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S. HRG. 111–799 

REFORMING U.S. FINANCIAL 

MARKET REGULATION 

HEARING 

BEFORE THE

COMMITTEE ON AGRICULTURE, 

NUTRITION, AND FORESTRY 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

NOVEMBER 18, 2009 

Printed for the use of the 

Committee on Agriculture, Nutrition, and Forestry 

( 

Available via the World Wide Web: http://www.agriculture.senate.gov 
COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY 

BLANCHE L. LINCOLN, Arkansas, Chairman 

PATRICK J. LEAHY, Vermont 

TOM HARKIN, Iowa 

KENT CONRAD, North Dakota 

MAX BAUCUS, Montana 

DEBBIE STABENOW, Michigan 

E. BENJAMIN NELSON, Nebraska 

SHERROD BROWN, Ohio 

ROBERT CASEY, Jr., Pennsylvania 

AMY KLOBUCHAR, Minnesota 

MICHAEL BENNET, Colorado 

KIRSTEN GILLIBRAND, New York 

SAXBY CHAMBLISS, Georgia 

RICHARD G. LUGAR, Indiana 

THAD COCHRAN, Mississippi 

MITCH MCCONNELL, Kentucky 

PAT ROBERTS, Kansas 

MIKE JOHANNS, Nebraska 

CHARLES GRASSLEY, Iowa 

JOHN THUNE, South Dakota 

JOHN CORNYN, Texas 

ROBERT HOLIFIELD, Majority Staff Director 

JESSICA L. WILLIAMS, Chief Clerk 

MARTHA SCOTT POINDEXTER, Minority Staff Director 

ANNE C. HAZLETT, Minority Chief Counsel 

(II) 
(III) 

C O N T E N T S 

Page 

HEARING(S): 

Reforming U.S. Financial Market Regulation ....................................................... 1 

Wednesday, November 18, 2009 

STATEMENTS PRESENTED BY SENATORS 

Lincoln, Hon. Blanche L., U.S. Senator from the State of Arkansas, Chairman, Committee on Agriculture, Nutrition, and Forestry ................................ 1 

Chambliss, Hon. Saxby, U.S. Senator from the State of Georgia ........................ 3 

Panel I 

Gensler, Hon. Gary, Chairman, Commodity Futures Trading Commission, 

Washington, DC ................................................................................................... 5 

Panel II 

Billings, Jeff, Manager of Risk Management, Municipal Gas Authority of 

Georgia, on behalf of the American Public Gas Association, Kennesaw, 

Georgia .................................................................................................................. 35 

Boling, Mark, Executive Vice President and General Counsel, Southwestern 

Energy Company, Houston, Texas ...................................................................... 32 

English, Glenn, Chief Executive Officer, National Rural Electric Cooperatives 

Association, Arlington, Virginia .......................................................................... 28 

Johnson, Robert A., Director of Economic Policy, The Roosevelt Institute, 

on behalf of Americans for Financial Reform, New York, New York .............. 36 

Schloss, Neil M., Vice President And Treasurer, Ford Motor Company, Dearborn, Michigan ...................................................................................................... 30 

APPENDIX 

PREPARED STATEMENTS: 

Nelson, Hon. E. Benjamin ............................................................................... 52 

Billings, Jeff ...................................................................................................... 54 

Boling, Mark (with attachments) .................................................................... 65 

English, Glenn .................................................................................................. 75 

Gensler, Hon. Gary ........................................................................................... 79 

Johnson, Robert A. ........................................................................................... 90 

Schloss, Neil M. ................................................................................................ 122 

DOCUMENT(S) SUBMITTED FOR THE RECORD: 

Joint Association Statement on Proposed Reform of Over-The-Counter 

Derivatives Markets ..................................................................................... 128 

QUESTION AND ANSWER: 

Lincoln, Hon. Blanche L.: 

Written questions for and responses from Jeff Billings ................................ 134 

Written questions for and responses from Mark Boling ............................... 136 

Written questions for and responses from Glenn English ............................ 142 

Written questions for and responses from Gary Gensler .............................. 144 

Written questions for and responses from Neil M. Schloss .......................... 152 

Conrad, Hon. Kent: 

Written questions for and responses from Gary Gensler .............................. 147 
Page

IV 

Klobuchar, Hon. Amy: 

Written questions for and responses from Gary Gensler .............................. 150 

Stabenow, Hon. Debbie: 

Written questions for and responses from Gary Gensler .............................. 148 

Written questions for and responses from Neil M. Schloss .......................... 152 
(1) 

REFORMING U.S. FINANCIAL 

MARKET REGULATION 

Wednesday, November 18, 2009 

UNITED STATES SENATE, 

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY, 

Washington, DC 

The committee met, pursuant to notice, at 9:36 a.m., in Room 

106 Dirksen Senate Office Building, Hon. Blanche Lincoln, Chairman of the committee, presiding. 

Present or submitting a statement: Senators Lincoln, Conrad, 

Stabenow, Nelson, Casey, Gillibrand, Chambliss, Lugar, Cochran, 

Johanns, Grassley, and Thune. 

STATEMENT OF HON. BLANCHE L. LINCOLN, U.S. SENATOR 

FROM THE STATE OF ARKANSAS, CHAIRMAN, COMMITTEE 

ON AGRICULTURE, NUTRITION, AND FORESTRY 

Chairman LINCOLN. The Senate Committee on Agriculture, Nutrition, and Forestry will now come to order. 

I want to thank Senator Chambliss and fellow members of the 

committee for being here today as we address one of the more important issues facing our nation and particularly our economy. I 

cannot overstate the significance of the subject matter of our hearing today. Financial market oversight reform is, quite simply, the 

single most important factor in our long-term economic recovery. It 

will be the foundation for our nation’s financial future, and reform 

is essential to reaffirm the integrity and the soundness of our financial system and to maintain our nation’s preeminence as a global leader in worldwide financial markets. Perhaps most importantly, we need financial reform to give comfort to our consumers 

and the businesses so that they can trust our markets to determine 

fair prices and to help manage risk. 

Over the last decade, we have seen deregulation sweep over 

America in a way that has simply devastated our economy. From 

the tragedy of the Enron bankruptcy in 2002 to the massive failures of Bear Stearns and AIG in 2008, a steady stream of market 

calamities has exposed fatal flaws in our regulatory system. These 

flaws have cost America dearly. 

And given this reality, business as usual is simply not acceptable. Fundamental financial market oversight reforms must pass. 

It is important to remember that while we must correct mistakes 

of the past, we do not want to overreact or veer too far in the other 

direction. We have a very difficult needle to thread here, but we 

are certainly all very capable of it. We have no desire to, nor will 
2 

we, act in a way that will prevent legitimate business activity or 

stifle innovation. 

But the word ‘‘innovation’’ cannot be a code word for unacceptable practices. Smoke-and-mirrors accounting schemes, massively 

leveraged by under- or non-capitalized transactions, or house-ofcards entities posing as investment vehicles are not the kind of innovation that prudent financial market oversight should foster. We 

can do better and we will. 

The task that is set before us is considerable, but it is not impossible. It is difficult, but it is not unattainable. It will be at times 

confusing, but the answers really are not impenetrable. We will get 

it done. 

Senator Chambliss and I intend to work together to produce legislation that will bring much-needed transparency and accountability to the over-the-counter derivatives market. In our legislation, I am looking to address issues such as prudential regulation 

related to enhanced capital and margin requirements, clearing of 

over-the-counter transactions, as well as a host of other matters, 

including forex trading and foreign boards of trade. The list is long, 

but we will get there. 

And I look forward to hearing from all of the interested participants, getting their views and cultivating a healthy debate on this 

topic. Today, we will focus specifically on three areas: End user 

margin and clearing, the definition of major swap participants, and 

mandatory clearing of standardized products. 

I particularly look forward to today’s testimony from end users. 

Knowing the importance of cash flow and working capital to businesses, I will be paying great attention to what they say about 

clearing requirements and margin as I will to how we address systemic risk. 

On December 2, we plan to hold a second hearing, at which 

Treasury Secretary Geithner will testify, and we will further analyze these and other issues. I look forward to hearing views from 

all sides on these very important matters to all Americans. 

Lastly, I want to commend Senator Dodd for the draft legislation 

he released last week and its comprehensive view of the nation’s 

banking oversight system. There are areas of mutual interest in financial market oversight, and I look forward to working cooperatively with him and his committee as we move forward. 

There is a lot of work to be done, but I know that we will pass 

reform legislation that truly does build something better. We owe 

that to America’s consumers and businesses, and they deserve no 

less than our very best efforts to ensure that the U.S. financial 

oversight system promotes and fosters the most honest, open, and 

reliable financial markets in the world. It is our responsibility as 

Americans to be leaders in this direction. 

Thank you all for your time today. I look forward to hearing from 

our witnesses and from my colleagues as we move forward to reach 

this goal. And as I said before, it may not be easy, but we can do 

it and we will. 

So thank you all for being here today. I will turn to my friend 

and colleague, Senator Chambliss, for his opening statements and 

then we will return to our witness. 
3 

STATEMENT OF HON. SAXBY CHAMBLISS, U.S. SENATOR FROM 

THE STATE OF GEORGIA 

Senator CHAMBLISS. Well, thank you, Madam Chairman, first of 

all, for your leadership on this issue and in particular for holding 

this hearing today. 

As you and I have discussed previously, we both strongly believe 

that the Senate Agriculture Committee and the Commodity Futures Trading Commission must be engaged in the development of 

any legislation addressing financial regulatory reform. This committee also has a responsibility to ensure that the CFTC continues 

to be able to effectively carry out its duties, and that is why I am 

really pleased that we have once again Chairman Gensler back 

with us to talk about not only the complexities of the issues, but 

the practicalities of where we need to go with respect to regulatory 

reform. 

While this issue is complicated, we cannot let the complexity of 

futures and swaps be an excuse for ignoring good public policy and 

ensuring that our markets are both safe and functional. 

In the past couple of years, a lot of people have become acquainted with one particular type of derivative known as a credit 

default swap, or CDS, which permits one party to transfer the credit risk of bonds or syndicated bank loans to another party. Since 

AIG was heavily involved in CDS, it seems simple enough to just 

blame swaps in general for the current financial crisis. However, 

that would be inaccurate, because the real situation is much more 

complicated. 

We need to distinguish between credit default swaps and the actual underlying securities represented by these swaps. Before we 

make a big policy change, like an outright ban on all over-thecounter derivatives or a requirement that these products only trade 

on an exchange, we need to ask ourselves whether this will even 

address the underlying problem. Why take a chance in these uncertain times to make legislative and regulatory changes that could 

possibly make things worse, potentially dry up more capital and 

force the cost of doing business higher? 

This does not mean that there isn’t room for improvement. I 

think the volatility that we have seen over the past year in some 

markets warrants extensive analysis and some regulatory changes. 

And while I may have concerns with some of the proposals that 

have been discussed to date, I am absolutely convinced that the 

market volatility and financial meltdown of the recent past make 

the case for more market transparency. 

How can we in Congress be sure of the outcome of sweeping reforms without first properly identifying the cause of these problems? And how can we identify the cause of the problem without 

authorizing and requiring more transparency through the collection 

of necessary data? Beyond requiring more transparency, I also believe this committee should explore how most effectively to regulate 

swaps, some of which are statutorily excluded from CFTC regulation and oversight. And we need to determine how best to encourage the clearing of certain derivative products without jeopardizing 

either the use of these risk management tools or the sustainability 

of our clearinghouses. 
4 

If Congress is truly interested in addressing the problem as opposed to politicizing a solution, we can no longer ignore the complexities of these markets. We must devote time to understanding 

these instruments and their applications. We must seek to understand the legitimate purposes that these complex instruments 

serve for large and small businesses in each of our States. That is 

why this hearing is so critically important. 

I want to raise one final concern about financial regulatory reform. I would hope that as this legislation progresses through Congress, we will take whatever steps are necessary to ensure that it 

does not conflict with the Farm Credit Act and that it does not inadvertently hamstring the Farm Credit Administration and the entities that it regulates, the Farm Credit System and Farmer Mac. 

We know that the Farm Credit System and Farmer Mac did not 

cause or contribute to last year’s financial crisis and that they have 

done a good job fulfilling their Congressionally mandated mission 

of providing competitive credit to farmers, ranchers, and rural 

America. 

We can thank our colleagues on this committee and the House 

Agriculture Committee for their insight and leadership years ago 

in establishing these entities and providing for a strong regulatory 

system through the Farm Credit Administration. I look forward to 

working with the Chairman and all of our colleagues on the Banking Committee to make sure the financial regulatory package does 

not negatively effect the Farm Credit Administration. 

Again, to my friend, the Chairman, thanks for holding this hearing. I know that it is a beginning of a process that recognizes the 

role of the Senate Agriculture Committee in broader financial regulatory reform efforts and I look forward, as always, to working sideby-side with you. Thank you very much. 

Chairman LINCOLN. Thank you, Senator Chambliss, and I, as always, look forward to working with you. I think we have got a 

great opportunity to find a good outcome and really be productive 

for the people of this country and certainly the marketplace, which 

we want them to have greater confidence in, and we can do that 

from here. 

