing to greenwich and save a lot of travel time on witness fees but in general connecticut has recognized thank you mr chairman because last time i didn't introduce this individual and there was someone else who i did introduce so i would like to welcome our witnesses but in particular under secretary robert steele who hails from connecticut's fourth district and he nailed greenwich down pretty well mr speaker mr chairman the undersecretary leads the treasury department's activities with respect to the domestic financial system to school policy and operations government assets and liabilities and related economic and financial matters i have appreciated the chance to get to know secretary steele who has extensive experience in the private sector as well as academic bob steele is a straightforward sharp and someone whose perspective and recommendations i appreciate respect a great deal and i welcome him thank you michel with that why don't we begin with you and we'll go down the list  think not on good morning chairman frank ranking member baucus and members of the committee it's a privilege to be with you today thank you for holding this hearing and inviting the treasury department to present our perspective on the important topic of hedge funds and systemic risk today i am representing both the treasury department more specifically secretary paulson and his capacity as the chairman of the president's working group on financial markets fostering financial preparedness is part of the core mission of the treasury department under secretary paulson's leadership the four members of the president's working group along with the office of the controller of the currency and the federal reserve bank of new york issued a call to action directing all market participants to undertake efforts that mitigate the likelihood and impact of a systemic risk of vent caused by private pools of capital private pools of capital which include hedge funds as well as private equity and venture capital funds exemplify the innovation that make our capital markets the strongest in the world these investment vehicles bring many benefits to our markets including liquidity price discovery and risk dispersion yet the rapid growth in size and scope of private pools of capital has brought challenges to our markets particularly in areas of investor protection market integrity and the potential for systemic risk to address these challenges the president's working group released principles and guidelines for private pools of capital in february these ten principles and the clarifying guidelines do not represent an endorsement of the status quo but instead reflects we hope the uniform view of all relevant regulators that heightened vigilance is necessary and appropriate while it is not our current expectation we should remain vigilant to the possibility that significant losses by a highly leveraged hedge fund could present systemic challenges to the broader financial system therefore the principles and guidelines make a number of very very specific suggestions for improving and market discipline so as to mitigate risk hedge funds clientele originally wealthy investors shifted to become one that is comprised more of institutional investors in many cases representing individual investors who may be less sophisticated investments the pension funds do have a responsibility to perform due diligence to ensure that their investment decisions on behalf of these beneficiaries and clients are prudent these principles also emphasize the responsibility of managers to provide accurate and timely information so that investors can make informed decisions additionally supervisors must work within the existing regulatory framework utilizing their broad authority to address issues of investor protection our next step is to ensure that all four groups of the market participants the regulators and supervisors the counter parties and the creditors the actual managers the private pools of capital themselves and the pool investors adopt these principles and guidelines we are very encouraged by the initial response as much good progress is currently underway additionally these principles and guidelines have been very well received by policymakers regulators industry leaders and the general public both in the united states and overseas regulators and supervisors are already involved in a range of important initiatives supervisors are engaged in ongoing reviews of creditors and counter parties practices these efforts are aimed at improving the sophistication and stress testing practice counterparty credit risk management and over the counter derivatives structured credit  post trade processing and structure of the over the counter derivatives market consistent with my reparative representation that we are not standing still just two weeks ago secretary paulson announced that we at the president's working group will work with the private sector to develop and adopt industry best practices for both investors and the asset managers of hedge funds the president's working group is facilitating this stablish of two separate complementary private sector groups one for hedge fund managers and the other comprised of hedge fund investors groups will develop best practices for their respective stakeholder groups that address investor protection enhanced market discipline and also help to mitigate  risk the president's working group will serve as an ongoing facilitator for these groups we are engaging a broad spectrum of market participants to develop high quality best practices the nature of a competitive  marketplace that when leaders adopt best practices others in the industry feel pressure to do the same all market participants must be accountable to help ensure the integrity of our capital markets while substantial progress has already been made the still much work to be done building upon efforts today all stakeholders must continue to do more we look forward to the development and implementation of coherent best practices for the investors and hedge fund managers our system works well when market participants recognize the benefits mitigate the risks and choose to be diligent we look forward to continue and continue dialogue with this committee on these important issues thank you sir and i look forward your