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MUNICIPAL BOND TURMOIL: IMPACT

ON CITIES, TOWNS, AND STATES

HEARING

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

MARCH 12, 2008

Printed for the use of the Committee on Financial Services

Serial No. 110–99

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin, 

LINCOLN DAVIS, Tennessee 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

ROBERT WEXLER, Florida 

JIM MARSHALL, Georgia 

DAN BOREN, Oklahoma 

SPENCER BACHUS, Alabama 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

DEAN HELLER, Nevada

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

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C O N T E N T S 

Page 

Hearing held on: 

March 12, 2008 ................................................................................................. 1

Appendix: 

March 12, 2008 ................................................................................................. 91

WITNESSES 

WEDNESDAY, MARCH 12, 2008 

Blumenthal, Hon. Richard, Attorney General, State of Connecticut .................. 17

Dillon, Terry, Chief Executive Officer, Atlas Excavating, on behalf of the 

National Utility Contractors Association ........................................................... 52

Dinallo, Hon. Eric R., Superintendent of Insurance, Department of Insurance, 

State of New York ................................................................................................ 16

Jain, Ajit, Chairman, Berkshire Hathaway Assurance Corporation ................... 65

Levenstein, Laura, Senior Managing Director, Global Public, Project and Infrastructure Finance Group, Moody’s Investors Service ................................... 69

Lockyer, Hon. Bill, Treasurer, State of California ................................................ 43

McCarthy, Sean W., President and Chief Operating Officer, Financial Security Assurance, on behalf of the Association of Financial Guaranty Insurers 67

Newton, Mark, President and Chief Executive Officer, Swedish Covenant 

Hospital ................................................................................................................. 50

Reeves, Hon. Tate, Treasurer, State of Mississippi .............................................. 48

Sirri, Erik R., Director, Division of Trading and Markets, U.S. Securities 

and Exchange Commission .................................................................................. 11

Vogtsberger, Martin, Managing Director and Head of Institutional Brokerage, 

Fifth Third Securities, Inc., on behalf of the Regional Bond Dealers Association ........................................................................................................................ 71

Wiessmann, Hon. Robin L., Treasurer, State of Pennsylvania ............................ 45

APPENDIX 

Prepared statements: 

DeLauro, Hon. Rosa L. ..................................................................................... 92

Blumenthal, Hon. Richard ............................................................................... 94

Dillon, Terry ...................................................................................................... 98

Dinallo, Hon. Eric R. ........................................................................................ 103

Jain, Ajit ............................................................................................................ 109

Levenstein, Laura ............................................................................................. 115

Lockyer, Hon. Bill ............................................................................................. 132

McCarthy, Sean W. .......................................................................................... 140

Newton, Mark ................................................................................................... 195

Reeves, Hon. Tate ............................................................................................. 198

Sirri, Erik R. ..................................................................................................... 202

Vogtsberger, Martin ......................................................................................... 210

Wiessmann, Hon. Robin L. .............................................................................. 217

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Frank, Hon. Barney: 

Chart entitled, ‘‘Sectoral Breakdown of Moody’s-Rated Issuers and Defaulters: 1970–2000 ....................................................................................... 224

Washington Post article, ‘‘Tax-Exempt Funds Yield a Surprise,’’ dated 

March 11, 2008 .............................................................................................. 225

Page

IV

Bachus, Hon. Spencer: 

Statement of the Municipal Securities Rulemaking Board ........................... 227

Kanjorski, Hon. Paul E.: 

Letter from the Government Finance Officers Association, the National 

Association of Counties, the National Association of State Auditors, 

Comptrollers and Treasurers, the National Association of State Treasurers, the National League of Cities, and the U.S. Conference of Mayors, dated March 11, 2008 ............................................................................ 244

Letter to the House Ways and Means Committee from various Members 

of Congress .................................................................................................... 253

Shays, Hon. Christopher: 

Letter to former SEC Chairman Christopher Cox from Hon. Spencer 

Bachus, dated January 23, 2007 ................................................................. 258

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MUNICIPAL BOND TURMOIL: IMPACT 

ON CITIES, TOWNS, AND STATES 

Wednesday, March 12, 2008

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10:04 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. 

Members present: Representatives Frank, Kanjorski, Waters, 

Watt, Sherman, Moore of Kansas, Capuano, McCarthy of New 

York, Lynch, Scott, Green, Cleaver, Moore of Wisconsin, 

Perlmutter; Bachus, Royce, Shays, Feeney, Hensarling, and Campbell. 

The CHAIRMAN. The Committee on Financial Services will come 

to order. 

I am pleased to see that the representative of the Securities and 

Exchange Commission passed security. I don’t know about your exchanges, but you’re okay on security. 

And this is as important a hearing as we are going to have. 

Earlier this year, when we began to talk about a stimulus package, there was a lot of pressure on Speaker Pelosi, who had been 

one of the leaders in the recognition of the need for a stimulus, to 

get into infrastructure, and it’s a very widely supported goal among 

Members of both parties, especially many Democrats. 

The speaker quite courageously, and I think thoughtfully, said 

no, we’re going to do something that can be spent quickly and infrastructure doesn’t meet that, but she gave her commitment that 

we would be working on improving infrastructure financing, because there is an admitted need in this country for bridges and 

highways and schools and sewer facilities, etc., all of which have 

to be paid for by the public sector. 

Today, we are here playing defense because due to grievous 

misjudgments made by elements in the private sector, the public 

sector in this country now faces unfair excessive costs as they try 

to meet those infrastructure needs. 

We are all, in America, capitalists today. We understand the 

value of the free market system. People on this committee understand the importance of the financial system as intermediaries in 

our system. 

But those who have argued that the private sector should be left 

essentially alone, and that public sector intervention would do 

more harm than good, have nowhere been more decisively refuted 

2

than in the situation in which the municipalities and the States 

find themselves. 

In yesterday’s Washington Post, and I ask unanimous consent to 

put this into the record, Alan Sloane notes that he discovered to 

his surprise that a tax exempt money market mutual fund is now 

paying a higher absolute rate than a Treasury fund, even though 

the one paying the higher rate is taxable and the Treasury fund 

is tax exempt. 

Here is the situation: Municipalities have been unfairly treated 

by the private sector for some time. I will be giving out this chart, 

‘‘Sectoral Breakdown of Moody’s Rated Issuers and Defaulters: 

1970 to 2000.’’ Under ‘‘General Obligation,’’ there it is. Number of 

Issuers: 14,775. Number of Defaults: 0. Despite that, there has 

been pressure on issuers to buy insurance. 

Now, to begin, the insurance for full faith and credit general obligation bonds has been unnecessary. 

Requiring general obligation issuers of full faith and credit 

bonds, where the taxing power of the entity stands behind them, 

requiring them to buy insurance is, as I said yesterday—it occurred 

to me, and I was fond of it, so I will say it again—like asking a 

vampire to buy life insurance, because nobody is going to ever have 

to pay off. 

The problem is that in this situation, the bloodsucking seemed to 

have gone in the opposite direction, because the vital substance of 

these municipalities has been sucked away, and what happened? 

Mr. Callen from Ambac had an interview in the Wall Street 

Journal, and he said, well, the premiums paid by the municipalities 

were golden. They were AAA and better sources of revenue, but it 

was kind of slow growth. 

So what some of these insurance companies did was, they took 

the insurance premiums from issuers that shouldn’t have had to 

pay premiums in the first place, and invested them in sophisticated 

instruments, and did it badly, and as Mr. Callen said, when we got 

into CDO squared, we were a little beyond what we understood. 

What happened? These private investments went bad. And who 

is paying the price? Among others, the municipalities. 

It is an odd situation in which issuers are now being charged 

higher interest because they are hurt by their insurers. They are 

better propositions than their insurers. 

We have had problems with rating agencies. There have been 

two scales. Rating agencies have had a separate scale for municipalities than for corporates. 

Why? Because if you rated municipalities, and again, I’m talking 

particularly about general obligations, although you can see it’s a 

pretty good ratio with some of others as well, if you rated municipals the same way you rated corporates, it would be boring, because everybody would get super duper triple A. And how do you 

make a business out of saying everything is perfect? So they get 

subjected to this separate rating system. 

This is not a minor technical matter. The cost of schools and 

highways and sewer treatment facilities and bridges and a number 

of other important facilities now costs the public more. 

There are areas where we have made mistakes in the public sector. This is an area where the private sector, left to its own, has 

3

made the great bulk of mistakes and the public sector is paying the 

price. 

So I want to send a message very clearly from myself as well as, 

I believe, the majority of this committee, and I have also had some 

bipartisan conversations on this. This has to be fixed. 

We cannot tolerate a situation in which elected officials trying to 

build schools and comply with mandates from the Federal Government to improve the treatment of sewage, to build highways, and 

to do other important things are charged much more than they 

should be charged, partly because of an initial undervaluing of 

their credit, and then compounded, adding injury to injury, by the 

fact that people took their premiums, and since they never had to 

pay any of those claims, had all the money to go invest, invested 

it badly, and inflicted damage on the public sector. 

I have to say, I mean, I am not one of those who invokes religion 

in the public sector. People are free to do that, but it is not something that I generally do. But for me, it is the time of year when 

we celebrate the exodus from Egypt, and I have to say now as an 

elected official who is a partner in governance with the cities and 

States, I want to say to the private sector that has enmeshed them 

in this set of circumstances in which they’re being unfairly penalized when they sell bonds, ‘‘Let my people go.’’ This is a time to 

cut them loose. And if we have to part the ‘‘red ink sea,’’ we will 

do that. 

But I do not think we can tolerate, as a society, this situation 

where people are being required to pay so much. 

Now, this has not been a traditional Federal role. Insurance has 

been State regulated. That is why we have one Federal regulator 

here and two very able State regulators. But that is not going to 

continue. I think the Federal Government has to be a partner with 

regulators such as we have here who have been stepping forward. 

And we intend to listen today, but I am submitting an invitation 

now: Give us solutions to this. We are determined, I believe the 

majority of this committee, and I think the whole Congress, to deal 

with this. 

Let me make one other statement, now. It’s a personal statement. But we spent a lot of time on the ethics rules yesterday, and 

it was very controversial. 

I will say this. I intend fully to comply with the ethics rules, so 

let me take this occasion to tell everybody, no, I’m sorry, I can’t 

have dinner with you and we can’t have breakfast, and if you see 

me sitting there, you have to leave me alone to read the paper and 

not buy me a cup of coffee, and that’s the new ethics rules, and I 

can live with them. 

But I plan today to buy some municipal bonds from the State of 

Massachusetts. I wish they weren’t being forced to pay such a high 

rate, given that they are for me double tax exempt, but given that 

they are, me as well as anybody else ought to buy them, and I really say that, my advice to people, I don’t usually do this, you get 

a great buy in municipal bonds right now. 

I didn’t want to say this before the hearing. I don’t want to be 

accused of sort of influencing, you know, and buying beforehand. 

But this is an intolerable situation. Some things are more complex than others. This one is clearcut. 

4

We have to have a situation in which those numbers—I’m told 

there has been since 2000 one default in a general obligation. It 

was a default where they were not in full compliance with the covenants, and in fact nobody lost any money, everybody got paid off. 

So we have to restore some rationality here. 

And this is one where the market has got it wrong. The market 

is a wonderful instrument, and it creates a lot of wealth, but it’s 

not a perfect instrument, and this is a case where if this doesn’t 

get corrected, we will have to intervene. 

The gentleman from Alabama. 

Mr. BACHUS. Thank you, Mr. Chairman. I appreciate you holding 

today’s hearing on the ongoing turmoil in the bond markets and 

the problems that cities and counties are facing in trying to issue, 

refinance, and price their municipal debt. 

This is the committee’s first hearing on the $2.6 trillion municipal securities market. We did have a hearing on bond insurers, at 

which time Mr. Dinallo testified, and I’d like to acknowledge at this 

time both the difficult and important work that you’re doing with 

the monoline bond insurers in preserving liquidity, which is very 

important to our municipal bond market, as we all know. 

Our hearing unfortunately comes at a time when that market, 

which I think the chairman, by his chart showed, has traditionally 

been known for its safety, security, and rate of return, presently is 

under severe stress. 

Constituents in my congressional district are being particularly 

hard hit by the crisis. In my home county of Jefferson County, Alabama, the breakdown of the secondary bond markets has forced the 

county’s interest rate payments on local sewer bonds to skyrocket 

from 3 to 10 percent, a more than triple increase. 

Most of these are revenue bonds, and these higher costs will ultimately have to come out of the pockets of the users, the water and 

sewer system there, or there will have to be a reduction of services, 

or, as I said higher fees. 

We need to act swiftly and responsibly to determine whether 

there’s anything we can do as a Congress to get these markets on 

track before too much more damage is done, although at the same 

time, I’m not sure what that will be, other than perhaps the SEC’s 

proposal. 

I would respond to the chairman that I’m not as convinced as he 

is about not having a need for bond insurance. 

I could see that, on occasions when you have an entity like 

maybe the port authority or you had a well-known entity, a State, 

but when you are dealing with particularly local governments or 

water boards that investors know nothing about, I would think 

that the insurance would almost be necessary to market the bonds. 

Local governments across the country are facing a hostile environment in which to raise funds, with new issues plummeting and 

many municipalities forced to pay significantly higher interest 

rates to attract investors. 

The downgrading of bond insurers and the constriction of the 

credit markets as results of the subprime mortgage problems have 

forced banks and hedge funds to dramatically reduce their municipal debt risk exposure. 

5

I think this reduction of risk we’re seeing in our economy, of people not willing to take as much risk, is probably a good thing. 

There has been too much risk in the past, and people are repricing 

that risk, and I don’t think there’s anything unnatural about that. 

The extent of its impact on the municipal bond market, the municipal securities market, is however a problem, which I am still 

hopeful may be transitory. 

As the economy picks up and liquidity improves, I think we’ll see 

a lot of improvements in this regard, although I’m not sure we’ll 

ever see the auction rate securities come back. 

But the resulting collapse of the secondary bond markets has further impaired the ability of local governments to manage their debt 

exposure, and this is a serious problem. 

Until the recent crisis, the secondary bond markets had ample liquidity, but auctions have been failing since the end of last year 

as the investment markets pulled back. 

On March the 5th, Bloomberg reported 536 unsuccessful auctions 

in the market for floating rate securities. That is a failure rate of 

68 percent of all auctions. 

According to Bank of America, the rate of failures reached 87 

percent on February the 14th, and has since ranged from 61 to 69 

percent. These are sobering statistics. 

Fortunately, this committee does have possible solutions available to better protect both local governments and investors. 

SEC Chairman Cox presented a vision last year for increasing integrity, transparency, and accountability in the municipal securities market. Chairman Cox’s initiative would require meaningful 

public disclosures that are current and understandable with a full 

accounting of all material information at the time of a new municipal bond issuance. 

Chairman Frank has agreed, at my urging, to invite Chairman 

Cox to appear before the committee later this year to formally consider his proposal. 

In addition to considering Chairman Cox’s proposal for greater 

disclosure and transparency, the committee will also need to examine the dual credit rating scale used by the rating agencies that appears to arbitrarily assign municipalities a higher risk rating than 

other debt issuers. 

This creation of risk perception has forced many municipalities 

to purchase insurance that, as the chairman said, may not have 

been otherwise necessary. 

More business is created for the rating agencies who analyze the 

bond insurers’ offerings, but it’s the local taxpayers who end up 

paying the increased cost. 

Not surprisingly, it has been the non-municipal debt that rating 

agencies severely under-assessed for risk, with investors in secondary markets absorbing huge losses as the result of a fundamentally flawed system of risk analysis. 

In conclusion, Mr. Chairman, the municipal bond markets, as 

you said, finance the development of roads, bridges, sewer and 

water systems, hospitals, universities, and other critical infrastructure upon which local residents rely. 

6

Efficient and liquid municipal finance markets are critical to 

keeping our economy moving forward and must be restored to 

working order as promptly as possible. 

Thank you. 

The CHAIRMAN. We have a vote; I believe it is to table the notion 

of requesting a privilege. But I think we can get some more opening statements in, and it usually takes about 20 minutes. So I 

apologize, but I think that will be the only vote for a while. 

The gentlewoman from California, the chairwoman of the Housing Subcommittee. 

Ms. WATERS. Thank you very much, Mr. Chairman. 

The need to hold this hearing reflects the growing impact of the 

subprime and home mortgage loan market crises across the domestic and global economy. 

Hedge funds, along with large commercial and investment banks, 

continue to take hits to their balance sheets as a result of their 

substantial investments in mortgage-backed securities of uncertain 

or clearly declining value. 

As a result, they have been flooding the market with bonds in 

a rush to sell assets. This has had a dual effect. 

First, demand for bonds has dropped over the past few weeks, 

putting upward pressure on yields and the cost of borrowing for 

bond issuers such as municipalities. 

Second, it has meant that large commercial and investment 

banks have not been willing to step into their traditional role as 

a backstop in the municipal auction rate securities market when 

these auctions have begun to fail. 

This has, of course, had disastrous results for municipal bond insurers, which have seen their costs of borrowing skyrocket. 

Simultaneously, the municipal bond market has been operating 

under the spectre that one of the bond insurance agencies could 

face a ratings downgrade. 

Currently, many municipal bond issuers purchase bond insurance primarily to take advantage of the higher rating the insurance 

confers on their bonds, even though the risk of default, even on 

municipal bonds rated below AAA, is statistically insignificant. 

Without access to bond insurance or revisions to the municipal 

bond, we need a way out of this bind if the absolutely essential 

$2.6 trillion tax exempt municipal bond market is to return to 

smooth functioning. 

I look forward to hearing from today’s witnesses, including my 

former colleague, now the treasurer of the State of California, Mr. 

Bill Lockyer, about potential solutions to this dilemma. 

I yield back the balance of my time. 

The CHAIRMAN. The gentleman from Alabama has a unanimous 

consent request. 

Mr. BACHUS. Thank you, Mr. Chairman. I ask unanimous consent to submit for the record a statement from the Municipal Securities Rulemaking Board. 

The CHAIRMAN. Without objection, it is so ordered. 

The gentleman from California, Mr. Campbell, is now recognized. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

I agree with many of the comments the chairman made in opening this hearing, but I think there’s another factor at work here, 

7

which I hope we, in all three panels today, will discuss, and I hope 

the chairman would consider, as well. 

Clearly, the risk premiums that exist now on municipal bonds, 

and I have personally taken some of the same actions in my home 

State of California that the chairman just described in his of Massachusetts, that risk premium appears to be unjustified at the moment. 

But I do believe that there are risks out there which we can’t tell 

what they are, and that’s part of what is driving this. 

In my home State, there have been several bankruptcies of governmental units, including my home county of Orange, in the last 

couple of decades, and there is at least one city municipal bankruptcy being threatened in California today. 

And these bankruptcies and these fiscal problems usually occur 

from one of two things. Either they take their investment funds 

and invest them in risky investments which then don’t turn out, 

and the municipality or civic organization loses money, or, and this 

is the great threat, I think, going forward, there is substantial, in 

many cases, unrecorded and unfunded liabilities largely for pension 

and health care and other union obligations, which are out there, 

which appear to be completely unsustainable, but they’re not 

shown on the books. 

So I’m a CPA, and this kind of stuff, as you can imagine, drives 

me nuts, and so one of the things I think we need to look at in this 

whole process is transparency, so that investors and potential bond 

insurers can see what is really going on in that municipality. 

If there are substantial pension obligations, they first of all 

shouldn’t be unrecorded, and they probably shouldn’t be unfunded, 

but they absolutely should be disclosed and discussed and put in 

as part of the risk factor. 

And my concern is that we do have potential failings of municipalities down the road if we don’t start exposing and dealing with 

all these things now. 

And so I do think that that is a part of the equation that I hope 

this panel and the subsequent panels will discuss and that we will 

have a part of the conversation, Mr. Chairman. 

The CHAIRMAN. Thank you. 

We have 5 minutes left, so we are going to break and vote. When 

we come back, we will have an opening statement from the former 

mayor of the city of Somerville, my colleague from Massachusetts, 

Mr. Capuano, and then we will get to the witnesses. 

[Recess] 

The CHAIRMAN. Please be seated. We want to move as quickly as 

we can. 

Please be seated. 

We will resume, and we will now turn to the gentleman from 

Connecticut for 3 minutes for an opening statement. 

Mr. SHAYS. Thank you very much, Mr. Chairman. 

I want to align myself with the basic thrust of your comments. 

I might take off a little of the rough edges, because you’re pretty 

emphatic about it. But I do buy into your comments. 

And I do want to say, in particular, I want to welcome the attorney general from Connecticut, Richard Blumenthal. I read his enVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
8

tire statement, and I agree with it almost in its entirety. I commend it to all the members to read. 

And I just, I am ending up, for me, what I wrestle with is why 

shouldn’t—why not just have the Federal Government insure municipalities? 

Because in the end, it’s really going to be the same taxpayers, 

and it does seems to me, however, small the fee is, the premium 

is, it seems like a premium that one should not have to pay, number one. 

And number two, given that the insurance companies are the 

ones that have gotten themselves in trouble, it seems unfair to, basically, the taxpayers, that they have to pay the penalty. 

I almost feel like municipalities should insure insurance companies, rather than insurance companies insure municipalities. 

I thank you for the time, and I welcome all our witnesses, but 

particularly my colleague from Connecticut. 

The CHAIRMAN. Thank you. And from time to time, we in Massachusetts are glad we have our suburban neighbors to clean up our 

act a little bit. As long as we’re in general agreement, it’s okay. 

The former mayor of the city of Somerville, the gentleman from 

Massachusetts, Mr. Capuano. 

Mr. CAPUANO. Thank you, Mr. Chairman. 

Mr. Chairman, I want to start my remarks by stating right from 

the outset that I do not enter this issue as a neutral observer. I 

am a former mayor. I am not neutral on this issue. I have very 

strong opinions. And I think what I’m about to say is on behalf of 

every single mayor and governor and government official who currently serves and doesn’t have the freedom to say what I’m about 

to say. 

The monolines started to back up some questionable municipalities. They’re no longer monolines. They’re now bond insurers. And 

they really use the municipal and State bonds to shore up their 

other risky investments. They’re completely upside down. 

But I don’t want to blame them alone. They’re in business to 

make money. They can’t do it alone. 

Even though the State municipal bonds are the safest investments in bonds you can make, they need the help of the credit rating agencies to basically hold hostage cities and towns and States 

across this country until they pay them a ransom. 

Now, they call those ransoms nice little things, like fees or bond 

enhancements, but it’s still a ransom: ‘‘Until you pay us, we’re not 

going to rate you in the way you deserve, the way your taxpayers 

deserve, and when we do, we’re still going to shake you down, because we’re going to make you get bond insurance that you don’t 

need.’’ 

To me, as I’ve said before, and I will continue to say, this is nothing more than legalized extortion. 

But even they didn’t do it alone. They had the help, or the acquiescence, if not the active help, the benign neglect of most Federal 

regulators, and many State regulators. They sat by and said, ‘‘Well, 

what’s the big deal?’’ 

This fell particularly heavily on poorer cities and towns who 

didn’t have the negotiating power of some of the larger bond 

issuers. 

9

The rating agencies, the bond insurers, and those compliant regulators effectively, in my opinion, stole billions, if not trillions of 

taxpayers’ dollars to put in their pocket. 

When people in my position, my former position, were not able 

to hire police, firemen, teachers, or sanitation workers, or to improve their cities and towns, we had to pay them their ransom, 

their extortion. And I will tell you that, unfortunately, I’m not—

there are mixed emotions. 

I’m not happy we’re here today, because my friends who are still 

at the city and town level are still being held hostage and are being 

hurt even more today because of the neglect and the malfeasance 

and misfeasance of people who have been doing this for years. 

I can’t tell you how much I will do to do my utmost to make this 

legalized extortion stop, to give the cities and towns and States 

their due, to let their taxpayers have their money back, and to stop 

this stealing from people whose money you don’t deserve to have. 

Mr. Chairman, I yield back whatever time I might have, unless 

you want to give me another 5 minutes. 

The CHAIRMAN. No, because it’s going to take 3 minutes for Mr. 

Shays comment on you now. But that’s fine. 

Mr. SHAYS. I would align myself with my colleague—[off microphone]—rough edges. 

[Laughter] 

Mr. CAPUANO. Mr. Chairman, without the rough edges, they 

don’t hear it. 

The CHAIRMAN. And you wouldn’t be yourself. 

[Laughter] 

The CHAIRMAN. The gentleman from Pennsylvania, the chairman 

of the Subcommittee on Financial Institutions, who has been taking the lead for us in dealing with some of the related issues here, 

such as the rating agencies, and who had a related hearing on this, 

Mr. Kanjorski. 

Mr. KANJORSKI. Thank you very much, Mr. Chairman. 

Mr. Chairman, I want to congratulate you for convening this 

hearing of the full committee on this important subject, because 

certainly it is a major part of what I think is a crisis of confidence 

in the credit markets of not only the United States, but indeed, the 

world. 

We must recognize the seriousness of the problem and the need 

for fast, pragmatic solutions. Even though some of these solutions 

will not always work, they must be tried, because the failure to try 

and the failure to stem the whirlpool that is occurring out there in 

the credit world could be catastrophic for the American economy 

and the world economy. 

I think it is so important in the bond insurance market to see 

the ramifications of what can happen when there is a disqualifier 

of losing a certain rating that is necessary and required of trustees 

of various funds who are purchasers of municipal bonds, that it can 

destabilize. Although a very small part of the premium world of insurance, the municipal bond market is a $2.6 trillion market, and 

it could be tremendously destabilized by the credit crunch that is 

prevailing today. 

But I may say, it does not only apply to the municipal bond market. It applies to the student loan bond market. It is now starting 

10

to spread into so many other fields. So we have a metastasizing 

that is occurring in the credit markets of the world. 

So this committee has the chief jurisdiction to put the effort forward to make the stops, and for that, I am pleased to see that we 

are going to have the treasurer of the Commonwealth of Pennsylvania, Robin Wiessmann, as one of our witnesses. I look forward 

to her testimony. 

And I look forward to what we are going to turn out here as a 

product, eventually. 

I ask, Mr. Chairman, that two letters, one to the Ways and 

Means Committee and the second letter from the Governor of Finance Officers Association, the National League of Cities, and the 

National Association of State Treasurers, the National Association 

of State Auditors, Comptrollers, and Treasurers, the National Association of Counties, and the U.S. Conference of Mayors be submitted and entered in the record with suggestions of some of the 

things that can be done. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Without objection. 

And with the consent of the committee, I’m going to go to one 

more speaker, because we have another former mayor of one of our 

large cities, and we did want to get his input, the gentleman from 

Missouri, Mr. Cleaver, and then we’ll go to our witnesses. 

Mr. CLEAVER. Thank you, Mr. Chairman. 

I want to associate myself with the statements of Mayor 

Capuano, both in tone and content. 

I served as the mayor of the largest city in the State of Missouri, 

and in the State of Missouri, State law prohibits any city or municipality from spending into the red, which means that every city 

in the State, at the end of its fiscal year, is debt free with regard 

to overspending. There’s no deficit spending. 

And so we don’t have either a debt, other than the bonds that 

we are paying on, but we have no debt, and no deficit. 

And in spite of that, we end up getting the roughest treatment 

from the bond insurance companies, and yes, the roughest treatment comes to the cities, even if they have the highest rating possible. 

We can’t get a AAA bond rating in Kansas City, Missouri, in 

spite of the fact that we have AAA status. 

Now, the State can get it, the State of Missouri can get it, but 

the municipalities—neither St. Louis nor Kansas City can get it, 

and we don’t have any deficit spending. 

Wilbur Ross, the billionaire, just bought $1 billion in municipal 

bonds. This is not some stupid guy playing the stock market. He 

knows what he’s doing. 

And if we can invest in municipal bonds $1 billion, and then 

have J.P. Morgan and Chase Company and Lehman Brothers recommend that debt, it seems to me that it’s safe. 

We have had one little piece of a default in almost 4 decades, 4 

decades, and then we still get ripped off. 

And so I’m here today—and I’m not going to leave—because I 

want to hear every single word that comes out of your mouths with 

regard to what is happening to cities, because I want to be able to 

translate this, not only to my home of Kansas City, but to the U.S. 

11

Conference of Mayors and the National Conference of Black Mayors, with whom I used to be affiliated. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. 

I would point out that there are some seats there. I know they 

say ‘‘staff,’’ but if staff comes, you can get up. If people want to sit, 

they should sit. 

We will now go to the witnesses, and we will begin, and as I said, 

this is an area—we have to vote, but we’ll get in one statement, 

and I think that we’ll be okay after this for a while. 

Historically, this has been State regulated, but there is a Federal 

role, as well. So we will begin with Erik Sirri, the Director of the 

Division of Trading and Markets of the SEC. He is a regular witness, and we appreciate, Mr. Sirri, your continued cooperation with 

us. 