I would also like to echo the comments of my colleague, Senator 

Chambliss, on the Farm Credit Administration and the importance 

of recognizing that there is not a necessity here in any way or 

shape or form to try to put them into a position where they are 

hamstrung or not able to continue to do the good work that they 

have done, so I appreciate his comments there. 

We would now like to welcome Chairman Gary Gensler to the 

committee. Chairman Gensler, welcome once again to the committee. We are proud that you are here and looking forward to 

working with you on this tremendously important issue as we move 

forward and working through the details of how we put our markets and our economy back on track. I know you have got a great 

insight into this in your work from multiple different areas where 

you come. And I am also usually relieved because I know that 

when the day has ended, that you usually get your marching orders from four lovely ladies at home. 

So we appreciate how you are grounded and, more importantly, 

how you are working hard to make sure that we get this right. So 
5 

we look forward to your testimony today, and welcome to the committee. 

STATEMENT OF HON. GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION, WASHINGTON, DC 

Mr. GENSLER. I thank you, Chairman Lincoln. I will mention to 

my three daughters your hello. And Ranking Member Chambliss 

and members of this committee, thank you for inviting me to testify on behalf of the full Commission today regarding regulation of 

over-the-counter derivatives markets and, if I am allowed, I am 

going to say a comment or two at the end about our joint efforts 

with the SEC on some harmonization efforts. 

But before I begin, I would really like to congratulate the new 

Chairman, Chairman Lincoln. I think this is the first time I am 

testifying before you as Chair. I want to thank Senator Harkin for 

his leadership of this committee and I look forward to working with 

all of you going forward. 

I would like to address regulation of the over-the- counter derivatives market in the context of two principal goals that I think there 

is a broad consensus around. One is promoting transparency of the 

markets, and two, lowering risk of these markets to the American 

public. 

In terms of transparency, the administration proposed and I fully 

support the following priorities. First, that all standardized derivative transactions should be moved onto regulated exchanges or 

transparent trade execution facilities, similar to what we have in 

the securities or futures markets. Increasing transparency for the 

standardized derivatives should enable both large and small end 

users to obtain better pricing on their derivative products. Just as 

transactions are on the securities markets and the futures markets 

available and you can see trade by trade what occurs there, and 

every corporate treasurer, assistant treasurer, or municipal government can see the transactions, we believe that same transparency 

will help benefit growth in America and promote market efficiency 

in America. 

If Congress were to exempt some end users—and I know you 

have a panel of end users you are going to be chatting with—exempt end user transactions from a clearing requirement, I think 

that—and I believe that those transactions could still be required 

to be brought onto the trading platform—a trade is where buyers 

and sellers meet— and still exempt them and separate out from 

the clearing requirement where there is this issue of posting margin that I know you will be talking about. 

Second, I believe all non-cleared transactions—these are the customized transactions which should still be allowed—should be reported to a trade repository so that the regulators can at least see 

those transactions. 

Third, data on the transactions themselves should be aggregated 

and made available to the public in an aggregate form, for both the 

customized and the standardized products. 

And fourth, stringent recordkeeping and reporting requirements 

should be required for the swap dealers with an audit trail so that 

we can effectively look into these markets even after the fact. 
6 

The administration has proposed, and at the CFTC we support 

lowering risk for American public. Again, I will talk about four 

principal components. First, standard over-the-counter derivatives 

transactions should be required to be cleared on a robustly regulated central clearinghouse. By guaranteeing the performance of 

these contracts submitted for clearing, clearing significantly reduces systemic risk. Clearinghouses significantly reduce systemic 

risk by removing the interconnectedness in this marketplace. 

I believe that all clearable transactions should be required to be 

brought into clearinghouses regardless of the end user, but if Congress were to decide to exempt transactions for certain end users, 

I would hope that would be narrowed to the corporate end users 

and it wouldn’t exempt transactions, for instance, with hedge funds 

and other financial investment funds. I think there is a difference 

in the needs of those. Also, I would hope we would still bring them 

into the trading requirement and exempt them from the margin or 

the clearing requirement. 

Second, swap dealers and major swap participants would be explicitly regulated for capital, so they have a cushion against risk. 

Third, the dealers would be required to post margin themselves. 

This would be the dealers posting margin, not the end users in this 

case. 

And fourth, the CFTC and SEC should be authorized to mandate 

robust business conduct standards to protect the marketplace 

against fraud, manipulation, and even aggregation position limits 

for the commodity space in this marketplace. 

If I might just take a moment to say, we have been working with 

the SEC to harmonize some of our rules. We are different agencies. 

We have different missions, but we have a lot of overlap. We have 

actually put together a report the President requested with 20 recommendations, 11 of which will require legislative assistance from 

this committee and the rest of Congress. Some of them are in the 

administration proposal we have already sent up. I just wanted to 

highlight in my 15 seconds left two, really quickly. 

One is I do believe with the significant risks that are in these 

clearinghouses, both futures clearinghouses, and new swap clearinghouses, that it is appropriate to look back to our oversight, the 

CFTC’s oversight, of clearinghouses, bring some of the core principles that have worked well to international standards, and ensure 

that in certain circumstances that the CFTC has a little bit more 

authority to write rules. This was included in the administration’s 

proposal and we have been working with the exchanges directly on 

some of that language. 

Second, we have found that our ability to enforce the markets 

and protect them against manipulations can be enhanced, and we 

have legislative language that we will be sharing with this committee on specific disruptive trading practices that we think it 

would be appropriate to try to enhance our ability to police these 

markets for manipulation. 

Again, we will be working with this committee on the other nine 

recommendations that need legislative assistance and I have included that in my written testimony. I look forward to working 

with this committee and Congress to bring this much-needed reform to the over-the-counter derivatives marketplace. 
7 

[The prepared statement of Mr. Gensler can be found on page 79 

in the appendix.] 

Chairman LINCOLN. Thank you, Chairman Gensler. I appreciate 

your comments here today and am looking forward to working with 

you. 

I will start with my questions and then turn to my colleague, 

Senator Chambliss, and then we will go in the order that people 

arrived to the hearing. 

Chairman Gensler, it’s my understanding that the more standardized a product is, the easier it should be or would be to clear 

and exchange trade, and that clearing and exchange trading are in 

some ways gold standard of risk management in the derivatives 

world. Given that, I do believe that moving as many of these contracts as we can through a clearinghouse or onto that regulated exchange is important. But I also believe there is a place for tailored 

contracts and some over-the-counter market transactions. 

My question is really who should make the determination as to 

what is standardized and should be cleared? Should it be the clearinghouse or should it be the regulator? If it is the clearinghouse, 

in my opinion, that does look to be somewhat of a—I don’t know. 

There is some concern there. My question to you is if, in fact, the 

clearinghouse was asked to do the clearing determination, what 

safeguards would need to be there and what is your position on 

who should make that determination? 

Mr. GENSLER. I—— 

Chairman LINCOLN. Maybe you could also mention some of your 

response to Chairman Frank. I know that there was a back-andforth on that, as well. 

Mr. GENSLER. Sure. I recall the first time I was in this committee room on February 25 for my confirmation hearing. This very 

question came up with then-Chairman Harkin. I believe that the 

regulators, the SEC and the CFTC, should have clear authority to 

determine that contracts are standard enough to be cleared. I believe we should also be able to rely on market mechanisms, that 

there is some presumption that if a clearinghouse were to accept 

it for clearing, that we should be able to hopefully rely on that, and 

the presumption is to get as many transactions and as many contracts to be cleared, and hopefully on these transparent trading 

venues. 

So to answer your question, I think the regulators should have 

clear authority to make the determination, but also be able to rely 

on some market mechanisms that the clearinghouses might, in fact, 

determine something is clearable, but we could add to that list and 

we would have to approve—to have a safeguard against the clearinghouse, we should also approve which transactions are clearable, 

hopefully by class of transaction just for efficiency. But in certain 

circumstances, we would do it contract by contract. 

Chairman LINCOLN. But to make sure I understand what you are 

saying, you are saying that should be predetermined? 

Mr. GENSLER. I think that it should be transparent. The marketplace should clearly know if they are entering a transaction—if an 

end user is entering into a transaction, they should know, is this 

one that has already been designated by the regulators and the 

clearinghouse to be, quote, ‘‘standard’’ or clearable, and I do be-
8 

lieve, thus, it should be transparent, and as you say, predetermined, and that the clearinghouses have a role to play, but the regulators should have clear authority to make a determination. 

Chairman LINCOLN. Thank you. 

A major swap participant is defined in the Treasury proposal as 

a non-dealer who maintains a substantial net position in outstanding swaps for the purpose other than to create and maintain 

an effective hedge, under the GAAP standards. I understand that 

some of the players want a limited definition of the MSP so as to 

not to kind of get pulled into that category, perhaps. Maybe there 

is reason for that for some, and for some, maybe there is not. 

Are you comfortable with the Treasury’s definition of major swap 

participant? Are the GAAP standards the appropriate standard to 

determine hedging, and if not, what is? Is a substantial net position standard workable and is it going to capture all the institutions that pose the kind of systemic risk that we are trying to get 

at? 

Mr. GENSLER. What we are trying to do in the legislation is ensure that there are two complementary regimes, that the dealers 

are regulated, they have to register and be regulated, have capital 

and business conduct standards, and then that the markets themselves have these clearing and trading requirements. 

Major swap participant is a term that nine months ago none of 

us knew. It was just created in the legislative language. But what 

it is really trying to address is the next AIG or the near-dealer, 

something that is not quite a financial institution, but it holds 

itself out to the public, as a substantial net swaps business. There 

are many counterparties that would be at risk if it failed. I don’t 

know its broad category. It is not meant to pick up the thousands 

of end users or even the hundreds of end users. But I believe it 

should be a category that is included, that we not just bring this 

regulation to the five or six large financial institutions. They are 

sort of the next AIG or the next swap dealer category. 

Chairman LINCOLN. Well, depending on what standards are 

going to be used to determine that, as an alternative, I mean, when 

you are looking for Congress to be helpful, could Congress use a 

gross notional exposure standard to determine who is going to register as a major swap participant, and if a gross notional exposure 

test is appropriate, what should the level be? 

Mr. GENSLER. I would want to work with you and the committee 

to see if that would be appropriate. I think, most importantly, is 

that the full registration and regulation would be of swap dealers 

and the next, I don’t know if it is several dozen, but the next several that really hold themselves out to the public as almost like a 

swap dealer and have a significant book of business with a lot of 

counterparties. And so I think it is more with regard to do they 

have other end users as counterparties as contrasted to are they 

just doing their business with Wall Street, would be the best test. 

And again, that is separate and apart from these issues of 

whether end users post margin or whether end user transactions 

are brought to trading venues. We should try to bring as many of 

these end user transactions into transparency. 

Chairman LINCOLN. Well, I mean, obviously, if we are working 

toward something that is going to provide more oversight and regu-
9 

lation, then standardization and what we use to standardize is 

going to be a key question. So we look forward to working with you 

on that as I definitely think that is going to be important, to have 

something more definitive about what that standard is going to be. 

And I have gone over my time, so I am going to wait for my second round and I will defer to my colleague, Senator Chambliss. 

Senator CHAMBLISS. Mr. Chairman, I guess if we could write 

down on paper very clearly what is standard and what is not 

standard, it would make our job a lot easier, and certainly that is 

something we are going to continue to wrestle with and work with 

you on. 

I want to, first of all, ask you a very practical question. We have 

got a very valued member of this committee who is here who also 

happens to be Chairman of the Budget Committee. As he moves 

forward next year, irrespective of what we do, we have got to have 

a clear picture of what it is going to cost. Part of the cost obviously 

is increasing the resources to CFTC to make sure that the new 

challenges that we give you, you are obviously capable of carrying 

out. 

CBO indicated that the House legislation would require an additional 235 employees by 2011 for CFTC—that is a 40 percent increase—resulting in an increased cost of $291 million over the next 

five years. Your agency’s total appropriation for fiscal year 2009 

was only $146 million. How will you implement these changes that 

are set forth in the House bill, for example, if you do not get the 

necessary increases in appropriations? 

Mr. GENSLER. Well, I thank you, Senator. I think our agency, unfortunately, has been sorely under-resourced for a number of years. 

With Congress’s help, we are just now back to the same staffing 

we were at in 1999, and that is even though the markets have 

grown at least four-fold and we have not yet even taken on this 

new authority, over what is nearly a $300 trillion market. The 

swaps market is roughly, in notional amount, 20 times our economy. So that means every time you buy a tank of gas, you can 

think of about $1,000 of derivatives behind that $50 tank of gas, 

somewhere, on average, in the economy. 

So in staffing, we do believe that we would need probably in the 

order of magnitude, 235 people to add to the approximate 2010 

staffing level of about 650 people. 

Senator CHAMBLISS. Okay. Many end users of derivatives have 

informed us that they do not believe that the benefit of clearing is 

worth the expense of posting margin at a clearinghouse, and we 

have talked through this time and time again. You have proposed 

that clearing members of a clearinghouse, such as financial institutions, could post margin to the clearinghouse for their end user 

counterparties who would then meet collateral requirements 

through credit arrangements involving non-cash collateral. 