questions  a member the board of governors of the federal reserve thank you very much chairman frank ranking member baucus and other members of the committee here today i appreciate the opportunity to appear on behalf of the board of governors of the federal reserve system to discuss th have the potential to reduce systemic risk by dispersing risks more broadly and by serving as a large pool of opportunistic capital that can stabilize financial markets in the event of disturbance at the same time the recent growth of hedge funds presents some formidable challenges to the achievement of key public policy objectives including significant risk management challenges to market participants of course if market participants prove unwilling or unable to meet these challenges losses in the hedge fund sector could pose significant risks to financial stability the board believes that the principles and guidelines regarding private pools of capital issued by the president's working group on financial markets just in february provides a sound framework for addressing these challenges associated with hedge funds including the subject of today's hearing the potential for systemic risk the board shares the considered judgment of g the most effective mechanism for limiting systemic risk from hedge funds is market discipline and the most important providers of market discipline are the large global commercial and investment banks that are their principal creditors and counter parties this emphasis on market discipline neither endorses the status quo nor implies a passive role for government in recent years the global banks have significantly strengthened their practices and procedures for managing risk exposures but further progress on this front is needed in no small part because of the increasing complexity of structured credit products such as collateralized debt obligations the board believes that even those banks with the most sophisticated risk management practices must further strengthen their enterprise wide systems to put the p w g principles fully into practice as these principles rightly emphasize supervisors of global banks are responsible for promoting market discipline by mom's during and evaluating banks management of their exposure to hedge funds as the umbrella supervisor of u s bank holding companies the fed continues to pay keen attention to hedge fund exposures and is working to ensure stronger risk management practices in addition to the reserve bank of new york the fed is actively facilitating collaboration and coordination among domestic and international supervisors of these global banks that are key counter parties and key creditors this area of significant focus targeting management of exposure to hedge funds is part of a broader comprehensive set of supervisory initiatives that seeks to ensure that banks risk management practices and market infrastructures are sufficiently robust to cope with stresses that may accompany a deterioration in market conditions to this end the federal service and focusing on five key supervisory initiatives first comprehensive review of firms stress testing practices second a multilateral supervisory assessment of the leading banks current practices for managing their exposures to hedge funds third a review of the risks associated with the rapid growth of leverage lending for a new assessment of practices to manage liquidity risk and fifth continued efforts to reduce risks associated with weaknesses in the clearing and settlement of credit derivatives and other over the counter derivatives indeed this committee should be assured that the federal reserve is taking on these initiatives great purpose and great result the initiatives  fully consistent with the founding purpose assigned to the fed by congress to help mitigate the risks to the financial system and the broader economy caused by periodic bounce bouts of instability and financial stress thank you again mr chairman be happy to respond thank you mr chairman congressman baucus and members of the committee i am pleased to have this opportunity to testify on behalf of the c f t c regarding hedge funds and systemic risks the chairman of the c f t c is a member of the president's working group on financial markets participated in the deliberations that resulted in the agreement announced by the p w g in february setting out principles and guidelines regarding private pools of capital including hedge funds i will focus my remarks today on how hedge  with the c f c statutory responsibilities under its governing statute the commodity exchange act or c e o at the outset outset i should emphasize that the c f does not regulate hedge funds per se however the c f t c encounters hedge funds as it performs two of its critical missions under the cea promoting market integrity and protecting the public from fraud in the sale of futures and commodity options hedge funds or on the c f t c s market surveillance radar when they trade unregulated futures and commodity options markets regardless of whether their operators and advisers are registered with or not with respect to investor protection if a collective investment vehicle such as a hedge fund trades futures or commodity options the fund as a commodity pool and its operator an advisor may be required to register with the c a p c and meet certain disclosure reporting and record keeping requirements futures markets serve an important role in our economy by providing a means of transferring risk from those who do not want it to those who are willing to accept it for a price in order for businesses to hedge the risks they face in their day to day commercial activities they need to trade with someone willing to accept the risk the hedgers trying to shed data from the sea if he sees a large trader reporting system are consistent with the notion that hedge funds and other professionally managed funds often are the ones absorbing the risks hedgers are trying to shed hedge funds also play a vital role in keeping the prices of related futures contracts in proper alignment with one another in addition hedge funds add to overall trading volume which contributes to the formation of liquid and well functioning markets over the past decade the average number of funds participating in futures markets has grown across nearly