Please go ahead. 

STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF TRADING AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. SIRRI. Chairman Frank, Ranking Member Bachus, and members of the committee, thank you for inviting me here to testify on 

behalf of the Securities and Exchange Commission about the current turmoil in the municipal bond markets, its impact on cities, 

towns, and States, and the Commission’s responses. 

There’s no question that the recent dislocations in the muni bond 

market have created unanticipated hardships for municipal issuers, 

and in some cases, have dramatically increased borrowing costs. 

Today, I’d like to discuss some of the current problems in the 

bond markets, with particular attention to problems that have developed in the market for certain short-term municipal securities 

known as auction rate securities. 

Auction rate securities are municipal bonds, preferred stocks, 

and other instruments with interest rates or dividend yields that 

are periodically reset through auctions, typically every 7 to 35 

days. 

Auction rate bonds are usually issued with maturities of 30 

years, but maturities can range from 5 years to perpetuity. 

Auction rate securities were first developed in 1984, and the 

market has grown to over $325 billion of securities, with State and 

local governments accounting for about $160 billion of the outstanding auction rate debt. 

As you know, hundreds of auctions for auction rate securities 

issued by municipal issuers recently have failed to obtain sufficient 

bids to establish a clearing rate. 

Consequently, issuers who decided to use this type of financing 

to obtain favorable short-term interest rates are instead paying 

what are known as ‘‘penalty’’ interest rates, which can be as high 

as 20 percent, at least until the next auction. In addition, investors 

cannot sell their holdings through the auction process until the 

next successful auction. 

The Commission has received many requests to address this 

market dislocation from municipal issuers, conduit borrowers, dealers, and investors. 

12

For a variety of reasons, including the current lack of dealer support for auctions and frequent auction failures, many holders of 

auction rate securities now want to sell them. Recent downgrades 

of bond insurers have caused many holders to desire to sell bonds 

insured by companies who recently have been downgraded or soon 

may be. 

In addition, many holders of bonds insured or supported by the 

credit of insurers whose ratings have not been threatened may now 

also wish to sell, which may be due to a general loss of confidence 

in the muni auction rate market. 

As a result of these factors, among others, we understand that 

sellers of muni auction rate securities have often far exceeded buyers in auctions, resulting in auction failures. 

Estimates of the value of recent failures for auctions of muni auction rate securities exceed $80 billion. 

Prior to the current disruption in the auction rate market, participating dealers retained to solicit bids for the auctions generally 

supported the liquidity of the auction rate securities by placing proprietary bids as necessary in order that the auctions not ‘‘fail,’’ and 

disclosed the fact that they might do so. 

However, in recent weeks, for a variety of reasons, including liquidity concerns and uncertainty surrounding the monoline insurers, participating dealers have ceased to intervene proprietarily in 

auctions, with the result that hundreds of auctions have failed. 

Due to these failures, and the resulting higher borrowing costs, 

we understand that some muni issuers and conduit borrowers 

would like to, and in many cases have begun the process to convert 

their auction rate bonds into variable rate bonds backed by letters 

of credit or other type of credit enhancement or fixed rate bonds. 

However, the ability to convert auction rate securities may be 

slowed due to heavy demand for such substitute instruments and 

further overall concerns about the credit markets. 

We also understand that certain participating dealers may be unwilling to accept bids from issuers in an auction because of questions about the scope of a settlement in a past enforcement action. 

The Commission has received several requests to consider ways 

to assist issuers with an orderly exit from current market conditions. 

On February 28th, the leadership of this committee asked the 

Commission to clarify for the market as quickly as possible that 

issuers can, within the bounds of applicable laws and regulation, 

participate in auctions for their own securities. The staff is developing approaches to providing further guidance in this area in light 

of market developments and the settlement. 

Due to the severity and immediacy of the auction rate market decline, and the implication for investors, Commission staff is developing appropriate guidance to facilitate orderly markets and continue to protect investors. 

This guidance would be designed to clarify that, with appropriate 

disclosures and compliance with certain other conditions, municipal 

issuers can provide liquidity to investors that want to sell their 

auction rate securities without triggering market manipulation concerns. 

13

This may also have the secondary effect of easing the substantial 

financial burden on muni issuers and conduit borrowers from unusually high interest rates. 

It should also facilitate an orderly exit from this market by municipal issuers and conduit borrowers who seek to do so. 

We hope to have such relief prepared by the end of this week. 

The CHAIRMAN. Mr. Sirri, I’m going to interrupt, just because 

this is a very important subject. 

When you use the phrase ‘‘municipal’’ there, is that in the broadest sense of the other tax exempts, as well? 

Mr. SIRRI. Yes. 

The CHAIRMAN. Thank you. 

Mr. SIRRI. Enhanced transparency would be a key component of 

this guidance, as it is to the auction process. 

For example, if municipal issuers or conduit borrowers want to 

bid in auctions, they must disclose, among other things, certain 

facts related to price and to quantity. 

Of course, issuers have to comply with their disclosure obligations under the Securities Act of 1933 and the Securities Exchange 

Act of 1934, as applicable. 

Staff anticipates that this guidance should remove any hesitancy 

on the part of broker-dealers and auction agents to allow municipal 

issuers to bid at auction. 

Of course, this guidance cannot modify the terms of contracts between buyers and sellers or contracts between issuers and bondholders, and so municipal issuer bidding could only take place if 

consistent with the terms of the auction rate securities as reflected 

in their respective indentures and governing instruments. 

The guidance does not address the amendment of the terms of 

any auction rate securities in accordance with their governing instruments. 

I also should note that the Commission staff is closely monitoring 

the potential effects of the developments in the muni auction rate 

securities markets on mutual funds, including money market 

funds, and on closed-end funds. 

Tax-exempt money market funds, with $465 billion under management, are key investors in muni securities and part of the $3.3 

trillion money market industry. Money market funds typically have 

as their investment objective the generation of income and the 

preservation of capital. 

To help meet this objective, they are required by Rule 2a-7 under 

the Investment Company Act of 1940 to limit securities in which 

they invest to high-grade, short-term instruments that the funds’ 

advisers determine also involve minimal credit risks. 

As part of this rule, Rule 2a-7 employs NRSRO ratings to determine whether funds may purchase a security. 

As much as 30 percent of the muni securities currently held by 

tax-exempt money market funds are supported by bond insurance 

issued by monoline insurance companies. Some of the securities 

may be eligible for investment by money market funds because of 

the insurance that monoline insurers provide. 

Given the importance of money market funds as investors in 

muni securities, some have raised questions regarding the effect of 

credit rating conditions in Rule 2a-7 on the funds’ ability to purVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
14

chase and hold muni securities affected by downgrades of monoline 

insurers. 

The Commission staff recognizes that a significant downgrade in 

a monoline insurer’s rating could result in the securities becoming 

ineligible under Rule 2a-7 for investment by money market funds. 

The credit rating conditions only create a ‘‘floor’’ below which 

funds may not invest, however, and constitute one among several 

risk-limiting conditions of Rule 2-a7. 

Since its adoption in 1982, this rule has continued to serve the 

purposes that the Commission intended. It is notable that, despite 

the current liquidity crisis, money market funds and their sponsors 

have not asked the Commission for any changes to the risk-limiting 

conditions of Rule 2a-7, including the credit rating floor. 

The CHAIRMAN. Mr. Sirri, I’m going to stop you here. We’re going 

to come back to you. This is a very important subject. I don’t usually do this, but I don’t want you to be rushed. This is very important, so we are going to go vote, and then we will come back. 

I have nothing to do until 3 o’clock. I hope the rest of you don’t, 

either, because we’re going to do this hearing. It’s as important a 

subject as we get. 

I appreciate the clarifications you have already given on this. We 

will be back as soon as we can. 

[Recess] 

The CHAIRMAN. Let’s take our seats. 

Sit down, please. 

We will resume, and Mr. Sirri, I apologize for interrupting you, 

but this is a hearing where we don’t want anyone to feel rushed, 

so please continue where you left off, and would other people please 

take their seats and be quiet. 

Mr. Sirri, go ahead. 

Mr. SIRRI. I believe we were talking about Rule 2a-7, so let me 

continue. 

The CHAIRMAN. Yes. 

Mr. SIRRI. There are also some other possible effects that a significant downgrade in a monoline insurer’s rating could have on 

money market funds. The municipal securities they hold include 

variable rate demand notes and tender option bonds that typically 

have liquidity backstops, or puts, that are provided by a financial 

institution. 

The CHAIRMAN. Excuse me. Hold on. 

All right, let’s get in here in a hurry or get out. I’m sorry for this, 

but we’re not going to add to the inescapable problem of the votes, 

so people, either stand or sit. 

Mr. Sirri, I apologize. Please continue. 

Mr. SIRRI. These liquidity features serve to provide a source of 

cash to satisfy redemptions by fund shareholders, and also to shorten the muni bonds’ maturities and make them eligible investments 

for a money market fund. 

A significant downgrade could terminate the put, and thus result 

in money market funds holding long-term securities that would be 

inappropriate for funds maintaining a stable net asset value. 

The Commission staff has been in regular contact with fund 

management companies, which are aware of these risks and have 

15

taken steps intended to protect funds, and thus fund investors, 

from the loss of these puts. 

Now that I’ve discussed mutual funds and other investment companies as investors in municipal auction rate securities, it’s important to also understand that closed-end funds are also issuers of a 

particular type of auction rate security, called an auction rate preferred security. The general loss of confidence in the auction rate 

market has spilled over into this market, and many of these auctions have failed, as well. 

There are important differences in how auction failures have affected municipal and closed-end fund issuers. 

Although closed-end funds also issue auction rate securities to 

obtain financing, they use the financing to leverage their investment in portfolio companies in order to seek higher dividends for 

the funds’ common shareholders. 

Also, although the funds have been paying penalty rates to their 

preferred shareholders to compensate them for the illiquidity, the 

rates generally are much lower than those paid by muni issuers. 

One effect of the respectively lower penalty rates is that the 

rates are generally not as detrimental to fund issuers. 

As long as the amount they pay to their preferred shareholders 

through penalty rates is less than the returns they generate from 

converting the proceeds of the financing, the underlying mechanics 

continue to work as intended and the funds have positive carry. 

This does not mean that the current status of auction rate preferred securities will continue, however. 

Although the closed-end funds pay the preferred shareholders the 

penalty rate, failed auctions mean that these shareholders may 

have to continue to hold the securities, which are perpetual, or attempt to sell them in a secondary market at what may be a heavy 

discount. 

Preferred shareholders have pressured closed-end fund companies to find solutions to the failed auctions, and the companies 

have recently begun to contact the SEC’s Division of Investment 

Management for guidance. 

Due to the special issues raised by the auction failures in the 

auction rate preferred securities market, such as those raised by 

the fiduciary duties owed by funds to both preferred shareholders 

and common shareholders, the staff guidance in the muni auction 

rate securities market may not extend to the closed-end funds 

issuers. 

The Division of Investment Management continues to asses requests for guidance, however, and to monitor the developments in 

this area closely. 

Thank you for the opportunity to testify in front of you today. I’d 

be happy to answer any questions you may have. 

[The prepared statement of Mr. Sirri can be found on page 202 

of the appendix.] 

The CHAIRMAN. Thank you, Mr. Sirri. That was very useful, and 

we will get back to it. 

Next, we will hear from Eric Dinallo, who is the superintendent 

of insurance for the State of New York. 

Mr. Dinallo. 

16

STATEMENT OF THE HONORABLE ERIC R. DINALLO, SUPERINTENDENT OF INSURANCE, DEPARTMENT OF INSURANCE, 

STATE OF NEW YORK 

Mr. DINALLO. Thank you, Chairman Frank. 

It’s good to be back before you. It’s an honor to testify. And I 

thought I would take a few minutes and update this committee on 

what has gone on since I testified in front of the subcommittee just 

about a month ago. 

I think substantial progress has been made in seeking company 

solutions in the monoline or bond insurance industry in helping facilitate market stabilization and beginning to define the future regulatory landscape for these activities. 

I hope our role reflects a proactive approach by the regulator 

here. I think that’s the proper approach here. I think we need to 

be facilitators, we need to be catalysts when we see something that 

has to be jump-started. 

I think doing nothing here would have been a grave error, and 

although we took some risk by getting involved, I think prudential 

risk in times of what has been described as a crisis is better than 

doing nothing, which is still a choice of doing something, you’re just 

not actually doing anything, you’re instead accepting the status 

quo. 

We began a three point plan in the fall. The three point plan consisted of: 

Number one, bringing new capital and capacity into the monoline 

insurance area; 

Number two, to begin to begin to deal with and prepare for 

chronically distressed bond insurers; and 

Number three, to begin to rewrite the rules of the road and develop new regulations and statutes in this area. 

I thought I would just take a minute and go over where we are 

in those three areas, and that will be a description of at least what 

our role has been to date. 

First, in the area of capacity and capitalization, we have created or facilitated conditions that have attracted approximately $7 billion of capital injections and a total overall capacity, including the 

Berkshire Hathaway offer of $12 billion in total that have helped 

insure the ratings of the two publicly traded companies, kept the 

market fairly competitive, and helped to stabilize that market. 

Those activities include inviting Ajit Jain of Berkshire Hathaway 

into the industry and helping facilitate the licensing of Berkshire 

Assurance Corporation in record time, and working with the other 

States in facilitating the licensing by 30 States in approximately a 

month, also receiving a bid on the municipal book for FJIC, Ambac, 

and MBIA from Berkshire. 

Second, we approved and facilitated MBIA’s capital raising, which led to $2- to $3 billion of additional capital into that company. 

And as you’re well aware from when I was here last time, we fostered and helped create the consortium behind Ambac that resulted 

in the capital raise that occurred just about a week ago. 

We worked with Wilbur Ross and spent a lot of time speaking 

with private equity, and between his purchases of bonds and injection in Assured, there’s a billion into the system, and we will be 

17

seeking out other capital, including other private equity on investors’ sovereign wealth, and some bulge bracket investment banks 

have sought licensing through the Department of Insurance. 

In the second category, concerning dealing with distressed companies, we have done the capital raising activities that we just discussed— 

The CHAIRMAN. Mr. Dinallo, we’re going to run out of time, and 

that’s in your written statement. If you could get to some of the forward-looking things, I think that might be more useful. 

Mr. DINALLO. Okay. 

The forward-looking ideas here are to facilitate reinsurance and 

support of the markets, to engage in the possibility of a rehabilitation or restructuring of the companies that would be done by the 

government, including the good book/bad book scenarios that have 

been talked about, the Citibank concept of an optionality built into 

such a situation. 

I have also spoken to this committee about the potential for a 

Federal backstop, which we could discuss, and I would explain 

what that would look like, if you have questions about that. 

The third category is around new regulations. We have done a 

serious research and discussion with experts of what new regulations would look like. We have drafts of those. 

Basically, we’re considering the requiring of more capital to be 

engaged in this industry, the elimination of certain guarantees of 

structured products, such as CDO squares, which you have discussed, the possible segregation of the businesses of structured municipal and possibly project finance, and finally, the prohibition of 

insuring credit default swaps and other instruments that cause 

events of default or acceleration, which is generally not regarded 

as a good thing for insurance book, because you can’t manage the 

claims if the worst-case scenario arises. 

And on the reinsurance, the Federal backstop, because I know 

that you’re seeking solutions that Congress could facilitate, my 

view is that a lot of the offers that we have received from private 

equity and from Mr. Buffett are essentially reinsurance transactions, and it seems to me that the Federal Government could 

rather inexpensively, in a certain sense, guarantee and reinsure 

the municipal sides of these books. 

That would actually, ironically, free up capital to put the structured side in the best possible position going forward, so their policyholders were as protected as possible, and for the Federal Government, it would at least be just a backstop. It would be simply 

a guarantee against the book that, as your statistics showed, was 

already proven to be a fairly safe bet. 

[The prepared statement of Superintendent Dinallo can be found 

on page 103 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Dinallo, and we’re going to pursue some of these. That’s exactly what we were hoping for. 

Next, we will hear from Attorney General Blumenthal. 

STATEMENT OF THE HONORABLE RICHARD BLUMENTHAL, 

ATTORNEY GENERAL, STATE OF CONNECTICUT 

Mr. BLUMENTHAL. Thank you, Mr. Chairman, and members of 

the committee. 

18

Thank you, first of all, Mr. Chairman, for having this hearing, 

and I want to join in saying how important it is, and say how 

pleased I am to be here with Superintendent Dinallo, who is doing 

great work, as the regulator in New York, in attempting to address 

many of these problems, and working very closely with the folks at 

Berkshire Hathaway Assurance Corporation. 

I am also pleased to be here with them, and particularly with 

Ajit Jain, and want to say that I’m going to try to avoid the rough 

edges, but I feel as deeply as anyone in this room about the cost 

of this system on the towns and cities and States around the country. 

The cost of insuring these bonds per year is about $2.3 billion. 

That’s money paid by everybody in this room and the people whom 

you represent. 

They are costs that are unnecessary and avoidable. They fall directly on taxpayers, and they inhibit infrastructure improvement 

and upgrading. That is exactly what the chairman mentioned at 

the outset of this proceeding. 

The cost is not just on them, but it’s also on investors, because 

the current dual system, the double standard that disadvantages 

municipalities and inhibits their use of public debt, is one that also 

confuses investors. It makes the market less transparent, and it restricts competition. 

I have an investigation ongoing into potential violations of law. 

This system is not just unfair and unwise as a matter of public policy; it is also, in how it has been perpetuated and sustained, quite 

possibly illegal under our Federal and State antitrust laws. 

My investigation is ongoing and active. It focuses on how this 

system started and how it was perpetuated, and I will say to you 

that our findings so far are very, very deeply troubling. 

We know there was a concerted effort among supposed competitors to maintain the dual rating system and kill attempts at reform. 

There were discussions among bond insurers aimed at retaining 

this dual rating system, when at least one of the rating agencies 

suggested modifying or eliminating it. 

And the net effect of these activities was clearly to maintain 

prices and prop up the market for bond insurance. 

This misuse of market power and restraint of competition is 

plainly anti-competitive and anti-taxpayer, causing direct harm to 

municipal and State customers— 

The CHAIRMAN. Mr. Blumenthal, hang on one second. 

That is another motion to adjourn. I do not plan to make that 

vote. I would advise other members, if you want to go and come 

back to do so, but I am going to keep going. 

Go ahead, Mr. Blumenthal. 

Mr. BLUMENTHAL. Thank you. I will be brief, and I would ask 

that my full remarks be included in the record, but just to summarize— 

The CHAIRMAN. Don’t feel rushed. This is too important. You 

know, the chicken scratchings can go on without us. 

Go ahead. 

Mr. BLUMENTHAL. Thank you. 

19

We have found no legitimate business reason for this dual standard by itself. Just as one example, a triple B municipal bond, according to Moody’s ratings, is one-fourth as likely to default as a 

triple A corporate bond. A municipality in that situation either has 

to buy bond insurance—and as I have described, we have documented how discussions perpetuated this system, involving the 

bond insurers as well as the rating agency—or a municipality has 

to pay higher interest rates for the debt that is issued. 

Either way, taxpayers and citizens pay more, $2.3 billion more 

every year to insure that debt than they would otherwise. And this 

dual rating system, so far as we know, has no justification. I will 

be interested in whether any is presented later in the day when 

you have at least some of the rating agency representatives before 

you, and I would suggest, with all due respect, that you put this 

question to them and request them to justify how the dual system 

can possibly be justified. 

Let me just close by saying that I am here to urge you to abolish 

it and prohibit it. It should have been prohibited in the 2006 Act, 

the Federal Credit Rating Agency Reform Act. In my view, arguably, it was prohibited because it is an unfair and anticompetitive 

practice. But, obviously it should be specifically prohibited under 

law, and I would ask that the United States Congress do that. It 

may well result, in any event, from voluntary actions by the rating 

agencies themselves because it is so contrary to the globalization 

of our credit markets that eventually it will probably fall of its own 

weight. But in the meantime, we are paying billions of dollars in 

unnecessary and unwise cost. 

Thank you, Mr. Chairman. 

[The prepared statement of Attorney General Blumenthal can be 

found on page 94 of the appendix.] 

The CHAIRMAN. Thank you. This has been very useful and very 

much in point. Mr. Sirri, let me express my appreciation, and 

please convey to the Chairman and the other members of the Commission, few though they may be these days, that what you have 

done has been very responsive, and the way you have explained it 

has been very helpful. 

On Rule 2a-7, I guess what you’re saying is that nobody has 

raised that of course. What we would hope to do is fix the ratings, 

or have the ratings fixed so that it wouldn’t come into play, that 

people would not be—and I agree with you. I don’t want to accommodate an inequitable and inaccurate rating system. 

Mr. Dinallo, you listed some very useful things we could do in 

terms of the regulations that would apply. Obviously under the current system in America, those are within the jurisdiction of the 

States. But would there be any Constitutional obstacle to our also 

doing them under Federal jurisdiction? I know many of us are reluctant to have preemption, but in some cases, there is some argument for uniformity. We could do a kind of regulation that would 

not preempt the State’s ability to go beyond that. 

And Attorney General Blumenthal, I would ask you as well. 

Would there be any Constitutional or other obstacles to our doing 

some of those things as a floor, for example, on the national level? 

Mr. Dinallo? 

20

Mr. DINALLO. I don’t think there would be any Constitutional objection to it. I am not such a staunch objector to a Federal regulatory system for insurance. But I would point out that I am fairly 

against an optional Federal charter, because I think you end up 

with a regulatory arbitrage situation. 

The CHAIRMAN. We’re not talking about that. 

Mr. DINALLO. But I think you could have—here you could have 

sort of a Federal floor on this. It is true, as Congressman Kanjorski 

said, that it was sort of shock and surprise at how much of the national and the global financial system was hung off of this small 

part of the market. 

The CHAIRMAN. This is separate from the optional Federal charter. I mean, that’s— 

Mr. DINALLO. I think it’s a place where the Federal Government 

should inquire, because it turns out that a big part of the economy 

is driven by this kind of insurance, which— 

The CHAIRMAN. You know, and there’s direct context, connection 

here. We talk about—and we have all acknowledged State and local 

spending on various infrastructure projects is impacted. As you 

know, there is an intermix of Federal and State and local funding 

there. So, Federal transportation policy can be frustrated by excessive charges at that level. 

Attorney General? 

Mr. BLUMENTHAL. I see no Constitutional objection. I think that 

preemption, as you know, Mr. Chairman, is very, very frequently 

used. I think as a State law enforcer, I would object to any preemption of State enforcement authority if there are— 

The CHAIRMAN. That’s a very good point. 

Mr. BLUMENTHAL. —criminal or even civil prohibition. 

The CHAIRMAN. Well, in fact, let me just underline that. Yes. It 

would be a grave error for us to try to do that because even if we 

were to promulgate some rules, we have no Federal enforcement 

entity for insurance, and it would be—that’s a very good point that 

you would have them work together. 

Mr. BLUMENTHAL. Exactly, Mr. Chairman. And I think that for 

all the reasons that Mr. Dinallo has stated so well, there might be 

an argument that more of the bond insurer or that aspect of the 

insurance industry might be federalized so far as rules of— 

The CHAIRMAN. Let me ask one last question here, and that is 

on the backstop. I would say, the gentleman from Connecticut, Mr. 

Shays, had mentioned that, and others had. And I know—and Mr. 

Buffet has also talked about doing that, and we are very pleased 

to have Mr. Jain here and we have talked to Mr. Buffet, and we 

will deal with that later. And there may be a context in which Mr. 

Buffet and the Federal Government are equally attractive alternatives, or maybe these days he might have the edge in the minds 

of some in terms of financial stability. 

But what about—what are your initial reactions, the two of you, 

to a Federal financial reinsurance? 

Mr. DINALLO. I think I’ll just tell you what I learned along the 

way that would maybe inform. When we explored the possibility 

that the investment banks would engage in a consortium, one of 

the very first ideas was whether it would just be a line of credit, 

essentially a backstop. And I thought the rating agencies would 

21

give it very high credit without actual capital being put up. I assume that the Federal Government’s guarantee would be even 

more highly rated. 

And so what you do is you put in place a reinsurance situation 

where you essentially guarantee a certain amount of capital in case 

there are defaults. What that does is it lets the insurance company 

release a lot of capital that it was otherwise holding to cover on the 

municipal side. And that would go towards a situation that would 

elevate the ratings across the board, including on the structured 

side. 

But if you were in a situation where you wanted to not have to 

do damage to other policies or establish the worst-case scenario of 

a good bank, a bad bank, that would be extraordinarily helpful to 

releasing capital and coming out of what looks like a liquidity 

crunch situation. 

The CHAIRMAN. Attorney General? 

Mr. BLUMENTHAL. I support it strongly, and the reason is very 

simply that it represents the best hope for achieving the goal that 

you stated at the start of the season, to let our people go, to free 

the towns and cities from a tax, a secret tax, that is now imposed 

by Wall Street. Let’s face the facts. Except for Orange County and 

a couple of other aberrations, no towns and cities and certainly no 

States cease to exist. They continue in business. They almost never 

default, and the Federal Government as a backstop would eliminate the tax that currently towns, cities, and States have to pay. 

The CHAIRMAN. Well, I appreciate that. I am going to finish with 

this, but it strikes me that as you talk, you mention Orange County. There have been a couple of bumps. But in every case, it seems 

to me it was because the issuer got cute and tried to get into investments that were over its head, and there would be nothing 

stopping us if we were to do this from saying, here, we are the 

backstop for full faith and credit, general obligation, plain vanilla. 

And if you start getting fancy, then you’re out of our loop. And I 

think that might save a lot of grief as well. 

Mr. BLUMENTHAL. Mr. Chairman, if I can just add, there is another aspect of this whole issue legally, which is that right now, the 

States often function as backstop for the towns and cities. 

The CHAIRMAN. Yes. 

Mr. BLUMENTHAL. In fact, one of the first actions I did as Attorney General was to go to bankruptcy court and prevent the city of 

Bridgeport from declaring bankruptcy and defaulting on its bonds. 

So the States will not let— 

The CHAIRMAN. Right. Because of the negative effect it would 

have had on everybody else, and in fact the bondholders were held 

harmless, and that may be another problem. 

Mr. BLUMENTHAL. Exactly. 

The CHAIRMAN. I would just—we have been joined by our colleague from Connecticut, and I just wanted to tell him we have 

been talking about his—the idea he and I had talked about, about 

the backstop, and we will be pursuing that further. 

The gentleman from Alabama. 

Mr. BACHUS. I thank the chairman. When it comes to the municipal securities market, we have functional regulators and they 

focus on different things. The Fed focuses on one part, and the inVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
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surance commissioners focus on another. You have all this, you 

know, obviously the SEC on broker-dealer matters. But are there 

gaps in that regulation, or is there a need for some—for better coordination? 

Mr. SIRRI. Well, Congressman Bachus, I think our chairman has 

gone on the record and said that he feels that disclosure, in particular in the municipal area, could be stronger. I think when you 

compare disclosure in the municipal area to, say, disclosure in the 

corporate area, some immediate gaps arise. And Chairman Cox has 

stated very clearly, I think he sent material up to the Hill that details this very precisely, that disclosure could be improved both in 

its accuracy, its completeness, and its timeliness. 

I think issues like accounting, accounting protocols, and the independence of certain accounting standard setters, could also be improved, so as to bring disclosure and the quality of information that 

investors get more in line with the standards we have in the corporate area. 

Mr. BACHUS. Okay. Attorney General Blumenthal, you proposed 

prohibiting different rating standards for the corporate municipal 

bonds. Would you—what about municipalities that may not be able 

to pay? I mean, how do you—and would you run through that? And 

you may—exactly how that would work? 

Mr. BLUMENTHAL. Well, I think that goes to the heart of the 

idea, and is obviously a very profoundly significant question. I’m 

not proposing that every municipality be rated triple A, but simply 

that the criteria and the standard be the same for the municipality 

as it would be for the corporation. And there are a lot of corporations that don’t deserve triple A ratings also. 

So, if a municipality has insufficient reserves, is not taxing 

enough, in fact is uncreditworthy for some reason, then it should 

be judged accordingly, but it should be judged by the same standard, not a dual standard, but a single, unified standard known either as a global standard or the corporate standard, call it what 

you will, it should basically be the same for corporations as it is 

for municipalities, but not give either of them a break. 

Mr. DINALLO. May I comment for just a second on the triple A 

rating issue? I think that it’s important to note what I think the 

bond insurers did here, because I heard the words ‘‘extortion,’’ etc., 

and I do think that there is a serious issue that has to be looked 

into. But they did perform one important function for small municipalities, water authorities, school boards, and hospitals. They essentially commoditized their bonds such that they could be traded 

in and out of triple A rated situations. 

Now we know that money markets, Fidelity, even hedge funds 

have triple A tranches that have to be filled with a triple A rating. 