I want you to help us think through this and help us understand 

how this would work with respect to daily margin settlement. What 

sort of expense do you believe these end users would incur in the 

form of fees or variation margin charges if, as you have proposed, 

their dealers were posting margin to the clearinghouse on their behalf? 
10 

Mr. GENSLER. The goal, I think, is to lower risk in the system 

and to move as much of these transactions off the books of the financial institutions once they have arranged them, and that is 

where the clearinghouse comes into place because it is safer than 

the financial institutions. No matter what we do in financial reform, financial institutions still, I believe, are going to be very 

large, complex, and they will house risk. That is their business. 

So if we can move these transactions in the clearinghouse, allow 

end users, just as they do now, to have individual credit arrangements, maybe unsecured or secured arrangements with the banks 

and have the banks move them to the clearinghouse and post the 

margin. Today, they are charged a credit arrangement. These 

swaps do have a credit fee in them. 

End users have raised their concern it might still raise their 

costs. They recognize there is a credit arrangement already, but it 

might raise their costs, and I recognize Congress might decide to 

exempt them. I hope we would keep any exemptions narrow, just 

to the corporate end users, hopefully not to the financial end users 

like hedge funds that do have liquidity and could post margin. 

Senator CHAMBLISS. One practical aspect of that that I have a 

problem with is, for example, Delta Airlines, who is a big user of 

this type of transaction, having to put up an airplane, a 777, for 

each transaction, or any other company taking part of their noncash collateral that they normally would post for a line of credit 

and having to put it up as collateral of some sort for one of these 

type transactions. Again, I am not sure how we resolve that to 

make sure that we do lower that risk you are talking about, but 

don’t hamstring these companies from not having the ability to 

post those non-cash collateral assets for lines of credit that they 

have got to have. 

Mr. GENSLER. Well, actually, Senator, today, many large institutions—I am not familiar enough with Delta’s own finances, but 

many large corporations have credit arrangements with the large 

Wall Street firms that say if we hedge a transaction and there is 

an exposure that develops six months or a year later, that they do 

have some arrangement. They might not be securing it with an airplane, but in some way, they are being charged for that credit arrangement. Even today, there is no free lunch there. There is a 

charge for the credit arrangement. It is just that they are not posting cash, and I don’t think they need to post cash in the future. 

Senator CHAMBLISS. Let me go to one other area that we have 

talked about before, and you know my concern regarding, making 

sure that we don’t take any action from a legislative standpoint 

going forward that handicaps U.S. markets as competitors from the 

standpoint of individuals utilizing foreign markets to carry out the 

same type of transaction that they are doing today on U.S. markets, and that we don’t overregulate them. 

In your testimony and in previous discussions, we have talked 

about the fact that you want to make sure that any U.S. company 

that trades on foreign markets still provides CFTC with information regarding those transactions so that we can have total transparency, and I understand why that is absolutely necessary. If you 

have got somebody trading on a U.S. market and a foreign market, 

if we are going to be able to let the general public know the finan-
11 

cial condition, obviously, you need to be aware of both those transactions, whether it is on foreign or U.S. market. 

Give us your thoughts about your impressions on the, number 

one, ability of foreign markets to give you the right kind of information, and secondly, on the receptiveness that you have seen from 

foreign regulators regarding providing information to U.S. regulators, both SEC and CFTC. 

Mr. GENSLER. I think that the crisis was so severe, both in Europe and in the United States and in Asia, that we do have a very 

good consensus. I am optimistic. I have worked in Europe, I have 

been over there and I have talked to the regulators almost on a 

weekly basis. They put out a paper about a month ago that said 

that they are going to be mandating that the standardized contracts be brought into transparent trading venues, just as we are 

considering here, mandating that the standard contracts be 

brought into central clearing, and they have also said that for the 

non- standard contract, they would be requiring the banks to hold 

higher capital. They actually used the word, I think, ‘‘significantly’’ 

higher capital. 

Now, their legislative process is different. They will take this to 

the European Parliament next summer. So they are really watching very closely what the Senate and the House do here. But I am 

very optimistic that though different cultures, different political 

systems, we will come out about the same on this with Europe, and 

between Europe and the United States, that is over 80 percent of 

these markets, and I think Canada, Mexico, and Japan are likely 

to work with this, as well, along the way. 

So I think you are absolutely right, Senator, but I am optimistic 

that we will be able to achieve consistent approaches. 

On information sharing, we have been very clear. We just 

wouldn’t want bank secrecy laws in another country to hold back 

that information. 

Senator CHAMBLISS. Today, on certain oil contracts that are traded on the London Exchange, the London Exchange provides CFTC 

with certain information to help with that transparency. Is the information that you are getting today from the London Exchange on 

those contracts, for example, adequate to allow you to feel that 

there is total transparency with those customers? 

Mr. GENSLER. It is the futures market, not swaps, but they have 

been very helpful. First, a year ago, they agreed to give us positions, and then two months ago, we negotiated further. Now they 

are giving us transaction data, as well. 

Senator CHAMBLISS. And is that the type of cooperative effort 

that it is going to take from all foreign markets? 

Mr. GENSLER. I believe it will, and as I said, I think I am optimistic that we will be able to see into their trading and trade repositories and vice-versa. 

Senator CHAMBLISS. Thanks, Madam Chairman. 

Chairman LINCOLN. Senator Stabenow? 

Senator STABENOW. Thank you, Madam Chairman, and welcome, 

Chairman Gensler. It is great to see you again. Madam Chairman, 

I also want to thank you for inviting Neil Schloss, the Treasurer 

of Ford Motor Company, a great Michigan company, to testify on 
12 

a very important part of the discussion about end users. We welcome all of the others on the second panel, as well. 

To follow up on what Senator Chambliss was talking about in 

terms of the international cooperation, it sounds like you believe 

that we can develop a system for regulating the futures markets 

internationally, that what is happening—am I hearing you right— 

is something that you believe will allow us to do that? One of my 

concerns is that without having an international regulatory regime 

for energy commodity futures and derivatives tradings and so on, 

that we are going to see companies that use derivatives to hedge 

legitimate business risks being placed at a competitive disadvantage, potentially, if we are not confident that we can do that. 

So am I hearing you say that you are confident, and what else 

would you need from us to be able to support your effort to be able 

to make sure there is an international agreement that is good for 

our businesses? 

Mr. GENSLER. I am optimistic. When the President met with 20 

heads of State in Pittsburgh, I think now we are about two months 

ago, he was successful in negotiating these core principles right in 

the G–20 statement to ensure that we brought the standard part 

of the markets onto clearing and onto trading venues. It was at 

that high a level, at the G–20 included. And then the European 

Commission, as I said, followed up. 

So I am confident. It won’t be exactly the same. It is two different cultures and two different political systems. But I am confident, and I agree with you, Senator, that we need that. 

I think it is important in the statutory language you pass here, 

if successful, that there be some recognition explicit authority for 

the Commodity Futures Trading Commission to register some foreign boards of trade. We have been using what is called a ‘‘no action’’ process, and I think that could be enhanced in statute. But 

I am confident overall that we will come close, maybe not exactly 

the same. 

Senator STABENOW. All right. Thank you. You and I have talked 

about concerns about end users and the impact of whatever we do, 

and we know that 92 percent of the largest American companies 

and over 50 percent of mid-size companies use derivatives to hedge 

business risk. So whether it is hedging the business risks associated with oil prices, as has already been talked about, or currency 

exchanges, the ability to provide financial certainty to companies’ 

balance sheets is absolutely critical for them and for us in terms 

of jobs and so on. 

So I appreciate your comments and your efforts to protect end 

users from diverting needed capital by providing the option to post 

non-cash collateral to meet the clearing requirements. However, we 

are in a situation where we have many companies that can’t use 

their non-cash collateral, such as a manufacturer who has a mortgage on a building because the mortgage agreement is preventing 

them from using it. I would dare say that anything right now that 

is viewed as non-cash collateral is taken, I would guess, for many, 

many of our manufacturers. 

So that still raises a great concern to me. I know you spoke a 

moment ago about arrangements that already exist, but this is 
13 

very serious for our manufacturers and I wonder if you might 

speak to how you would handle that situation. 

Mr. GENSLER. Well, I think that every manufacturer in your 

State and in all of the States suffered gravely when AIG went 

asunder and $180 billion of our taxpayer money, I mean, roughly 

$3.5 billion per State. I think in Michigan, it would be bigger because per person—— 

Senator STABENOW. Right. 

Mr. GENSLER. You could do the calculation. And so that is the 

risk we are trying to protect again, that large financial institutions 

aren’t so interconnected with the economy at large and that we try 

to move these transactions over to these well-regulated clearinghouses. 

I do think that there is a competing public policy interest that 

you just raised about the posting of margin, and that is what Congress is debating, these two public policy interests. One is lowering 

the risk of these financial institutions, and two is the interface 

with the end users. 

And that is why I truly believe we can also lower the cost to 

these end users by having every treasurer, every assistant treasurer being able to see on a screen where the transactions have 

traded. And so a manufacturer in Michigan would be able to see 

where a manufacturer in New York last traded and price and volume of the transactions. Even if Congress decides to exempt it from 

the clearing requirement, I think that would be just an unfettered 

good for manufacturers, to see the prices and the volumes of these 

transactions and have them—just as we do in securities markets. 

Senator STABENOW. Mr. Chairman, I agree with you on transparency, that is critical, and we are working through how we balance minimizing the risk to businesses, to consumers, to all of us 

in our economy and at the same time not creating a situation 

where we are diverting working capital that is so critically needed 

right now for so many of our businesses. And so I look forward to 

working with you as we work our way through to find the right 

balance. 

Thank you, Madam Chairman. 

Chairman LINCOLN. Senator Gillibrand. 

Senator GILLIBRAND. Thank you, Madam Chairwoman. 

Today, we are going to hear from a number of our corporate end 

users on derivatives, and these companies obviously, as we have 

discussed already this morning, use derivatives on a daily basis to 

hedge risks that are an integral part of their daily risk and of their 

businesses. 

As we look at the regulation of derivatives going forward, my 

question is, do you see a difference in the various sources of derivatives and their ultimate uses, and I will give you some examples. 

For example, would you see a difference in a futures contract for 

copper that might be used to hedge the future costs of a manufacturing company’s basic materials, which is sort of what Senator 

Stabenow is concerned about, than, say, an instrument like a credit 

default swap, which might have a less obvious benefit and has recently shown to have a greater potential detriment to the financial 

system? 
14 

And just to boil that down a little bit, in the credit default swap 

market, we have two kinds. We have naked and we have covered. 

Naked means there is no underlying ownership of the assets that 

you are talking about. Covered is much more like an insurance policy. It is quite ironic that we heavily regulate gambling, which is 

like the naked variety, and we heavily regulate insurance, which 

is like the covered variety, but we don’t regulate at all if it is called 

a credit default swap, which I think is what goes to your point, Mr. 

Gensler, about some of your concerns. 

So if there is greater risk associated with a specific derivative 

class, should they be regulated in a different manner with significantly higher safeguards associated with that regulation? For example, if you are going to be in the CDS market, do you want higher capital requirements so it doesn’t undermine what Senator Stabenow is trying to say for a manufacturer that is trying to offset 

the price of copper because that is an input for their business, visa-vis another financial firm that may be using CDSs because it is 

a great way to create capital or a great way to hedge risk in a different respect? 

Mr. GENSLER. I think, Senator, you raise an excellent point. I believe the draft administration bill allows this, but if it doesn’t, it 

would be a worthy enhancement, to make sure that business conduct standards, capital charges, and the like could be set by different class—in terms of capital, it would be the bank regulators 

largely setting capital, but that they might be able to set capital 

different by class of contract. Credit default swaps are event contracts. One day, you think it is only this, and the next day, it gaps 

out and has a far different value because of the default. So it might 

be worthy to have different capital charges as an event contract, 

as you say. So I do believe there may be differences. 

On business conduct standards, the administration bill, I think, 

has a robust set of charges to the SEC and CFTC to write business 

conduct standards. Credit default swaps also have a very real 

interplay to the securities markets, with individual stocks and protecting against insider trading and manipulation. I believe it is 

there already, but we would look forward to working with you if 

you think there is more that needs to be in the administration proposal on business conduct standards. 

Senator GILLIBRAND. Well, I was mostly just interested in your 

opinion, if you think that this is an important issue to analyze fully 

and make recommendations on or not. 

Mr. GENSLER. I do think that there are unique qualities of each 

category of swaps. Interest rate and rate swaps are very different 

than energy swaps, for instance. 

Senator GILLIBRAND. Right. 

Mr. GENSLER. We have asked for authorities to set aggregate position limits across markets where they perform a significant price 

discovery function. I think that is important in the commodity 

space. It is not really applicable to interest rate, for instance. 

Senator GILLIBRAND. Right. 

Mr. GENSLER. Credit default swaps, I do think have unique circumstances, particularly the interplay that you mentioned to the 

securities market and to issuers. 
15 

Senator GILLIBRAND. Okay. Second area of inquiry: Has the 

CFTC examined the impacts of the reform proposals on small businesses and farmers who may not directly participate in the swaps 

market but may indirectly be utilizing derivative contracts through 

an intermediary? And an example of this is a greenhouse farmer 

may enter an agreement to receive natural gas at a certain rate 

through an intermediary, who in turn would then use a derivative 

contract with a supplier to lock in a fixed price for that gas. So my 

concern is what impact would these small businesses and farmers 

see from the proposals that are currently before Congress? 