all markets also it appears that funds on average hold positions in more markets today than they did a decade ago one notable notable development over the past five years has been the increased participation by hedge funds and other institutional investors in futures markets for physical commodities these institutions have allocated a portion of the investment portfolios they manage into commodity linked investment products a significant portion of this investment finds its way into futures markets either through the direct participation of those whose commodity investments are benchmarked a commodity index or through the participation of commodity index swap dealers who use futures markets to hedge the risk associated with their dealing trader reporting system for surveillance purposes the large trader reporting requirements for hedge funds are the same as for any other large trader in addition to regular market surveillance to see if he conducts an aggressive enforcement program that deters would be violators by sending a clear message that improper conduct will not be tolerated the financial distress of any large futures trader poses potential risk their futures market pen's with respect to commodity pools operating as hedge funds you see f t c addresses these risks to its oversight of futures clearing houses and the clearing member firms each clearing house this oversight reason regime is designed to ensure that the financial distress of any single market participant whether or not that participant is a hedge fund does not have a disproportionate impact on the overall market it is to this oversight regime that the c f t c does its part in helping to mitigate systemic risk in closing the c f t c will remain vigilant in utilizing the tools provided in the cea market surveillance disclosure reporting record keeping and for an enforcement authority to fulfill its statutory responsibilities as hedge fund participation in futures markets continues to expand this concludes my remarks and i look for your question next dr jury who's a director of the division of market regulation the f c c chairman frank ranking member baucus and members of the committee on behalf of the securities exchange change commission i appreciate the opportunity to speak to you today regarding recent initiatives being taken by the commission with respect to hedge funds as you know the president's working group released principles and guidelines regarding private pools of capital these principles compliment and inform the regulatory and supervisory work of each of the p w g agencies with respect to investors but to sherry's creditors and counter parties even if the commission believes that private pools of capital such as hedge funds bring significant benefits to financial markets the commission is also working diligently to protect hedge fund investors and other market participants against fraud and to ameliorate through its oversight of internationally active securities firms the broader systemic risks such bonds potentially pose to our financial system the commission's work in this area includes bigger some foresman activities related to the federal securities laws the commission's consolidated supervised into the program and as appropriate regulatory improvement marks today on the oversight function at present the commission supervises five securities firms on a consolidated or group wide basis these include bear stearns goldman sachs lehman brothers merrill lynch and morgan stanley these firms are known as the c f c s or such firms the commission oversees not only the registered broker dealer but also the consolidated entity that is the holding company which may include regulated entities such as foreign registered broker dealers and banks as well as unregulated entities such as derivatives dealers and the holding company itself the commission c s c program is designed to provide holding company supervision in a manner that is broadly consistent with the oversight provided to bank holding companies by the federal reserve the aim of this program is to diminish the likelihood that weakness in the holding company itself or any of the unregulated and these places a regulated entity such as a bank or a broker dealer or the broader financial system at risk the c f c s are subject to a number of requirements under the program including monthly computation of a capital adequacy measure consistent with the bottle standard maintenance of substantial amounts of liquidity at the holding company level and documentation of a comprehensive system of internal controls that are subject of commission inspection the primary concern of the c s c program with regard to hedge funds revolves around the risks they potentially pose to c s c firms specifically and through c s c s to the financial system the commission c s c program monitors in assesses these risks in several ways first the commission staff meets at least monthly with senior risk managers at the c f c s to review market and credit risk exposures including those to he provides information not only concerning the potential risks to see it but also a broader window into the relationship with hedge funds and those hedge funds potential impact on the broader financial markets second commission staff has recently engaged targeted discussions with the c s about the challenges of measuring credit exposures to hedge funds and finally the commission staff has embarked on a joint project project with the federal reserve and the u k s financial services authority to understand current industry practices of banks and broker dealers in managing their exposures to hedge fund the agencies have identified a number of issues related to the extension of credit to hedge funds and are now addressing those issues in a second phase which entails more detailed work by the principal regulator of each taken together these efforts allow us to identify some trends that we in our supervisory colleagues as well as the risk managers at the large banks and securities firms will follow more closely the demise of amaranth and the issues associated with the bear stearns managed hedge funds also provide some interesting data points to consider first some of the largest most systemically important hedge funds are beginning to look more and more like mature