So what I think they essentially did was they took sort of a statistical gamble, which has paid off, in that they did not in fact examine every one of those authorities. And the rating agencies themselves did not rate every one of those authorities. 

I think I would just challenge a bit that it would be a very difficult and inefficient and expensive system that would have every 

single municipality, authority, school board, hospital, or museum 

rated by the rating agencies, or, in fact, examined by the insurers. 

But across the whole board, as Chairman Frank showed, the gamVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
23

ble is a good, safe gamble, it seems. And I think that was the system. 

I don’t want to comment on the investigations, but it seems to 

me that approach was a way to let all municipalities come to market and be commoditized in a positive way so they could be held 

as they deserve statistically triple A rated. If you begin to pluck, 

cherry-pick out of that system, and I’m sure it’s perfectly appropriate for Florida and California to want to do this, you will create 

a situation where the lesser municipalities, so to speak, which still 

statistically are good bets, will find it much more difficult to come 

to market. So the system will have to change dramatically. 

Mr. BACHUS. It does appear to me at least that there has been 

a double standard or there have been harsher ratings on the municipal securities, when as you say, they have historically been 

much safer. So, you know, I have not understood that. 

Let me ask you this. What about the difference—we talked about 

general obligation bonds. What about revenue bonds? Is there a different approach to them? Since the revenue bond is a dedicated 

source. And Mr. Sirri or—well, anyone who would like to— 

Mr. DINALLO. I would say that one thing you’ll learn this afternoon is I would seek answers from the rating agencies about how 

they would go about doing the ratings. I know it sounds kind of 

tautological, but the point is, I think that what municipalities do 

doesn’t necessarily fit well into sort of the box checking that the 

rating agencies usually look for. They don’t have a revenue stream. 

They don’t have a return of equity. They don’t have capital. It’s a 

very different way of judging. What they have is a very secure 

promise on a risk, on an obligation. And I agree with those who 

have commented it may be the most secure of all. 

But in fact I would urge the rating agencies not to necessarily 

rate them the same as corporates, because they’re not going to be 

able to be rated the same as corporates. They don’t have the same 

structure. But they need to be statistically brought in line with 

corporates under their own system. And I think the SEC will work, 

I assume, with rating agencies to try to produce that and get better 

standardization. 

Mr. BLUMENTHAL. And I would just add, if I may, sir, that there 

are ways to minimize the tasks of the rating agencies in looking 

at either revenue bonds or the school boards and the resource recovery agencies or all of the municipal agencies and simply say or 

ask, are there backstops, for example, State guarantees? And in 

many instances, it will be found that the reason why their default 

rates are so low is the State will not let them default, period. End 

of story. And so why are they paying insurance? Well, they’re paying insurance because they have been bludgeoned and intimidated 

into doing it by the markets and by the powers that be. 

Mr. BACHUS. Mr. Sirri. Thank you. 

Mr. SIRRI. I would just point out that there is a difference between general obligation and revenue bonds. General obligations 

are backed generally by the taxing, full faith taxing authority of 

the municipality, whereas with revenue bonds, the payments are 

secured by some particular project, whatever it is. 

Much that we have been talking about today about the strong 

credit performance of municipal securities is related to general obliVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
24

gation instruments. When it comes to revenue instruments, the picture becomes somewhat more cloudy. Not all revenue bonds are insured. They’re not all wrapped. And in some cases, there have been 

performance issues. And in those cases, because the performance is 

secured by a particular project, you can’t bring in general taxing 

authority. 

Mr. BACHUS. Yes. And there is some political pressure on not 

raising rates or not raising charges. And sometimes a Federal 

judge has to intervene. 

The CHAIRMAN. Thank you. The gentleman from Massachusetts. 

Mr. CAPUANO. Mr. Chairman, I just want to assure the gentlemen at the table that though I wasn’t here, I was watching from 

a secure location. 

[Laughter] 

Mr. CAPUANO. First of all, Mr. Sirri— 

The CHAIRMAN. Excuse me, but that’s because he was the author 

of the ethics bill. It has nothing to do with you. That’s why he had 

to be hidden. 

Mr. CAPUANO. Mr. Sirri, I want to thank you and the SEC for 

the report you have done. I haven’t read the whole thing yet, but 

what I have seen of it, I like, and what I have heard of it, I like. 

However, it’s only a portion of the problem that I’m interested in. 

Honestly, I cannot believe that anybody is going to look me in the 

eye and tell me that most GOs have to go to auction at all. Most 

of them don’t. Most of them—and those who do only go to auction 

because they’re bundled with something that’s junk. And so—I understand what you’re saying and I don’t disagree with you about 

the ARS. That’s a problem. It’s a serious problem for the country, 

and I’m glad you’re addressing it—finally—but you’re addressing it. 

At the same, it’s only a portion of the problem. 

Mr. Blumenthal, thank you for being smoother than me, but I 

heard you say almost the exact same stuff I said, just nicer. And 

I would encourage you not— 

Mr. SHAYS. Much nicer. 

Mr. CAPUANO. And I would encourage you, though, not to wait 

too long for Congress to act. We tend not to act until way too late 

on almost everything. And if we don’t do it, I’m begging you to 

please do it and gather your other attorneys general to do it. And 

I’m also asking you, you know, you have all kinds of laws. You 

have RICO laws, you have all kinds of laws you can use on cabals 

that extort people. Basically, that’s illegal, and it shouldn’t be allowed, and if I can help you in any way, that’s fine. 

I do have some comments, though, Mr. Dinallo, about some of the 

things you just said. I will tell you that in Massachusetts, it’s exactly as Mr. Blumenthal said, cities and towns have gone bankrupt, 

but not a single bondholder has been unpaid because the State 

steps in and pays directly. Not one. 

And according to—this was just handed to me this morning. This 

is from Moody’s. Source: Moody’s Investors. GOs, since 1970, 

14,775, not one default. Not my numbers. Moody’s. Not one default. 

They didn’t say the big ones, the small ones, the tiny ones, the ones 

that don’t matter. You could also have things like pooling of 

issuances. If you have some small community that needs a fire 

truck, you pool it with five other communities and issue that bond. 

25

And if the State of New York doesn’t want to step in behind, fine, 

then the State of New York should know that their cities and 

towns are going to pay higher rates. But for those States that have 

the foresight and the wisdom and the desire to provide the backup 

for the municipalities, they should be allowed to do so. 

Now, I understand that. And I’m not—I’m hoping that some of 

your commentary is not based on the fact that most of these people 

are there. I also want to make one particular point. When I asked 

the credit agencies to rate my city, I paid for that. They didn’t come 

in and say, ‘‘Oh, Mike, we’re good guys. We’re just going to do it 

for you.’’ Not only did I pay for it, I wined them, I dined them, I 

bused them around, I begged them, I treated them nice. And I had 

to keep my mouth shut the entire time. I don’t have to do that any 

more. 

[Laughter] 

Mr. CAPUANO. So let’s not pretend that they’re doing us a favor. 

And by the way, I also want to be very clear. The dual system is 

a problem, but it is not the only problem. If we had a unified system, they would still rate me, my poor city, lower than somebody 

else who is just as likely to pay back their bonds. Corporations go 

bankrupt every day and walk away. Most municipalities don’t, particularly those who have States that back them up. We’re not going 

anywhere. 

So even with a unified rating system, that’s all well and good, 

but it is only one step towards the final process. The final process 

is to treat all bond issuers the same, only looking at the likelihood 

of the bondholders being paid back, and that is a fair and reasonable standard. Other than that, it’s extortion, especially when you 

have only a handful of people making those judgments. I guess I 

must—I don’t know if I have a question in there somewhere, but 

they can— 

The CHAIRMAN. Let me just, if the gentleman would yield briefly, 

let me just underline what’s been said. Several of us here were 

State legislators, my colleague from Massachusetts, and were mayors. Here is the point: No State, no State legislators, no governor, 

can allow any one of its municipalities to default because then 

every other municipality would pay through the nose. So that is 

why this is not just some charity here; this is self-defense. 

The particular municipality, you might pity the municipal workers there. Services may get cut back. Maybe the trash won’t get 

picked up. But we can guarantee you, we have all been there, you 

can’t do that. Because if any one municipality falters, every municipality in that State would pay, and there isn’t a State governor and 

legislature in the country who doesn’t understand that, and that’s 

why the State guarantee is such a good one. 

I’m sorry. 

Mr. DINALLO. No. But if that’s the absolute truth, which I don’t 

dispute, then you could essentially federalize the rating systems for 

municipalities. It wouldn’t be an outrageous concept to either socialize the rating agencies completely and take out the conflict that 

the Congressman just recited. That’s not— 

Mr. CAPUANO. Sign me up. 

Mr. DINALLO. That has been discussed. You could, on the municipal side, essentially federalize that rating system and say that the 

26

U.S. Government through the States, through the municipalities 

will stand behind all those obligations, and I assume it would immediately get the equivalent of a triple A rating in those asset 

management situations that I described before. I mean, these are 

not insane ideas. You just described a situation where you’re essentially saying, as the chairman of the Financial Services Committee, 

that we just don’t let those fail, which is probably a good situation 

for the reasons you say, you could change the system. 

The CHAIRMAN. The gentleman from Connecticut. 

Mr. SHAYS. I thank you again, all three of you, for being here. 

I was waiting for that vote that never happened, so I didn’t hear 

your statement. I did read yours, Mr. Blumenthal, and thought it 

was again quite excellent. 

I’m struck with a number of different reactions. One is, again, it 

seems to me that local municipalities are better off than the insurance companies that were rating them. And I just find that, you 

know, rather curious. And we all have stated that you’re not going 

to see defaults, which is fairly obvious. I moved to the City of 

Bridgeport that previously had attempted to go bankrupt, and the 

local community rose up in arms, and the State said no way are 

you going to go bankrupt. 

The only value I see—and then I’m struck by this reaction, that, 

particularly with subprime, the rating agencies have lost their 

brand. They are meaningless, because they have been so wrong. 

They were wrong about Enron. They were wrong about other companies, but in particular, they were wrong about the subprime 

market. And so I’m even questioning the value of rating agencies 

now. 

The only thing I am struck with is that there is value in having 

a mayor or governor in fact, have to be held—be given a grade as 

to how they’re managing the city. But other than that, if I was an 

investor, I’m struck by the fact that the ratings are almost meaningless. Tell me why the ratings aren’t meaningless. Tell me why 

a businessman or woman in this day and age who is investing 

would pay much attention to rating agencies. 

Mr. DINALLO. I’ll just say, I’ll just give a general response and 

defer to Mr. Sirri. I think the credit markets need some efficient 

commoditization that they can rely on. You cannot take away all 

ratings. It would I think result in sort of credit market chaos. I 

think that the municipalities are potentially a separate situation. 

But once again, we’re dealing with thousands and thousands of 

companies, and it is impossible for credit providers, loan givers and 

investors to make all of those individual distinctions, especially 

when they’re running a large asset base. 

Mr. SHAYS. I hear that, and yet they have been so wrong. 

Mr. DINALLO. They have had some—well to be fair, they have 

had some dramatic wrongnesses, there is no doubt. But I bet if we 

look at it statistically, you would actually give them a higher grade 

than just based on some of their largest so to speak mistakes. To 

be fair. I think that they need to stand up on those. They need to 

get over this inference of a conflict of interest, but I don’t know 

that I know a better system. That’s all that I’m saying. 

Mr. BLUMENTHAL. I would just add that I agree, Congressman 

Shays, and I want to thank you, by the way, for your work on beVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
27

half of Connecticut’s towns and cities in infrastructure and credit 

and so forth. 

Mr. SHAYS. This is called the quid pro quo that we have developed. Thank you, Dick. 

Mr. BLUMENTHAL. But I would agree that—I would agree with 

Mr. Dinallo that in theory there is a need for some objective, dispassionate, disinterested agency that evaluates whether investors 

will be paid back. In other words, the likelihood of default, the 

creditworthiness of a corporate bond. In the municipal situation 

where there is the kind of State guarantee— 

Mr. SHAYS. See, that’s the irony. That’s why I wonder what is the 

value of the rating, because they’re going to be paid back. They can 

say that a town is well-run or not well-run, but in the end, it’s almost irrelevant. 

Mr. BLUMENTHAL. And the problem is that they have no business 

telling Bridgeport or Stamford or Boston or any other city whether 

it is being run well. That’s for voters to decide. All they should be 

deciding is will somebody who buys the bond receive his or her 

money. And in the case of most cities, there’s no question that they 

should be getting triple A ratings, and that’s why in my view, a 

single, unified standard would accord many of the towns and cities, 

and States obviously, a triple A rating because of those legal guarantees, but also because they’re not going anywhere, as Mr. 

Capuano said more eloquently than I could. They’re going to be in 

business, and they are not going to default when they have to go 

into the market again and again and again in the future. 

Mr. SHAYS. Mr. Sirri? Thank you, Dick. 

Mr. SIRRI. I think it is interesting to realize how credit rating 

agencies came about. Historically, they came about over 100 years 

ago when investors sought to understand the credits of, at the 

time, railroad bonds. At that time, people couldn’t distinguish between the credits, so they looked at credit rating agencies to help 

them with that. So in that context, they were a point of efficiency. 

Fast forward to today, I think you have pointed out quite correctly some issues with credit rating agencies, whether it’s Enron 

or certain issues in the subprime area. But in some ways, this has 

partially been addressed with the Credit Rating Agency Reform Act 

of 2006. To my reading of that Act, what Congress thought to point 

out to us was that we should let the competitive markets determine 

how useful credit ratings are. 

So to what we’re talking about there, a few things have happened. We have seen new credit rating agencies enter the market 

that weren’t there before. We now have nine credit rating agencies 

where we used to have five. If it’s the case that these credit ratings 

aren’t useful, then one of two things will happen, I believe, in the 

long run: (a) if they don’t improve, investors will ignore credit ratings. They’ll start to be written out of the process; and (b) the second thing I think will happen is that credit rating agencies have 

an incentive, given this legislative framework, to improve their act. 

And I believe they will over the long run. 

I think you’ve seen some steps in that direction. They won’t happen instantly, and there may be a role for entities like ourselves, 

the Securities and Exchange Commission, to step in. Our chairman 

has indicated that we will engage in some rulemaking this year I 

28

think that’s based on some of the things we’ve observed. But there 

is this framework under which credit rating agencies are governed, 

and I think this will play out over time. 

Mr. SHAYS. This may seem like a stupid question, but wouldn’t 

the best investment be the State that has the worst credit rating 

and therefore the highest interest rate? 

The CHAIRMAN. Yes. 

Mr. SHAYS. Yes. I mean. 

Mr. BLUMENTHAL. And— 

Mr. SHAYS. So you really want to find the worst. I’m sorry, Dick. 

Mr. BLUMENTHAL. You know, just to put a footnote on the point 

that has been made. You know, the elephant in the room here— 

Mr. SHAYS. Don’t use elephant. You can use donkey. 

The CHAIRMAN. That’s right. We’re for diminishing the number 

of elephants in the room. 

[Laughter] 

Mr. SHAYS. Give him the microphone and you’re dead. 

Mr. BLUMENTHAL. You know, it may well be that there are a few 

more credit rating agencies, but let’s face the facts. It’s a highly 

concentrated market. You have S&P and you have Moody’s, and 

they dominate the market. It is a highly concentrated market. And 

in the long run, Mr. Sirri may be right, but it’s a very long— 

The CHAIRMAN. Can I just—if I could interject. And there is also 

the question—Mr. Sirri is right—we generally like competition, but 

there is some question here about where the competitive effects are 

pulling you. Who’s paying? And I think there is a question here 

about how the, you know, where the competition, in some cases, 

the way it is now structured, might have had a countervailing effect, and that’s one of the things I hope will be addressed in the 

rulemaking. 

Mr. SIRRI. There is one other point I’d like to make. We have 

been focusing on credit ratings, but I think it’s also equally important to focus on market prices, or in this case on yields. If all municipalities were as we say, and that none of them were ever to default, then those bonds should all trade at the same yields, but 

they don’t. The market actually, as it trades bonds, prices them at 

different yields. And that’s— 

The CHAIRMAN. That’s right. And by the way, the market is 

wrong. I mean, it’s demonstrably wrong. There would still be some 

different yields but probably because you have different State tax 

structures. For me, the double tax and triple tax exemptions would 

give you one market versus another. But I do think this is a case 

where the market clearly doesn’t get it right. 

Mr. SIRRI. It may be. I mean, it’s hard to say. I appreciate the 

point you make, since the default rate is so low. But not only do 

they trade at different yields, but as credits change, as municipal 

credits change, you see yields widen on those credit— 

The CHAIRMAN. Yes, but again, isn’t it—that’s because the credit 

rating agencies have been giving different views, and that may be 

changing. 

The gentleman from Massachusetts, Mr. Lynch. 

Mr. LYNCH. Thank you, Mr. Chairman. I want to thank the 

members of the panel for helping us. Just to pick up on this last 

point, I do agree with Mr. Capuano and the attorney general who 

29

have talked about the disconnect between the corporate bond rating and the municipals. But I think there is value in the rating 

system for the—principally for the second reason that Mr. Sirri 

raised, which is not all municipalities are the same. We need that 

competitive incentive for municipalities to get their act together, as 

Mr. Sirri said. 

And we don’t have to look back very far. The whole change in 

GASB 45 where municipalities now had to lay out in their financials the long-term pension obligations and health care obligations 

with respect to their employees over the long term, we saw some 

municipalities handle that very well, others not well at all. And so 

now it’s a huge burden on some older cities with a lot of public employees. 

So I think relative to a measurement between municipalities and 

States and towns, I think that that rating is an important factor 

for investors to consider. But let me just—aside from that, would 

there be a way, rather than this whole tangled mess that we have 

right now with the rating agencies, would it not be possible for the 

Federal Home Loan banks to step in here? The chairman has 

talked about a Federal backstop. Mr. Shays has talked about a 

Federal backstop. What about the Federal Home Loan banks 

issuing, say, a letter of credit on the bond rather—in place of I 

guess or maybe even belt and suspenders, on the bonds themselves? Is that something that could work or take the—you know, 

take this rating agency, and at least the double standard, mitigate 

that somewhat? 

Mr. DINALLO. Well, I was about to comment that on the $236 billion line of credit that the Fed just created, you could in a sense 

take a small sliver of that and stabilize the bond insurance industry overnight. I mean, the stress amounts that are at issue there, 

as I testified to the subcommittee, are somewhere in the range of 

$7 to $10 billion. In other words— 

Mr. LYNCH. Just on that thought, if you did it, you know, nationally, how do you eliminate the moral hazard of backing up someone 

who’s not doing the right thing? Unless you do it on a municipalityby-municipality basis? And say here’s the opportunity. You have to 

prove yourself. 

Mr. DINALLO. Well, the moral—look, the moral hazard problem 

is a serious problem. I think that is why I sort of illuminated that 

everyone assumes that there really is no chance of a municipality 

defaulting on its obligations. 

If that is really true, then the moral hazard is already baked into 

the system, it seems to me, and you might as well save all the 

money on the wrap and the insurance and the Federal Government 

should just sort of de-clear it, so you will have moral hazard, but 

it seems to me you have just kind of annunciated today that the 

moral hazard is already there. The markets do not seem to believe 

it. 

Mr. LYNCH. I appreciate that. 

Mr. DINALLO. If you took it away, you would get at a very 

wealthy truth, so to speak. 

Mr. LYNCH. Mr. Blumenthal, any thoughts on that? 

30

Mr. BLUMENTHAL. I think it is an idea that ought to be explored. 

Certainly anything that relieves costs—the Home Loan Bank 

Board may be a good prospect—should be explored; absolutely. 

Mr. DINALLO. I think that the chairman’s point is well taken. I 

do have one idea. The way that most municipalities have gotten 

into trouble is on their asset liability match and sort of investing 

in situations to try to boost their returns and cover their liabilities. 

If you were essentially guaranteeing their backstop and then prevented them, because they would not have to go into some of the 

riskier investments, and sort of take out the moral hazard of getting into the situations that we described before, you might be able 

to take out what is the most difficult moral hazard, which is the 

risky investment side. 

Mr. LYNCH. Mr. Sirri, do you have anything to add to that? 

Mr. SIRRI. No, not in particular. I would just point out that any 

time you issue a guarantee like that, you have to manage your liability with respect to the guarantee. As people have said, that can 

be difficult. 

I think the moral hazard issue is a serious one and one that has 

to be thought about. 

Mr. LYNCH. Mr. Chairman, I yield back. 

The CHAIRMAN. Thank you. Let me just note, by the way, as my 

colleague talked about or somebody talked about, the $236 billion 

in the Fed. Apparently, the Fed is by statute currently prevented 

from getting into the longer term municipal bonds, and we are in 

the process of writing Chairman Bernanke. 

I think what the Fed has done this week has been neutral, but 

if they can take AAA mortgage backed securities in the swap with 

treasuries, we are talking about something that has a higher value 

even than that. 

We are going to explore that with the Fed as well. I think we 

are all moving in that general direction. 

The gentleman from Texas. 

Mr. GREEN. Thank you, Mr. Chairman. I thank the witnesses for 

appearing. 

Let me start by asking if we are in essence talking about the 

auction rate securities and available rate demand notes, is that the 

bottom line here that is creating the increase in fees and costs that 

we are seeing? Is that where we are? 

Mr. SIRRI. I think my comments earlier were directed to relief 

that we are aiming to providing in the auction rate securities 

space. 

The variable rate demand obligations space still appears for the 

most part to be functioning well, although there have been some 

capacity issues there. 

Mr. GREEN. With the monoline insurers, when their credit rating 

is downgraded, the cost of their borrowing increases, correct? This 

impacts the bond issuer. 

It does not impact what we will call the notes that they already 

have in place, the debt that is already in place. It does not impact 

their debt service payments. 

It does impact their payments on new acquisitions going forward; 

is that correct? 

31

Mr. SIRRI. One place—in general, I think what you are saying, 

the answer is yes. One place it can have an important effect is the 

relationship in the variable demand space, variable demand obligations. 

If there were to be a sufficient problem with an insurer, then 

these bonds could be put back to a backstop provider. Again, the 

bonds are issued. I just want to point out there could be a significant effect there. 

Mr. GREEN. My intelligence indicates that the cost of borrowing 

increases greatly when the credit rating is downgraded. Give me an 

example of what ‘‘greatly’’ really means, please. 

Mr. DINALLO. You can take a look at what happened to the Port 

Authority, I guess. One week, they were paying 3 to 4 percent, and 

when the wraps sort of fell off and the auction rate market went 

haywire, they were paying 18, 19, 20 percent. We are talking about 

the Port Authority of New York and New Jersey, which is about 

as good of a bet as you can reasonably imagine, as Chairman 

Frank said earlier. 

Mr. GREEN. Permit me to ask you, if you can, to translate that 

into dollars so I can get a more comprehensive understanding—3 

percent in dollars and the 18 to 20 percent in dollars, please. 

Mr. DINALLO. I cannot quite do that for you. I do remember that 

the week that they had to pay, that one week was, I think—it 

might have been just for the day, it was several hundred thousand 

just for that day. I am speculating a little. 

Mr. GREEN. Did you say several hundred thousand? 

Mr. DINALLO. Yes, I believe so. 

Mr. GREEN. We have gone from a few thousand dollars to several 

hundred thousand dollars? 

Mr. DINALLO. If you took what Mr. Sirri said earlier, which is on 

the day we were testifying, 600 or so auction rate bonds failed, I 

think across that list, you are into—I am going to speculate—it has 

to be hundreds of millions of dollars for that round of bonds. 

Mr. GREEN. I was going to get to that, the failure at an auction, 

when you have that, then you have the penalty interest rate that 

you have to contend with. 

Is the penalty interest rate contained within some codified agreement? How do we find the penalty interest rate? How does it get 

defined in this process? 

Mr. SIRRI. When the auction rate instrument is set up, it provides for the eventuality that an auction possibly may not succeed. 

When that happens, there is a maximum rate or penalty rate that 

is set. It could be particularly high. We were using the example of 

20 percent. It might be lower. It might be 6 or 7 percent. That depends on the design of the instrument. 

It is part of the set of documents and contracts, the auction rate 

agreements, that constitute the papers supporting the issue. 

Mr. GREEN. The auction rate fails because the company, the 

bonding company, no longer has its AAA rating. All this is no fault 

of the municipality? 

Mr. SIRRI. The failure here is defined as having more sellers of 

the bond than buyers. If a group of sellers came and wanted to sell 

100 bonds but there were only 80 bonds that wanted to be bought, 

that auction would fail. 

32

Mr. GREEN. I understand. The reason you do not have the buyers 

is because of the ratings the insurer’s have; is that correct? 

Mr. SIRRI. That may be one of the reasons, but there could be 

other reasons, too. Let me give you a concrete example. 

When you start to have some failures in this space, you could 

also have failures in credits that are otherwise unaffected, say 

credits in the student loan space, where the underlying credits are 

perfectly fine. There may be explicit or implicit government supports. 

What people anticipate is their auction may fail for whatever 

reason. Knowing their auction may fail and given that people who 

hold this paper have a very high demand for liquidity, they view 

it as a short term money market substitute. They do not want to 

be the last person to get out, so they jump for the exits. If people 

anticipate folks jumping for the exits, they all jump for the exits, 

and thus you see good credits where there is not a question of a 

downgrade, you see in those credits failed auctions. 

Mr. GREEN. Final question. The municipality, in this scheme that 

you just gave to me, is not at fault in this process. Nothing has 

happened with the municipality. It is still there. They are still 

doing the same things they have been doing. It is the insurer that 

has the problem. 

Mr. SIRRI. If I can interpret ‘‘fault’’ as saying there has not been 

some event at the municipality in terms of its credit or its ability 

to— 

Mr. GREEN. Let me ask someone else to respond. 

Mr. DINALLO. I think the way to phrase it would be to say that 

the underlying creditworthiness of the municipality had not 

changed, and that instead, there were two events that were going 

on, there was a doubt as to the viability of the insurance wrap that 

you are referring to, the AAA wrap, and in general, at exactly the 

same time, the credit markets were starting to withdraw credit and 

liquidity, so the auction rate market, I think, was impacted both 

by the monoline crisis and a general tightening of credit. 

The CHAIRMAN. The gentlewoman from California. 

Ms. WATERS. Thank you very much, Mr. Chairman. I would like 

to thank all of our panelists for being here today. 

It is very important that we understand what is going on and see 

what we can do to assist in dealing with this economic situation 

we find ourselves in. 

Mr. Dinallo, it strikes me that we have a somewhat odd situation 

here. On the one hand, you have bond insurers having started to 

insure much riskier bond products, such as mortgage backed securities. On the other, an entire class of bonds, municipal bonds, 

which seem to have to rely on borrowing the bond insurer’s AAA 

ratings, even though their riskiness is probably much lower than 

the municipal bond rating system reflects. 

Am I correct in identifying this duality and if so, how are you 

dealing with it at the State level? 

Mr. DINALLO. I think you are correct in identifying the duality 

and we have spent quite a bit of time talking about it. 

At the State level, I think we have gone in to try to both stabilize 

the markets and infuse capital to make sure that we do not at least 

33

lose the ratings that were attached to the municipality on the 

structured side. 

What I find interesting is that as presented to the bond insurers, 

the ratings for the structured side were usually already AAA rated. 

In other words, it was the super senior tranches of the CDOs and 

the banks wanted the equivalent of a credit default swap to basically assure that no matter how the value changed, they had a 

AAA wrap around that. 

The municipalities, as we pointed out today, ironically, many 

people believe they were woefully underrated or unrated. 

If you were a computer just judging risk, the monolines took a 

riskier bet in uplifting them from no rating or A or AA into AAA. 

It is all very ironic now and clearly not true. 

If you were going in and relying purely on the ratings or a lack 

of a rating, it was the case that you were essentially being riskier 

on the municipality side just from a ratings point of view. 

I think there is going to be a large sorting out, which is appropriate and should be done quickly, which we are working on the 

new regulations to get there, about essentially separating the businesses potentially going forward, assuring the credit default swaps 

are no longer the instruments for securing that kind of obligation, 

and probably prohibiting credit CDO squared, which is the sort of 

recreation from a BBB into a AAA, sort of the silk purse out of a 

sow’s ear problem that exacerbated it. 

Mr. BLUMENTHAL. Can I add just an answer as well, please? 

Ms. WATERS. Yes. 

Mr. BLUMENTHAL. I think the thrust of your question is absolutely right. What happened was a great many of these instruments, the CDOs, the SIVs, the structured investment vehicles, the 

structured finance securities, were overrated, and the municipalities were underrated. 

I ran across a quote. It happens to be from Warren Buffett. It 

is not directly quoted, so I apologize if he did not say it or if I am 

getting it wrong. 

He said: ‘‘It’s poetic justice in that the people who brewed this 

toxic kool-aid found themselves drinking a lot of it in the end.’’ 