Mr. GENSLER. I believe, Senator, they would have a very real 

benefit. Right now, for many small businesses or small municipalities and nonprofits, when they use a derivative, they might just do 

one every two or three years. They often have to go out and hire 

a financial advisor, maybe pay $50,000 or $100,000 just for that advisor to give them advice. What do they do on this hedge, this important hedge for their business or hospital? 

I think if we bring transparency all the treasurers and assistant 

treasurers can see the pricing, we are going to see that small businesses actually are benefited. That is where the biggest information deficit is, is small and medium-sized businesses. 

Senator GILLIBRAND. Thank you. Thank you, Madam Chairwoman. 

Chairman LINCOLN. Senator Conrad. 

Senator CONRAD. Thank you, Chairman Lincoln, and thank you 

and welcome to the Chairmanship of the committee. We are delighted to have you as our leader and have great confidence in the 

skills that you will bring to this committee. We especially appreciated the leadership you provided in the last farm bill discussion, 

along with the Ranking Member, the current Ranking Member. We 

had a good team and we have got a lot of challenges ahead. 

I think this is one of the most important hearings of the year. 

I remember very well, Senator, several years ago, Warren Buffet 

called derivatives a nuclear time bomb, and we saw the bomb go 

off. I will never forget as long as I live being called after one of our 

Group of Ten meetings, Senator Chambliss, being called to the 

Leader’s office, and I got there and there were the leaders, Republican and Democrat, of Congress and the Chairman of the Federal 

Reserve and the Secretary of Treasury and they were telling us 

they were taking over AIG the next day. They weren’t there to ask 

us, they were there to inform us. And they told us in no uncertain 

terms they believed if it was not done, there would be a global financial collapse. That is about as stark as anything can be. 

So already, just on the AIG debacle, we have seen taxpayers saddled with $180 billion of debt. We must act to prevent that from 

ever happening again. I believe the administration proposals are 

important and balanced and a good beginning. 

I do want to register skepticism about a super- regulator. After 

having served on this committee for 23 years, I am concerned that 

CFTC would be down the end of a long dark hallway at the SEC, 

and I don’t think that is appropriate. I would be very concerned 

about them not having the knowledge of the commodities that 

CFTC oversees that have been in CFTC’s jurisdiction and domain 

and, frankly, in the domain and jurisdiction of this committee. So 
16 

I do want to register skepticism on the notion of a super-regulator, 

but that is not what I want to ask you about, Chairman Gensler. 

We have heard from several end users who will be testifying on 

the second panel that if they are forced to come up with additional 

capital to meet the clearing costs, the additional capital required 

of clearing costs, that would put them in a difficult situation. One 

thing I would like to understand is how much are we talking about 

in terms of clearing costs? Can you put in perspective what we 

would be talking about in terms of margin requirements in a clearing situation? 

Mr. GENSLER. Senator, I first want to thank you for your comment and support for the Commodity Futures Trading Commission. 

I, too, have found great expertise in the building, great staff that 

knows the derivatives market. As you look to the broader financial 

reform and councils and powers that are possibly considered for 

other regulators, I think it is important that market regulators, the 

SEC, as well, stay as independent, vigorous protectors of the markets and investors. 

In terms of the cost. You are correct. There is potentially a cost 

of the extension of credit. If somebody wants to hedge a risk, 

maybe they are hedging $100 million, a big risk, $100 million of 

oil delivery, on the first day, the prices haven’t moved. But a month 

later, the prices have moved and the question is, do they have to 

post something for that valuation difference. 

In the futures markets, one does that already. That is how futures have been regulated for 70-some years. In the swaps markets, it is all individually negotiated, and that is why I have used 

the same words—I have said, leave it individually negotiated between those end users and Wall Street. Allow them to do what they 

wish. Currently, there is some pricing in that credit arrangement. 

The end users have said they are concerned that if we require it, 

it might go up, and it is very hard to tell whether that is correct, 

whether that is one basis point in that example of $100 million. 

In natural gas, I am told, a lot of these current swaps will charge 

as much as five cents a million cubic foot for the credit arrangement. We don’t have transparency in these markets right now, so 

I don’t have good statistics. 

Senator CONRAD. All right. My time has expired, but I would just 

say to you, I think you will find a lot of allies on both sides of the 

aisle on this committee with respect to CFTC jurisdiction. It is 

critically important to commodities, and many of us represent commodity States, that the regulator understand commodities. So I 

think you will find strong allies on this committee. 

Mr. GENSLER. I thank you. 

Chairman LINCOLN. Thank you, Senator Conrad, and I don’t 

know that I need to echo that, but I will, that this committee does, 

or at least many of us do believe that. 

Senator Lugar. 

Senator LUGAR. Chairman Gensler, a bipartisan financial crisis 

inquiry commission has been established to look at the whole crisis 

and derivatives. It is my understanding that they are to report 

their findings by December of 2010. Now, I remember a hearing in 

this committee held a year ago October by Senator Harkin, and we 

had excellent witnesses. They described at that point, and this is 
17 

a year or more ago, that mortgages had been issued by local bankers and they sold them on to higher levels. They sold them on, 

packaging and packaging. Finally, they got pretty big packages at 

certain levels in the financial community and they sought firms 

like AIG, as it was mentioned prominently in that hearing, to get 

insurance. They were describing the derivative process as one of 

trying to obtain insurance for whatever risk there might be in 

those large packages. 

But then one witness intrigued us by saying that you could buy 

not only insurance, but you could also express opinions through derivatives. So we said, what is this, a public opinion poll? They said, 

not exactly, but nevertheless, if you still felt that you were not 

quite secure, you might bet on, for example, the failure of the banking system of Iceland, or Pakistan, or something of this variety. 

Some of these situations or opinions might come home and balance 

out your risks some more. 

Now, this was startling to all of us, but nevertheless, whether 

opinions are being expressed in such extravagant ways in derivatives, the mortgage thing did catch people’s attention. I have read 

reports, and maybe you could confirm this, that as many as 25 million mortgages were issued that were subprime quality or worse. 

There was large encouragement by the United States Government 

for much of this. Some of it came really through some of our government firms. Private firms were encouraged, and banks, likewise, 

to do the same thing. This may not be the entirety of the world crisis, but it is a very large part of it, and that is why this inquiry 

by this commission is important. They need to identify really what 

it is that we are looking at here. 

At the end of the day, whether it was extravagance in terms of 

idealism by our government that everyone should own a house, 

even if they could not pay for it, and everyone ought to have a 

mortgage, and people tried to keep insuring this through various 

derivative instruments, it was a catastrophe. How do we prevent 

these kinds of excessive public sentiments? Is the transparency 

that might come through the legislation now, or with amendments 

that might be suggested by you, likely to solidify unwise decisions 

with regard to things like prime or subprime mortgages or other 

unusual loans or transactions? And what is meant when people 

called about the dark passages or the ideas that somehow there are 

sort of blacked out areas that those of us who are unsophisticated 

really don’t know about and should not know about? Are all of 

these going to be uncovered? Will the transparency bring to light 

good transactions, and bad, transactions? 

Can you make a general comment about how we avoid the crisis 

again and how we identify correctly what happened this time so at 

least we might correct through public policy some of those areas? 

Mr. GENSLER. Senator, I think there are many causes of the crisis, but I think we could all agree that the over- the-counter derivatives marketplace was one of the factors—not the only factor. And 

in the marketplace, it is currently not regulated in Europe or here, 

or in Asia, so there is not transparency. But at the size that it is, 

and a notional amount nearly 20 times our economy, just to give 

it a whole size, there are many important and fundamental things 

it does—hedging, corporations hedging their risk, interest rate, oil 
18 

risks, and so forth. But there are, as you said, some event contracts, expressions of opinion, as you say. 

I do think that transparency in this marketplace, if we could 

bring as much as possible onto regulated exchanges, would help 

market participants foremost, that they would see the pricing. As 

Senator Chambliss earlier said, it was to determine the fair prices 

and hedge risk. I think moving transactions will allow end users 

to do that, but also that regulators could see the pricing. 

I think that we need to make sure that dealers have sufficient 

capital and that there are business conduct standards, and real 

rules of the road. It used to be, well, this is an institutional market. We don’t need rules of the road because it is all big women 

and big men dealing with each other. And we are really saying, no, 

we need some business conduct standards here, as well. 

Senator LUGAR. Well, I strongly favor the transparency that you 

are talking about. Likewise, I am cognizant of the costs that come 

with people who are using these markets. I think we must be 

thoughtful about this. The results of this catastrophe are really unparalleled, and the long term costs of this are going to be borne by 

our grandchildren. This is not just simply a business transaction 

proposition. 

Now, I am hopeful that transparency, at least inclusion of as 

much of this, leads to better decision making, both by businesses 

and government. My fundamental question is this. Even after we 

know the score, how do we prevent mistakes? Is the transparency 

likely to bring these things to the fore? 

Mr. GENSLER. I think it is a big component. It is not the only 

component, and that is why we, I believe, need to also lower risk 

in the four ways that I mentioned in my testimony, getting as 

many transactions into the clearinghouse, away from these concentrated financial institutions. I mean, we only have five, six, 

seven that are really large in this industry right now here in the 

United States, and the same number overseas. So they are, in a 

sense, too big and too interconnected to fail. So we move the transactions away and make sure they have sufficient capital, as well. 

Senator LUGAR. And hopefully give you sufficient capital to be 

able to enforce whatever the situation is. 

Mr. GENSLER. Well, yes, because our $147 million this past year 

is small compared to any one department—any one swaps department of a large Wall Street firm. It is billions of dollars of revenue 

and costs. 

Senator LUGAR. Thank you. Thank you, Madam Chairman. 

Chairman LINCOLN. Thank you, Senator Lugar. 

Senator Cochran. 

Senator COCHRAN. Madam Chairman, thank you. 

One thing occurs to me, and that is what is the practical consequence of the changes the Obama administration is recommending that we make? What are the practical consequences? I 

know we have another panel that will come along and tell about 

how they use the markets to transact their business and to market 

what they sell and finance the transactions that they have to make 

to be successful in the marketplace. From your standpoint, though, 

are they wrong when they say that the Obama administration’s 

proposals are going to cost more? Isn’t that going to be passed on 
19 

to consumers, like people who borrow money to buy cars or whatever, or businesses who use airplanes? Are the operational costs 

going to go up? What is your reaction? 

Mr. GENSLER. I think the practical effect of the administration 

proposal, which I do fully support, is to lower the risk to the American public. Now, lowering the risk of these large financial institutions, which I think in some regards were mispricing liquidity, 

mispricing their capital, and had too little capital, could well take 

some leverage out of the system, some risk out of the system. And 

when you do that, they may well pass on costs. But I don’t believe 

there is any free lunch, that the financial firms did get too highly 

leveraged and too much debt and through derivatives were possibly 

extending too easy credit, so to speak. 

So I do believe that the end users would be able to hedge their 

risk. They would be able to tailor products. We are fully supportive 

that they could customize products. I do believe they would get 

lower execution costs by the transparency initiative, and where the 

real sort of rubber meets the road is whether they are included in 

this clearing requirement, which it may well be that Congress decides not to require that, and that is the balancing act that Congress is looking at. 

Senator COCHRAN. Thank you. Thanks, Madam Chair. 

Chairman LINCOLN. Senator Johanns. 

Senator JOHANNS. Madam Chairman, thank you. 

Mr. Chairman, it is good to see you. I want to start out and tell 

you how much I appreciate you taking the time to get around and 

stop by our offices. I think that is a very decent thing to do and 

very, very helpful in kind of thinking through some of these issues. 

I think you have a committee here that kind of approaches this 

and recognizes the obvious need to do some things here, but I think 

we also recognize that, done wrong, this has some very, very serious consequences even for farmers in North Dakota or Nebraska in 

terms of how they manage their risk and a whole host of other people, not to just mention the agriculture community. 

And I have some concerns here, I must admit. There is never 

time to go into all the concerns, so I am going to try to jump into 

a couple of things that just kind of jump out at me every time I 

think about this. 

The first concern is, to be very candid with you, this reminds me 

a little bit of the climate change legislation. In theory, we can all 

agree about its merits and what it might be doing, but in reality, 

if you don’t get the world on board, you are not going to get very 

far. 

Now, if I were a small country out there, recognizing that just 

by its nature derivative trading is an international phenomena— 

I mean, we are trading in oil and commodities that sell in the 

international marketplace and hedging risk, et cetera—just by its 

nature, if I were a president of a small country out there, I would 

wait for the rest of the world to pressure down the regulatory atmosphere for the business community, and then I would find the 

sweet spots and I would do something different and I would gather 

all the business. What is going to stop that from happening? 

Mr. GENSLER. Well, I think, Senator, that you are right that capital and risk know no geographic boundary or border. But I am op-
20 

timistic, having worked closely with the Europeans and some of the 

other North American regulators, that we are going to come out 

with a consistent framework. There is still a lot in front of us, in 

front of this Congress, in front of the European Parliament. And 

I think these are the major centers of capital. So if we regulate our 

derivative dealers and the Europeans regulate theirs and we ensure through legislation that they can only have access to U.S. customers if they are comparably regulated, consistently and comparably regulated, I think that goes a far way. 