financial institutions diversifying their portfolios beyond leverage equity and fixed income strategies and diversifying active beyond their activities in proprietary trading second hedge funds generally have become more sophisticated about liquidity risk management in part by negotiating more flexible credit terms with the other banks third in some markets hedge funds are the major providers of liquidity the impact that the bear stearns managed hedge funds losses subprime market illustrates this point finally leverage can be achieved in a myriad of ways the ability to engineer economic leverage through structured products is almost infinite and that can be seen in the c d o markets the supervisory focus on leverage we believe is the right one that is far from simple in today's innovative financial markets while these trends can will continue to challenge the regulated institutions their supervisors the focus on recent years on counter party credit risk management has clearly been good for financial institutions and the financial system as a whole after the failure of long term capital management in one thousand nine hundred eighty the counterparty risk management policy group brought together senior policy managers from the major commercial and investment banks which usually seen a risk to consider the lessons of that the report addresses democrats concerns by articulating best practices and karna party risk management appropriate to such regulated entities such as banks and securities firms the counterparty risk management policy group also issued a second report in july of two thousand and five that dealt with developments since the initial report including the proliferation of products with embedded leverage and securitization more work remains to be done in these areas and we must not in fact become complacent here in conclusion there is no guarantee that the favorable additional efforts to expand their risk management capabilities we will continue to work with our p w g colleagues and other market participants including some of the larger hedge funds to further this agenda i thank you for the opportunity to testify today and i'd be happy to take your question attention requirement for those that did not otherwise have one because they were required to register for some other reason i think it's important to consider the commission's authority over hedge funds quite correctly make the distinction that there and on the on the registered in books and records requirements are in place for the unregistered entities we would have no authority to require that that may be i understand that but you're not before court now before the congress sometimes sometimes we don't question  there the potential benefit of something like that has to do with fraud in the markets and the example that you gave the potential cost of something like that is to cause those hedge funds to leave archer to leave the us and perhaps locate overseas when i was a none of them that when we asked them  things that we've talked about at treasury this has developed in a patchwork basis and there isn't an overarching strategy that people have chosen regulator or chosen not to be regulated and that's the reality of the situation if we c together and collaborative way to do that well i think that there's no question and just a week or two ago secretary paulson announced that one of the goals he had was to look at this and a holistic basis and i would think that as part of that examination with the goal of important issues of transparency and disclosure and then i think you asked me to comment further on the issue of moral hazard i think you're correct transparency disclosure important issues but i would want to frame it with to whom and for what in that basically we believe the key aspects of transparency and disclosure in the president's working group and that we've tried to codified in the principles and guidelines really relate to specific areas very good transparency and disclosure from the fund manager to the regulated entities that are providing the capital and loaning the money and the disclosure there should be quite good in our guidelines we've written about this and tried to give very specific examples of the type of transparency and disclosure that's appropriate and if you don't have that type of very very high transparent it should be reflected in margin and the terms of credit and that should be the governor on that issue to provide the protection that the best protection that we could for mitigation of systemic risk the second issue of disclosure really is between the investor and the fund manager and once again in our guidelines and principles we tried to give very examples of what one should expect to invest and hopefully raising that standard and we intend to raise the standard further with specificity with the committees that i described th think of disclosure and transparency with regard to the more specific issue about the talks that i made on morrow hazard i think there's a clear issue these are our investments of a certain type they're less liquid they're private and therefore the idea that that approval or regulation or registration provides comfort it would be a false comfort that might not recognize has the potential to be a false comfort that does not recognize by virtue of the oversight this committee and others can bring to bear by virtue of the discussions that undersecretary steele and i have there is a laser like focus in the market on trying to ensure all the stakeholders around hedge funds  they really need to continue the progress that's been made in recent years on subjects of due diligence and evaluation and making sure that that stakeholder community is fully invested in fully understanding what's going on this is a i think important skin in the game the most responsibility the most focused on ensuring that they have the right collateral are these very counter parties and creditors that we're talking about they are the lifeblood for hedge funds to important to the investors themselves and when we talk about market discipline we say that they really need to make sure that they're putting their money where their mouth is and i think we're very encouraged by the discussions that have commenced that they're going to adopt these principles and