The folks who brewed the mix are now having to swallow it. The 

point is that we need to change this system so it does not happen 

again. 

Ms. WATERS. Mr. Chairman, I thank you very much. Even 

though we do not have time to get into it, I would hope that at 

some time we can really get into understanding the tranches and 

how they were packaged, how it worked, and how they were determined to be risky or not. 

That is one area where I just need more information. 

The CHAIRMAN. We certainly are going to try hard. I am not 

going to promise anybody that by the end of this year, I am going 

to understand what the derivative of a collateralized debt obligation really means. I will just take comfort in the fact that nobody 

else seems to know either. 

[Laughter] 

The CHAIRMAN. The gentleman from Pennsylvania, and then the 

gentleman from North Carolina. 

34

Mr. KANJORSKI. What was it that you did not understand, Mr. 

Chairman? 

My problem is somewhat related to what Ms. Waters has been 

addressing. There are so many bad signs here. I recall about 3 

weeks ago meeting with one of the monoline insurance carriers 

that did not get into as much difficulty as some of the others. 

They showed me a study that they had undertaken of their competitors. One of them was the pools of securities that were purchased and insured by their competitors, and it showed that in one 

year, in 2007, 18 percent of the first installments on the mortgage 

obligations were not paid. 

The only thing I can relate to is the prior experience I had on 

a board of directors of a small bank that when our default rate on 

mortgages went above one percent, everybody seemed to get into a 

nervous state and started at least experiencing the pains that may 

indicate a heart attack. 

How did we get to an area where 18 percent of the mortgages 

did not even perform on the first installment and why did not people know about this? Two, why did it not set off a bell in any number of places, from the owners of the securities, the purchasers of 

the securities, the people that made up the pools, or for that matter, the insurance carriers that were putting their resources into 

the pools? 

It seemed to me everybody turned a blind eye and should have 

known with even a cursory review of the record that something 

was wrong. 

I will grant one thing. It is practically impossible to figure out 

what is where and what the impact is because there does not seem 

to be any inventory that exists in the public realm anyway that you 

could find out how these securitized pools are manipulated and sold 

off in various configurations. 

Certainly, should not a regulator—and maybe I should direct this 

to you, Mr. Dinallo—is your inspector or auditor of these insurance 

companies able and does he make an in-depth analysis of the securities held as collateral to know whether or not they are performing, and if they are not performing, does he take some action 

to indicate therefore, they do not meet the criteria established by 

the law? 

Mr. DINALLO. I think that is a great point. There is a history 

here where in fact there is something called the Securities Evaluation Office of the NAIC, which is a group of 100 people who value 

securities separately. 

We did once, I am told, long before I came onto the scene, seek 

to value hybrid securities, hybrid equity securities, differently than 

the rating agencies, and it created a brouhaha because the States 

in their capacities, regulators, were sort of daring to question to not 

create chaos in the marketplace. 

I am considering sort of juicing that up. It is located in New 

York. I think it is important, but do recall, please, Congressman, 

that our first order job is solvency and I think on solvency of policyholders, we have done quite well, frankly. 

People will be paid on their losses it looks like because the assets 

of the insurance companies exceed the most aggressive liability 

projections or losses by someone say like Mr. Ackerman. 

35

I think on that, we have done well. On the AAA rating that 

comes before the insurance company, I will just tell you that I have 

a theory. You asked a question, a rather large macro question. I 

will say that the Congressman who has since departed hit on moral 

hazard. 

There was a day that when you gave a loan as a banker, you 

stood behind that loan. You owned the risks of that loan, and you 

had a book of business that was built on making good underwriting, good loan decisions. 

Someone then had an idea that we could securitize that book of 

business and do good things. We could extend more loans to people 

who wanted homes or to buy a car or finance their children’s education, and so it was securitized, and the banker could do more 

loans. 

That first book of business was excellently built and it performed 

rather well. On the fourth or fifth iteration of that, it became a 

more dangerous undertaking. 

Insurance. We need to be very careful that we do not over 

securitize the underwriting that is going on there, and it is something that I am very worried about. 

Mr. KANJORSKI. Thank you. You may not be aware that the Governor of New York announced his resignation. I suspect you are an 

appointee of the Governor. 

The CHAIRMAN. Why are we getting into that? 

Mr. DINALLO. I am. 

Mr. KANJORSKI. I would recommend to the new Governor that— 

The CHAIRMAN. Let’s not get into that. Let’s go on. 

Are there any further questions? 

Mr. KANJORSKI. No. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. I thank you, Mr. Chairman. Let me first comment, I 

left the room after Mr. Capuano because I did not want to go after 

him. There was so much passion in his voice. A lot of the points 

he was making, the concerns about this resonated, but there is also 

a side here that is reflected by the chairman’s comments about lack 

of understanding here, that may lead to some slightly different conclusions on how we proceed. 

I think the value of this hearing is to expose that there are a 

number of irrationalities in this market as we have seen in virtually every market recently. 

The first question I want to ask is, who is the prime regulator 

of this market? Whose responsibility as regulator would it be to 

step into the void that you all are describing here? 

Mr. DINALLO. I guess that would be me, Congressman, to the extent that most of the monoline insurers are either located or domiciled in New York. 

Mr. WATT. This is a New York issue, which leads me to one of 

the other irrationalities of this. We are dealing with a national 

market. This reminds me that the first irrationality I dealt with in 

this whole context, in the whole bond issuance context, was back 

in the mid to late 1970’s when lawyers in the State of North Carolina could not issue opinions on bonds, legal opinions on bonds of 

any kind. It was all done in New York. 

36

Mr. DINALLO. I may not have answered your question correctly. 

If you are asking who is responsible for the rating agencies and the 

ratings of bonds, creditworthiness. 

Mr. WATT. I am asking if there is some regulator who, if a problem emerged in this market context, in the bond issuance context 

in general, is there a regulator we could point to and say this person has responsibility for it. 

If there is not, then that is the first problem that it seems to me 

we have because everybody then will be pointing the finger at everybody else, the same way that everybody has been pointing the 

finger at everybody else on the whole other side of the credit crisis. 

Is there a regulator that has super responsibility for this? I 

would have assumed Mr. Sirri would have been the first person to 

answer this question, not somebody at the State level. 

I am not trying to influence that. I am just trying to find out who 

the regulator is. 

Mr. SIRRI. I took Mr. Dinallo’s answer to be for the bond insurers, and I think he clearly has responsibility for the monoline bond 

insurers there. 

With respect to understanding your question, when you talk 

about the issuance of the securities, municipal securities are by 

and large exempt securities. The Securities and Exchange Commission, which generally oversees the offering of corporate securities, 

not so for municipal securities in the same way because they are 

exempt from the 1933 Act. 

That said, there is a framework in which there are various— 

Mr. WATT. So, you are telling me there is no regulator. Is that 

what you are telling me? Does the Fed have the authority to step 

into this and be a super regulator? 

Mr. SIRRI. I think what I am saying is we are not a super regulator in the sense that we are all encompassing. We have various 

touches on the market, however, with respect to certain kinds of 

fraud that may occur. We have authority with respect to the operations of brokers when they trade— 

Mr. WATT. Who would we hold accountable if this thing was completely out of whack as it is? Who would we hold accountable for 

that other than the market? 

We all know that the market got out of whack. Was somebody 

supervising the market? I thought this was going to be a simple 

question. Apparently, it is a lot more difficult than I thought it 

was. 

Mr. SIRRI. I think the best way I can answer it is there are various pieces that are divided between various entities. 

For us, when it comes to credit rating agencies, when it comes 

to the work that brokers do in selling these securities, we have authority there. When it comes to issuance, the Securities and Exchange Commission does not. When it comes to the monoline insurers who wrap these securities, we do not. 

Mr. WATT. Thank you. I yield back. 

The CHAIRMAN. The gentleman from Georgia. 

Mr. SCOTT. Thank you, Mr. Chairman. I would like to just ask 

a question dealing with something that is happening across the 

country, if any of you care to respond. 

37

There are examples where communities across the country are 

experiencing incredible interest rate increases. I call to mind an example, a couple of examples that some of you may be aware of, 

where I recently read that Underwood Memorial Hospital in 

Woodbury, Pennsylvania, my own alma mater, the University of 

Pennsylvania’s health system, and the Pennsylvania Intergovernmental Cooperation Authority all have had outstanding auction 

rate securities, and have all experienced interest rate increases, as 

much as from 4.5 to 8 percent. 

This is happening in various places throughout the country 

where people are telling us of similar experiences of incredible interest rate increases. 

I was just wondering if you think that providing additional 

sources of credit enhancement, such as that which is provided by 

the Federal Home Loan Bank’s letters of credit and similar ideas 

are of value in addressing the financing needs of these communities? 

Mr. Blumenthal. I would say yes. You hit on a point that I think 

is very, very important. Even before this credit crisis, the cost of 

those debt issues were rising in terms of interest and also in terms 

of insurance. The insurance companies, the bond insurers, were 

charging more and more as a percentage of what the interest savings could be. 

That is a means that I think we have discussed today to reduce 

or minimize those costs. I think again going back to the question 

that was raised before and I was going to raise it when the Congressman was still in the room, clearly, in this whole system, there 

are gaps in terms of regulation. I think that is an important point 

that has emerged today. 

There are gaps and there are some overlapping jurisdictions, but 

there are clearly deficiencies in the law that need to be corrected. 

One of them is the absence, in my view, of a provision that prohibits the dual system that again disadvantages the health system 

of your alma mater. 

Mr. SCOTT. Thank you for that. Let me go to another point. With 

the initial question being whether we need to worry about a municipal bond or a muni market melt down, do you believe, each of you, 

that this issue is being overblown, or do you feel we have yet another blow to the economy ahead with bond insurers? 

Do you believe it to be true that more and more insurers will lose 

their AAA ratings as Moody’s and S&P look as though they are 

ready to lower the grades on more insurers, even such names as 

Ambac and MBIA? 

It appears to be quite worrisome when a firm is downgraded to 

AA, it is most difficult for them to do any more municipal business. 

Is this not the case, or is it not the case that many of these companies are themselves to blame for the mess that they are in after 

expanding out into the risky securities that some say they had no 

business or experience in insuring? 

Will it not be hard to find investment banks who are willing to 

bail these guys out and will there even be a bail-out if necessary, 

or do you believe that investors will simply have to take these 

losses? 

38

Finally, would an industry-wide bail-out be even a legitimate option as getting banks to agree on how much each should pitch in 

to help might prove difficult itself? 

Mr. DINALLO. I think, Congressman, that it is a very difficult set 

of questions to answer that you have asked. I think the infusions 

of capital that you have seen into the bond insurers have at least 

for now maintained the AAA ratings of at least four or five of them, 

and others are going to shake out and possibly go to a lower rating. 

If I were to be asked whether these were sufficient capital infusions for the absolute long run, I cannot answer that because the 

question is as difficult as answering exactly where is the economy 

going to be in fact several years from now. 

If mortgage defaults continue at a certain rate, then we are probably going to be okay, if they are as projected by the rating agencies, but if they take off into a worse scenario, then the rating 

agencies will, I presume, require more capital as those projections 

go up. 

Likewise, that could also have a serious pull on the municipal 

side because if there was a tax base erosion, then the municipalities could presumably default if permitted to default at a higher 

rate than they otherwise have been. 

It is a question that is linked to the economy. That is why I 

think we should inject capital prudently and it should be market 

based solutions and let the assumptions crisis that we are in and 

the potential liquidity crisis play out a little bit. 

Mr. SCOTT. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from Missouri. 

Mr. CLEAVER. Thank you, Mr. Chairman. Mr. Sirri, my city needs about $1 billion to upgrade its storm 

water sanitary sewers, combination sewers. I stepped out a few 

minutes ago to meet with Mayor Jim Odom, who is the mayor of 

one of the suburban communities in Kansas City, Missouri. His 

City is Belton. He just told me he needed $2 million to upgrade 

their infrastructure. 

The National Service Transportation Policy and Revenue Study 

Commission says that we need $255 billion a year, a year, to upgrade the infrastructure around the country. If that is in fact true 

and if municipalities are going to do it, they are going to have to 

access the debt market to do it. No city has that kind of money in 

the city treasury. 

When you add the market volatility, then municipalities are in 

serious trouble. 

Is there something that the SEC can do within its regulatory authority to correct not a perceived problem but a very real problem 

with the bond rating agencies that to a large degree, and I want 

to talk to them directly about it, are causing the problem. 

Do you see that the SEC has any responsibility for helping us 

out of what I think is a crisis? 

Mr. SIRRI. I think there are several things we are doing at the 

moment. The first is, and I referred to this earlier, that we are providing some relief to dealers in the auction rate area so that municipalities, perhaps such as some of the ones you mentioned, 

would be able to bid for their bonds at auction, and be able to have 

those bids taken. 

39

That should help in the short run. In the longer run, right now, 

and you brought up the credit rating agencies, as we speak right 

now, we are examining the credit rating agencies for a number of 

issues, most of them related to subprime, but that work will continue. 

Our Chairman has asked that we engage in some rulemaking 

where appropriate this year to get at some of the issues that we 

have talked about. I think that rulemaking is still to be flushed out 

as to what it will entail precisely. 

I think we do take very seriously our responsibility, our authority over the credit rating agencies is new. The Act was promulgated 

in 2006. It really just came on line in 2007. We are barely 9 

months into our authority here. 

I think we do not want to do something untoward, to do something that is not carefully— 

Mr. CLEAVER. Do something what? 

Mr. SIRRI. We want to be careful in our use of authority here. 

The Chairman has instructed us to be very measured, to think very 

carefully about what kind of rulemaking we engage in. 

The CHAIRMAN. That is the Chairman of the SEC. 

Mr. SIRRI. I am sorry, the Chairman of the SEC. I am sorry. Very 

good. 

The CHAIRMAN. He is more measured than me. 

[Laughter] 

Mr. CLEAVER. I am not suggesting that you do something irresponsible. I am not sure it sounded like I was saying that. 

I am asking that the SEC use the responsibility it has been given 

legislatively to deal with the problem. I understand you have not 

had that for a long period of time. 

What I hope to convey to you is that it is a problem that is growing daily. It is not getting any better because the crumbling infrastructure around this country is not going to stop until we deal 

with this problem. 

Is there something that you can do? Can you tell them to stop? 

Mr. SIRRI. I think with regard to a number of things, we do have 

authority. For example, if in the process of our exams we were to 

find out there was anti-competitive behavior going on, and we have 

had some discussions here at the table about the nature of what 

that anti-competitive behavior may be, our authority is very clear 

there, that we could step in and stop that. 

Mr. CLEAVER. Do you not think there is anti-competitive behavior? 

Mr. SIRRI. I do not want to jump ahead of where our exams are. 

We are looking at— 

Mr. CLEAVER. We have nine rating agencies—maybe that suggests something is awry. 

Mr. SIRRI. It certainly raises that possibility. There are possibly 

some other benign explanations for it, but I certainly take your 

point. 

We started our authority with five. We have had nine come in. 

As I said before, I think some of the cures that are provided by the 

Act will take some time. I certainly appreciate there is more urgency there and that we need to be focused on the here and now 

as well as a longer term view. 

40

Mr. CLEAVER. Mr. Blumenthal, if you could write out a script for 

the SEC to address the problem, what would it be, please? 

Mr. BLUMENTHAL. On the credit rating agencies? 

Mr. CLEAVER. Yes, on credit rating agencies. 

Mr. BLUMENTHAL. What I would like to see is that the SEC 

would require a single unified standard. In other words, I believe 

that under the current statute, it has authority to mandate that 

single standard, but it may be a fair issue for them as to whether 

they feel the statute does provide authority, so I am suggesting 

that there be explicit congressional action in that regard. 

I believe that as part of this rule, they can and should take that 

action to make the system fair and eliminate these disparities. In 

effect, the system that we have right now puts municipalities in a 

lesser category of existence. 

I will say to your point about anti-competitive conduct, that is 

precisely the focus of my investigation. It is not only on the dual 

standard and the way it started and perpetuated and maintained, 

but it is a variety of other practices that the rating agencies have 

engaged in doing that raise the cost of those ratings, the so-called 

notching practices, the basketing practices. 

These terms have meaning and I know this hearing is not focused on the details of the rating agencies, but there are very, very 

profound and significant questions under the antitrust laws about 

whether or not they have restrained trade or otherwise impacted 

competition. 

Mr. CLEAVER. Thank you. 

The CHAIRMAN. The gentleman from Colorado. 

Mr. PERLMUTTER. Thank you, Mr. Chairman. I am sort of with 

Mr. Kanjorski and Mr. Frank in not understanding some of the terminology. I would just like to go to basics for a second. 

I represent an area with lots of school districts, and some health 

and hospital authorities, and they want to issue a bond. They have 

to get some money to build a new hospital or new school. Those are 

the guys, if I understand it, that are going to be affected by these 

higher interest rates. 

Is that right or wrong? 

The CHAIRMAN. The court reporter is very able, but she is not 

good at nods. 

Mr. BLUMENTHAL. Yes. 

Mr. DINALLO. Yes. 

Mr. PERLMUTTER. Thank you, Chairman. 

Let’s move the credit enhancement piece aside for a second. 

Somebody who is going to invest or buy these bonds will look at 

a revenue stream that is generated by the township or the area of 

authority or whatever, look at the expenses, and say that looks like 

a good buy for me and I will buy it at 5 percent. That is how I look 

at the risk of this. Is that right? 

Mr. DINALLO. Yes. 

Mr. PERLMUTTER. There are a bunch of these out there. Some of 

what we have done, the market has done something to try to short 

cut analyzing the revenue stream and whether it is legitimate and 

a solid revenue stream or in the instance of some of my neighborhoods where there are lots of foreclosures and lots of people who 

are not paying their property taxes or sales tax has dropped, the 

41

revenue stream is not as solid as it once was. Still have all those 

expenses. 

Some of these municipalities or authorities then buy down the 

risk; right? They buy down the risk by either getting letters of 

credit from a bank or they find an insurance company to buy down 

the risk, or they get a credit agency, the credit agency looks at everything and says this is a good risk. 

Is that how this is working? 

Mr. SIRRI. I think you mentioned two different kinds of risk 

there. When you cited the letter of credit, you are talking generally 

about liquidity risk, that is the idea that the bond can be re-sold. 

When you talked about a monoline insurer wrapping the bond, 

you are talking about credit risk, the idea that if the municipality 

does not make their timely payments, that someone will step in 

and make it for them. 

In the third instance, when you talk about the credit rating 

agency, you are talking about an opinion of a third party about the 

likelihood that they make timely payments. 

The three of them interact together in the way you say. 

Mr. PERLMUTTER. To be able to peddle or sell the bond. Where 

is it that we are running into trouble? 

Is it because we do not have insurance any more or because the 

credit agency is saying hey, the markets are very difficult out there 

right now, we are going to tighten down on everybody, just like the 

appraisers and the accountants are tightening down, and the regulators are tightening down. 

Is that the problem? Or is it because nobody has any money to 

buy these things? 

Mr. DINALLO. I think Mr. Sirri just helpfully asked me to answer 

that question. I think there are several factors that are contributing to the issue. The rating agencies, I think, have gotten tougher because they have sensed a certain scrutiny, and I think it is 

appropriate for them to tighten up a bit. 

It is the case that the bond insurers that would otherwise be giving the wrap have been under pressure and their ratings, which 

are the wrap that you talk about, have gone down or been in danger of going down. 

The credit markets that are sometimes the way those municipalities come to market, the variable rate markets, etc., are very tight 

as Wall Street and other liquidity providers are beginning to worry 

about their capital requirements and pulling away from the lending 

activity that everyone just kind of got used to and maybe overly 

used to. 

There are several factors that are contributing to it. We discussed today one other that is kind of at the heart of what you are 

saying, which is a belief that the rating agencies essentially have 

a two tier system for rating corporate credit risk versus municipality credit risk, and that the underlying credit decisions around 

municipalities should be more liberal, so to speak, and they should 

not have to pay as much because they ought to be starting off from 

either a higher rating or any rating at all, which some of them cannot even get rated so they buy the wrap. 

The CHAIRMAN. We have a vote. We can finish. 

42

Mr. PERLMUTTER. As regulators, are you seeing any trouble? One 

of the things we have been dealing with is this subprime mess here 

and we are seeing lots of foreclosures. 

Do you see any problem with the revenue side? That municipalities really are starting to— 

Mr. DINALLO. In a worst-case scenario, I have two concerns. My 

immediate concern, which I think is clear to everybody, is that the 

mortgage foreclosures and the mortgage defaults will definitely put 

a huge pull on the CDO side of the obligations that the monoline 

insurers have put out, and that will in turn put stress on the municipal side of their books. 

Likewise, I do believe that if the economy goes abruptly and 

more so in the wrong direction, you may have underlying stress on 

the municipalities. I think that is where you will hear Ajit Jain 

from Berkshire say that it is not quite as safe, the risk, as everyone 

seems to be saying, that it is a riskless investment. I read his testimony. 

Mr. PERLMUTTER. Thank you. 

The CHAIRMAN. Thank you. I am not going to go vote. It is an 

adjournment. I will stay here and we will get to the next panel. We 

will finish with the gentlewoman from Wisconsin. 

Ms. MOORE OF WISCONSIN. Thank you so much, Mr. Chairman. 

I was very fascinated, Mr. Sirri, by your testimony and others regarding the auction rate securities and specifically want to know 

more about the Federal backstops that you might suggest. 

I can see that you think that perhaps there is something that 

can be done in the regulatory area. I have heard others talk about 

the Federal Home Loan Bank. 

As people want to get rid of these bonds and switch them to variable rate, you said that had been slowed tremendously because so 

many people are trying to do it. 

I noticed in the footnote in your testimony on page four that you 

said some banks have already reached their entire yearly capacity 

for writing letters of credit policies. 

What more can you do or what role could the Fed provide in enabling people to make these swaps? 

Mr. SIRRI. What we have done specifically here is we have made 

something clear that had been slightly unclear to the market. We 

have a situation where we have issuers of bonds, municipalities, 

who are paying particularly high rates because their auctions have 

failed. 

We have a situation where we have investors in bonds who normally would be happy to get those high rates. Of course, that is 

what they like to do at auction, but they also have a demand for 

liquidity. Because the auctions have failed, they cannot move their 

paper. 

What we are striving to do this week is to issue some guidance 

by the staff of the SEC saying that municipal issuers can bid 

through dealers at auction and repurchase their paper, take it off 

the market. First, that is helpful to them, and second, by bidding, 

many of the auctions we hope will not fail. Once they do not fail, 

those rates will come down and the issuers’ rates that they pay will 

be more in line with the traditional rates they pay for their credits. 

43

We have provided some guidance there to make it clear that will 

not be deemed ‘‘manipulation,’’ and that is one of the reasons why 

dealers have been not willing to accept the bids of municipalities. 

Ms. MOORE OF WISCONSIN. Because there would be a huge discount to muni’s if they bought their paper back? 

Mr. SIRRI. There was an enforcement settlement in 2006 where 

there was some actual manipulation by dealers. In the wake of that 

settlement, dealers became very conservative. In our view, perhaps 

slightly overly conservative, and that is fine that they do so. They 

do not want to run afoul of the securities laws. 

We just want to clarify for them that in this instance, and perhaps generally, that when they bid at auction, if they bid in a precise way that has good disclosure around it, they will not be 

deemed to manipulate the market. 

We want to be very, very clear, we are not saying anything about 

the contracts around these. There are various private issues about 

the contracts, about the agreements between the parties. The SEC 

is saying nothing about those whatsoever. 

We are just clarifying that the municipalities can place bids 

through dealers and neither the auction agents, the dealers, nor 

the municipalities will be deemed to have manipulated under a set 

of circumstances that has a lot of disclosure around it. 

Ms. MOORE OF WISCONSIN. Thank you for that clarification. 

The CHAIRMAN. I thank the gentlewoman. I thank the panel. The 

panel is dismissed with our thanks. There are a lot of specific 

things and we will all be back to this. 

We will call our next panel, Mr. Lockyer, Ms. Wiessmann, Mr. 

Reeves, Mr. Newton, and Mr. Dillon. Will you all come forward? 

I thank the panel. This is a very important subject, and while 

not all of the Members are here, people are watching this elsewhere, and there are staff members here on both sides, so we will 

get right to it. 

First, we have Bill Lockyer, the treasurer of the State of California. Mr. Lockyer, do you want to go ahead? If you need to be 

excused after your testimony, feel free. Why don’t you begin? 

STATEMENT OF THE HONORABLE BILL LOCKYER, 

TREASURER, STATE OF CALIFORNIA 

Mr. LOCKYER. Thank you very much, Mr. Chairman, and members of the committee. It is the red eye and Ambien on the plane 

that does not seem to work well for me. 

The CHAIRMAN. We have about 50 Members in California who 

will not be sympathetic to that. 

[Laughter] 

The CHAIRMAN. None of them are here, so you go ahead. 

Mr. LOCKYER. The committee considers upheavals in capital markets that dramatically affect governments, taxpayers, and investors 

across the Nation. I commend you for shedding light on these 

issues and appreciate the opportunity to share perspectives from 

California, the largest municipal bond issuer in the United States. 

I would like to start by addressing the issue that lies at the foundation of much of the turmoil that led to this hearing, the system 

used by major U.S. rating agencies to grade municipal bonds. 

44

If you remember back when we were taking tests in school, what 

if you had aced every test and still received a grade lower at the 

end of the semester than a classmate who failed four exams. You 

would with total justification call the teacher’s grading system unfair. 

Unfortunately, for American taxpayers, that is exactly the same 

situation faced by governmental entities that issue bonds. 

The agencies hold municipal issurers to a higher standard than 

corporate issuers. There has been considerable comment on this by 

the Chair and others, so I simply point out that disparate treatment results in higher payments and that the system is fundamentally flawed. 

The rating agencies’ own studies substantiate these claims. Municipal bonds rated Baa by Moody’s have a default rate of .13 percent while corporate bonds rated Aaa by Moody’s have defaulted at 

4 times that rate or .52 percent, and similarly with the other rating 

agencies. 

S&P, who by the way, of the rating agencies has been the one 

most resistant to considering change, published an article last Friday on muni ratings, and focused on unrated bonds, ones that do 

not rely on a government’s strength of issuance. 

With regard to the rated municipal bonds at issue in this debate, 

however, the same article contained updated numbers of default 

statistics that support these claims, showing the disparity between 

corporate and municipal defaults. 

California has never defaulted on its bonds, yet, the agencies 

refuse to give the State a AAA rating. It undermines the functioning of an efficient and transparent market. It misleads investors by falsely inflating the risk of buying municipal bonds relative 

to corporate bonds, and worse from my perspective as the State’s 

banker, it costs taxpayers billions of dollars in increased costs and 

bond insurance premiums. 

If the State received the AAA rating it deserved, we could reduce 

taxpayers’ borrowing costs by hundreds of millions of dollars over 

the 30 year term of still to be issued bonds that have been approved by our voters to finance infrastructure development. Billions 

of dollars more could be saved by municipal issuers across the 

country. 

We have asked the rating agencies to work with us to devise a 

unified rating system based on default risk. We believe that reform 

would make the market more efficient and transparent and better 

serve taxpayers and investors. 

A number of other State treasurers and finance officials have 

signed those letters or written similar letters of their own. You will 

hear from some shortly. That letter is attached, Mr. Chairman, to 

my written testimony. 

The rating issue flows naturally into the question of bond insurance. Municipal issuers buy insurance to obtain a AAA rating that, 

in many cases, they already deserved, based on the de minimis risk 

of default. 

Insurers’ AAA ratings are then transferred to the issuers’ bonds. 

Our policy on insurance is similar to most muni issuers. If by insuring bonds we can save taxpayers more money in interest than 

it costs to buy the insurance, we will insure the bonds. 

45

During the 5 years of 2003 to 2007, California spent $102 million to insure $9.1 billion in GO bonds. 

Defenders of the current rating system argue that the market 

understands the distinctions between corporate and municipal rating scales. I would suggest that argument holds no water. 

If investors truly possessed that understanding, our taxpayers would have had no need to spend $102 million on insurance. The 

fact that investors placed value on insurance, that it is an enhancement of our credit, shows the market does not understand fully the 

distinctions between the two ratings. 

Even though bond insurers almost never paid out a claim since 

muni issurers almost never default, the industry is in crisis because of risky bonds they insured in other markets. Some monoline 

insurers are fighting to save their AAA status while rating agencies have downgraded others and the AAA rating of insured bonds 

purchased by investors has been lost or is in danger. 

The effect of these downgrades on municipal issuers differs depending on the type of the bond. Most of our State’s outstanding 

debt is in fixed rate bonds, but downgrades do affect debt service 

with respect to other bonds, and you have talked earlier about auction rate and others. 

The CHAIRMAN. Mr. Lockyer, we need you to summarize and finish up, if you can, and then we can get to questions. 