That hypothetical that you mentioned always gnaws at us and 

we have to find ways to close that. But that small country that you 

mentioned wouldn’t have the capital, wouldn’t have the end users 

in that country. 

Senator JOHANNS. But it might be able to attract it through its 

sympathetic regulatory atmosphere. I appreciate today it may not 

be much of a player, but it may be sophisticated enough to recognize. And you are—well, let me get to this, without bantering too 

much about this. You are never going to be able to assure us of 

that, are you? I mean, that is always going to be a risk and possibility if this legislation passes. 

Mr. GENSLER. But I could ensure you this. If we don’t do this in 

the United States, others won’t do it. We have to show the leadership and, I think, rise to the occasion to bring regulation here. And 

the President was successful in Pittsburgh to get 20 heads of state 

to sign on. It was a brief statement, but an important statement 

about this. I think it is very encouraging. 

Senator JOHANNS. That is what we are being told about climate 

change, too. 

The second thing I wanted to ask about—two things relative to 

the margin requirements. Again, I would love to have an hour with 

you to delve into that deep, but let me delve into—— 

Mr. GENSLER. Tell me when you want to schedule it. 

Senator JOHANNS. Okay, great. We might do that. We will do 

that. 

Here is what worries me about the margin requirements. Number one, if I take this bank of money to put it into bringing down 

risk by posting, in effect, a cash bond of sorts, because that is basically how it works, I have taken that money out of the economy 

and it is now on the sidelines. Now, I have probably brought some 

risk down. In fact, in the no-risk transaction, we would require 100 

percent and then there wouldn’t be a risk. But that is not how a 

free economy works. So that is the number one concern, and I see 

I have just run out of time, but the second concern is this. 

The little guy out there, the small, medium-sized risk hedger, 

whoever that is, is going to be very limited in how much margin 

they can put up, how much capital they have access to in reality, 

and so I just worry that what you are really doing here, if you 

pound down on these margin requirements, is you have just set a 

course where bigger gets bigger and we exacerbate the problem of 

too big to fail. And I will guarantee you, sitting on the Agriculture 

Committee and the Banking Committee, it is a very bipartisan 

frustration that we are dealing with, too big to fail. 

Mr. GENSLER. I share that frustration and that is what animates 

me. On the other side, is I think that the large financial houses are 
21 

keeping a great deal of risk on their books. The largest financial 

houses often have between ten and 20 percent of their balance 

sheet extending credit. Credit is being extended in these derivative 

contracts. They are central counterparties. They are not well regulated for it. They are also in the underwriting business and proprietary trading business and the leasing businesses and so forth. 

So that is why, as a public policy matter, and Congress will 

weigh trying to move as much of this into central clearinghouses 

but also weigh the concerns of these end users about posting margin. If they are exempted, I think the next panel, I am hoping you 

will hear, is fine and, in fact, it is a huge benefit for small and medium-sized companies to see the transactions trade by trade on 

trading platforms. 

Senator JOHANNS. Yes. I will just wrap up with this, before my 

microphone gets shut off. Transparency is good. I like transparency. I have tried to emphasize transparency is a good thing. 

How you execute that, again, I think it can send you down a pathway of just encouraging bigger and bigger and bigger to meet the 

requirements that we impose upon the private sector. Thank you. 

Chairman LINCOLN. Senator Thune. 

Senator THUNE. Thank you, Madam Chair. 

Mr. Chairman, I think the whole focus of this debate has got to 

be how do we figure out the right way, the balanced way to constrain some of the risk that led to this massive collapse and meltdown that we saw last fall. And I think a lot of this debate, too, 

comes down to some definitions, who is in, who is out, who is covered, who is not. 

And one of the questions I guess I would ask of you, because you 

stated earlier that the regulator should be the appropriate entity 

to determine what is a standardized contract, and I guess I would 

ask you, in light of that, how would you define a standardized contract? 

Mr. GENSLER. I think—a very good question. I think there should 

be a presumption that if it can be cleared, a clearinghouse accepts 

it, it would be a presumption that it would be clearable. If it had 

a volume of transactions and had a pricing, clear pricing—one of 

the things about clearinghouses, they need to know what the pricing is of these transactions. 

I remember in February, actually, in front of the committee when 

then-Chairman Harkin asked me the question, I provided in writing, and I would be glad to get it to you, Senator, five different factors that could be. But it was related to a presumption that if it 

is accepted for clearing, then it would be standardized, if the clearinghouse took it. If there was such volume in the contract. If it was 

so similar, there was just one feature that was different, as if 

somebody was trying to evade the standardization, that would be 

a factor, for instance. 

Senator THUNE. Okay. Do all derivative end users, in your opinion, create systemic risk to the financial markets? 

Mr. GENSLER. I think that the greatest systemic risk is housed 

within the large financial entities. And though individual transactions don’t, or even sometimes collection of transactions don’t 

pose that type of risk, that when you go across, if we exempt a 

whole class of transactions, it is a significant part of the market. 
22 

Again, there is not much transparency here. But the end user 

transactions are significant in dollar amount and even a larger 

number of the individual transactions, because usually end users 

have smaller transactions. 

Senator THUNE. Right. Do you think that all end users ought to 

be subject to the same level of Federal oversight? 

Mr. GENSLER. I am glad you asked the question. I am not for the 

end users having oversight. I am for the swap dealers having oversight and that the requirement would be on the swap dealer to 

bring the transaction into a trading venue, and that would benefit 

the end user. If Congress were to say that the transaction was 

brought into the clearinghouse, it would be the responsibility of the 

swap dealer to bring it in. But the end user wouldn’t have oversight, if I can—— 

Senator THUNE. Okay. If you have a derivative end user like, 

say, for example, a rural electric cooperative who relies on standard 

over-the-counter contracts, should they be forced onto exchanges or 

central clearinghouses if it is a legitimate hedging transaction, 

something that they are simply doing to manage risk? 

Mr. GENSLER. I think they should be able to manage risk however they wish to manage risk. If it is a customized or tailored 

transaction, then I would say no. But if a trading venue actually 

listed it for trading, it was so standard, it is a one-year contract 

for natural gas and it was similar to many of the transactions currently listed on the exempt commercial markets that we know of 

and talk about, ICE Atlanta, then the swap dealer would be required to bring it and make sure that small rural electric cooperative would be able to see the transactions of similar electric cooperatives in other States. They would never see the name, but 

they would see the price and volume. I think that would benefit 

them. 

Senator THUNE. Okay. Thank you, Madam Chair. Thank you, 

Mr. Chairman. 

Chairman LINCOLN. I think—— 

Senator CONRAD. Madam Chair? 

Chairman LINCOLN. Sure? 

Senator CONRAD. Might I just make a quick observation that in 

that meeting that I described where we were told government was 

going to take over AIG because there would be a global financial 

collapse if it was not done, what became clear is that AIG had written insurance contracts and they didn’t have the capital to back up 

the commitment. And somehow, we have got an absolute obligation 

to make sure that can’t happen again, and I don’t know how you 

do that without some margin requirement. It would be unthinkable 

that we were to permit that same circumstance to occur again. 

Chairman LINCOLN. I think we have got a few questions left, but 

we would like to do maybe one quick round, because we do have 

another panel and we do have a nomination hearing, so I am going 

to defer to my colleague, Senator Chambliss. I know he has got to 

step out for a few moments. 

Senator CHAMBLISS. Thank you, Madam Chairman. 

Picking up where Senator Conrad left off there, you talked about 

some of these institutions being too big to fail and the sophisticated 

institutions that were dealing in this—that do deal in this market, 
23 

and that those are the regular players, so to speak, in the market, 

versus the small businessman who might kind of almost inadvertently get involved in this. 

If we had total transparency, if AIG had been required to report 

to you or to the CFTC the nature and the details of all of their 

transactions, would not that have put not only CFTC in a better 

position, but the potential buyers of AIG products or investors in 

AIG products in a much better position to look at them and say, 

wow. They have got all these transactions out there and all these 

obligations out there, but they don’t have the capital. And aren’t 

these sophisticated traders just that? They are so sophisticated 

that they would have known that AIG was not capable of delivering on the products that they were selling, or that their capital 

was so low that there was no way they could meet those commitments and they wouldn’t have made the investment if there had 

been total transparency at that time. Is my thinking right there? 

Mr. GENSLER. Senator, I think that the markets need more than 

that. Transparency is critical—— 

Senator CHAMBLISS. I understand that—— 

Mr. GENSLER. —but as Senator Conrad said, I think the need to 

have the authority to effectively say an AIG or the next AIG has 

to have capital, has to have cushions really built in, and even business conduct standards and so forth, are critical, as well. 

Senator CHAMBLISS. I understand that, and that is why we have 

got to look at the other portion of that. But from a transparency 

standpoint, isn’t that correct, that investors would have been so sophisticated that they would not have made additional investments 

in AIG? 

Mr. GENSLER. Though I would like to agree with you, as I would 

like to agree with every Senator, I think that the crisis showed 

that many sophisticated actors made whopping big mistakes. And 

AIG—I think we can’t just rely on sophisticated actors making the 

choices. I think we need to regulate the big swap houses and make 

sure they have the capital and the business conduct standards 

right there. 

Senator CHAMBLISS. I guess my point is, I don’t disagree with 

what you are saying, but I agree that there has got to be transparency, and I think we have all said that today. There will be 

some additional issues relative to the margin requirements, position limits, whatever, but my point is that if we don’t put in legislative language a requirement that there be total transparency and 

that transparency would lead an investor to shy away from somebody who is undercapitalized, then I think we have failed. So I 

want to make sure that we are talking along the lines of putting 

in legislative language the capability of an investor to be assured 

that the seller of a product does have the capital to back up that 

product. 

Mr. GENSLER. I think such transparency would be a positive and 

a net benefit to the markets and I think it sounds like we are in 

agreement, but we need other factors, as well, in this—— 

Senator CHAMBLISS. I don’t disagree with that, but yes. Okay. 

Thank you. 

Chairman LINCOLN. Just quickly, in the last farm bill, we passed 

some reforms that granted CFTC the authority to regulate con-
24 

tracts with a significant price discovery function. I would just like 

to hear from you how those reforms are working. Specifically, how 

many of the SPDC reviews have you undertaken since you have 

been given the authority to do so and how do you plan to use this 

authority in the future? 

Mr. GENSLER. I thank you. The authority really was looking at 

trading venues called exempt commercial markets and trying to 

bring greater regulation to those where the contracts were similar 

or look-alike, as the documents had significant price discovery. We 

went through rule writing in the spring, and then subsequent to 

the rule writing have put out the determination, I think it is 43 

individual contracts. Because—— 

Chairman LINCOLN. That is more than predicted, I believe. 

Mr. GENSLER. More than was predicted, that is correct. But subject to the rules, there are four factors to be considered. We have 

put them out. One has actually been determined to be—because it 

was the first one we put out, the other 42 are still getting public 

comment and so forth— one has been determined. It is the natural 

gas contract on ICE, and then ICE Atlanta then had to put in place 

the self- regulatory functions that this committee and Congress required of them, and we are getting now the reporting and so forth. 

And we are going to sort through—we are in a determination phase 

now, but we are going to sort through the other contracts. Most of 

them are in the—in fact, I think all of them are in the energy 

space. 

Chairman LINCOLN. Thank you. 

Senator Conrad? 

Senator CONRAD. Thank you, Madam Chairman. 

I want to go back to this question that was kind of ping-ponging 

back and forth with Senator Chambliss, because I think it is very 

important we get this right. A couple of years ago, I was at a charity dinner and had seated next to me a man who was in charge 

of all derivatives trading worldwide for a major financial institution that no longer exists. They were brought down by this derivatives disaster. And during the course of this dinner, we talked 

about derivatives. 

I raised with him—because just a few weeks before, I had asked 

my staff to bring me a formula that is used to measure the risks 

of a derivative deal. I wanted to see if I could understand it, because I have a Master’s in business and I would have had that 

training about the time most of the people running these companies would have had their training. So I just wanted to see, would 

I be able to understand it. They brought me a formula. I couldn’t 

make heads nor tails out of it. 

I said to this man, again, who was in charge of all derivatives 

trading for this major firm worldwide, I said, how many of the top 

executives of your firm do you think understand these formulas 

that determine, supposedly measure the risk of a deal? He said, ‘‘I 

don’t think any of them understand it.’’ He said, ‘‘I don’t understand it.’’ 

And I tell you, I remember my feeling when he told me that. My 

God, this is the guy that is in charge of derivatives trading worldwide for a major company and he doesn’t understand the formulas. 

And I understood, because, you know, I am pretty good in math. 
25 

I couldn’t understand it. And I will bet you a lot of money these 

guys would go to board meetings. Nobody wanted to be embarrassed and ask the question, what does this really mean? 

And in AIG’s case, the vast majority of that company was sound. 

They were doing strong business worldwide. What brought them 

down was a 500-member outfit that engaged in these derivative 

deals, and they never—they couldn’t conceivably back up the insurance products that they were selling. And they almost brought this 

whole thing to its needs. 

So for this member, transparency, absolutely. And to the point 

Senator Chambliss was raising, I do think it would make a difference if people were able to see, because, I mean, this gentlemen 

told me nobody knew how many derivatives deals were out there 

because there was no place it was reported. That has got to be. 