put them into action  let me start sir and i'll invite my colleagues to comment as the establishment of the president's working group in one thousand nine hundred eighty eight was born out of an issue which was basically understanding and learning from the market  that was the idea and my brief period i think that this is the appropriate way to consider them and secretary paulson has convened the president's working group actively and with all of the principles of the president's working group in as governor war said in a laser like way to use his word focused on these issues and so the idea of financial preparedness which really is the link up to systemic risk has been the focus one of the key focuses of the president's working group a limit total or described in any needing any additional scope or aperture well under normal circumstances i agree with you but now you're really per pound regulations or guidelines  guidelines they're not legislatively constructed guidelines they're from the working group and of course they come out of the working groups office downtown they come from the treasury is participants of your capacity to regulate that's a pretty dangerous way of operating within our system but you call in the people that you're regulating you say we're going to construct guidelines for you we have no legislative authority to do that there's no law allowing us to do that just an executive order but we anticipate you're going to participate and follow those guidelines and that you don't seem to ask why and i'm just asking question why would they follow your guidelines of the fact they have the fear of god if they don't they've got four massive regulators they're going to come down on some guy and he's not a good is that a good principle to get things done then the other  the other regulators or people of members can speak for themselves but from the treasury department we're in constant communication and regular communication with the leadership on the hill and describing what we're doing both as i said when i began i appear here today i think the idea of having a flat organization and getting the benefit of other people's perspective but the idea of vetting which was your choice would not the situation at all your material with these other agencies  with my colleagues here all with the other a national economic council they were we shared our perspective with them and have the benefit of ongoing discussions on economic policy continually you have i think the president's working group after a long term capital and nine eleven submitted a request to congress that's my recollection but i don't know congress congressman up at the request of congress as you know the president's working group and as its constituent members have responded to questions inquiries that have come up certainly provided technical assistance i think the point worth more working groups you're having babies a new generation is being born here and i'm trying to when your marriage was  regulation does not disturb anybody i'll try to describe it in a way that's not disturbing but i did view it as encouraging and basically what we're trying to do as we discuss described in the guidelines and principles is to structure there's no body to it there's nothing we can identify you know what right who's leading what rights we don't how big your we don't how many people you and you probably have the combined number of employees that exist in every one of your respective organisations and other people that you can get to participate in government start very large umbrella operations and probably find little need to go through the legislat process and then finally one of the questions i'm asking what do we have a countervailing weight to you up here in the legislative branch of government you know if i want to get under our structure we're supposed to be creating and passing the laws that implement you give you the authority to lectures i'm just a little i'm going to try and find your address that suitability would be a hedge fund expert but then i got to thinking about anybody who could talk about the details of exploration of pluto probably has a pretty good grasp of what's going on in a hedge one so i welcome you to the hearing without acknowledgeme just overall i was curious in looking at the ninety nine presidential working group report is that there was a recommendation relative to c p l filings what is the commodity pool operator filings and can you tell me what the current frequency of reporting is today is it still annual or is it quarterly to get back to my reason for asking is it was annual the report suggested that they at least moved to quarterly and the reason for that suggested modification was to provide additional transparency to market participants that brings to before my generalized observation about this problem we can't really describe who it is that we would like to subject to whatever regulatory regime be it self regulation or government regulation we should report we don't know what it is they should report if we could identify who they are but the most troubling aspect of it all is the frequency of reporting is so insufficient in light of the trading strategies that all you would be able to do is get the license tag number of the truck that just ran over you you wouldn't really get anything that c be instructive before the untoward event were to occur that leads me to wonder if we couldn't have some set of triggering devices for example those commodity operators have some set of requirements which they must  but not all hedge funds are registered so you have people outside your regulatory regime and not all c p s or hedge funds so we seem to have some regulatory arbitrage that would lead a smart business practitioner to figure out where the radar is weakest and that's where i make my border crossing on the other hand we had a multi regulatory team agree that under certain triggering circumstances and mister i'm going to some agreed upon percentage of business activity that would be generally viewed as aberrant and in bank terms we have limits on loans to one borrower as a for example parallel where that individual firm is engaged in a counterparty relationship where the counter parties from a regulatory perspective might not be as strong financially