Mr. LOCKYER. The variable markets have been hit because of the 

insurance difficulties. 

The States are grateful for the fact that the SEC has indicated 

that they may provide rules that will provide assurance soon to 

local entities that if they repurchase, that it does not constitute a 

default or some manipulation of the market. Replacing the dual 

bond system with a unified approach, Mr. Chairman, is a needed 

reform, and we hope that you will be able to assist. 

[The prepared statement of Mr. Lockyer can be found on page 

132 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Lockyer. We appreciate the leadership you have taken. The letter you put together will be put into 

the record as well as anything else people want to submit. 

Ms. Wiessmann, please go ahead. 

STATEMENT OF THE HONORABLE ROBIN L. WIESSMANN, 

TREASURER, STATE OF PENNSYLVANIA 

Ms. WIESSMANN. Chairman Frank and members of the Financial 

Services Committee, thank you for inviting me to testify today 

about the current turmoil in the municipal bond marketplace, and 

what I have termed the collateral damage that is being experienced 

by State and local government entities. 

My name is Robin Wiessmann and I am Pennsylvania’s Treasurer. My professional experience that is relevant to today’s hearing 

includes municipal and State agency supervision, 24 years as an 

investment banker, which includes 10 years as an owner of a 

broker-dealer investment banking firm, and 15 years of asset management oversight. 

Today’s financial market problems are very disturbing to me, especially the failure of many auction rate securities and the high 

reset rates on variable rate demand bonds. 

46

They are imposing extraordinary volatility and stress on all municipalities including States, local governments, other local political 

subdivisions, and student loan providers. 

This credit crisis is affecting them through no fault of their own, 

but due to market disruption unrelated to the prudent financial 

management of State and local governments. 

Such market disruptions are costing taxpayers in terms of increased expenditures and constrained budgets. Further, the potential exists that in an already tenuous financial situation, it may 

worsen and disrupt the provision of basic government services, including the availability of student loans for the next school year. 

The market is in desperate need of some help, and to those who 

say let the market correct itself, one must recognize that the market has been unable to adjust itself. 

While I have great faith in the resiliency of the American economy, the market has demonstrated an inability to self correct. 

While I applaud the Federal Reserve’s action yesterday in announcing the securities lending facility program, nevertheless, the 

situation in the municipal markets requires and demands a more 

targeted relief for this market. 

I want to speak about Pennsylvania for one moment. The current 

state of the national economy is very difficult and challenging, but 

the real challenge is, as I said, the challenge in the credit markets. 

Nevertheless, we in Pennsylvania are relatively optimistic about 

the Commonwealth’s economic outlook and debt portfolio. Due to 

Pennsylvania’s conservative debt policies and conservative investment policies, we are again relatively well positioned to weather 

the current market uncertainties and challenges. 

However, the turmoil does have wide ranging implications and 

my concern extends beyond the Commonwealth’s direct debt to the 

agencies, counties, municipalities and school districts. 

I would like to turn now to some very specific recommendations. 

I would like to call on the Federal Government to provide liquidity 

and confidence to the municipal marketplace. Encouraging investor 

confidence in the municipal bond market, which will bring in more 

buyers and result in liquidity, is essential, so that market participants can have the time to restructure their products, services, and 

securities. 

In particular, I would call on the Federal Government to consider 

temporary actions to provide liquidity such as serving as a buyer 

of auction rate and variable rate securities, providing liquidity 

which they have provided to the general market with specific direction to maintain the auction rate and variable rate market of municipal issuers, and providing short term credit enhancements for 

bonds suffering market failure because of downgrades of their bond 

insurer, so that the bonds can resume trading at reasonable interest rates. 

There has been much discussion about credit ratings, and based 

on my years working on Wall Street, I know firsthand that the 

credit of investments is primary. I also know that credit evaluations of governmental obligations have withstood the test of time. 

However, I do have some observations about the market. Since 

municipals are governed by such challenging standards and are 

monitored very closely, they are, as we have heard many times 

47

today, seldom in default. Despite the scrutiny and the reduced likelihood of default, they are often perceived and priced as inferior 

credits. 

I would corroborate and support many of the statements that 

have been made here today. 

There should be some mechanism for the true creditworthiness 

of governmental debt obligations to be recognized. That will only 

happen when some adaptation of the current rating system is 

made. A credit rating system that is analogous to the corporate rating system would serve this purpose and make bonds comparable. 

Specific distinctions could provide the differentiation if necessary 

among municipal credits. 

Another reason for this is very market driven. Buyers are now 

investing across asset classes based on relative value, and this simpler classification might facilitate this crossover buying, which in 

turn will provide greater liquidity and market demand for municipal credits. 

Markets change. Guidelines evolve. We need to adapt. 

I would also suggest that there are mechanisms that should be 

put into place to support trading, when disruptions in the market 

occur, as has occurred recently. Just as triggers were established 

in the equity markets, I suggest that the Federal Reserve or other 

Federal agencies offer stop gap temporary measures to support and 

sustain the municipal markets in times of psychological or actual 

crises, such as what we have been experiencing. 

Had measures such as these been available in December or January, we might not have experienced the cascading effect of liquidity and credit concerns which are now impacting fixed rates and 

unenhanced paper. 

Some of the other immediate solutions that I will not go into detail on have been cited before, raising the bank qualified debt limit 

from the current $10 million level to $25 million, permitting an additional advance refunding of bonds, altering the rating requirement under Rule 2a-7, and permitting Federal Home Loan Banks 

to offer letters of credit, and allowing governments to purchase 

their own debt. 

I would like to speak just one more moment and speak about 

looking forward and doing better going forward. 

It is clear from our current credit crisis that changes need to be 

made in our approach to the marketing and securities market. 

There are three major factors that are necessary in order to effectively direct our capital markets: First, a principles-based code of 

conduct for business operations, a deliberate conscientious decision 

making process with consideration of market ramifications as they 

relate to consumers, capital markets and the economy as a whole, 

not just the business entity itself; second, transparency and complete disclosure of financial operations and securities structures; 

and third, a regulatory discipline that accurately reflects the realities of today’s marketplace. 

Thank you very much for your time. 

[The prepared statement of Ms. Wiessmann can be found on page 

217 of the appendix.] 

The CHAIRMAN. Thank you, Madam Treasurer. 

Next, the Treasurer of the State of Mississippi, Mr. Tate Reeves. 

48

STATEMENT OF THE HONORABLE TATE REEVES, TREASURER, 

STATE OF MISSISSIPPI 

Mr. REEVES. Thank you, Mr. Chairman, for the opportunity to be 

here today. I would ask that my entire statement be entered into 

the record. 

The CHAIRMAN. Anything that anybody wants to put into the 

record will be put in, without objection. 

Mr. REEVES. For the record, I am serving my second term as the 

State Treasurer of Mississippi. I am the immediate past president 

of the National Association of State Treasurers, and I am currently 

serving at the request of Treasurer Lynn Jenkins of Kansas, our 

Association’s current president, as the chairman of the Legislative 

Regulatory Committee, which has jurisdiction over issues that relate to the municipal marketplace. 

Accessibility and affordability of the capital markets and the liquidity of those markets is of great importance to your Nation’s 

State and local governments. The capital we raise in the municipal 

marketplace builds our schools, hospitals, roads, and other vital infrastructure and public projects. 

In times of disaster, municipal issuers are often called upon to 

use public debt to finance recovery efforts. New York City’s post9/11 liberty bond program and the Gulf opportunity zone bond after 

Hurricane Katrina are two of the most prime examples in recent 

years. 

My experience as treasurer of a State that bore the brunt of the 

largest natural disaster in the history of our country certainly confirms the advantages of tax exempt borrowing. 

Many of the post-Katrina recovery projects in Louisiana, Alabama and Mississippi have been and are being aided by the Gulf 

Opportunity Zone Act of 2005. 

The bonds we have been able to issue as a result of congressional 

action have greatly benefitted the recovery efforts and the citizens 

of the affected regions. 

I would be remiss if I did not take this opportunity to thank the 

members of the committee as well as every other Member of Congress for your willingness to help my own home State in the aftermath of Katrina. Our recovery is far from complete, but the financial resources through appropriations and tax law changes approved by Congress make possible what seemed like a nearly impossible task of rebuilding in late August of 2005. 

It is extremely important to remember that what brings my colleagues and me before the U.S. House Financial Services Committee this morning is the current situation in the municipal marketplace, and it is not a general decline in the underlying credits 

of municipal issuers, but a disruption in the corporate marketplace 

caused by the collapse of securities backed by subprime mortgages. 

In fact, the current stress in the bond insurance industry is not 

at all caused by the consistent highly profitable cash flow derived 

from insuring municipal debt. 

Instead, the problems with the insurers, and by extension the 

public debt they insured, are a direct result of their decision to insure higher risk ventures in the corporate securities markets. 

The current loss of market liquidity has affected public issuers 

across the country. The end result is a failed auction resulting in 

49

dramatic spikes in interest rate costs on bonds which have little 

risk of default. In some cases, the rates have jumped to upwards 

of 20 percent. Obviously, the taxpayers foot the bill as the cost of 

capital increases. 

In our State, we have been more fortunate than many with respect to our exposures in today’s unstable market. By statute, we 

cannot have greater than 20 percent exposure to variable rate debt. 

In practice, we have a well diversified portfolio that generally 

helps position us to weather and even take advantage of short term 

aberrations in the market. 

Of our $3.2 billion debt portfolio, less than $140 million currently 

is held in auction rate mode securities. We have had one failed auction, but due to the diversification of our portfolio, this failed auction will only contribute an additional 2/100 of 1 percent to our 

overall debt service payments in the current fiscal year. 

The following week, our auction was priced at a level more in 

line with our expectations, and although it was and continues to 

be trading at a level significantly above the SIFMA index. 

Many of the specific issues that are before the committee today 

as it relates to the present market disruption are, in my opinion, 

short term aberrations caused by the credit crunch. Having said 

that, the issue of bond insurance, liquidity, and rating agency 

scales on municipal bonds are longer term issues that must be addressed. 

I am not convinced that Congress necessarily should play a role 

in all of these issues, but to the extent you should, I would recommend consideration of the following: 

A traditional role of the Federal Government in past financial 

crises has been to provide short term price stability and liquidity 

to the market during extremely difficult times, until the market 

can find its own footing. Clearly, these are extraordinary difficult 

market conditions. 

The Department of the Treasury, at the request of the National 

Association of State Treasurers and other market participants, recently released extremely helpful guidance on re-issuance rules for 

auction rate securities and variable rate demand bonds. 

This guidance allows many issuers to convert out of auction rate 

securities into different products, such as fixed rate maturity 

bonds, without having the bond deemed to be re-issued which can 

be costly to our governments. This has allowed our issuers to save 

taxpayers money and limit their exposure in a volatile market. 

Some tax exempt bond issuers secure letters of credit from 

strongly accredited financial institutions to achieve lower borrowing costs. Letters of credit can be particularly helpful as a 

source of liquidity for small issuers who do not have strong bond 

ratings or large bond issuances. They are also useful to issuers of 

every size as a mechanism to diversify access to credit markets 

through large, well known institutions. 

As has been mentioned today, the Federal Home Loan Bank System is not allowed under current law to offer this AAA guarantee. 

Legislation proposed in this Congress would permit that, and I personally would like to tell you that I appreciate the support of 

Chairman Frank, Subcommittee Chairman Kanjorski, CongressVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
50

man Bachus, Congresswoman Pryce, and other members of the 

committee who have co-sponsored this legislation. 

Of course, the fact that we have separate scales on municipal 

and corporate debt makes little sense to me and many of my colleagues. 

Moody’s has indicated that the default rate on investment grade 

municipal bonds from 1970 through 2006 is approximately .1 percent, far different from the 2.1 percent default rate among all investment grade corporate securities over the same period. 

Yet, municipal issuers pay a penalty to the market for the different scales which leads to higher costs of capital that is borne by 

the taxpayers. 

It may be that the market will resolve this particular concern. 

I think it is important that Congress be aware of this discrepancy, 

and to the extent that the rating agencies voluntarily establish a 

global rating scale that more accurately reflects relative credit risk, 

the market will be better off. 

Of course, the Securities and Exchange Commission treats the 

two rating scales as equivalent under Rule 2a-7, which governs 

qualified investments in money market mutual funds. This rule effectively requires that States’ money market mutual funds must 

hold investments rated AA or better. 

I believe that a relaxing of Rule 2a-7 requirements would benefit 

both issuers and investors. 

No single solution exists to solve the current market turmoil. To 

the extent possible, Congress, the SEC, and market participants all 

have a role in navigating our financial system through this storm. 

The key is to encourage investor confidence in the municipal 

marketplace. 

I will conclude my prepared remarks by reminding you that the 

capital raised through the issuance of debt in the municipal markets is vital to our great country. Working together, we can continue to ensure a viable efficient market which ensures the lowest 

cost of capital for our State and local governments, thereby maximizing the benefit to all of our taxpayers. 

Thank you. 

[The prepared statement of Mr. Reeves can be found on page 198 

of the appendix.] 

The CHAIRMAN. Thank you. Let me just say to the witnesses that 

I am apologetic and I appreciate your staying. If you want to get 

something to eat, you have time. There is a cafeteria right downstairs. I know people have been here all day. We are going to get 

to our third panel. 

Let me get right to Mr. Newton. 

STATEMENT OF MARK NEWTON, PRESIDENT AND CHIEF 

EXECUTIVE OFFICER, SWEDISH COVENANT HOSPITAL 

Mr. NEWTON. Good afternoon. Thank you, Chairman Frank. My 

name is Mark Newton, and I am the president and chief executive 

officer of Swedish Covenant Hospital, located in Chicago. 

I offer a ground-level view of this current situation and crisis. 

Swedish Covenant Hospital is a 334-bed urban community hospital. We are the largest remaining independent hospital on the 

51

north side of Chicago, and we serve a very culturally diverse community. Over 50 languages are spoken— 

The CHAIRMAN. We have a time problem, so I want to get right 

to how—we stipulate that this is a very important institution—you 

were affected by this— 

Mr. NEWTON. Well, Swedish Covenant is a Federal disproportionate share hospital, and as such we represent this critical safety 

net for the uninsured and underinsured. And we consider ourselves 

your partner in serving these communities. 

The cascading nature of this turmoil over the last few months indicates that there is no predictable fire break on the horizon. And 

as the president and CEO of a hospital, I’m no stranger to responding to these kinds of community health risks, competitive market 

changes, malpractice crises, nurse staffing shortages, and possibilities of revenue stream cuts. 

We have been able seemingly to weather each one of these risks 

to the healthcare system while trying to expand our infrastructure, 

and the key to our ability to respond truly has been the availability 

of predictable and efficient capital. 

Let me share some details of our story. Since 2000, when I first 

joined Swedish Covenant, we have had hospitals close in our community with over 500 beds removed and 3,000 jobs removed from 

the community. Our best response has been to invest in new facilities, services, and technologies, while others have downsized and 

curtailed services. This is not only out of a sense of mission, but 

it is also our view that it is important that we strategically invest 

in health care facilities for our community. 

We now find ourselves responding to a crisis that requires us to 

reinvent our balance sheet and rethink strategies of capital spending. We are currently in a refinancing process that is going to cost 

over $1 million in transaction fees. This amount is being taken directly from patient care. Our monthly insurance costs have historically been in the range of $600,000 a month, that has increased by 

an additional $350,000 a month, an increase that is directly related 

to failed auctions and the result and expectations of bondholders of 

default rates of interest between 10 and 15 percent. 

The CHAIRMAN. We are not talking malpractice insurance here. 

You are talking about the bond insurance, correct? 

Mr. NEWTON. Correct. 

The CHAIRMAN. Yes. I just wanted to be very clear that it is just 

the bond insurance. Thank you. 

Mr. NEWTON. All of this turmoil clearly has lessened the confidence in the financial markets. And what we find is that we have 

to be more alert to unintended consequences as we restructure our 

balance sheet. 

Today our debt is approximately $150,000, with 83 percent fixed 

and 17 percent variable, and it is either insured by bond insurance 

or supported by bank letter of credit. We are an underlying TripleB-plus credit. Our fixed rate now is 4.9 percent. We expect the 

fixed rate to increase to 6.5 percent. 

After refinancing, we will have to increase the percentage of variable debt to about 60 percent. One unintended consequence is even 

greater reliance on bank letters of credit, which by nature are 

short-term. The cost of bank credit enhancement as a replacement 

52

for traditional bond insurance has increased significantly. Credit 

enhancement capacity has been reduced as we look forward in the 

next 3 months to a massive period of debt refinancing by hospitals 

such as Swedish Covenant Hospital. This remains a yet unexplored 

dimension of this ongoing crisis. 

If this crisis is not resolved, hospitals like Swedish Covenant will 

face significant cost increases on our existing debt and may have 

very little capacity for access to new capital in the next few years. 

We would slow down projects investments in projects such as implementation of an electronic medical record; we would postpone 

expansion and renovations of core infrastructure; and we would 

conserve other spending to maintain needed cash balances as 

banks tighten other credit terms such as higher minimum levels of 

cash on hand. 

Perhaps my final observation is that organizations such as mine 

truly need a fire break in this current cascading crisis. As I noted 

before, as your partner in providing health care services, we really 

need and want to get back to the basics of caring for people. The 

fabric of an efficient and effective health care system depends on 

access to stable and predictable sources of capital. 

I want to thank the committee for the opportunity to discuss this 

important issue, and I welcome any questions. 

[The prepared statement of Mr. Newton can be found on page 

195 of the appendix.] 

The CHAIRMAN. Thank you. I’m going to go vote, and we are 

going to come back. I appreciate your indulgence. People should 

feel free, you have 15 or 20 minutes to maybe get lunch. Not this 

panel, because we’re going to be right back here with the others. 

But we will get right back to you. And I thank you. Our commitment to this issue, I think, justifies all of us doing this. 

[Recess] 

The CHAIRMAN. On behalf of the National Utility Contractors’ Association, I should note that I spoke with Chairman Jim Overstar 

of the Transportation and Public Works Committee because we did 

want to make clear what the impact of this is on services such as 

health, as we have seen from Mr. Newton, and infrastructure in 

general. And Mr. Overstar strongly recommended that we ask 

someone from the National Utility Contractors’ Association, so I’m 

glad that we were able to arrange that. Mr. Dillon, please go 

ahead. 

STATEMENT OF TERRY DILLON, CHIEF EXECUTIVE OFFICER, 

ATLAS EXCAVATING, ON BEHALF OF THE NATIONAL UTILITY 

CONTRACTORS ASSOCIATION 

Mr. DILLON. We appreciate your letting us testify today, Mr. 

Chairman. And I’m going to put a little different kind of color to 

your meeting today, so let’s see how this thing goes for you. 

My name is Terry Dillon, and I am the owner of Atlas Excavating in West Lafayette, Indiana. We have 150 employees who 

work on sewer, water construction, highway, and road reconstruction projects throughout the State. My wife and two sons are partners in my business. 

My written statement today supports the need for municipal 

bonds and their effect on infrastructure projects. I will leave the 

53

reading of the statement for you and move on to actual projects 

these bonds are used for, and try to put some color in today’s testimony. Ten miles south of Lafayette, Indiana, is the small town of 

Stockwell, where about 300 residents reside. Three years ago, you 

could drive through this town and see puddling sewage in the 

streets and in the yards. There was a bad sewage stench in the air. 

The local kids would be riding their bikes through the sewage and 

playing in it; small children could be seen playing in the muddy 

sewage as if playing in a sandbox. 

Stockwell residents took control of this issue, and had a sewage 

system designed, financed, and built. Financing was done through 

the SRF program, the OC Grants, and municipal bonds. Today residents are painting the houses. They have cleaned up their neighborhood, and have taken their community back. It’s a thriving Indiana town again. 

My company, Atlas Excavating, has done about 30 such projects 

across the State of Indiana. In each one of these towns that we 

have gone into, I have found a dilapidated city and a bad attitude, 

and once these sewage lines have been repaired and the city has 

been cleaned up, the towns thrive once again. 

Next, the City of Indianapolis is under Federal mandate to clean 

up its dumping of raw sewage through sewage overflows. This is 

at a cost estimate of around $2 billion, of which these are supposed 

to be done over the next 20 years. Indianapolis also has 80,000 septic tanks in the city limits that have to be replaced with a piped 

treatment system, and posted all over the City of Indianapolis at 

ponds and streams are big red warning signs where overflow structures dump raw sewage into the waterways. The signs say, and I 

quote, ‘‘Caution, sewage pollution. Keep out of the water. People 

who swim in, wade in, or swallow these waters may get sick.’’ And 

it is repeated in Spanish. 

Finally in the City of Lafayette, there is a 42-inch concrete sewer 

line that runs from Staley’s Corn Syrup Plant 10 miles to the sewage treatment plant in the City of Lafayette. The sewage line goes 

through woods, creeks, residential neighborhoods, back yards, camp 

grounds, and playgrounds. This line is in such bad decay that it 

breaks 2 to 3 times a year, and in the last 10 years, my company 

has repaired this line on most of its breaks. I want you to imagine 

a 42-inch-diameter concrete pipe that has 5-inch wall thickness, 

with a daily flow of 15 million gallons per day. This 42-inch pipe, 

which was put in around 30 years ago, now has paper-thin walls, 

with a maximum thickness of about 1 inch left in the 5-inch-thick 

concrete walls. This pipe is a disaster waiting to happen. 

My most memorable repair to this line was 5 years ago. The city 

engineer contacted me, requesting immediate response to a sewer 

break. Normally you get a call giving you hours to respond, but the 

urgency in her voice sent me driving to the site immediately. When 

I got there, it looked like a crime scene. There were fire trucks and 

emergency vehicles lining the roads to get to it, and the site was 

cordoned off. I ran up to the failing spot, and found a 20-foot-long, 

5-foot-deep, 12-foot-wide sinkhole. In the hole, raw sewage was 

running down the broke and exposed pipes at a very rapid rapid 

rate, indicating a high flow and massive surcharging. The swirling 

of the water in the hole was eroding the ground conditions. I immeVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
54

diately had emergency crews who were standing there, gawking in 

the hole, get back away from the hole, and at the last minute, I 

grabbed a city official who was standing by the hole by the back 

of his shirt and pulled him back, and said, ‘‘I said get out of the 

way.’’ At that point in time, the ground caved in out from underneath his feet; however, he did not fall into the hole due to my pulling him back. Had he fallen into that hole, it would have killed him 

instantly. 

While that is scary, it is not the worst of the day. The reason 

that the emergency vehicles and the fire department were there 

quickly became aware to me when I looked at the surroundings. 

We were in a playground, and two small children were playing on 

a swing set 100 feet away from us. It would have been a very bad 

day if one of those children had fallen into that hole. If you fell into 

that particular sinkhole, your next stop would be the grinder 

pumps at the treatment plant. 

This entire line has now been replaced, largely due to municipal 

bonds. Are bonds important to our infrastructure needs? Yes. It is 

probably the single most important funding source that we have, 

bar none, across the Nation. 

Gentlemen, clean water is to me more important than oil. Without clean water to drink, you won’t live more than a week. We need 

your help and you need to help take control of this bond market 

and the infrastructure across this country and help be responsible 

for it. I personally believe that you alone, with me working in this 

industry, we are the gatekeepers of our infrastructure system, and 

it is the greatest asset that the United States has. 

Thank you for letting me testify today. I will be happy to answer 

any questions. 

[The prepared statement of Mr. Dillon can be found on page 98 

of the appendix.] 

The CHAIRMAN. Thank you, Mr. Dillon. That’s precisely why I 

consulted with Mr. Overstar, who is our chief infrastructure chairman, and why he recommended you. I should note that I believe 

we will be joined on this committee within a few days by the new 

Member of Congress from Indianapolis, Andre Carson, who is succeeding his grandmother, and we look forward—although we regret 

the circumstances of having him. 

I want to note that Deputy Treasurer Paul Rosenstiel has replaced Treasurer Lockyer on the panel. And I want to move quickly 

here. But let me just ask—a number of things that we have talked 

about, merging the dual risk, some other things that are clear—I 

have been struck—a number of witnesses have mentioned, Mike—

Massachusetts, Mr. Lynch—Federal Home Loan Bank. We will be 

looking at all those things. What about the question of a Federal 

re-insurance for particularly general obligation, full faith and credit 

municipal bonds? Any comment on that? Let’s start with you, Mr. 

Rosensteil. 

Mr. ROSENSTIEL. Well, I think that is the kind of thing that can 

give investors confidence. With the dual rating structure, unfortunately investors don’t think that our ratings are as strong as we 

think the risk of State general obligation and other general obligation and strong revenue bond issues is. So I think the Federal GovVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00058 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
55

ernment stepping up and saying, you know, ‘‘This is not risky,’’ 

that’s a good idea. 

The CHAIRMAN. Ms. Wiessmann? 

Ms. WIESSMANN. I think if the Federal Government steps up to 

provide assurance in the marketplace, it is a good thing; however, 

actually administering it, there are differences among credits introduced in the marketplace. And actually managing and administrating the implementation of that, I think, will be a challenge. 

The CHAIRMAN. Are there real differences among full faith and 

credit general obligation funds, do you believe? Or should there be? 

Ms. WIESSMANN. Credit and markets are continually dynamic. 

They change all of the time. It’s based on facts and circumstances 

at the time. So at different points in times, yes, there are differences among them. 

The CHAIRMAN. Among full faith and credit general obligation? 

We have the record that none have defaulted, you know, since 

1970. So what are the differences? 

Ms. WIESSMANN. There are varying degrees of strength. I’m not 

disagreeing with the point that they’re very, very strong and very 

secure. But they are because they have certain operating requirements, reporting requirements. They have accounting requirements. And to make sure that the incentive is still in place for 

them to achieve good credit ratings and to not have issues requires 

some administrative— 

The CHAIRMAN. Well—the Federal Government could make some 

things conditional. But—it’s sort of circular. If they don’t have a 

good credit rating because credit rating agencies don’t give them 

good credit and because markets undervalue—solidity. 

Mr. Reeves? 

Mr. REEVES. Thank you, Mr. Chairman. I think that I agree in 

general terms with Treasurer Wiessmann. The reality is that in 

the municipal marketplace, relative risk is always going to be important, and it’s going to be important either relative to the way 

in which rating agencies rate securities, or it’s going to be important relative to the buyers who are actually buying those securities— 

The CHAIRMAN. But we are talking about full faith and credit 

general obligation bonds. Are there real differences and risks? 

Mr. REEVES. Absolutely. There are real differences in risk. I 

mean if you look at the general obligation of the State of Pennsylvania, which has a very diversified economic situation within the 

State or my State and the State of Mississippi relative to the general obligation of a smaller entity that may not have the sort of diversified situations. Now, in terms of— 

The CHAIRMAN. Which has never defaulted. 

Mr. REEVES. The default risk is one component of the overall risk 

structure— 

The CHAIRMAN. Well, but that’s so fulfilling. Yes, if you leave it 

entirely to a market which undervalues the—and to a credit rating 

agency with a dual structure, then those differences are built in. 

The question is, what would happen if the Federal Government 

stepped in and said, ‘‘You know, with regard to these, there has 

been a default. We don’t think that the way the rating agencies 

have treated them reflects reality.’’ 

56

Mr. REEVES. Well, I agree that the way in which rating agencies 

have treated municipal issuers has not reflected reality because 

when I say ‘‘relative risk,’’ I think relative risk means not only 

amongst general obligation credits of larger entities and smaller 

entities. Relative risk also includes that of the corporate marketplace as well. And that’s where the real distinction has been in the 

past, in my opinion. 

The CHAIRMAN. By the way, the record does not show that the 

size of the State makes any difference whatsoever. There is simply 

no difference with regard to defaults with regard to State, because 

they don’t default. 

Mr. REEVES. I would agree with that, Mr. Chairman, but I would 

like to just note that when you talk about the entire municipal 

marketplace, you’re not just talking about— 

The CHAIRMAN. I said, Mr. Reeves, full faith and credit general 

obligation. I understand that. But that’s exactly yes, there are 

some differentiations there. But even there, though, the market—

the market undervalues all of this, but in different levels. 

The gentleman from Pennsylvania? 

Mr. KANJORSKI. Thank you very much, Mr. Chairman. As I understand it, the question in the municipal bond market is not that 

there aren’t funds available the people would like to buy bonds 

with; it is the problem of getting to a triple-A rating, which is required by many of the entities that invest in municipal bonds. So 

having lost in some instances the value of the insurance wraparound, that because the rating agencies were able to sell their 

wrap-around, triple-A rating to the particular municipal bond 

issuer, these qualified across the board to all potential buyers. Now 

that has disappeared, and in some instances the fiduciary relationship of the pension fund or whoever buys these bonds is now being 

forced to divest themselves of the bonds because they failed to meet 

the legal requirement of a the triple-A rating. Is that correct? 