But then we have got to go another step. We have got to make 

certain that folks have the capital to back up the promises that we 

are making. Is that your position? 

Mr. GENSLER. It is, Senator. I think that one of the critical functions of the regulatory group—and financial regulation failed the 

American public. I mean, there is no doubt about that. But the financial system also failed, and it wasn’t just AIG. It is to make 

sure that these financial institutions, and they are more highly 

concentrated today than they were ten years ago—it is not uncommon, it happened in the airline industry, it happened in the drug 

industry—but in this industry, it is so consequential because they 

are intertwined in the fabric of every company, all the end users 

you will hear from and so forth, that they have enough capital, that 

their business conduct is such that it lowers risk, not heightens 

risk, and in my recommendation that we move what we can off the 

books into these central clearinghouses. 

They operate as a fiduciary duty, with a profit motive, as they 

should. They are for-profit companies. That means they want to 

make as much profit on as little capital and survive. They don’t 

want to go under. But that is different than the responsibility to 

the taxpayers that I feel in my job every day, is to make sure that 

there is enough capital that this crisis can’t happen again. 

Chairman LINCOLN. Senator Lugar, anything else? Senator Cochran, Senator Johanns? 

Senator JOHANNS. I hope you don’t take my asking hard questions as feeling one way or the other about this. I just think we 

have to ask hard questions. I once had a law school professor tell 

me—and anybody who has gone through law school has probably 

heard this—hard cases make bad law, this law professor said, and 

it is true. The most difficult AIG kind of cases can sometimes lead 

to terrible results if we are not paying attention. 

So let me just ask you on this margin phenomena, could AIG borrow money to make the margin call? I mean, they have access to 

great—or did have access to great capital at one time. Could a company go out under the administration proposal and meet the margin requirements by borrowing money? 

Mr. GENSLER. They could. They could. But importantly, the large 

financial houses, like an AIG in the future, would be less interconnected because these transactions would have to be moved off 

of their books into these clearinghouses. What happened in AIG, 
26 

they had about a $450 billion credit default swap book and their 

counterparties were not asking for margin to be posted. They said, 

well, they are fine, you know. And one day in September of last 

year, they were downgraded by the rating agencies and all of a 

sudden they had to post $30 billion, and you know the rest of the 

story. The taxpayers put it up. 

Senator JOHANNS. It is just, you look at AIG and you wonder how 

people got paid so much to make such poor decisions, to be very 

blunt about it. And it is not just AIG. There were a lot of very, very 

bad things going on. 

To follow up on this question of capital to cover risk exposure, 

I mean, all of our economy is working with risk exposures. I buy 

a million-dollar life insurance policy, hypothetically. They are 

banking that they get to use my premiums long enough before they 

have to pay out on that. And in the world, some risk is—a situation 

in life insurance, well, some die sooner than expected, others don’t, 

and on and on. But if you had a phenomena, say, in the casualty 

industry where you had a massive hurricane event, for example, 

yes, the claim problems can be absolutely overwhelming. They do 

not have oftentimes enough money sitting there to cover all of the 

claims, right? And isn’t that the balance we are trying to strike 

here? 

Mr. GENSLER. It certainly is, but I think this was more than just, 

if I can say it, an analogy of the 50-year flood or the 100-year flood. 

I think that the financial system had—and the regulatory system 

had real gaps and this over-the-counter derivatives marketplace is 

a real gap. 

We do have regulated securities markets. We have regulated futures markets. 

Senator JOHANNS. Sure. 

Mr. GENSLER. This market is larger than the futures markets by 

orders of magnitude. I think we need to bring similar discipline to 

it. 

Senator JOHANNS. And again, I am going to work with you to try 

to get there. I just want to make sure that in this hard case, we 

don’t make bad law. That is why I ask these questions. I think it 

is just important that we try to get a sense of what we are doing 

here, so thank you, Mr. Chairman. 

Mr. GENSLER. I appreciate the hard ones and even the easy ones. 

Senator JOHANNS. Great. Thanks. 

Chairman LINCOLN. Senator Grassley, we are finishing up the 

second round. If you have got anything for the Chairman, we would 

ask it now and we will then move to our second round. 

Senator GRASSLEY. Thank you. We have questions from end user 

witnesses after you and they are going to testify that exemptions 

for bona fide hedgers and legitimate end users should be granted 

from regulated exchange requirements because it will, in short, 

break the bank. CAn you elaborate on what specific threats these 

users pose to financial stability? 

Mr. GENSLER. Good to see you again, Senator. I believe that it 

is the large financial institutions that pose the greatest risk. But 

at the end of every financial institution, there are thousands of end 

users. So it is not any individual end user, but what we are really 
27 

trying to do is lower the risk to the American public and promote 

transparency. 

Exchanges that you mentioned are actually a benefit to end 

users, and I think most end users would like to have transparency. 

What they are worried about is posting margin on something called 

a clearinghouse. A clearinghouse happens after the transaction, 

and while it is related to an exchange, I think that is what they 

are most worried about, is the cost of possibly posting margin. But 

the real risk is the large financial institutions being so interconnected. 

Senator GRASSLEY. Your testimony includes support for a trade 

repository that would assist regulators. Could you expand on who 

and how this repository would be administered and how will this 

be kept independent from market players? 

Mr. GENSLER. I think it is important that trade repositories and 

clearinghouses, which will serve in some way the public, broad 

public, be robustly regulated by the market regulators for governance, that the governance is an open governance and not sort of 

controlled by sort of a club deal amongst dealers. And the trade repositories are a place where all the regulators should be able to see 

the transactions. That is a regulatory transparency. And that our 

trade repositories and the European trade repositories, I believe, 

should be open and available that we can see as regulators that information. 

Senator GRASSLEY. Okay. Probably all the witnesses at the hearing will agree with you that greater transparency and more information for both market participants and consumers will be beneficial. One recommendation is to aggregate data on the OTC trades 

and make them available to the public. Could you explain how you 

would make this available to the public but at the same time safeguard information that could be used to manipulate the markets? 

Mr. GENSLER. As we do it, the CFTC, we put out a weekly report 

right now on the futures market and we aggregate data around 

large traders and we put that out every Friday. I think, similarly, 

we should promote aggregate data of customized and standardized 

product out to the marketplace. I do think market participants also 

benefit if individual trades are transparent, if they are standard 

enough to be listed on execution facilities. And that is really one 

of the best ways to protect against manipulation. 

But I also hope to work with this committee and you, Senator. 

I think we need to enhance the CFTC’s authority to police the markets against manipulation and we do have some statutory language 

to address specific disruptive practices. 

Senator GRASSLEY. Thank you, Madam Chairman. 

Chairman LINCOLN. Thank you, Senator Grassley. 

Chairman Gensler, thank you again. You have been most gracious with your time. We appreciate that. We look forward to continuing to work with you as we move forward to find the kind of 

solutions that will really put our economy back on track and provide that kind of confidence in the consumer and the marketplace 

that we all know that we need, and more importantly, that we can 

provide, so—— 
28 

Mr. GENSLER. Madam Chairman, members of the committee, I 

thank you and I look forward to working with all of you and making our staff and me available to any questions you have. 

Chairman LINCOLN. Great. Thank you for joining us today. 

We would like to now call the second panel, if we could. First of 

all, we have got Glenn English, who became the fourth executive 

officer of the National Rural Electric Cooperative, chief spokesman 

for the nation’s consumer-owned cooperative electric utilities. He 

represents the national interest of electric cooperatives and their 

consumers before 

the United States Congress and executive branch, the Federal 

agencies. 

We are also being joined by Mr. Neil Schloss, Treasurer for Ford 

Motor Company, a position to which he was elected in March of 

2007. He joined the Ford Motor Company in 1982 as a financial analyst in the comptroller’s office. From there, he has progressed 

through a series of finance positions at Ford Aerospace before 

transferring to Ford in 1990. 

We would also like to welcome Mark Boling, who is an Executive 

Vice President and General Counsel of Southwestern Energy Company. Prior to joining Southwestern in January of 2002, he was in 

private practice in Houston, specializing in oil and gas transactional work. 

We are also being joined by Jeff Billings of the Municipal Gas 

Authority of Georgia, Manager of Risk Management. Jeff is responsible for the development and the execution of hedging strategies 

for the Gas Authority’s hedging program. He also works closely 

with the members and partners of the Gas Authority to develop 

and implement hedging plans. 

And we are also joined by Dr. Robert Johnson. Dr. Johnson is an 

international investor and consultant to investment funds on issues 

of portfolio strategy. He currently serves on the United Nations 

Commission of Experts on International Monetary Reform under 

the Chairmanship of Joseph Stiglitz. Dr. Johnson is also the Director of Economic Policy for the Franklin-Eleanor Roosevelt Institute 

in New York, and we are pleased to be joined by him as well. 

Thank you, gentlemen, for coming to work with the committee on 

such a critical issue and we look forward to your testimony and 

then are, again, grateful for your being able to stay and answer our 

questions, as well. 

Congressman English. 

STATEMENT OF GLENN ENGLISH, CHIEF EXECUTIVE OFFICER, 

NATIONAL RURAL ELECTRIC COOPERATIVES ASSOCIATION, 

ARLINGTON, VIRGINIA 

Mr. ENGLISH. Thank you very much, Madam Chairman. I, too, 

want to join others in congratulating you on your new position. We 

certainly are enthusiastic about the kind of leadership that we 

know that you will provide to this committee and to rural America 

in general, so congratulations once again. 

Chairman LINCOLN. Thank you very much. 

Mr. ENGLISH. Thank you. I think most of the members of this 

committee, certainly those that are present, are very familiar with 

electric cooperatives. I don’t need to really go into the background 
29 

about there being not-for- profit, consumer-owned, 930 cooperatives 

in 47 States all across this country. 

But certainly we have a great interest in the subject at hand. We 

want to commend the committee and certainly encourage transparency, encourage any action that you can take that will deal with 

any market manipulation that may be taking place and any abuses 

that we may have seen in the past. 

I recall some 20 years ago—goodness, it doesn’t seem that long, 

but 20 years ago when I served as Chairman of the subcommittee 

in the other body dealing with this very same issue, wrestling with 

some of the very same questions that I heard asked this morning. 

So this is one that has been with us and I commend you for continuing to work to get it right and to get it focused. 

I certainly appreciate and understand also that much of the discussion this morning is with regard to some of the larger participants in the derivatives market and the impact that they have had 

recently on our economy and some of the shortcomings that we 

have seen in that marketplace. 

I am here to represent some of the smallest of the participants 

in this particular market, but we have just as great an interest in 

a functioning market and legislation could have just as great an 

impact with regard to electric bills for those 21 million people who 

are represented on the Agriculture Committee through the cooperatives that you have in your particular States. And in this particular 

case, we find that we are concerned about one thing, and that is 

affordability. 

It is important for us to be able to hedge. It is important for us 

to be able to reduce risk. And certainly that has helped in keeping 

electric bills reasonable and affordable for our membership, and we 

need to continue to do that in the future. I think that a lot of the 

members of the committee fully understand how volatile fuels can 

be and the impact that can have on the electric bills of your constituents. Certainly, anything that we can do to bring stability in 

that area is certainly beneficial. So we want everyone to understand where we are coming from there. 

Interest rates swaps are also very important to us and can have 

a very big impact. As you know, we don’t have a lot of cash on 

hand. Much of our cash has to go into that infrastructure. The 42 

percent of the distribution lines of this country that are owned by 

electric cooperatives must be maintained by electric cooperatives. 

So we have a huge amount of infrastructure that has to be dealt 

with and a lot of the resources that we have go into that particular 

region. 

Not having money on hand puts us in the difficult position that 

the more volatility that is brought into constructing our plants and 

financing our infrastructure obviously means we have to go into 

the marketplace and borrow more money, and in some cases we 

have to borrow a lot of money. If we have one other element added, 

namely the volatility of fuels if we can’t hedge without clearing, if 

we can’t deal with swings in the marketplace, because it means we 

have to borrow a great amount of money for margin that is going 

to impact those electric bills each and every month. 

As the Chairman just recently discussed in response to a question from this committee, there is no question that the margin call 
30 

issue is a big issue for us. It is a big concern for us. If, in fact, we 

are suddenly hit with the need for a margin call to go out and borrow a lot of money to be able to meet that margin call, that can 

have a huge impact as far as the electric bills of some local electric 

cooperatives. So where we are coming from and what we are focused on is dealing with this particular issue. 

Of the legislative proposals that we have seen put forth, both 

from Treasury and from others here within the Congress, we have 

been working with the various committees and trying to find out 

if there isn’t some way that the smallest of those who use these 

markets, not for speculative purposes but for purposes of legitimate 

hedging, if there isn’t some way in which we can assist the committee in this issue of providing a great deal more transparency 

while dealing with manipulation, but at the same time not impacting those electric bills of the folks back home, in trying to keep this 

thing at a manageable degree. 

Now, attempts have been made. Certainly, the Treasury Department has made that attempt, and one of the proposals here in Congress is to use GAAP. The difficulty that we have with using GAAP 

is that while it does through its exclusion provide a way in which 

you can deal with the margin issue, the question is whether we can 

qualify on any particular trade for GAAP. So it brings more uncertainty in, and uncertainty itself provides us with difficulty. 