as we would like where that fund has an excessive investment from certain protected classes for example high degree of reliance on pension fund money where that fund has changed its profile within a certain period of time from a routine practice all of that said those are parameters you should decide but under those circumstances what would be wrong when we have been to five that kind of aberrant actor from making a nonpublic disclosure disclosures and beyond that we do see the operators in the pools when they're operating within our markets to a large trader reporting system and that's going to be there whether they're registered where they're fi practice shouldn't those folks be subject to some sort of require disclosure in that event i agree with you completely that the issue of transparency to the funding so as to understand these types of challenges is exactly a good question i think that the way we've thought about this is i'm going to defer to governor warsh who can describe to you how they're convening all of the regulators to talk about best practices and sharing expertise reporting regulation i'm just talking about a private reporting regime so you can act on our social benefit and as you and others have rightly pointed out the regime of regulating hedge funds for example within the four walls or within the borders of the us is a is a difficult exercise this capital is remarkably nimble and as a result we're finding ourselves increasingly working with our counterparts overseas to accomplish many of those same objectives i think the principles put down by the country i've been in communities in cities such as cleveland ohio and now in atlanta and other places where whole blocks of boarded up you know people are losing these homes and we all know why were extended and aborted to people many of whom certainly could not repay them we are learning about products such as no verification of income of course the interest only and on and on and on my question is well and also understanding and knowing now bear stearns exposure to the subprime loans recently required the firm to be allowed to have its hedge fund three point two billion to rescue the two fund what can you tell me about other hedge funds that might be in trouble because of exposure to sub prime loans and can we expect as some are predicting a collapse in the financial markets as a result of the prime crisis and recent loan performance in the subprime market appears to support the premise that the crisis certainly is not over particularly with the numbers of adjustable rate mortgages setting you raise the point about three billion dollars being used to bailout the funds managed by bear stearns the way those that funding is done is on a secured basis by which i mean funds are lent against actual securit themselves so in that sense capital was provided to support that funds it was actually only to one of the two bear stearns funds as far as we know and we think that number was a little less than three billion we think was slightly over one billion at that point but  moving beyond to the general point of your question how would we know whether some more of this is coming our are our main window and some of the other questions asked questions that were related to our main window into the indirect it's through the providers of capital into the financial systems the regulated banks and the regulated securities firms are the primary providers of capital to hedge funds who in turn purchased securities or instruments linked to subprime mortgages when we go into inspect those providers of capital in the case of the have we look at all those things holistically and make sure as best we can that they are not impairing the financial health of the regulated entity itself or of the holding company in that sense by doing that we believe that we're appropriately minimizing the risk in managing the risk that a failure of a large systemically important firm such as a big investment bank would in fact bring risk to the financial system communities is very real and generating very real losses in the financial markets from the federal reserve perspective i think our overall view is that there are certainly losses that we might not be at the bottom of this but they don't appear to be raising to this point systemic risk issues that no way would suggest that that the very real problems that some of the some of your constituents all theirs ha having aren't real and obviously the federal reserve working with other regulators are doing our best to try to address those issues but the financial markets are certainly repricing risk in this environment in the housing markets and more broadly the losses that have been felt by hedge funds and other financial intermediaries are certainly forcing them to go back to first principles revisit their exposure and what we're trying to do in our supervisory capacity is ensure that they still have adequate cushions that they still have sufficient capital so that they can operate robustly in these markets and from the perspective of the institutions we oversee we don't see any immediate systemic risk issues that are up one of the i want to call my attention was in the last couple weeks it says a street's next big scandal and it goes on to talk about traders and hedge funds colluding to profit from privileged information i won't go into a lot of giving the heads up to their hedge fund clients the banks who words are two fold it's better if you can imagine profits on commissions and profits on the trades meanwhile mutual funds and unwittingly subsidize by buying stocks at higher prices or selling lower ones than they otherwise would it's a slippery slimy slope lamenting lamented a mutual fund manager adding that all these leaks make poor beating returns harder to achieve and then says regulators have been slow to crack down on what's quickly become an open secret the u s attorney's office and the that it's hard for us to get our arms around exactly what the problems with hedge funds may be but i know one thing when you get a big money operation like this people are trying to make money on it and obviously brokers can take advantage of this they may do that there's just a lot of things we have to do allegations and i'm concerned about what we're doing that might prevent