We are not talking about having to create an investment tool 

process by which the owners or purchasers of these bonds can continue to exist as they have in the past. And since they do not know 

what the rating is, they cannot depend on the rating right now, 

and the insurance companies are either incapable because of their 

draw-down of equity to issue the amount of capacity that they had 

in the past, we no longer have that clear triple-A rating. 

Is that basically—do I have it right or do I have it wrong? 

Ms. WIESSMANN. In that segment of the market, yes. 

Mr. KANJORSKI. Well, so it seems to me that we have about a 

$2.6 trillion market. It has probably been working for your friends 

and associates in the construction industry and in the municipalities. It is a question of how do we get back to that status, so there 

isn’t an interruption, as there has been? 

And one of the interruptions would be the insurance companies. 

Their equity is being drawn down because they have wrapped too 

many high-risk securities that now they have to come forward and 

show support for that, and that limits the amount of equity they 

have left in their companies to give the triple-A guarantee to new 

issues. Is that about the correct analysis? 

Mr. DILLON. But I would like to say, Congressman, there there 

has been—construction work is slowing and stopping. It’s being afVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00060 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
57

fected immediately right now. And really it just has happened in 

our industry in Indiana probably in just the last three to five— 

Mr. KANJORSKI. But we could probably cure that if we were to 

decide to pass a very limited Federal financing instrument and say 

that municipal bonds from this day forward may be insured by this 

Federal agency for the next 12 months or until other insurance in 

the private market is obtainable for a reasonable price. And that 

would then jilt the market right back to being a very sound tripleA document. Is that correct? 

Mr. DILLON. That is my understanding from our local city engineer. 

Mr. KANJORSKI. Right. And we should all be in favor of that, 

finding a way. So now we are in the darkness, trying to find the 

light. The problem that I have is it is quite an invasion and disruption of the private market. The question that I pose to you, and 

perhaps the treasurer from Pennsylvania: At what point should we 

worry about invading the private market? Is it so pervasive the 

risk to going on with municipal bonds and public projects, that we 

ought to just as a matter of course in good public policy delve into 

it to solve the immediate problem of stimulating the market to 

begin to operate? 

Ms. WIESSMANN. Well, that goes to the heart of my testimony, 

which is that I do think these are very unusual circumstances, and 

that the increases and the expenses and the stress that is being 

created on States and municipalities and entities is something that 

needs to be obviated. And I have called for some intervention, both 

from a liquidity standpoint, and if the Federal Government were to 

see to having some from a insurance standpoint, if the Federal 

Government found fit to do that on a temporary basis, I think it 

would be justified. 

Mr. KANJORSKI. Well, let me follow that reasoning. It would take 

us a considerable length of time to establish a new municipal bond 

government guarantee corporation. From my experience standing 

here, we are probably talking years, unfortunately. So that is one 

of the reasons I came up with the argument and the idea a number 

of months ago to use the Federal Home Loan Banks. If we authorize the issuance of letters of credit to operate as an insurer of municipal bonds, that could be implemented almost immediately. We 

have it all collateralized, and available in all 12 Federal Home 

Loan Banks across the country, and they could be operable almost 

immediately, or certainly within 30 days. 

Ms. WIESSMANN. I think you have three State treasurers here on 

the panel, who have all concurred that would be a very good idea. 

Mr. KANJORSKI. So we ought to urge our fellow members on the 

Ways and Means Committee to move as quickly as possible on that 

piece of legislation as a surgical procedure to at least restart the 

municipal bond operation to move projects along in the country, is 

that correct? 

Ms. WIESSMANN. In my opinion, yes. 

Mr. KANJORSKI. Right. 

The CHAIRMAN. Thank you. Next? The gentleman from Massachusetts. 

Mr. CAPUANO. Thank you, Mr. Chairman. 

58

I’d like to ask each member of the panel—I notice that several 

of you work with treasuries in one hospital and one independent. 

I just want to make it clear in my own mind. Are you all currently, 

or any of you not currently issuing bonds on a regular basis, either 

for the State, or on behalf of cities and towns, or on behalf of the 

hospital? Are you not in the bond market? Oh, you—I’m presuming 

you are in the bond market. 

Mr. ROSENSTIEL. We are in the bond market today, selling a billion dollars of revenue bonds because of the fact that they are not 

working— 

Mr. CAPUANO. That’s—I just want to know if you were in the 

market. 

Mr. ROSENSTIEL. Yes. 

Ms. WIESSMANN. The Commonwealth of Pennsylvania has issued 

bonds very recently. 

Mr. CAPUANO. And I assume that you don’t issue bonds directly, 

you just benefit from them when you can? 

Ms. WIESSMANN. Correct. 

Mr. CAPUANO. So then it’s fair for me to believe that I have to 

be a little wary of everything you say, because if you’re in the market, you really don’t want to get the credit rating agencies upset 

with your State. You really don’t want to get the bond insurers 

upset with your State. And I don’t blame you. I was hostage for 9 

years, I had to very nice and very professional, so I’d have to tell 

you that I feel sorry for you and I look forward to the day that you 

are released from your hostage situation, and then can speak freely. 

In the meantime, I would like to know, if you can tell me, if you 

feel—again, I would never ask you to hurt your State or municipality, so if you have to couch them or just want to skip, go right 

ahead. Does anybody think that the dual-rating system is good or 

fair? Does anybody think that the similar treatment that’s required 

by the SEC or the dual-rating system, is fair? 

Ms. WIESSMANN. I made in my comments, I commented that the 

origination of the ratings, which of course have a long history at 

this point up until now have withstood the test of time. But our 

markets have become much more complicated, and when times call 

for it, changes should be made. 

Mr. CAPUANO. That strikes me as a very nice and professional 

way to say they’re not fair, and you know— 

[Laughter] 

Ms. WIESSMANN. Well, I like to approach things constructively. 

Mr. CAPUANO. That’s fair. I can’t tell you how good it is to have 

some freedom. Believe me, when you get it, it’s great. 

[Laughter] 

Mr. CAPUANO. I’m just curious. I know you each come from different States. I assume the three of you can answer; I’m not sure 

if the other two can. If you can, I’d appreciate it. Do your States 

back up municipal bonds? I know in Massachusetts if a city or 

town has trouble, the State will take it from Local 8. And they 

come in right away and we have had cities go bankrupt, and not 

a single bondholder has missed a beat. I’m just curious, is that true 

in each of your States? 

59

Mr. ROSENSTIEL. There is nothing legislatively that requires it, 

but in fact when there have been problems, there has been a history of the State stepping in to— 

Mr. CAPUANO. So there’s a history, a recent history of that happening? 

Mr. ROSENSTIEL. Yes. 

Ms. WIESSMANN. In Pennsylvania, it also is done on a case-bycase basis. It’s not legislated, but there is often a considered moral 

obligation. 

Mr. REEVES. We have a specific conduit issuer in Mississippi, 

which by the way was very useful in the immediate aftermath of 

Katrina. But we do have a specific conduit issuer that on certain 

issues when requested does all for the moral obligation of the 

State. I will tell you just for the record that along with that moral 

obligation comes additional responsibility by the issuers to satisfy 

the members of the board that sits on that conduit issuer, including myself. Yes, we do have a conduit issuer. 

Mr. CAPUANO. Good. And can you answer me relative to Illinois? 

Do you know? 

Mr. NEWTON. I can answer relative to my institution. 

Mr. CAPUANO. Okay. That’s fair. What is the answer for your institution? 

Mr. NEWTON. We’re totally dependent on ourselves and our own 

performance. 

Mr. CAPUANO. Okay. And do you know—again I don’t expect you 

to know, but I figured you might— 

Mr. DILLON. No, I don’t. I don’t. 

Mr. CAPUANO. Okay. 

Mr. DILLON. If you want to know how to put pipe in the ground, 

I’m your guy. 

[Laughter] 

Mr. CAPUANO. We’re doing that right now in my city. As we had 

a brief discussion, my city is currently in the middle of doing a 

major sewer project that has been put off for 20 years, and had I 

been able to save all the money I had to waste on bond insurance, 

I could have done it years ago, and a lot of people’s homes and 

businesses would not have flooded. 

In that case, I appreciate you being here. I don’t have any real 

questions for you. I can only tell you that if you have heard us say 

anything here that you think has been wrong, then I would suggest 

if you haven’t, then talk to your local cities and towns, your mayors, and in particular your county commissioners. Whomever issues 

the bonds, in particular, GO’s and revenue bonds, and see if they 

think it’s wrong. And again, when the time comes when you are no 

longer in the market, I’d love to have a further discussion with you 

to see what your personal experience has been. In the meantime, 

I would like to say to the credit rating agencies and the bond insurers in the market in the room tonight, this afternoon, please don’t 

hold against them what I have said. 

The CHAIRMAN. The gentleman—I was sorry but not surprised to 

hear your report that this has already begun to affect a slowdown. 

Anything that your association wanted to send to us along those 

lines, we would be glad to put in the record, because I think it is 

important to show that, as I said, we’re not talking about some 

60

narrow technical matter, but some real problems that will slow 

down the rate of needed physical improvements. 

The gentleman from Texas? Oh, I’m sorry, the gentleman from 

Connecticut. 

Mr. SHAYS. Yes. Thank you, Mr. Green, as well. Just on behalf 

of Ranking Member Spencer Bachus, I’d like to enter into the 

record a letter that Mr. Bachus sent to Securities and Exchange 

Commission Chairman Christopher Cox on January 23, 2007, not 

2008, more than 14 months ago, long before the issues in the municipal securities market that we have been discussing here today. 

The letter states concerns that Mr. Bachus had about the oversight 

of the municipal securities market and the situation particularly in 

Jefferson County, Alabama. So if I could submit— 

The CHAIRMAN. Without objection, that will be part of the record. 

Mr. SHAYS. Thank you. 

The CHAIRMAN. And the gentleman from Texas is recognized. 

Mr. GREEN. Thank you, Mr. Chairman. And I thank the members of the panel for appearing. It appears to me that we are talking to a great extent about the monoline market. Is there anyone 

who is of the opinion that this market should be regulated at the 

Federal level? Or if you’re at liberty to say, and perhaps I should 

start with Mr. Newton. Mr. Newton, should this market be regulated? 

Mr. NEWTON. I don’t know if I can give you a specific direct opinion on regulating the monolines. What I can share with you is that 

what really precipitated this was the failure in the auction market. 

And to the extent that there is oversight of the auction market, and 

to the extent that we can have available to us other options for 

credit enhancement, that would be a wonderful thing. 

Mr. GREEN. The failure in the auction market is due in great 

part to the way the mono insurers conducted themselves, is that 

correct? 

Mr. NEWTON. That’s my understanding. Correct. 

Mr. GREEN. So regulating that market would mean that we 

would again get back to the monoline market. I don’t know how we 

get away from that. Maybe you can help me to understand how we 

get away from it. 

Mr. NEWTON. Well, what really makes health care work is having this predictability and capacity of capital. And when we run up 

against things that frankly—I, like you, don’t understand all of the 

arcane science of how these markets may choose to work, what I 

would be greatly in favor of is if transparency and visibility and 

greater understanding of the kind of debt instruments that are involved, that would be very helpful, if that helps clear the market. 

But what we’re facing is a bolus in the market of this refinancing, and that to me on a looking forward basis is really my 

greater concern. The past is past. I mean I can’t really give some 

more in-depth conversation about how it really got this way. 

Mr. GREEN. Well, Mr. Dillon, do you have a comment on it, 

please? 

Mr. DILLON. No. I really can’t advise you on that. 

Mr. GREEN. Do you think that we should, the feds should regulate the monoline market in any way? 

61

The CHAIRMAN. Well, let me just say in fairness to the witness, 

he was invited here to give his information about what the impact 

of this crisis has been on the industry he represents. He was not 

asked to be prepared on the— 

Mr. GREEN. Thank you, Mr. Chairman. I appreciate it. Well, let 

me ask this question. Would regulation—and if this is the wrong 

panel to ask a question of, my apologies again—but would regulation have been of benefit, any kind of regulation in the monoline 

market have been of benefit to us in terms of preventing the failures that we’re talking about? 

Ms. WIESSMANN. I would just suggest that the insurance companies would respond today that they are regulated; they just happen 

to be regulated by different States. And one thing that I have been 

struck with about this is how different the different insurance companies are. So I do think it would be beneficial for there to be some 

uniformity of standards as it relates to the marketplace that 

they’re operating in, so that there is a greater understanding of 

how they are conducting or managing their risk relative to this 

very important market sector. 

Mr. GREEN. Thank you, Mr. Chairman. I’ll yield back. 

The CHAIRMAN. The gentleman from Missouri. 

Mr. CLEAVER. Mr. Chairman, I have one question—I’m anxious 

for the next panel—uniform standard. I mean insurance companies, 

Ms. Wiessmann, you said would argue that they are regulated—if 

there is a regulation supposed to be at the State level. And so I 

guess I’d like to know if you know of any kind of regulatory control 

over an insurance company that has addressed any of the issues 

that we’re raising today? The dual standards, student loans. I don’t 

know if Mr. Dillon talked about the problems with student loans. 

Ms. WIESSMANN. Well, I think there are a number of factors, 

here. The dual standards I think are generally referring to the rating agencies in terms of all of that. 

Mr. CLEAVER. Yes. 

Ms. WIESSMANN. It is a complex mix. It’s an interplay of a number of different factors. When I said that I thought that it would 

be useful to have some uniform standards, if there are particular 

criteria that Congress or other interested parties think need to be 

put into consideration when insuring municipal bonds, I think you 

could develop those. So I think there is something that you can do. 

I think we do have to do it, to say wholesale regulation is—I’m not 

really in a position from a jurisdictional standpoint to argue that. 

But I certainly think that there’s a lot to be done to improve the 

information we have as well as knowing how the risk is allocated. 

So— 

Mr. REEVES. I’d like to just touch on that. The regulation of the 

insurance industry has been an issue handled by the States for a 

long period of time as to whether or not that’s the right approach 

or not that’s not something I should necessarily comment on, because again, as the treasurer said, it’s not under my jurisdiction. 

But what I would like to say, and I think this is extremely important, is that the fact that the insurers have had the complications that they’ve had, and that they’ve lost their credit ratings 

really speaks to—as it relates to the challenges that we face today, 

speaks to a larger issue, and that is the lack of liquidity in the 

62

market. The real challenges that we have in the auction rate securities market is due to lack of liquidity. The reason that the insurers losing their triple-A ratings, at one reason, has really exacerbated the problem is because of the Rule 2a-7 requirements. Okay? 

So in essence, when the insurers lost their triple-A ratings, many 

of these securities were no longer eligible under Rule 2a-7. The 

chairman earlier mentioned his sensitivity to the private marketplace. My opinion is that the least invasive solution in the short 

run is actually a relaxing of the 2a-7 requirements for municipal 

bonds. Because the reality is it makes no sense that a 2a-7 fund 

can purchase a double-A corporate and not a single-A muni, when 

in fact the reality is and the facts show that that single-A muni has 

less of a default risk than the double-A corporate. So in my view, 

the least invasive solution in the short run is that relaxation and 

as the chairman mentioned earlier, secondarily, an additional possibility which again requires legislation, which takes time, is the 

allowance of the Home Loan Bank to offer letters of credit again, 

which would infuse liquidity. 

Mr. CLEAVER. Thank you, Mr. Chairman. 

The CHAIRMAN. Again, what we stress is the case where the low 

rating of the insurance drags down the entity it is insuring. This 

is the lead life preserver. You would be better off without the life 

preserver and floating on your own. 

The gentleman from Colorado? 

Mr. PERLMUTTER. Thanks, Mr. Chairman. And I guess, I have so 

many questions, I don’t know where to begin but just basic question to the treasurers: Why do you have to go through Moody’s if 

you are California or you are Pennsylvania or Mississippi, why cannot you just go straight to somebody who buys bonds and not have 

to go through any of this stuff? 

Mr. REEVES. Well, one of the main reasons is that among the biggest buyers of municipal bonds are mutual funds, and they require 

the ratings. That is in their bylaws for each of their funds, that 

there have to be generally two ratings. 

Mr. PERLMUTTER. Okay, so the mutual fund before it buys says 

we have to have something from Moody’s? 

Mr. REEVES. That’s correct. 

Mr. PERLMUTTER. Or we have to have insurance? 

Mr. REEVES. We have to have certain rating levels from usually 

at least two rating agencies. 

Mr. PERLMUTTER. Is there anything in the law that says that 

they have to have that? 

Mr. REEVES. I don’t believe so, but I am not an expert on their 

law. 

Mr. PERLMUTTER. So if you went to a mutual fund, and I have 

represented for instance Pennsylvania Higher Education Authority, 

which apparently is struggling to make some loans because it cannot borrow any money or sell bonds, but your Pennsylvania Higher 

Education Authority. And you say, ‘‘But we are a good credit risk, 

and we can put on the dog and pony show to any bond buyer out 

there and prove to you that we are worth 5 percent interest, and 

that is a good risk for us. Why don’t you do that?’’ They just say, 

‘‘Sorry, you have to go through Moody’s,’’ or some other? 

63

Mr. REEVES. There is that and there are other buyers who buy 

the bonds and then turn them into variable rate bonds and 2a-7 

requires the ratings and just in general I think investors, individual investors, get a sense of security. The ratings have provided 

an important function in our market. 

Mr. PERLMUTTER. But, Mr. Treasurer, listening to Mr. Lockyer, 

I am going wait a second, California has issued $9 billion worth of 

whatever, it has paid $100 million to insurance companies and to 

the credit rating agencies, you could have taken that $100 million 

and gone to Leonard Perlmutter and say, ‘‘Hey, we are good credit 

risk, will you buy $100,000 worth of our bonds?’’ Why do you not 

do that? 

Ms. WIESSMANN. The short answer is that you rely on the negotiation of the credit markets, which are far larger than anything 

a State or a particular entity could access. When you talk about 

Pennsylvania student loans, there are securities on loans of $7 billion. We would have to find a lot of one-on-one placement in order 

to fulfill that type of liquidity requirement, which it brings us back 

to the point that it really does—rating agencies have provided an 

objective, a perceived objective standardization in the marketplace, 

just as the insurers have been up to this point have been perceived 

as creating a marketability for these. 

The CHAIRMAN. Will the gentleman yield? 

Mr. PERLMUTTER. Certainly, yes. 

The CHAIRMAN. There is nothing objective. I understand that you 

were held hostage by this, but I do not understand why you, the 

victims, would defend a rating system that has totally undervalued 

you, that has cost you a lot of extra money. There is just no validity to this. They are drawing distinctions among bonds that never 

default. So I understand why you are forced into it, but frankly 

now some of them come in, I have to tell you at this point, and I 

have said it before, the ratings agencies worth—I have said about 

editorial writers, they come down from the hills after the battle is 

over and shoot the wounded. So they are never there to help anybody in advance, but I do not understand how you can talk about 

them as being objective. 

Ms. WIESSMANN. I just want to qualify, number one, I do not feel 

held hostage to them at all. I feel quite independent in fact, but—

and I do not think that what I say here today is going to affect the 

credit rating of Pennsylvania. 

The CHAIRMAN. But I am saying this, as the gentleman from Colorado said, we have bonds that never default and you were all held 

hostage, what you are saying is if you did not go and subject yourself to the rating agencies and to this insurance, which is dragging 

people down because it is lower rated than you ought to be, you 

could not sell. 

Ms. WIESSMANN. I just want to say I mentioned before that markets change. The sophistication of buyers, the sophistication in 

America in terms of what municipal bonds are is quite different 

from when rating agencies were first added. 

The CHAIRMAN. But now you are worse off, is that what you 

mean? 

Ms. WIESSMANN. And they provided market access. 

64

The CHAIRMAN. I’m sorry, I want to get back to the gentleman 

from Colorado, but I do not think that is the case because you are 

now paying more than you used to, so if they are more sophisticated, that must mean that you are worse than you used to be as 

a credit risk, and I don’t think you are. The fact is if they were so 

sophisticated, you would not be in the situation of having rates go 

up when there is no valid reason for it. 

The gentleman from Colorado? 

Mr. PERLMUTTER. And I will just cut it off at this. I can understand why the hospital authority or something else needs to go 

through a middleman, Moody’s or have to have some backup from 

an insurance company because the marketplace or the Smith Barneys or the Goldman Sachs or whoever buys these bonds does not 

really understand you, but California, Pennsylvania, Mississippi, 

for goodness sakes, it really does not make sense to me how this 

process works. 

Ms. WIESSMANN. Unfortunately, we just respond to the market. 

We are trying to change the market. We are trying to educate people that we are better credits, but we are in the market today with 

$1 billion worth of bonds, and we bought bond insurance on them. 

Mr. CAPUANO. Will the gentleman yield for a second? 

Mr. PERLMUTTER. Certainly. 

Mr. CAPUANO. I appreciate your trying to educate them. Why 

would they get educated when they make money by being—well, 

uneducated? 

Ms. WIESSMANN. What I mean is the investors. 

Mr. CAPUANO. Why would the investors do it when they get a 

higher rate of return? 

Ms. WIESSMANN. That is a very good point. 

Mr. CAPUANO. If you are telling me that you are going to educate 

me, and when I am educated, I am going to get 5 percent back on 

my bond as opposed to 8 percent on my bond, guess what? I will 

stay stupid. 

[Laughter] 

Mr. CAPUANO. So therefore, how can you educate the people who 

are making money on the backs of your taxpayers? 

Ms. WIESSMANN. You are defining part of our problem, but there 

are also a lot of investors, especially we had at other times in the 

market, as recently as less than a year ago, many of our bonds 

were bought by hedge funds. They put in a great bid for our bonds. 

They drove our interest rates down, and the reason they did that 

is they then put it into trust and they sold variable rate bonds. 

They now have had to unwind those trusts because of the problems 

of the bond insurers. That has been one of the problems. 

Mr. CAPUANO. Because they were bundled with risky bonds. They 

were not sold individually. 

Ms. WIESSMANN. They put into the trust insured bonds, and 

when the insurers were downgraded, the bonds— 

The CHAIRMAN. Right, the insurers downgraded because they 

went into other things and not your bonds. 

Ms. WIESSMANN. Yes, that is exactly right. 

The CHAIRMAN. We are going to have to break now, but we have 

Stockholm Syndrome here, where you start thanking the kidnapper. 

65

[Laughter] 

The CHAIRMAN. People need to be much less accommodating intellectually to a system that has just mistreated you. We have to 

go and vote. 

Mr. CAPUANO. Mr. Chairman, just one point? 

The CHAIRMAN. Yes? 

Mr. CAPUANO. Just one point. I need to remind everybody that 

even Patty Hearst said good things about her captors. 

The CHAIRMAN. Yes, they talk about that. Anyway— 

Ms. WIESSMANN. We would not be on this panel if we did not 

think there should be changes to be made. 

The CHAIRMAN. I understand, but you have to make the arguments for the changes, not by defending the objectivity of the existing system. That is not going to help us. I want to say to the next 

panel that we will be back. It may take us about a half-hour. There 

are a couple of votes. I apologize but your testimony will be valuable. Let’s take a little break. We will be back in about 45 minutes. 

If you can stay, I appreciate it, and we will get to you. 

[Recess] 

Mr. CLEAVER. [presiding] We apologize for how often we have to 

leave, and I wish I could tell you that this was unusual, but we 

are going to proceed and Chairman Frank will join us shortly. We 

are going to move on with the third panel, and we will begin to receive your testimony. By the time the chairman returns, hopefully 

we by then can become ‘‘dialogical.’’ We will begin with Mr. Jain, 

Berkshire Hathaway Assurance Corporation. Thank you for being 

here. 

STATEMENT OF AJIT JAIN, CHAIRMAN, BERKSHIRE 

HATHAWAY ASSURANCE CORPORATION 

Mr. JAIN. Thank you to the members of the committee. It is my 

privilege to appear before you today. My name is Ajit Jain, and I 

am with Berkshire Hathaway. Recognizing the value of your time, 

I will get right to the three issues you have asked me to address, 

which are: One, the circumstances that prompted us to form Berkshire Hathaway Assurance Corporation, a new bond insurer, and 

the offer we made earlier this year to protect the municipal bond 

portfolios of the insurers. Two, the value of bond insurance to bond 

insurers and investors. And, three, what I think the future looks 

like for the bond insurance industry. 

The first issue then is our decision to enter into the bond insurance industry. This was prompted by a phone call from the New 

York Superintendent of Insurance. I confess that when I was told 

that a regulator was calling, I was prepared for a complaint. Instead, he was calling to discuss a business-like approach to solving 

a problem, involving us to create New York-based insurer. Clearly, 

flattered by the phone call, we wanted to reciprocate by helping address a problem of national importance. 

At about the time the superintendent called us, we felt there was 

a real possibility that the bond insurance industry would undergo 

a structural and permanent shift. For almost 20 years, we have 

been considering entry into this business. With our triple A ratings 

and excess capital position, this segment was always a natural for 

us. The attractive macro-features notwithstanding, when we anaVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00069 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
66

lyzed the risk/reward characteristics of a typical transaction, we 

concluded that the pricing did not adequately compensate the capital provider for the risk, especially the tail risk. By ‘‘tail risk’’ I 

mean a black event defined as a random, difficult to predict event, 

an event that may have never happened and therefore is unlikely 

to happen. But when it does happen, it has a huge impact. 

In about October of 2007, with the advent of the subprime crisis 

and the increased awareness of the financial losses it could bring, 

we hypothesized that risk in general, and financial credit risk in 

particular, would no longer be underappreciated and underpriced. 

Pricing going forward would reflect an expectancy of loss plus a 

reasonable return to the risk bearer. 

In addition, we believe that the franchises of the existing industry leaders could be mortally wounded by the subprime and structured finance exposures. Whether or not these companies would 

raise additional capital, we believe there is a good chance that they 

could no longer maintain their all important triple A ratings. If 

that happened, there would be an opening for us in the business. 

As for our offer to reinsure the municipal bond business of existing insurers, here again the New York superintendent gets the 

credit. He forced us to consider how our capital could be deployed 

to help alleviate the increasing pressure on the existing players 

and their policyholders. A comprehensive solution, including the 

structured finance and the municipal obligation, was everybody’s 

first priority. However, we could not untangle the complex financial 

transactions that made up the structured finance portfolios. While 

we continued to feel that historical pricing on the municipal bond 

business was inadequate, we could at least take on that risk with 

a price adjustment, which we made in our offer to reinsure the 

company’s municipal bond business. 

I would like to briefly explain why we believe the offer had the 

merits from several perspectives. First, from the municipality’s perspective, having a solid, triple A insurer backing their bonds would 

almost certainly have avoided the steep increases in interest cost 

that we have seen in the variable and auction rate securities. Similarly, for the bond investors, our protection may well have avoided 

the steep price decreases in the value of the bonds that they witnessed 2 weeks ago. Furthermore, by releasing capital from the 

municipal side of the business, the structured finance policyholders 

could have had more capital available to pay for their losses. Finally, the shareholders of these companies, having shared the 30 

year municipal bond obligations, the companies could then negotiate with their counterparties to terminate their structured financial obligations and ultimately return capital to the shareholders. 

This might have been the best outcome for the shareholders given 

where the shares of these companies were trading then and are 

trading now. Despite these benefits, also it was clearly not in the 

best interest of the management of these companies, whose interest 

appeared to have trumped the combined interest of the investors, 

issuers, policyholders, and shareholders. 

The second issue I have been asked to address is the benefit of 

bond insurance to issuers and investors. On this point, I can add 

almost nothing to what has already been spelled out by so many 

others. Historically speaking, the cost of a financial guarantee inVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00070 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
67

surance policy was more than justified by the reduced interest that 

the municipalities paid investors for the funds being borrowed. 

Speaking historically once again, the rating enhancements of the 

insurance was good for investors because it helped maintain a stable and liquid market for bonds. 

Given where we are today then, I can well understand the committee’s interest in the large issue I am to address, which is where 

are we going with all of this? What my answer lacks in helpfulness, 

it makes up for in honesty: I do not know. There is a great deal 

of uncertainty. For our part, we are tiptoeing into the water and 

while we are writing business at pricing levels that are economically attractive to us, I remain very concerned about the long-term 

viability of the business in general and for us particular. 

There are several reasons for my concern: First, as is true in all 

insurance, the product that is being sold is nothing more than a 

future promise to pay. With recent headlines of municipalities having to pay as much of 20 percent on auction rate securities and 

some insured municipal bonds selling at higher yields than corresponding uninsured bonds, buyers have every right to question— 

Mr. CLEAVER. Mr. Jain, I notice you have a couple more pages, 

three more pages, if you could summarize that for us. 

Mr. JAIN. Okay. 

Mr. CLEAVER. And perhaps during the question and answer period, you will be able to respond to questions on that. 

Mr. JAIN. Sure. The buyer has every right to question the value 

of the bond insurer’s promise to pay. This concern about the integrity of the product is further reinforced by the ‘‘good bank,’’ ‘‘bad 

bank’’ talks that are being discussed these days. 