So as the committee wrestles with this issue, as you look at how 

we can provide more transparency, if you look at how we might 

deal with any manipulation that might be taking place, I would 

simply urge the committee to do everything that they can to also 

keep affordability for some of the small users that are using it for 

legitimate hedging purposes in mind, as well. 

I thank the committee and I appreciate it very much. 

[The prepared statement of Mr. English can be found on page 75 

in the appendix.] 

Senator CONRAD. [Presiding.] Thank you, Mr. English. 

We will go next to Mr. Schloss, the Treasurer of Ford Motor. 

Welcome. 

STATEMENT OF NEIL M. SCHLOSS, VICE PRESIDENT AND 

TREASURER, FORD MOTOR COMPANY, DEARBORN, MICHIGAN 

Mr. SCHLOSS. Thanks very much, and good morning. 

Senator CONRAD. Please proceed. 

Mr. SCHLOSS. Madam Chairman, Ranking Member Chambliss, 

and members of the committee, my name is Neil Schloss and I am 

the Treasurer of Ford Motor Company. I want to thank the committee for inviting me to testify and share the views of Ford Motor 

Company on a very important issue regarding financial derivatives 

and their regulation. The views that I express today are those of 

Ford Motor Company and their subsidiaries. 

Derivatives are an integral part of Ford’s business of manufacturing, sale, and financing of vehicles worldwide. Ford employs derivatives to manage business risk so we can achieve stable cash 

flow and profitability in an increasing volatile global economy. We 

do not use derivatives to speculate or bet on potential changes in 

the economy or the financial markets. Our use of derivatives are 
31 

focused on mitigating risks arising from our normal business operations. 

We fully support the legislation to increase transparency and 

oversight of the over-the-counter markets and participant activities. As an end user of derivatives, Ford would benefit from 

strengthening the derivative market and bank counterparties. We 

agree with general intent of most of the draft legislation that focuses on swap dealers and major swap participants and to exclude 

end users such as Ford and its affiliates from clearing, margin, and 

capital requirements. 

Like other end user manufacturers with captive finance companies, we are concerned that margin requirements would significantly increase our costs and liquidity requirements and could provide a disincentive to hedging our business risks. Most corporations 

do not have immediate and low-cost access to liquidity, such as the 

Federal Reserve discount window or FDIC-insured deposits. An end 

user raising capital requires lead time and is often very expensive. 

Ford’s use of derivatives shows why the regulations are critically 

important to all end users. As of September 30, the net fair value 

of our derivatives was about $800 million, and this is the amount 

that the bank counterparties would have to pay us to terminate existing transactions. Our total derivative notional outstanding is 

about $108 billion, which includes $93 billion of hedging interest 

rates, $14 billion hedging foreign exchange, and about a billion 

hedging commodity price risks. The automotive derivative book is 

just over $7 billion, and that is small compared to historical levels, 

and especially small compared to our financial services book, which 

is about $101 billion. But as the markets change and as our business grows, that could change significantly. 

Although we see the merits of credit default swaps, or CDS, in 

facilitating risk management and access to capital, we do not buy 

or sell CDS derivatives ourselves. 

In the automotive business, Ford uses derivatives to hedge currencies and commodities in order to lock in near- term certainty for 

our revenue and costs for global vehicle production. We are a capital-intensive business with various manufacturing facilities producing and selling cars around the world. For example, we use 

over-the-counter derivatives to hedge currency exposure resulting 

from our F- series production here in America in U.S. dollars and 

some of the sales being sold in Canada and Mexico in Canadian 

dollars and pesos. Similar exposures and trade flows exist all over 

Ford’s worldwide operations on finished products, components, and 

raw material. 

We also use over-the-counter derivatives to hedge commodities, 

such as aluminum and copper, and we opt to long-term supply 

agreements to hedge those commodities that do not have a deep or 

liquid derivative market. 

Many of the product and sourcing decisions are made years in 

advance of when the product actually reaches the customer. Without hedging, we would be exposing ourselves and our customers to 

high volatility and price risk. 

One of the biggest concerns relating to the derivative market reform is the potential disruption that would have on a pretty fragile 

asset-backed securitization market. Mandatory clearing and mar-
32 

gin requirements for securitization derivatives, which as you all 

know makes up a significant part of Ford Credit’s funding today, 

would cause major structural changes on our existing transactions 

and future transactions in what is still a fragile market, despite 

TALF’s success. 

During the credit crisis, many financial institutions curtailed 

credit capacity, but Ford consistently supported most of its 3,000- 

plus dealers and Ford Credit’s portfolio of more than three million 

active retail accounts. It is vital in that recovery that the 

securitization market continue so we can continue to support our 

dealers and our customers. 

In our view, securitization trusts should qualify for end user exemption, as well, because securitization derivatives are uniquely 

structured and only protect the investor. In absence of end user exemption, we would strongly advocate that securitization derivatives 

be allowed an exemption similar to that which is being widely distributed for foreign exchange swaps and forwards in various Senate 

and House proposals. 

So in summary, we appreciate that Congress recognizes that end 

users such as Ford use derivatives to mitigate risk. As legislation 

is crafted, the distinction between pure risk mitigation and speculation is important to maintain. End users represent only a small 

fraction of the estimated $600 trillion outstanding in the over-thecounter market. All our derivatives are used to risk mitigate, and 

credit risk that is entailed within them are priced and fully paid 

up front when the transaction begins. 

We thank this committee for giving derivative market reform the 

serious attention it deserves and inviting us to share our views 

with you, and at the end of the panel, I welcome your questions. 

Thank you. 

[The prepared statement of Mr. Schloss can be found on page 122 

in the appendix.] 

Senator CONRAD. Thank you, Mr. Schloss. 

Mr. Boling. 

STATEMENT OF MARK BOLING, EXECUTIVE VICE PRESIDENT 

AND GENERAL COUNSEL, SOUTHWESTERN ENERGY COMPANY, HOUSTON, TEXAS 

Mr. BOLING. Thank you. My name is Mark Boling and I am Executive Vice President and General Counsel of Southwestern Energy Company, an independent energy company primarily engaged 

in natural gas exploration and production within the United 

States. I appreciate the opportunity to appear before you today and 

provide testimony regarding the very important legislative effort to 

reform the over-the- counter derivatives market. 

One of the biggest challenges in enacting legislative reforms for 

the over-the-counter derivatives market is that the term ‘‘over-thecounter market’’ covers a vast array of products across a number 

of markets, thereby making it extremely difficult to implement an 

effective one-size-fits- all solution. In this regard, it is important to 

note that energy derivatives did not cause the financial crisis of 

2008. Credit default swaps and subprime mortgages did. It is also 

important to note that while we have witnessed the greatest economic crisis in 80 years and perhaps the most volatile commodity 
33 

markets Southwestern ever experienced, over-the-counter derivatives in the energy markets performed well, did not create systemic 

risks, and, in fact, helped many end users manage and hedge their 

risks during this very difficult time of extreme volatility. 

We support all legislative efforts to improve the transparency 

and stability of the over-the-counter derivatives markets and to ensure market integrity by preventing excessive speculation, manipulation, and other abusive practices. However, we believe that any 

such legislation must recognize the significant differences between 

the various derivative markets and make a clear distinction between those market participants that engage in hedging transactions with a goal of managing the price risk inherent in their 

business and those market participants that engage in speculative 

transactions with the goal of achieving profits through the successful anticipation of price movements. 

My testimony today will focus on four things: Why over-thecounter swaps are so important to independent energy companies 

like Southwestern; the impact on Southwestern and other independent energy producers if they are required to clear or post cash 

margin for their hedging transactions; Southwestern’s recommendation for the treatment of hedging transactions; and 

Southwestern’s support of market transparency and reporting. 

Southwestern Energy Company is a growing independent energy company. Since 2005, Southwestern invested over $6.5 billion in its 

operations, all of which are located in the United States. These investments have resulted in substantial domestic job creation, increased direct and indirect business expansion, and significant Federal, State, and local tax revenues. Within our company alone, we 

have increased our employee base from 248 employees at year-end 

2004 to approximately 1,500 employees today, an increase of over 

600 percent. Our ability to make over $6.5 billion of capital investments and 

create thousands of job opportunities during this period was primarily due to our ability to generate a reliable cash flow from the 

sale of our natural gas production and to gain access to additional 

funds borrowed under our bank revolving credit facility. The ability 

to generate our reliable cash flow was due in large part to our use 

of over-the-counter derivatives to lock in natural gas prices. Southwestern uses these derivatives as a risk management tool for our 

natural gas, a commodity that we produce, own, possess, and market. We do not use derivatives for speculative purposes. 

Southwestern regularly hedges its natural gas price exposure by 

entering into over-the-counter swap transactions with multiple 

counterparties with S&P credit ratings ranging from triple-B-plus 

to double-A. Southwestern has typically hedged 60 to 80 percent of 

its expected natural gas production volumes for the following year. 

Southwestern does not post collateral with any swap counterparty 

for a very good reason. Natural gas swaps lower Southwestern’s 

business risk and makes it a much more stable company. Like all 

commodity producers, Southwestern is naturally long in commodity, and hence naturally subjected to the risk of falling commodity prices. Southwestern’s swap counterparties understand that 

Southwestern is reducing its business risk when transacting overthe-counter swaps, and therefore the credit risk to the swap dealer 
34 

is greatly diminished, thereby eliminating the need for Southwestern to post collateral. 

Increasing hedging costs by forcing all standardized derivative 

trades onto a clearinghouse will result in fewer market participants, more price volatility, and less price discovery. Because of the 

increased cost, fewer market participants will be able to hedge, or 

the ones that can hedge will hedge a lower volume. With fewer 

transactions and fewer participants in the marketplace, there will 

be more price volatility and less price discovery. By driving out the 

bona fide hedgers, the market share of speculators will increase, 

which does not create a healthy functioning environment. A 

healthy market requires a balance between bona fide hedgers and 

speculators. 

Finally, if the independent energy producers are forced to post 

cash collateral for natural gas hedging activities, they will be unable to fully invest in their business, the exploration and production of natural gas. The additional cost from posting cash collateral 

will be substantial and necessarily require that independent energy 

producers reduce their capital investments, resulting in a dramatic 

reduction in drilling activity, fewer jobs, and a significant decrease 

in domestic natural gas production. 

After analyzing the potential costs of posting cash collateral, 

Southwestern determined that during 2009, without hedging, 

Southwestern would have drilled 240 fewer wells in its Fayetteville 

Shale Project, resulting in the loss of 1,500 jobs and a total economic impact to the State of Arkansas of $1.6 billion. In addition, 

fewer wells drilled in the United States means less domestic gas 

is produced, and less gas produced unfortunately means higher 

prices for consumers. There is a real world effect to a mandatory 

clearing requirement for all standardized over- the-counter derivatives. 

Southwestern believes the solution to these problems would be to 

provide an exemption from the clearing and margining requirements for bona fide hedging transactions where at least one party 

involved is a company that produces, owns, and sells the commodity and the transaction is directly related to managing commodity pricing risk inherent to that company’s operating activities. 

In conclusion, a clearing requirement for over-the- counter derivatives, when applied appropriately, can play an important role 

in mitigating operational and counterparty risk for large segments 

of the over-the-counter derivatives market. However, we believe the 

broad application of a clearing requirement for all over-the-counter 

derivatives will hurt many American companies, particularly in the 

energy sector, by effectively taking away the most powerful tool for 

managing price-related risk. 

It is our hope that the concerns we have raised are addressed so 

that any proposed legislation does not significantly impair our ability to use derivatives to prudently hedge the risks we face in our 

day-to-day operations or to ensure our continued access to the credit sources we rely upon to grow our business. Ultimately, what 

matters most is that American companies continue to be allowed 

to cost effectively manage risk in a manner that enhances market 

stability and contributes to both the overall health of the economy 

and our country’s goal of achieving energy independence. 
35 

Madam Chair and members of the committee, this concludes my 

testimony. I would be happy to answer any questions. 

[The prepared statement of Mr. Boling can be found on page 65 

in the appendix.] 

Chairman LINCOLN. [Presiding.] Thank you. 

Mr. Billings. 

STATEMENT OF JEFF BILLINGS, MANAGER OF RISK MANAGEMENT, MUNICIPAL GAS AUTHORITY OF GEORGIA, ON BEHALF OF THE AMERICAN PUBLIC GAS ASSOCIATION, KENNESAW, GEORGIA 

Mr. BILLINGS. Thank you. Madam Chairman Lincoln, Ranking 

Member Chambliss, members of the committee, I appreciate this 

opportunity to testify before you today. My name is Jeff Billings 

and I am the Risk Manager for the Gas Authority of Georgia. The 

Municipal Gas Authority of Georgia is the largest nonprofit natural 

gas joint action agency in the United States. We have 76 public gas 

system members in five States, including Georgia, Florida, Alabama, Pennsylvania, and Tennessee. Together, these systems meet 

the gas needs of approximately 243,000 customers. 

I testify today on behalf of the American Public Gas Association. 

APGA is the national association for publicly- owned not-for-profit 

natural gas retail distribution systems. There are approximately 

1,000 public gas systems in 36 States. 