that from happening in the future without really judging whether it's really happening now or not and what perhaps if anything the f c c is doing in that particular area of this whole business of collusion and people just simply take advantage of inside information and knowledge sure well let me let me address that question first let me say it's a very important question and it's one that runs to the heart of the mission of providing fair capital markets and investor protection so there are two things that you that you put together that at times i think make make that make sense in this context one is the behavior of a broker dealer protecting customer information and the others as you pointed out the concentration of wealth and hedge funds and the fact that they are large  that they're big clients of the brokers we should be very clear about one thing the broker dealers have an obligation to protect the proprietary nature of customers order flow to do so to not do so would violate the securities laws regardless of whether it's a single entity that's a person that's being taped or a large hedge fund that's being kept a broker dealer must protect the confidential nature of that order flow and not leak it out to people for their own benefit or for the benefit of their clients that is a violation of securities law we have adequate authority to go after that and as you've noted we have gone after such behavior we have brought cases that in that way with regard to what you specifically mentioned with hedge funds having access to such things are off of compliance inspections and examinations has actually publicly said that we are looking exactly for that we've gone and requested out of a large number of broker dealers information data actual detailed trading data and we're trying to piece together and look for exactly the footprint of exactly what you are citing that is a tip or a trade coming and then in order timing and other trades front running the eventual consummation of that trade benefiting some other parties who are actually in process are looking for that so i would say that it's probably you know the article mary characterized the idea that we're running behind there but i think we're very much aware of that the difficulty of course is detecting but we are looking with all our tools to detect that and i think we're crystal clear let me turn to an area that concerns me and i mentioned in my opening you talked about the principles and the guidelines which were revealed earlier this year and this question of the industry's best practices my concern and i'm not that concerned about the extremely wealthy investors and hedge funds but i am becoming increasingly concerned about the institutional investors basically pension funds there are many individuals who are not wealthy who may be receiving a payment or will receive a payment from the pension fund the fiduciary which aside to get into a hedge fund and i'm not sure what knowledge they actually have i don't know if some of the due diligence you've spoken about and some of the  i want to make sure that these people who are representing more middle america if you will actually know what the heck they're getting into i can't judge whether they're good investors or not but at least they would have full knowledge is it moving in that direction congressman you ask an important question and in my opening comments i chose or tried to highlight that we at treasury in the president's working group think this is a crucial issue as i said when hedge funds began it was the province of wealthy individuals and then it spread to foundations and endowments but today it's basically pulling others into the area where they're affected and in particular through pension funds and things of that ilk when we wrote the principles and guidelines we very demanding investor and we give specific examples of what they should want to understand the importance of diversification as they construct the proper portfolio for that pension plan i'm quite comfortable that the way we're going and the forward leaning perspective with the status quo we're not confirming and instead when we convene the group of individual people to help us think about the investors and the best practice for investors our plan is to include key members of that group the very best people from the pension world to help set standards and rules that can be a signpost for people that want to understand best  not been any new proposals for increased regulation is not an endorsement of the status quo i think that is important for people to take but there was a recognition that this is an ongoing issue and the absence of any specific new regulatory scheme right now is not a door to the status quo i appreciate your putting it that way don't texas thank you mr chairman i thank the witnesses for appearing today i also thank the ranking member in his absence and would like to pick up where the chairperson left off with the responsibility of the british ery but let's start with the notion and premise that historically hedge funds have been available to sophisticated investors sophisticated investors are not sophisticated by virtue of their knowledge knowledge alone does not make one a sophisticated investor unfortunately or fortunately as the case may be to become a sophisticated investor one has to have a certain amount of assets a different with that premise that you have to have a combination of assets and knowledge to be a sophisticated investor for the purpose of investing in a hedge bond for this as we define sophisticated investors the federal securities laws provide for  various tests income levels in some instances investment and other instances assets so the assets are important to this process and my concern and it is a serious concern unsophisticated funds when you have these funds commingled then we have a problem because no matter how much knowledge the people of quire who are part of a pension fund they won't become a sophisticated investor the knowledge alone will not make them sophisticated investors traditionally the reason we've had these sophisticated investors and hedge funds is because they could suffer the loss if they suffered a loss we had an individual o family that lost money and as bad as that is it would not have the kind of impact