I will end there given that I have run out of time, and I want 

to thank you for giving me the chance to address you. 

[The prepared statement of Mr. Jain can be found on page 109 

of the appendix.] 

Mr. CLEAVER. Thank you very kindly. 

The next witness is Mr. Sean W. McCarthy, president and chief 

operating office, Financial Security Assurance, on behalf of the Association of Financial Guaranty Insurers. 

Mr. McCarthy? 

STATEMENT OF SEAN W. MCCARTHY, PRESIDENT AND CHIEF 

OPERATING OFFICER, FINANCIAL SECURITY ASSURANCE, 

ON BEHALF OF THE ASSOCIATION OF FINANCIAL GUARANTY INSURERS 

Mr. MCCARTHY. Mr. Chairman, Ranking Member Bachus, and 

other members of the committee, I am Sean McCarthy, chair of the 

Association of Financial Guaranty Insurers, AFGI, and the president and chief operating officer of Financial Security Assurance 

Holdings, Ltd., and its monoline, Financial Security Assurance, 

FSA. 

AFGI is an association of 11 monoline primary insurers and reinsurers. Established in 1971, the monoline bond insurance industry has generally been a triple A-rated industry. It was initially 

founded to provide bond insurance to the U.S. municipal bond sector and today serves the municipal public infrastructure and asset 

back markets globally. As monolines, we provide financial guaranVerDate 0ct 09 2002 17:12 Jun 04, 2008 Jkt 041730 PO 00000 Frm 00071 Fmt 6633 Sfmt 6633 K:\DOCS\41730.TXT TERRIE
68

tees and related products only. We do not provide other forms of 

insurance, such as property and casualty, life, auto, or health insurance products. 

It is a highly regulated and transparent industry with few exceptions. The monolines are required to be licensed in States and/or 

countries in which they operate. For example, the monolines are 

regulated by the New York State Insurance Department and in the 

UK, by the Financial Service Authority. Of the six companies providing primary guarantees, three are public companies and three 

are privately held. All are subject to or voluntarily provide disclosure, consistent with the 1934 Act reporting requirements. The rating agencies also require ongoing information. 

The industry’s practice is to underwrite at least investment 

grade risks, meaning investment grade or better, with low severity 

of loss when default does occur. In addition to providing financial 

guarantees, monolines also provide surety bonds and credit derivatives, whose terms exactly mirror a financial guarantee. All of 

these policies have pay-as-you-go settlement terms, and there is no 

requirement to post collateral if the underlying credit deteriorates, 

thus minimizing liquidity risk. 

Over the past 5 years, monolines have insured more than $1 trillion of U.S. funds to fund essential public projects, almost $82 billion of the funds to fund infrastructure outside of the United 

States, and more than $1 trillion of asset-backed bonds globally to 

lowering funding costs. The issuers do not pay more for bond insurance. The premium paid for the guarantee allows them to lower 

their overall cost of funding. Additionally, bond insurance provides 

for a larger, broader public finance market because it increases investors’ capacity for individual credits. 

For investors, bond insurance provides protection against default 

of principal and interest, built in analysis, surveillance and remediation so that problems can be worked out before a default. Bond 

insurers do not guarantee market value. As a result of conservative 

underwriting, the industry has up until now had a low loss record 

of three basis points on net debt service. This contrasts with the 

banking industry’s weighted average annual charge-offs on principal of 60 basis points from 1992 to 2006. 

What has happened lately? The crisis originates from a specific 

type of security: collateral debt obligations of asset-backed securities, referred to as CDOs of ABS, or another form, CDOs of CDOs. 

These contain large amounts of U.S. subprime residential mortgages in concentrated forms. While home equity lines of credits, securities called HELOCS, and subprime mortgages may also generate claims for the financial guarantors, they will not be of the 

magnitude to imperil the company’s credit ratings. Thus, some 

companies made a mistake in a single asset type class. This does 

not represent a systemic failure nor does the industry request a 

Federal bailout. Going forward, industry members who have been 

degraded will do whatever possible to get back to a triple A level. 

We also expect the rating agencies to recalibrate their models with 

more conservative assumptions on all forms of asset-backed transactions, including the oversight of the monolines. The monolines 

will respond accordingly. 

69

Even if a bond insurer goes into run-off, it can renew its capital 

reserves through investment income and freeing up of reserves if 

the bonds it has insured mature or are called. AFGI, as an association, does not take a point of view on how monolines are structured. I will say from the perspective of my company, FSA, it does 

not make sense to require companies to split into municipal and 

structured finance units, as the model works appropriately now if 

correctly applied with conservative underwriting. 

I would also like to add a perspective on the causes of the recent 

option rate failures, which, while due in part to credit concerns 

about the bond insurance industry for sure, were also driven by 

dealers backing away from an implied obligation to provide liquidity and to credit liquidity concerns in general. In most cases, bond 

insurers will work—we certainly are working with issuers to convert auction rate to either fixed or variable rate bonds. 

One further point: We believe that unrealized marks that insurers are required to take through the income statement on insurance policies issued in a credit default swap form under US GAAP 

are obscuring the true performance of the industry. Absent any 

claims under the guarantee and given the insurer’s intent to hold 

these contracts until maturity, decreases or increases to income 

due to the marks will sum to zero by the time each contract has 

matured, eliminating any economic impact. These contracts are 

functionally identical to the financial guarantee policy and are not 

inherently more risky. Therefore, we can submit the fact that 

CDOs of ABS were insured in the credit default swap form have 

nothing to do with the economic loss that will be taken on these 

structures, it is the assets underneath them. 

I thank you for taking the time to listen to me, and I would be 

happy to answer any questions. 

[The prepared statement of Mr. McCarthy can be found on page 

140 of the appendix.] 

Mr. CLEAVER. Thank you very much, Mr. McCarthy. 

We will move now to Ms. Laura Levenstein, the senior managing 

director of Global Public, Project & Infrastructure Finance Group, 

Moody’s Investors Services. Thank you very much for being here. 

STATEMENT OF LAURA LEVENSTEIN, SENIOR MANAGING DIRECTOR, GLOBAL PUBLIC, PROJECT AND INFRASTRUCTURE 

FINANCE GROUP, MOODY’S INVESTORS SERVICE 

Ms. LEVENSTEIN. Thank you. Good afternoon, Chairman Frank, 

and members of the committee. I am pleased to be here on behalf 

of my colleagues at Moody’s Investor Service to discuss our rating 

system for municipal bonds and how that system is designed to address the attributes of the municipal market. I will also describe 

some of the more recent changes we have made to our municipal 

rating system as a result of our ongoing dialogue with issuers, investors, and other market participants. I should note that more 

than 35 percent of the municipal bond issuances are not rated by 

Moody’s or any other credit rating agency. Therefore, the information contained in my testimony is based on the securities that 

Moody’s has rated in the municipal market and our comments 

should not be construed as being applicable to the entire universe 

of municipal issuance. 

70

Moody’s first began rating municipal securities in 1918. Today, 

our U.S. municipal rating system is used for rating securities 

issued in the U.S. tax-exempt and taxable bond markets by State 

and local governments, nonprofit organizations, and related entities. This system is different from our global rating system, which 

is used for rating issuers and issuances of non-financial and financial institutions, sovereigns and sub-sovereign issuers outside of 

the United States as well as for structured finance obligations. 

Our municipal rating system grew out of and reflects the unique 

dynamics and needs of the municipal bond market and its participants. There are two aspects of the municipal bond market that 

have historically been particularly important. First, while it should 

be noted that the loss experienced from non-rated municipal 

issuers has been higher than that for the rated universe, municipal 

securities rated by Moody’s have had relatively low credit risk 

when compared to rated corporate or structured finance obligations. This low credit risk is primarily the result of the special powers and the role of municipalities as public entities. These include 

their ability to levy taxes and the likelihood that in the event of 

financial distress, municipalities or other public entities will receive support from a third party, such as a State government. Because of these and other factors, the municipal market has had 

limited default and loss experience and our municipal rating system reflects that reality. 

Second, investors in municipal securities have traditionally had 

different perspectives and risk advertised in corporate bond investors. Municipal investors generally have been more risk averse and 

less diversified in their investment portfolios. They typically have 

been more concerned about the liquidity of their investments and, 

in the case of individuals, more dependent on debt service payments for income. They have typically been highly intolerant of 

seeing their investment portfolios experience diminished value or 

reduced liquidity, which can occur as a result of an issuer’s financial distress, even if the bonds do not ultimately default. 

In response to these market characteristics, are municipal ratings more finely distinguished among municipal securities than do 

our corporate ratings? Because the risk and potential severity of 

loss is low, our ratings focus primarily on the risk that an issuer 

will face financial distress. This can result in delayed payments 

and reduced liquidity. 

If municipal bonds were rated on a global rating system, the majority of the ratings would fall between just two categories: triple 

A and double A. This would eliminate one of the primary values 

municipal investors have historically sought from our ratings, 

namely, the ability to differentiate the relative credit risk among 

various municipal securities. We have been told by many investors 

that not providing that differentiation would make the market less 

transparent, more opaque, and presumably less efficient for both 

investors and issuers. 

Nonetheless, Moody’s recognizes that the municipal bond market 

has evolved in recent years, and we have taken steps to respond 

to the changing needs of investors and issuers. For example, in 

2002, to accommodate the trend we saw of some taxable bonds 

being placed outside the United States, we began offering entities 

71

issuing such securities the opportunity to request a global rating. 

We also began providing broad guidance on how our municipal ratings would translate into global ratings. In 2006, we conducted extensive surveys of market participants. As a result of that feedback, in 2007, we announced that when requested by issuers, we 

would assign a global rating to any of their taxable securities regardless of whether issued within or outside the United States. We 

also published a conversion chart that allows the market to estimate a global rating from a municipal rating. 

Finally, since our last formal outreach to market participants in 

2006, we believe that the market has continued to evolve. As a result, we plan to assign global ratings at an issuer’s request to any 

tax-exempt bond, including previously issued securities, as well as 

new issues beginning in May 2008. We are also re-evaluating the 

overall market use and understanding of our municipal ratings and 

will be issuing a request for comment this month. 

Moody’s has always maintained an active dialogue with investors 

and issuers to understand what would help make our municipal 

rating system most useful, and we welcome additional market feedback on measures that would improve the overall transparency and 

value of our rating systems. 

Thank you. 

[The prepared statement of Ms. Levenstein can be found on page 

115 of the appendix.] 

STATEMENT OF MARTIN VOGTSBERGER, MANAGING DIRECTOR AND HEAD OF INSTITUTIONAL BROKERAGE, FIFTH 

THIRD SECURITIES, INC., ON BEHALF OF THE REGIONAL 

BOND DEALERS ASSOCIATION 

Mr. VOGTSBERGER. Good afternoon, Chairman Frank, and members of the committee. Thank you for the opportunity to be here 

today. State and local governments depend on a smoothly functioning municipal market to finance schools, roads, hospitals, water 

and sewer systems, and other vital infrastructure. This is a timely 

and important hearing, and I commend you for your attention to 

these issues. 

My name is Martin Vogtsberger. I am a managing director and 

head of institutional brokerage at Fifth Third Securities, a regional 

broker-dealer, which underwrites fixed rate municipal bonds and 

variable rate demand obligations. Like most regional broker-dealers, we have not been active in the auction rates securities market. 

But I am here today representing the Regional Bond Dealers Association, of which my firm is a member. The Regional Bond Dealers 

Association is a new association that represents securities firms active in the municipal bond markets. Many of our members, including my own firm, are active in the municipal market. 

One of the things that makes the municipal market unique is 

that it is dominated by many thousands of State and local entities 

that issue bonds in relative size issue sizes. In many cases, these 

small issuers do not attract the attention of large global securities 

firms, so the municipal market depends on the participation of regional firms to function smoothly. 

The disruptions we have recently seen in the municipal market 

are the result of a perfect storm of negative events starting last 

72

summer. Sparked by the deterioration in residential real estate and 

especially subprime mortgages, credit markets began to freeze up. 

Investors retreated from the credit markets, liquidity dried up, and 

prices fell. While municipals were not as affected as other asset 

classes at the time, they were not spared. Hedge funds and arbitrage funds, who have become increasingly active participants in 

the municipal market, faced margin calls and began selling assets. 

Finally, it became clear that some of the bond insurers who provide credit enhancement to more than half of the outstanding municipal bonds were suffering from their exposure to subprime mortgages, structured credit products and other assets, but notably not 

from their municipal bond exposure. These events together caused 

stress on the municipal bond market similar to what other sectors 

of the credit market experienced last year. The disruption was felt 

most in markets for products that are designed to mimic money 

market instruments, including auction rate securities and to a lesser extent, variable rate demand obligations and tender option 

bonds. 

The most frustrating aspect of the current market disruption is 

that it is occurring despite the fact that the underlying fundamental credit quality of State and local governments has not eroded over the last several months. To be sure, the credit ratings of 

many thousands of bond issues have been lowered, but that occurred not because of weakening financial positions of States or localities but because of downgrades of some of the monolined insurers. 

State and local governments have suffered in several ways as a 

result of the current market stress. First, some of the auction rate 

securities are now paying owners penalty rates on auction rate securities whose options have failed. Often, these penalty rates are 

well above market rates. Many issuers are trying to refinance out 

of auction rate securities into more economical forms of financing. 

In some cases, however, this is difficult because of lack of asset to 

credit enhancement. In addition, issuers who have come to market 

with traditional, long-term, fixed rate bonds have had to pay higher 

financing costs than they otherwise would have because of lack of 

credit enhancement and a general loss of market liquidity. 

One question that has received significant attention in the context of the current market disruption is the rating scale used by 

bond rating agencies from municipal bonds, which differs significantly from the scale used by other debt securities. The separating 

scale of municipal bonds cost State and local governments money 

when they issue bonds, either because they have to issue bonds at 

a lower rating or because they have to buy bond insurance to issue 

at a higher rating. A strong argument can be made for encouraging 

rating agencies to rate municipal bonds on the same scale as other 

debt securities. 

Although important segments of the municipal market have experienced significant stress in the last several months, the core of 

the market has remained relatively strong. Issuers of traditional, 

long-term, fixed rate securities have still been able to access the 

market to finance new public investment. This is attributed to the 

strength of municipal bonds as an asset class and is hopefully a 

73

sign that the market’s distress will not have long-term negative implications for States and localities. 

Thank you again, Chairman Frank, for the opportunity to be 

here. I look forward to your questions. 

[The prepared statement of Mr. Vogtsberger can be found on 

page 210 of the appendix.] 

The CHAIRMAN. Thank you. I apologize for being a little late, but 

again this is very important, and I appreciate all of you staying 

here. Let me start with Mr. Jain. And you reiterate, and we appreciate, we had a chance to talk with Mr. Buffer, and we appreciate 

your being here, you reiterate that you still think that going into 

the municipal only insurance business would be a very good deal? 

Mr. JAIN. At current pricing levels, we certainly feel there is an 

attractive opportunity for us. 

The CHAIRMAN. Meaning that you could get—there would be a 

very low default rate, so a fairly low premium structure and you 

could make some money? 

Mr. JAIN. That is correct. 

The CHAIRMAN. Well, of course, we are also thinking one possibility of course—well, I guess two things. There is a question about 

whether, and I apologize, I just tried to read your statement, you 

have made that offer but no one has taken you up on it, is that 

right? 

Mr. JAIN. On the re-insurance for the existing municipal bond— 

The CHAIRMAN. Have you thought about just going to that business and saying to the municipal issuers, ‘‘Here we are, come and 

be insured?’’ 

Mr. JAIN. We are doing that as we speak. Over the last 2 months 

now, we have insured about four billion-plus of secondary market 

transactions and have written premiums. 

The CHAIRMAN. What about primary, have you thought about 

doing it for the primary? 

Mr. JAIN. Absolutely. We are in the process of trying to get 

ready, but you need a license in each and every State before you 

can write a primary transaction. 

The CHAIRMAN. Unless the Federal Government were to pass a 

statute that licensed this. I can’t think of any obstacle to our doing 

that constitutionally. It could be a specific license. The Federal 

Government could license you to do that for municipalities only, 

you know, for municipal bonds. If the Federal Government were to 

pass such a license, would that facilitate your efforts? 

Mr. JAIN. We are, since we made our application to the NAIC, 

through the NAIC to the individual States, we now have 31 licenses already. 

The CHAIRMAN. All right. I’ll tell you how to get 19 licenses in 

a hurry. We’ll file a bill for a Federal license. You’ll get 19 more 

licenses in about 4 hours. 

Mr. JAIN. Thank you. 

[Laughter] 

The CHAIRMAN. Now I do want to get to the issue of the duality. 

And I understand, Ms. Levenstein, your argument, but it seems to 

be somewhat circular. Well, first of all, I was struck with what Mr. 

Jain says in his statement. If the rating agencies had just one rating, there would be little need for a financial guarantee insurance 

74

marketplace because much municipal debt on a stand-alone basis 

wouldn’t require the enhancement. So he’s arguing against interest, and we appreciate the honesty of your doing that. But—and 

then, Mr. Vogtsberger, as I understand it, you’re saying you think 

there’s a strong argument—let me put it this way. Ms. Levenstein 

is, it seems to me, arguing, if I read correctly and listened to your 

statement, that the reason for the dual track is consumer demand; 

that the people who want to buy municipals because they are 

less—they are more risk-averse, they want a separate rating system. Is that essentially what you are saying? 

Mr. VOGTSBERGER. Right. I think when you add mutual funds as 

proxies to households, roughly 70 percent of the municipal market— 

The CHAIRMAN. And they want a separate rating system? 

Mr. VOGTSBERGER. —are households, and they rely on ratings 

to— 

The CHAIRMAN. Well, but, why do they—I understand that. But 

that’s not the question. Please, let’s stipulate. We’ll get to whether 

or not there should be ratings in entities that never default. One 

default that was fully paid off since 1970. But why two ratings systems? That is, I understand they want ratings. But why—I mean, 

what we’re being told is this. You know what? If we rated municipals the way we rated everything else, they’d always get 100. It 

would be boring. So, therefore, it wouldn’t be good enough. That’s 

the tail wagging the dog. That’s the cart before the horse. That’s 

all those metaphors. I mean, our—do investors demand a separate 

rating system from municipals because municipals don’t fail 

enough to make the current—to make it interesting? I mean, let 

me ask you, Ms. Levenstein. Do investors in your view demand a 

separate rating system? 

Mr. VOGTSBERGER. No. They demand a rating. 

The CHAIRMAN. All right. Mr. Jain, you say if we had a separate 

rating system, it would just show that everybody was solid. Ms. 

Levenstein, your argument appears to be that while you’re meeting 

the needs of investors by a separate rating system, what’s the evidence for that? 

Ms. LEVENSTEIN. We have been rating based on this scale since 

1920. 

The CHAIRMAN. No, that’s simply that you’ve been doing it. But 

the fact that you’ve been doing it doesn’t mean that there’s an investor demand that you keep doing it. So, what makes you think— 

Ms. LEVENSTEIN. But we’ve queried—we have queried the market many, many times, and the— 

The CHAIRMAN. In what sense? You’ve done a survey? Have 

you— 

Ms. LEVENSTEIN. We’ve reached out and had one-on-one meetings. We’ve had briefings. We’ve done publications. We’ve— 

The CHAIRMAN. And they have told you that they insist on a separate rating system, even though they know that there’s no default? 

Ms. LEVENSTEIN. Yes. 

The CHAIRMAN. All right, I’m going to tell you, I’m skeptical. 

Sometimes—I’m sure you’re being honest with the results, but I 

don’t know how these things are done. I mean, let me put it this 

75

way. You say, well, in general, you talk about likeliness of default, 

but you’re saying that when people buy municipal bonds, they’re 

not interested in likelihood of default. They’re interested in financial stress on the entity, even though your own evidence is that financial stress on the entity appears to be unrelated in any statistically significant way to default. I mean, is that a rational basis 

for the market to do this? 

Now, I do understand the argument that, well, no, but they’re 

not as tradable. Right. They’re not as tradable because of your rating system. It seems to me that’s very circular. So why would people wanting to buy bonds not be influenced by whether or not they 

were going to default? And why is that relevant for corporate and 

not for municipal? 

Ms. LEVENSTEIN. Well, I think they are influenced by that. But 

ratings have multiple attributes. Ratings don’t measure one aspect 

or one metric. Ratings are meant to provide relative rankings as 

well as— 

The CHAIRMAN. Well, but relative rankings, one in ten million 

versus one in a million? Relative rankings of what? 

Ms. LEVENSTEIN. Relative ratings of likelihood of default. 

The CHAIRMAN. Okay. And what is the likelihood—so, why don’t 

you then put municipals in with everybody else and let them take 

the relative ranking of likelihood of default? Why can’t you rate 

municipals like everybody else on the relative likelihood of default? 

Ms. LEVENSTEIN. Well, on a forward basis, as I’ve stated in the 

testimony, we are going to do that. We are going to offer at the 

issuer’s request to rate both— 

The CHAIRMAN. I’m sorry. I didn’t realize. So from now on, if an 

issuer wants to be rated the same was a corporate— 

Ms. LEVENSTEIN. That’s correct. 

The CHAIRMAN. So the investor demand apparently— 

Ms. LEVENSTEIN. —of this year. 

The CHAIRMAN. —wasn’t so strong after all? 

Ms. LEVENSTEIN. I’m sorry. Excuse me? 

The CHAIRMAN. Do you expect investors now to stop buying 

them? 

Ms. LEVENSTEIN. No, I don’t. But I do expect investors to still 

want to know what the relative ranking is, as well as the absolute 

likelihood of default of default. 

The CHAIRMAN. Relative ranking of municipals and corporates together? 

Ms. LEVENSTEIN. Relative ranking of municipals amongst municipal securities, and then the likelihood of default across the whole 

spectrum. 

The CHAIRMAN. Well, let me ask you, you are all sort of market 

experts. If there is no—do I really care whether it’s one in a million 

versus 1 in 900,000? I mean, why is that important information for 

me to have? 

Ms. LEVENSTEIN. Because risk premiums are based on relative 

rankings, not— 

The CHAIRMAN. Yes, but, then why—they’re not absolute? 

They’re relative? 

Ms. LEVENSTEIN. Yes. 

76

The CHAIRMAN. Is that rational—I mean, you would pay more for 

one in a million than for 1 in 900,000? 

Ms. LEVENSTEIN. I don’t know if those are— 

The CHAIRMAN. You know, I mean, I’ve been listening for years 

people tell me you politicians, you act emotionally, you act irrationally. We, the market, are lucid. Based on today, not so much. 

The gentleman from North Carolina. 

Mr. WATT. Mr. Jain, you were about to make three points at the 

end of your testimony that you didn’t get a chance to make. I’m 

going to give you the opportunity to make those three points quickly, if you can do it. 

Mr. JAIN. The three points I was going to make was in relation 

to the outlook of the industry and why I felt the outlook of the industry was uncertain in general and our role in particular. And the 

reasons I have concerns for the outlook for the industry. Firstly, as 

we talked about, in insurance, the product that we are selling is 

a promise to pay. And buyers have rightly so have started to question what the value— 

Mr. WATT. And when you say industry, are you talking about the 

insurance of these bonds, or are you talking about the bonds themselves? 

Mr. JAIN. I’m talking about the bond insurance industry. 

Mr. WATT. The bond insurance industry, not municipal bonds in 

general? 

Mr. JAIN. No. 

Mr. WATT. Okay. So you’re talking about the insurance, and I 

guess if there weren’t two rating systems, a triple A and a double 

A, as I understand it, there wouldn’t be any insurance would there? 

Mr. JAIN. There would be less of a need for bond insurance. If 

a number of the— 

Mr. WATT. What does that insurance do, other than provide an 

absolute guarantee of payment in a market in which there is a one 

in one million absolute guarantee of payment anyway? 

Mr. JAIN. The insurance certainly provides peace of mind to 

somebody who cannot really assess what are the true odds of the 

loss, to be able to get— 

Mr. WATT. But isn’t that what the triple A rating, or that’s what 

the rating would do anyway, isn’t it? 

Mr. JAIN. Right. But— 

Mr. WATT. So you are—the insurance adds an extra layer on top 

of the rating? 

Mr. JAIN. Extra layer of protection in the event of default. 

Mr. WATT. But do people understand that there hasn’t been any 

default anyway? 

Mr. JAIN. I am not sure— 

Mr. WATT. Historically? 

Mr. JAIN. I am not sure about that. A lot of the product is sold 

in the retail market, and I’m not sure if the retail investors are sophisticated enough to be able to analyze individual credits. What 

they do rely upon are the ratings of the underlying municipality 

and— 

Mr. WATT. That’s what Ms. Levenstein does, right? 

Mr. JAIN. And the bond insurance protection— 

77

Mr. WATT. Which is what you do? So you are—I mean, people are 

really paying a premium for both of those things, both of which do, 

as I understand it, essentially the same thing. 

If you—if you give a triple A rating, Ms. Levenstein, isn’t that 

a virtual guarantee that there’s going to be payment? Historically, 

hasn’t that been the case? 

Ms. LEVENSTEIN. Historically, that is the case, but— 

Mr. WATT. Okay. All right. 

Ms. LEVENSTEIN. —I think you could step— 

Mr. WATT. And if he gives an insurance premium, then does that 

do anything other than charge me an insurance premium to get the 

same historical guarantee? But I guess it gives me that assurance 

going forward. I’m not relying on history any more. I’m relying on 

his policy? 

Ms. LEVENSTEIN. Can I just provide a little bit of background 

that may be helpful? 

Mr. WATT. Absolutely. 

Ms. LEVENSTEIN. I don’t think that price or yield is driven only 

by the rating. I think it’s driven also by the size, name recognition, 

amount of disclosure that’s available. There are other factors. 

Mr. WATT. Insurance premiums are driven by that, too? 

Ms. LEVENSTEIN. Insurance premiums. Sean should answer that. 

Mr. WATT. Mr. Jain? 

Mr. JAIN. The insurance premium is, as far as we are concerned, 

is driven first and foremost by what our expectancy of loss is. 

Mr. WATT. Okay. Well, let me ask this question, Mr. Jain. You 

say you’re getting, if you get these other 20 States or so, you’re 

going to get into the primary market. Are you going to require in 

that primary market, are you going to require insurance? 

Mr. JAIN. We are providing the insurance, so, you say will I require? 

Mr. WATT. You’ll be playing on both sides, as I understand it, at 

that point. You’ll be in insurance, and you’ll be a purchaser of the 

bonds? 

Mr. JAIN. No. No. We are not talking about us and our role in 

terms of purchasing the bonds. We will be the risk bearer taking 

on the insurance risk of the default of underlying bonds. 

Mr. WATT. And you will be what else? 

Mr. JAIN. That’s it. 

Mr. WATT. Well, what are you now? 

Mr. JAIN. We are a bond insurer. 

Mr. WATT. Okay. And once you get in on the next level after you 

get all these licenses, what will you be? 

Mr. JAIN. We will be a bond insurer. 

Mr. MCCARTHY. I think perhaps the point that he was making 

is that right now, Berkshire Hathaway is participating in the secondary market. 

The CHAIRMAN. It’s secondary and primary. The license is what 

is primary. Is that the— 

Mr. MCCARTHY. —I think he’s making is that once he obtains all 

of the licenses, he will participate in the primary market. 

Mr. WATT. Okay. Well, and the question I was asking is, once 

you do that, will you require insurance also, or will you not? 

Mr. MCCARTHY. No. He’ll be— 

78

Mr. JAIN. We will be—let me explain what I meant by the role 

we are playing right now. A number of bonds come into the market 

without any insurance whatsoever. These bonds end up with traders or with retail investors. At some point, these traders or these 

retail investors come to us on these uninsured bonds looking for insurance protection. We write insurance protection for these bonds 

on a secondary market basis, as opposed to negotiating with individual issuers, which is a primary basis. 

Mr. WATT. I think I— 

Mr. JAIN. So in both cases we are playing the role of an insurer 

only. 

Mr. WATT. I think you’ve confused me sufficiently. 

Mr. JAIN. I’m sorry. 

The CHAIRMAN. Let me just—I want to go back to Ms. Levenstein 

again. Somebody just suggested, and you said, and I’m glad to hear 

that, that you’re going offer the municipal issuers the choice. Will 

there be a price difference in what they’re charged? 

Ms. LEVENSTEIN. We haven’t decided yet, and that’s still under 

discussion. If there would be any incremental price, it would be an 

ongoing monitoring price. I should point out also that we currently— 

The CHAIRMAN. You would charge an ongoing monitoring price to 

the corporation—I mean, different than—I don’t understand that. 

Why should they— 

Ms. LEVENSTEIN. Because there is additional work that we need 

to do in order to translate the ratings. But I would like to— 

The CHAIRMAN. Well, no, no. So that’s really taking back what 

it said in your opening—if they’re in the same rating system as the 

corporations, why should—are they paying twice for this? I don’t— 

Ms. LEVENSTEIN. No. We’re providing a municipal scale rating or 

a rating under the municipal system, and we are going to effectively translate that to the equivalent of a corporate rating or a— 

The CHAIRMAN. Why don’t you just rate them in the first place? 

Oh, so you’re going to charge—so a municipality that wants to be 

rated as a corporate might have to pay more because they’ll be first 

rated as a municipal issuer and then they have to pay a translation 

fee? 

Ms. LEVENSTEIN. I think that hasn’t been determined yet, but 

they will be first rated under the municipal system and then we 

will apply the— 

The CHAIRMAN. Well, what if they just said, I’ll skip the municipal system. Just rate me like anybody else right away? 

Ms. LEVENSTEIN. That’s not what we’re planning to do right now. 

The CHAIRMAN. I find that, from our public policy standpoint, unacceptable, and we would certainly try to legislate against that. To 

charge them double to be treated like anybody else— 

Ms. LEVENSTEIN. No, we’re not charging them double. 

The CHAIRMAN. Yes. That’s what you’re saying. You’ll charge 

them to be a municipal— 

Ms. LEVENSTEIN. No. 

The CHAIRMAN. You’ll charge them for the separate rating when 

they don’t want a separate rating and then charge them again to 

get the same rating as everybody else. 

79

Ms. LEVENSTEIN. We’re providing a municipal system rating 

which will allow for the sort of differentiation and relative ranking, 

which is valuable to the market. We’re also providing or will provide upon request, only upon request, a global scale— 

The CHAIRMAN. I must say, I misunderstood what you said. 

When you said you were going to offer them a choice, what you’re 

going to offer them is a second item for which you can charge them. 

And I think you will be continuing to be abusive of them in that 

regard. 

Ms. LEVENSTEIN. Again, I— 

The CHAIRMAN. You’re going to charge—they have to—get rated 

like anybody else, they have to pay for two ratings. 

Ms. LEVENSTEIN. No. That is incorrect. 

The CHAIRMAN. You just said that. They’re going to be rated as 

municipal whether they want to or not, and then if they also want 

the global rating, there’s an extra charge for that. 

Ms. LEVENSTEIN. What I said is we hadn’t determined it yet. 

The CHAIRMAN. No, but—well, if you do—if you don’t, then I 

withdraw my comment. But if you do, then you’re charging them 

double. And when you suggested to me that they’ll have a choice, 

yes, I have a choice. I can buy—pay for two or I can pay for one. 

But that’s not what I usually mean by a choice. 

Ms. LEVENSTEIN. But the other thing I should point out, it 

wouldn’t be double. But the one thing I would like to point out is 

that we have offered global scale ratings or global system ratings 

since 2003 for any taxable issues, and it is interesting to us that 

we’ve only had 18 issuers— 

The CHAIRMAN. Do they pay extra for that? 

Ms. LEVENSTEIN. They do. 

The CHAIRMAN. Okay. Well, surprise, surprise, they don’t want 

to pay extra for it. Secondly, taxable is different than tax exempt. 

Ms. LEVENSTEIN. I don’t think that’s— 

The CHAIRMAN. The fact that people may not want to pay extra 

doesn’t mean that they wouldn’t make the choice if they didn’t have 

to pay extra. 

The gentleman from Massachusetts. 

Mr. CAPUANO. Thank you, Mr. Chairman. Mr. Chairman, I beg 

to differ with what you said earlier. The investors are very lucid. 

Why would they want to do the right thing in order to get a lower 

return? They love the system they have now because they get eight 

points back when they should be getting five. They get seven points 

back when they should be getting four. Why should they change it? 

Why would any of these people at this table change the system 

when with a good system they’d be out of business? We wouldn’t 

need you. So I think you’re investors, and you are very lucid. You 

got it right. You have them by the short hairs. Keep them screaming. Don’t worry about it. 

Mr. McCarthy, I beg to differ when you saved us $40 billion? 

Mr. MCCARTHY. Correct. 

Mr. CAPUANO. That’s like the local gang coming into my little 

corner store and saying we saved you $100,000 because your place 

didn’t burn down last week. We gave you protection. You didn’t 

save anything. You saved it because you have the system rigged so 

80

that cities and towns can’t get the ratings they deserve due to their 

default rates, their lower default rates. You didn’t save anything. 

How can you possibly be shocked that they’re now attempting to 

pretend to do the right thing and going to charge us for it? But I’m 

supposed to say thank you? When I was a mayor, I would say 

thank you. Have another croissant. I don’t have to say that anymore. Getting double charged for doing what you should be doing 

in the first place, I don’t have to say thank you. I can call it what 

I’ve said it is. It’s extortion. All I see is the rate for extortion is 

going up. 

I do want to ask one thing. On the historic default rates, am I 

wrong? Is my information incorrect that corporate double A bonds 

that are rated by Moody’s have defaulted at a rate 43 times higher 

than double A rated munis? 

Ms. LEVENSTEIN. No, I don’t believe you’re wrong. 

Mr. CAPUANO. Yet they get a better rating. How is that defensible? If you’re going to do this, then stick with the dual system. 

Just change how they get done. Why? Keep the dual system. Give 

the munis a better rate. They’re a better deal, according to your 

own dual system. And I understand fully well that somehow I must 

be mistaken here in the documents you gave and the written testimony you said that you used analytical methodologies. Okay. That 

sounds very complicated, very mathematical, very precise. But then 

I just heard you say the reputation or the name recognition of the 

community. So if you don’t know where my community is, though 

my community has never defaulted, just because you don’t know 

where it is, I have to pay more? 

Ms. LEVENSTEIN. No. That wasn’t— 

Mr. CAPUANO. That’s obscene. That’s offensive. 

Ms. LEVENSTEIN. That wasn’t what I was saying. What I was 

saying is the way the market prices things sometime depend— 

Mr. CAPUANO. If the market knew that I was going to pay them 

back, they would price—I have no problem with ratings. I just 

want to be rated on a fair and equal footing. I have no problems 

with ratings, and I do understand that rateds is different than 

unrateds. I understand that within rateds—I accept all that. That 

doesn’t bother me. 

But put me in the category, put us in the category that we have 

earned. You didn’t give it to us. We earned it by paying our bills. 

We’ve done what we were asked to do. We have done it better than 

corporations, and yet you still punish us because we have been silent. I’m not being silent today. And I don’t expect to be silent ever 

again because I now have this new freedom that I am finding very 

good. 

Simply treat us fairly, and there would be no problems. You can 

continue making a few bucks. You can continue insuring those 

issuances that need insurance. Everybody goes on. Everybody’s 

happy, everybody makes a few dollars. The cities and towns get to 

do what they need to do. My sewers get fixed. My cops get hired, 

and you’re still in business. Stop sticking it to us because you can. 

Otherwise, we will find ways to stop you. 

Mr. Chairman, I yield back. 

The CHAIRMAN. I thank the gentleman. I would note Mr. Jain’s 

comment that if in fact the municipal issuances, the municipal 

81

bonds were rated the same as any other, there wouldn’t be any insurance business because they would all do well. Mr. McCarthy? 

Mr. MCCARTHY. Just one point. I think— 

The CHAIRMAN. Your microphone is not on. 

Mr. MCCARTHY. I’m sorry, Mr. Chairman. One of the functions 

of the insurance business in the municipal area is that we quote 

a bid in the market for every particular bond, and there are thousands and thousands of municipal credits. We have a very, very 

large staff that analyzes municipal bonds, and really the value 

we’re bringing to, as an industry, to the municipal investor is that 

first we’re putting our capital up so that to the extent that something does happen, whether there’s a payment shortfall or something else, we stand by that. 

I think the chart that the chairman produced earlier is a Moody’s 

chart that actually excludes defaults that might be taken by the 

model lines. So the model line— 

The CHAIRMAN. No. No. 

Mr. MCCARTHY. It’s not? 

The CHAIRMAN. No. There were just no defaults. These weren’t 

defaults that were paid by somebody else. 

Mr. CAPUANO. Mr. Chairman, I want to be clear. I don’t think 

that you have no role in the marketplace. I think you do have a 

role. But I want you to market my bonds on the basis of the likelihood of me paying them back. And you can’t do that without 

Moody’s giving me an appropriate rating. 

Mr. MCCARTHY. Right. We’re not the arbiter of whether we get 

used or not. 

Mr. CAPUANO. Oh, I understand that. 

The CHAIRMAN. But I also would have to add— 

Mr. CAPUANO. Because you’re the beneficiary of it. 

The CHAIRMAN. I would also add while that’s a nice model, in 

fact the way it’s worked out for many municipal issuers, they have 

been carrying their insurers. They have in fact been rated higher 

than their insurers, and the insurers have dragged them down, and 

they have had to pay more money because of the low rating of their 

insurers, who improvidently invested the money. 

Mr. MCCARTHY. Well, some—in the model line insurance industry— 

The CHAIRMAN. Yes. 

Mr. MCCARTHY. —there are several companies, thank goodness, 

FSA, which I represent—have maintained their triple A’s from all 

three rating agencies in our State. 

The CHAIRMAN. But let me say this. I don’t know anybody who 

had to pay more for his car because his car suddenly became worth 

more than his insurance agency. You’re saying it only happened 

with some insurance agencies— 

Mr. MCCARTHY. No, no. 

The CHAIRMAN. Some insurers and not others. 

Mr. MCCARTHY. No. 

The CHAIRMAN. Where the lousy performance of their insurers 

cost them money. 

Mr. MCCARTHY. Well, the financial wellbeing of the companies, 

if you think of it this way, as I said in the testimony, if you look 

at the CDOs of ABS, different model line companies were exposed 

82

to a single asset class which have very large losses and severe 

losses, and that single asset class— 

The CHAIRMAN. Which asset class is that? 

Mr. MCCARTHY. CDOs— 

The CHAIRMAN. Okay. Excuse me. You say were exposed to. Now 

does that mean they were walking down the street and it wafted 

in and they caught it like pneumonia? 

Mr. MCCARTHY. No. 

The CHAIRMAN. They didn’t—they weren’t exposed to it. They 

took the profits from the municipals and went out and bought it. 

They weren’t exposed to it. 

Mr. MCCARTHY. No, I don’t that’s—I think the way it actually 

works is that each company has capital— 

The CHAIRMAN. Excuse me, Mr. Callen said in the Wall Street 

Journal from Ambac, we took the profits, which were very good and 

very secure, and we went and invested in things, and we invested 

in things we didn’t fully understand, CDOs. He wasn’t exposed to 

it. He jumped in. 

Mr. MCCARTHY. I would speak— 

The CHAIRMAN. Well, but, that’s one of the big companies. 

Mr. MCCARTHY. I can speak for the industry generally, I can 

speak for FSA specifically. 

The CHAIRMAN. Well, then, don’t talk about it, but the fact is— 

Mr. MCCARTHY. But Mr. Callen I can’t speak for. 

The CHAIRMAN. But you weren’t exposed to it. These other— 

Mr. MCCARTHY. No. We didn’t underwrite that— 

The CHAIRMAN. I understand that. But the point I’m making is, 

you know, the passive voice probably ought to be banned from the 

English language. It’s the great excuser. Oh, we were exposed to 

it. No, they weren’t exposed to it. They tried to make some money 

and made a bad guess. 

Mr. MCCARTHY. Well, they underwrote it, meaning that those 

transactions that with a triple A— 

The CHAIRMAN. But they volunteered to go and underwrite it because they thought they’d make money. 

Mr. MCCARTHY. That’s correct. 

The CHAIRMAN. They were—yes. All right. 

Mr. MCCARTHY. That’s correct. 

Mr. CAPUANO. Mr. McCarthy, if my city had gotten the rating I 

deserved according to these charts, I would have been triple A from 

day one and I wouldn’t have needed bond insurance, so I wouldn’t 

have been exposed to anything, because I wouldn’t have had to get 

bond insurance. 

Mr. MCCARTHY. We would—well, I’m not sure. We will still 

quote— 

Mr. CAPUANO. And I would say thank you very much, no thank 

you. 

Mr. MCCARTHY. And investors may or may not decide— 

Mr. CAPUANO. And by the way, even when I needed bond insurance, I was never any lower than a B. 

Mr. MCCARTHY. Right. 

Mr. CAPUANO. And guess what? I didn’t want to be put in with 

junk bonds. 

Mr. MCCARTHY. Right. 

83

Mr. CAPUANO. The people who did the CDOs, they chose to throw 

me into junk bonds. They were using my good credit to cover their 

lousy choices. I didn’t get exposed by voluntary. I didn’t ask, oh, 

gee, please throw me in with the junk bonds. 

The CHAIRMAN. We’re going to move on. 

Mr. MCCARTHY. I think it’s important to note that each of the 

companies that have experienced distress, MBIN Ambac, for example, have raised significant amounts of capital. 

The CHAIRMAN. They didn’t experience distress. They made lousy 

investment decisions. These were not—you know, they didn’t experience distress. They made bad investment decisions. 

Mr. MCCARTHY. You’re exactly right. 

The CHAIRMAN. Okay. Thank you. The only question I had was, 

my colleague from Somerville, I don’t know if you know Massachusetts, but did you go to Cambridge to get those croissants you were 

giving people when you were mayor? 

[Laughter] 

The CHAIRMAN. I didn’t think they had croissants in Somerville. 

All right. I’m sorry. The gentleman from Missouri. 

Mr. CLEAVER. Thank you. I hope you understand, and I feel very 

similar to my colleague. As a former mayor, we have—for 8 years, 

I had to tiptoe around with the rating organizations—agencies, because we didn’t—you know, the lawyers said, you know, you can’t 

irritate them, you know. We have a double A rating with perfect 

payments with regard to the general obligation bonds, and so you 

have to play nice. 

And so, like my colleague, I’m irritated, because I don’t have to 

play nice now. You know, I guess maybe the mayor in Kansas City 

is afraid. I’m curious, Mr. Vogtsberger, or you and Ms. Levenstein, 

how much money have you had to pay out in municipal bond defaults in the last 10 years? 

Mr. VOGTSBERGER. As a bond underwriter, we don’t pay any 

money out for municipal bond defaults. We buy bonds and then remarket them. 

Mr. CLEAVER. Well the truth is, nobody pays anybody off in municipal bonds, because there haven’t been any defaults. 

Mr. VOGTSBERGER. There have been defaults in municipal bonds, 

not general obligation bonds, but— 

Mr. CLEAVER. Where? 

Mr. VOGTSBERGER. Hospitals, for example, private colleges, industrial development revenue bonds. Those are all municipal bonds 

that from time to time— 

Mr. CLEAVER. I’m talking about municipalities. 

Mr. VOGTSBERGER. Municipalities, very few. 

Mr. CLEAVER. One? 

Ms. LEVENSTEIN. But that’s of the rated Moody’s universe. There 

may be others that are unrated. I simply don’t know. 

Mr. CLEAVER. Okay. But you can’t name one? 

Ms. LEVENSTEIN. I only know of one that was within our rated 

universe, that’s correct, of a GO— 

Mr. CLEAVER. A municipality. I’m not talking about a— 

Ms. LEVENSTEIN. A general obligation pledge from a municipality. 

Mr. CLEAVER. On the full faith and credit of that city? 

84

Ms. LEVENSTEIN. Yes. They defaulted. There would have been 

others—there were others that were different types of revenue 

pledges. 

Mr. CLEAVER. One out of how many? 

Ms. LEVENSTEIN. One out of about 28-, or 29,000. 

Mr. CLEAVER. Don’t you think that the cities need a rebate now? 

This is a serious question. 

Ms. LEVENSTEIN. No I don’t. 

Mr. CLEAVER. Why not? 

Ms. LEVENSTEIN. Because, again, I think we provided to the market— 

Mr. CLEAVER. What? 

Ms. LEVENSTEIN. —what the market wanted, what was usable. 

Mr. CLEAVER. What did you provide Kansas City? 

Ms. LEVENSTEIN. We provided ratings that provided relative 

ranking. 

Mr. CLEAVER. I’ll tell the people when I go home this weekend— 

Ms. LEVENSTEIN. That’s what the market told us they— 

Mr. CLEAVER. —because all they know is that they’re having to 

pay, that our city is having to pay high insurance, no low interest, 

and there’s no—there’s such a minute change that we’re going to 

go into default, that it’s almost absurd that we have to do it. And 

you’re saying you don’t think anything has gone wrong there? 

Ms. LEVENSTEIN. I think the market is pricing what they perceive to be the risk. 

Mr. CLEAVER. So everything is fine? 

Ms. LEVENSTEIN. All we’re doing is providing an opinion of the 

relative credit ranking, and that’s what we have done. 

Mr. CLEAVER. So everything is fine? You don’t see a problem 

with— 

Ms. LEVENSTEIN. What has changed is that there is more of a 

crossover market and the market appears to want, as well as the 

municipal rating system, the global system. And that’s why we’re 

offering it on a forward basis. 

Mr. CLEAVER. When did you discover this as the point, I mean— 

Ms. LEVENSTEIN. We first started to talk to the market about 

this in 2001, and we talked to the market in 2001. We talked to 

over 100 participants in the market. The feedback that we got at 

that time— 

Mr. CLEAVER. What—who— 

Ms. LEVENSTEIN. —that for a certain segment of the market, 

global ratings would be helpful. 

Mr. CLEAVER. Did you talk to the— 

Ms. LEVENSTEIN. Only that segment. 

Mr. CLEAVER. —the U.S. Conference of Mayors, the National 

Conference of— 

Ms. LEVENSTEIN. We talked to issuers. We talked to investors. 

We talked to intermediaries. 

Mr. CLEAVER. But you didn’t—you never talked to any of the 

mayors or the organizations representing mayors? 

Ms. LEVENSTEIN. We talked to issuers, so we did talk to— 

Mr. CLEAVER. Who? 

Ms. LEVENSTEIN. —who were representatives of mayors. I don’t 

have the list. But we did talk to over 100 representatives. 

85

Mr. CLEAVER. And they didn’t go off? 

Ms. LEVENSTEIN. No, they did not. 

Mr. CLEAVER. Boy, I’d like to see them. 

Ms. LEVENSTEIN. In fact, the overwhelming opinion was to keep 

things the way they were, and that’s what we did, except for the 

small segment of the market that was taxable issuance outside of 

the United States or swap obligations. And so between 2003 and 

2007, we offered global system ratings to that segment of the market. 

Now as I’ve said earlier, it is clear that there’s a change, and it 

is clear that there would be value to the market of global system 

ratings. So we will provide those on a forward basis to any issuer 

who wants them. 

Mr. CLEAVER. The State government of Missouri has a triple A 

rating. 

Ms. LEVENSTEIN. Yes. 

Mr. CLEAVER. I think there are only five States with triple A in 

the United States. Our creditworthiness is higher than the State, 

and we have a double A. How do you explain that? 

Ms. LEVENSTEIN. Well, I’m not in a position today to discuss the 

difference between your city and the State of Missouri. But certainly we could get back to you if you wanted to have that discussion. 

Mr. CLEAVER. I do. 

Ms. LEVENSTEIN. But clearly, we think on a relative ranked 

basis, but that’s not the case. 

Mr. CLEAVER. I’m sorry? 

Ms. LEVENSTEIN. If you were to relatively rank the city versus 

the State, we think the State is stronger. But if you would like to 

talk about the specifics of that, we can— 

Mr. CLEAVER. I want to talk about a rebate. When can we meet 

to talk about a rebate? 

Ms. LEVENSTEIN. I don’t think that’s warranted. 

Mr. CLEAVER. I’m sorry? 

Ms. LEVENSTEIN. I don’t think that is warranted. 

Mr. CLEAVER. If we have a vote, it would be. 

Mr. CAPUANO. Mr. Chairman, if the gentleman would yield for 

one minute. 

The CHAIRMAN. Go ahead. 

Mr. CAPUANO. As I understand it, the people that you were talking to are the very people who make money at this business. So 

you basically ask people, do you want to continue making more 

money than you would otherwise make if we make the system 

right? And you also talk to maybe a few hostages, people who 

didn’t have the freedom to tell you what they really wanted. Or did 

you talk to anybody who had been a former mayor or a former 

issuer of bonds when you asked the market participants? 

Ms. LEVENSTEIN. I don’t know if we did or not. 

Mr. CAPUANO. I mean, my expectation is market participants 

means either the people who are making the money, and you basically ask them, do you want to make less money? And they said 

no. And then you might have asked a few people who are hostages, 

would you like us to change it so you can save some money? And 

they said, oh, no, please don’t do that, because if you do that, you’re 

86

going to lower our rating. That’s not the market participants that 

mean anything to me. Those are hostages, and those are people 

who are making money on the backs of my taxpayers. Their interest is no interest. 

The CHAIRMAN. And I think you have a feedback loop here between the rated and then people who were asked. But let me ask 

you this. You said the State versus the city. What about if there 

were other instances— 

Ms. LEVENSTEIN. There are instances. We do rate a number of 

intercept programs and other types of bonds. 

The CHAIRMAN. Straightforward question. 

Ms. LEVENSTEIN. Yes? 

The CHAIRMAN. If the State stands behind the cities, are there 

still differences in the ratings? 

Ms. LEVENSTEIN. It depends on the mechanism that the State 

uses to stand behind the city. If the State stood completely behind 

the city and it was effectively a guarantee, then there would be no 

difference. 

The CHAIRMAN. Thank you, that was the question. 

The gentleman from Colorado. 

Mr. PERLMUTTER. I was never a mayor, and I don’t have that 

sense or hostility that my two friends have shown, but I have done 

Chapter 9 bankruptcies, and so I do recognize that there are risks. 

I don’t know whether these were Moody rated. I don’t know whether there was a lot of underwriting or bond insurance behind it, so 

I recognize something here, but I have just some very basic questions again. First, who pays Moody’s to do a credit rating, the buyers of the bonds or the issuers of the bonds? 

Ms. LEVENSTEIN. The issuer does. 

Mr. PERLMUTTER. The issuer does. Who pays, Mr. Jain, I kind of 

heard that it could be an investor wanting to protect the investment or it could be the issuer could buy the insurance, the issuer, 

is that right? 

Mr. MCCARTHY. The issuer in a primary market and an investor 

in a secondary market position who owns the bonds already. 

Mr. PERLMUTTER. Now, I asked the last panel, is there any law 

that says State, Federal, that requires Denver Health and Hospitals, who I spoke to a half-hour ago, to get rated by Moody’s or 

to buy insurance before they issue bonds and sell the bonds, is 

there any law? 

Ms. LEVENSTEIN. No, there is not. 

Mr. MCCARTHY. No, there is no law. 

Mr. PERLMUTTER. Okay, how many ratings agencies are there? 

Ms. LEVENSTEIN. There are nine recognized rating agencies. 

Mr. PERLMUTTER. Nine recognized for municipal or government 

type— 

Ms. LEVENSTEIN. Nine recognized by agencies, there are nine. 

Mr. PERLMUTTER. And not to pick on Moody’s but since you are 

here, how much of that market, of those nine agencies, how much 

of the rating business do you do, does Moody’s do? 

Ms. LEVENSTEIN. I do not think that I know how much we do relative to the other rating agencies. 

Mr. PERLMUTTER. Alright, so but the real reason we are here 

today, and the two mayors really and the chairman are talking 

87

about some structural things as to why people do not get better 

rates, the purpose of our hearing today though was here we were 

going along merrily, people are doing their—selling their municipal 

bonds, everything is honky dory until we hit February and all of 

a sudden it goes from 4 percent to 20 percent for the Port Authority in New York. 

Mr. MCCARTHY. Right. 

Mr. PERLMUTTER. And there has not been any testimony that the 

Port Authority of New York became any greater credit risk in February than it was in January or that the Denver Health and Hospitals are any greater credit risk— 

Mr. MCCARTHY. That is correct. 

Mr. PERLMUTTER. —than they were. What happened? 

Mr. MCCARTHY. Well, what happened, I tried to cover, and not 

well, in my testimony. Essentially, auction rates, if I can give you 

just a one minute history of the floating rate market at the municipal area. Going back 25 years ago, which is when I had a lot more 

hair, the first floating rate transactions that were done were called 

‘‘upper floaters.’’ Cleveland Electric did the first transaction, and 

essentially they were just like auction rate deals today, meaning 

that there was a promise for the investment banker to re-market 

these bonds on a periodic basis and find new investors, okay. Then 

those bonds in the 1980’s, right after they got formed, failed to actually clear the market. 

Mr. PERLMUTTER. There were not any buyers? 

Mr. MCCARTHY. There were not any buyers because they couldn’t 

because there was again a market stress environment, if you remember back then, municipal long rates were 15 percent and the 

issue that happened there was that the community decided to attack real bank liquidity to these transactions such that if there was 

a put, that it was a bank who really is in the business of providing 

their liquidity to these transactions. That is the way that market 

operated for 20 years. Three years ago, all of a sudden investment 

bankers said, ‘‘You know what, we don’t really need the liquidity 

provider. What we can do is we can re-market it for you and you 

will save 10 basis points instead of paying a liquidity provider 

some. We will charge you a little bit more for the re-marketing fee, 

but we will promise that we can make that market.’’ 

Now, I will tell you that part of the problem was that stress or 

the downgrade issues that have happened in the monoline area 

started people being nervous about owning option rate bonds that 

did not have liquidity. And no option rate bonds have liquidity attached to them, so they started to put them to the investment 

banks. Well, that is not really what they do. So they tried their 

best to re-market them. 

Mr. PERLMUTTER. Just a basic question, option rate bonds does 

not have liquidity behind it but it does have a revenue stream behind it? 

Mr. MCCARTHY. It does not. They have to clear the market. The 

way these structures work is they are floating rate, they are owned 

by funds and they are counted as a short-term financial instrument. Therefore, the difference between a variable rate demand 

bond, which has liquidity, and an auction rate bond that does not, 

those were counted as short term products. But the reason why 

88

that interest rate spiked up for all the auction rate products, regardless of whether it is the Port Authority, a student loan transaction or the State of California, was because investors, the liquidity market started to dry up and investors were nervous and not 

comfortable that they would own this bond and not be able to get 

out of it. They owned the bond thinking it was variable rate and 

therefore a short term security, which they had to qualify for. And 

they thought it is like musical chairs that say, ‘‘Holy cow, if I don’t 

put this back to the re-marketing agent right now, I am going to 

own this as a long-term bond, and that is not what I intended.’’ So 

all of those bonds came back. 

Now, at FSA, we are spending—kudos to our municipal finance 

analytical team, they are spending 23 hours a day underwriting 

transactions to try to convert municipalities from auction rate, regardless of who did them, to either floating rate or fixed rate to 

solve this particular problem. And it has nothing to do with the 

quality, which in most cases for option rates is very good, it has 

nothing to do with the credit worthiness of the municipality. 

Mr. PERLMUTTER. Thank you. 

Mr. CLEAVER. A follow-up, please. 

Mr. PERLMUTTER. I would yield to Mr. Cleaver. 

Mr. CLEAVER. Thank you. One final question, what do you call 

the professionals who are paid a fee to unwind the option rate securities into other instruments? 

Mr. MCCARTHY. Well, investment bankers. 

Mr. CLEAVER. I’m sorry? 

Mr. MCCARTHY. Investment bankers and then financial advisers 

are the two counter-parties. You can speak to that better. 

Mr. VOGTSBERGER. That is right, yes. Investment bankers who 

underwrite bond issues are, as Sean mentioned, working to restructure option rate bonds into either variable rate bonds or fixed rate 

bonds, and they are paid a fee to do that. 

Mr. CLEAVER. By whom? 

Mr. VOGTSBERGER. By the issuer. 

Mr. CLEAVER. That is all. Thank you, Mr. Chairman. 

Mr. CAPUANO. [presiding] I want to thank you for putting up 

with this abuse today, and I hope you did not take too much of it 

personally, but at the same time, honestly, it is the first time I 

have had in 18 years to tell you what I think, and I was not going 

to pass up the opportunity. I also hope that you get some of the 

frustration and some of the disappointment that has happened over 

the years, and my hope, my preference is that the industry takes 

action without government interference, if you want the truth. 

However, I will tell you that if something does not happen, the 

likelihood of government involvement increases dramatically, and I 

think you have heard some of the frustrations. Some of the things 

that have been mentioned here today, I think many of us agree 

with relative to some of the SEC rules and some of the other 

things. But like many times, I for one would prefer that the market 

does its own work but government regulation to me is not a swear 

word, it is a bastion of last resort. 

Before we dismiss, before we end this panel, the Chair notes that 

some members may have additional questions for the panel, which 

they may wish to submit in writing. Without objection, the hearing 

89

record will remain open for 30 days for members to submit written 

questions to these witnesses and to place their responses in the 

record. 

With that, I declare that this hearing is adjourned. 

[Whereupon, at 4:15 p.m, the hearing was adjourned.] 

(91)

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March 12, 2008

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