that we can have on a market the system itself the people who happen to be a part of society because if a pension fund takes a serious hit then we have a lot of people that we have to concern ourselves with as opposed to a family as opposed to an individual who has an ordinate amount of money and god bless the person who has it i think everybody ought to be a millionaire in a country where one out of every one hundred ten persons is a millionaire in fact in this country it's almost it's almost on healthy not to be a millionaire so everybody ought to want to try to become a millionaire in america the richest country in the world country where we can spend three hundred fifty three million dollars a day on a war and still do well so my question and my concern has to do with having persons who have who are not sophisticated even if they have ph d s in economics still not sophisticated investors and when this if something goes belly up and the stock market of twenty nine would never have gone belly up shouldn't have gone belly up but it did enron shouldn't have  but it did we've had other instances where institutions long term capital should not have failed but it did and nothing fails until it does and when it does then we have problems and taxpayers pick up a large portion of the tab because people eventually who are pensioners will go to the public trough in the form of public assistance and they need assistance and they ought to receive it by the way so i do concern myself with this notion of  fiduciary being able to shoulder all of the burden for what can happen when those funds are intermingled and we have a law that's a real concern for me and i don't know that i've heard anything that addresses this concern to the extent that i feel comfortable with this the continuation of this as it is currently perhaps as a way to do this and my chairman is very enlightened and i'm sure that that he will help me through it as well as others but maybe there's a way to do this and not create the consternation that we're going to that i have and maybe it's just me but i have on behalf i think of the working people in this country who are finding more and more of them money going into th at market this is a sophisticated market and people who engage in this ought to have a better understanding and the capital to back up a lot of the losses that they may suffer that my time with the thirty second question would be this you're quite correct and how you characterize sophistication the federal securities laws provide that you have to be have some level well income or assets to buy a hedge fund as well as an individual and that's that's as you state it you bring up the issue of t of the real and you are noting that there seems to be something that doesn't match because unsophisticated people find themselves in to invest in investments that are normally held by sophisticated i think there's two things one the first is what you observe th person has an increase has a heightened responsibility to invest for those people but the other is the amount of investment that's made a fiduciary if acting properly for c a pension fund would never plunge fifty or eighty percent of their assets to one or more hedge funds they would prudently place a small amount of assets in the hedge fund when you turn to an individual one of the reasons why we have wealth and income standard says there is a chance the individual investor might place half their wealth in a hedge fund and that's dangerous that's why we have the high wealth standard what i'm pointing out is that when a fiduciary is acting and they're investing a pool of say a pension fund moneys it's not going to be the case that thirty fifty or ninety percent that pools in hedge funds it's going to be the case that hopefully a prudent amount as i have a critically important role to play here market discipline is tough medicine and i think congresswoman to your point losses will no doubt individuals and institutions that  collateralized debt obligations and other security when the markets turn against them and it's those laws for all institutions to go back to first principles revisit their valu revisit the ratings that rating agencies have put on these securities to make sure they know where their risks are and at the federal reserve obviously as regulators and supervisors of u s bank holding companies we are keenly focused on ensuring that the risk held by these institutions are manageable we're not in the business of trying to ensure that there aren't losses but only to ensure that there are capital cushions risk management pro out there i would expect that the valuations of these securities are at the crux of what regulated institutions are looking at as we speak the valuations that have been put on securities that tend to be more complex that tend to be less liquid is both art and science and i think that those institutions that role models that rely wholly on history of the last four or five years are learning market lesson that is many of these new products though they have been tested to some degree in recent months may not have been subjected to the most adverse stress tests and i think speaking for the federal reserve that's part and parcel of one of our priorities is to ensure that the stress test work that we've done with regulate take into the next level to ensure that there are not risks that are brought to bear some and it seems as though what's happening in the water leeway we have the largest residential financial market for housing in the world it's ten trillion dollars and it's a terribly important asset to the economy and to the housing market it's now going through a process of revaluing certain parts of it but i wouldn't describe it in any alarming way other than it's going to go through the process of resetting prices people readjusting their margin as the market adjust for a common mutual fund that you find today and some hedge funds do exactly that other hedge funds as we've been talking about investing the exotic instruments so it's actually the job of the through all of that and find packaging of instruments for the beneficial owners it's really it's very very difficult to take the future off the hook in my view that's really where the rubber meets the road and it extends to the point where the