APGA’s number one priority is the safe and reliable delivery of 

affordable natural gas. If we are to fully utilize natural gas at longterm affordable prices, we ultimately need to increase the supply 

of natural gas. However, equally critical is to restore public confidence in the pricing of natural gas. This requires a level of transparency in natural gas markets which assures consumers that market prices are a result of fundamental supply and demand forces 

and not the result of manipulation or other market abuses. 

Public gas systems depend upon both the physical commodity 

markets as well as the over-the-counter derivatives markets to 

meet the natural gas needs of our consumers. Both markets play 

a critical role in public utilities securities natural gas supplies at 

stable prices. 

Since 2005, APGA has been a strong supporter of increasing 

market transparency, limiting excessive speculating, and providing 

the CFTC with the resources it needs to protect consumers. APGA 

believes that provisions relating to the unregulated energy trading 

platforms contained in the CFTC Reauthorization Act passed last 

Congress was and is a critically important step in addressing our 

concerns. 

We commend this committee for its work on the Reauthorization 

Act. However, APGA believes that significant regulatory gaps still 

exist with respect to the over-the-counter markets. Congress should 

provide the CFTC with additional statutory authorities to enhance 

transparency, limit excessively large speculative positions, and help 

prevent market abuses. 

As this committee considers reforms to OTC markets, we are extremely concerned about the cost impacts of proposals that would 

require all standardized OTC transactions to be cleared. Mandatory clearing would significantly impair the ability of public gas 
36 

systems to engage in the gas supply strategies that we have historically utilized. 

Under current practices in the OTC markets, many public gas 

systems, based upon their very high creditworthiness, are not required to post collateral as long as their exposure stays below a 

predetermined threshold. In contrast, the mandated clearing of all 

OTC transactions would require public gas systems to post initial 

margin for all transactions and to meet maintenance margin calls 

whenever required and on little notice. This would constitute a significant financial and operational burden on public systems that 

would be borne 100 percent by consumers. 

In the case of the Municipal Gas Authority of Georgia, mandated 

clearing would require, based upon our current hedge positions, the 

posting of initial margin in the range of $163 to $243 million. In 

addition to the initial capital requirements, we would also be responsible for additional capital contributions based on mark-tomarket calculations. 

It has been suggested that the clearing requirements would be 

less burdensome if some end users are given the option of posting 

non-cash collateral. Unfortunately, the alternative of using noncash collateral would not provide any relief to public gas systems. 

Non-cash collateral would entail the deposit of liquid assets and 

public gas systems simply do not maintain liquid assets in the 

quantity necessary to meet the requirements associated with clearing. 

APGA understands that proposals to require clearing of all OTC 

transactions are intended to address issues related to systemic risk 

and prevent future bailouts. However, the hedging of natural gas 

supply purchases by public gas systems using non-cleared bilateral 

OTC derivatives do not prevent systemic risks to the market. 

In addition, the proposed mandate to clear all standardized OTC 

derivative transactions would increase costs for public gas systems 

and their municipalities, an increase which, again, would be borne 

100 percent by consumers. This increase in consumer cost comes 

without any benefits. In essence, we feel it would be punishing the 

victims. 

We look forward to working with the committee towards the passage of legislation that strikes an appropriate balance that allows 

end users, such as public gas systems, to continue to use the overthe-counter markets without incurring additional costs to hedge 

risk while enacting reforms that would protect our financial system. Thank you. 

[The prepared statement of Mr. Billings can be found on page 54 

in the appendix.] 

Chairman LINCOLN. Thank you. 

Dr. Johnson. 

STATEMENT OF ROBERT A. JOHNSON, DIRECTOR OF ECONOMIC POLICY, THE ROOSEVELT INSTITUTE, ON BEHALF OF 

AMERICANS FOR FINANCIAL REFORM, NEW YORK, NEW 

YORK 

Mr. JOHNSON. Madam Chairman, Ranking Member Chambliss, 

and members of the committee, I want to thank you for inviting me 

to testify before you here today. I represent on this day Americans 
37 

for Financial Reform, who are a collection of 200 organizations who 

are taxpayers, workers, and the end users’ end user. 

The American people clearly sense that there is something deeply flawed in the current structure of our financial markets. The financial sector calamity spilled over and did great harm to the lives 

of many Americans and people throughout the world. When they 

are properly designed, financial markets play a fundamental role 

in the resource allocation of our society. Financial markets serve to 

aggregate savings and allocate them to productive use and to 

transfer risk to entities that bear it most comfortably. The system 

we have had in place in recent years and the one that is still in 

place as we meet today has revealed itself to be profoundly flawed. 

Efforts to repair these market structures in light of the crisis 

should address and seek to rectify four core problems: Excessive leverage, opacity and complexity, the ability to buy insurance without an insurable risk, and the misalignment of incentives, where 

the private incentive to take risk exceeds the social desire to bear 

that risk. 

Certain types of derivative structures have contributed to all of 

these problems and it is time for a thorough redesign of the market 

system to fortify the real potential derivative instruments and repair the obvious flaws in structure that have caused so much harm. 

I must admit that I am very surprised by the intense focus on 

end users of derivative instruments. They are at present, by their 

own claim, a relatively small part of the market, and that focus 

does appear to me to have substantially misdirected energy away 

from the essential task of financial reform that is before the United 

States Congress and that centers on the regulation of large-scale 

financial institutions who threaten our economic system. 

This diversion of focus on end users is not independent of that 

quest and it is a dangerous exercise for at least two reasons. First, 

efforts to legislate what type of institutions are exempt from restrictions of healthy market practice runs the risk of creating loopholes that could be large enough to drive a jet aircraft through. 

End users’ exemptions are drawn too broadly and they would allow 

anyone and everyone to claim them, especially the large ‘‘too big to 

fail’’ institutions that stand next to the public treasury and are the 

dominant actors in the opaque OTC market. That would directly 

undermine the need to bring these markets out of the dark. It 

would enable the largest market participants to remain in the 

shadow, where they earn profits—extraordinary profits—but put 

society and the public treasury in peril. 

In addition, end user exemptions may inadvertently spawn large 

organizations or divisions of the organizations the incentive to create Enron-like entities as the risk implicit in creating legislation 

that confers special advantage for special types of market participants. 

A second danger is the exemption of certain classes of financial 

products, such as foreign exchange forwards and swaps or any 

products that are traded on foreign platforms and serve to drive 

more activity offshore, perhaps to locations where the underpinning 

market structures are themselves quite unsound. Foreign exemptions will also divert creative energy into the creation of complex 

foreign exchange-based products to qualify for the exemptions and 
38 

avoid the scrutiny and structures that they require for systemic 

safety. 

There has been a great deal of recent testimony, and it goes into 

some length to justify end user exemptions. This body of testimony 

tries to illuminate the consequences for end users, require them to 

trade upon exchanges or submit their transactions to clearinghouses. While I do agree that some increase in cost will be borne 

by these end users if the current structures are replaced by more 

robust and healthy market structures, I believe the magnitudes of 

the costs they report that they would incur pale in comparison to 

the cost this crisis inflicted on society. 

I do agree that the end users were not the primary cause of the 

recent crisis and they are not deserving of any particular punishment. Yet punishment is different than the adjustment to the removal of unhealthy subsidies. I don’t believe their arguments 

should dissuade you from undertaking profound institutional reform, even reform that impacts their practices. 

Economists are fond of saying there is no such thing as a free 

lunch, and efforts to hedge market exposures by commercial users 

are primarily a transfer of risk rather than a diminution of underlying risk. An oil hedger is not reducing the volatility of oil prices, 

but merely transferring the risk to another party who will bear 

that risk for a price. 

When market structures are weak and unsound, they underprice 

that insurance and encourage the over-use of insurance. In the case 

of OTC derivatives that are largely run by the handful of ‘‘too big 

to fail’’ banks, the insurance offered to end users is often underpriced because the risk is borne in part by the public or the taxpayer who underpin the safety net that backstops these banks. 

Removing the back room subsidy and excessive use it inspires, 

something oftentimes referred to as moral hazard, would lead to an 

increase of cost to providing that risk insurance. Removing the subsidy would diminish profits for end users. That leads to less use of 

insurance and some greater cost for the consumers of those end 

users’ services. 

Where I differ with many of the end users is the claim, I believe 

this would be a good thing—is that I claim this would be a good 

thing for the nation as a whole. Removing subsidies to the buyers 

of insurance does not make the world a more dangerous place. It 

merely redistributes who bears that risk away from those who had 

provided the subsidy. 

The American private sector, be it end users of financial products 

or financial institutions, do not need to clamor for subsidies from 

the taxpayer in order to thrive. That type of rent-seeking behavior 

is demoralizing for society and it is unproductive. It weakens the 

economy in the long term, and furthermore, government willingness to abide efforts to exact subsidy actually weaken the companies who receive them. The dependence on government subsidy allows the private sector’s creative powers to atrophy. We would all 

do much better in the long term if we were shown tough love, were 

refused state welfare and forced to focus on new product development and innovations in the marketplace that would create a 

strong, profitable, productive future in the business sector and for 

the nation. 
39 

Reforming the financial structure of the U.S. marketplace is essential to restore confidence in the United States. Transparent 

market structures, proper capitalization, regulation, restoration of 

market discipline to our largest financial institutions are the essential ingredients that are needed to restore that confidence. 

Finally, if this is done properly, it will also greatly diminish the 

possibility that future financial bailouts will reemerge and crowd 

out the use of our public finances for much-needed infrastructure, 

education spending, health care, and other things that make our 

society stronger and our lives more secure. 

I will submit the balance of my remarks for the record. I thank 

you, and I look forward to your questions. 

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

90 in the appendix.] 

Chairman LINCOLN. Thank you, Dr. Johnson, and thanks to all 

of you all for joining us today. 

We have heard some testimony today that our financial system 

has been put at risk by certain actors who have been over-leveraged and undercapitalized. It is important we find a balance to protect markets and consumers, and to that end, I just have a couple 

of questions for all of you and then a couple of specific ones for you, 

Dr. Johnson. 

It has been argued that with wider bid-ask spreads, capital 

charges, and other fees, that using OTC derivatives to hedge might 

be more convenient, but it is not necessarily less expensive than 

exchange trading, even without factoring in the possibility of mandated margin costs. To that end, would you compare the costs 

maybe, and you don’t have to do this today if you don’t have it at 

your fingertips, you could certainly submit it for us, which I think 

would be very helpful, but to compare the costs for me of one of 

your most standard contracts conducted over-the-counter versus 

similar costs of an exchange-traded hedge. As I said, if you don’t 

have that breakdown now, it is certainly something you can get to 

us in detailed data later, which I think just would be very helpful 

to members of the committee, to really see what that comparison 

might be. 

And then the other question is to discuss the parameters of a 

possible end user exemption that you or your group members might 

support. Do you believe that the financial end users or their affiliates should be permitted to use such an exemption, or should we 

work to exempt smaller end users and if so, where would you draw 

the line between the less and more significant players? Or maybe 

would you suggest some other type of a test in terms of what we 

could put in there. 

So those are the questions I would like to throw out for you all 

and would like you to answer. 

Dr. Johnson, you have heard these end users’ arguments today, 

and obviously you have heard them before, but they are very concerned about the additional margin requirements of mandatory 

clearing and that those requirements will make hedging with futures contracts prohibitively expensive. What do you make of their 

arguments, and if there were to be an exemption for end users, 

what should it look like, in your opinion, or are you adamantly opposed to any exemption? 
40 

Also, what are your thoughts on a new resolution regime? I think 

it is very important for us to eliminate the prospect of ‘‘too big to 

fail’’ and I understand that we need a resolution regime in place 

that would account for how we very methodically deal with those 

who think they are too big to fail. We must make sure that they 

are not. 

So I am just opening it up to the panel. Yes, Congressman 

English. 

Mr. ENGLISH. I will take a crack at that. Some of our members 

have formed and gone together, because we are so small, with our 

own entity we have created and we own it that does these kinds 

of hedging for our membership. We did take a look at—earlier this 

year, we had about 18 of our members who were, in fact, hedging, 

and if they had gone to a clearing device that they would have to, 

in order to meet these requirements, they would have likely had to 

come up with about $300 to $400 million in order to cover what we 

would anticipate would be the margin cost. If you look at that at 

about five percent, you are talking about roughly somewhere in the 

neighborhood of $15 million that those 18 entities would have to 

incur in additional expense. 

We do have some of our trades that are on the exchanges, so it 

is not that everything is over-the-counter. Most are, and this is the 

primary reason for it. 

Chairman LINCOLN. Thank you. 

Mr. SCHLOSS. I guess I will cover a couple of the questions that 

you asked, because I think the cost comparison one is one that, 

from a transaction-specific base, we all in the case of over-thecounter derivatives pay a credit charge up front from the standpoint of the unique credit charge. So how would that compare to 

what it would actually cost if you did to go an exchange, I think 

is yet to be seen if you go that way from the standpoint of the market development. 

I think for end users, and in our case specifically, the margin requirement that would come from a standpoint of not only the upfront margin for every transaction, but as you heard earlier today, 

as you go in time, the market value of that transaction changes, 

so the posting of margin changes. And going through an exchange 

will tie up valuable working capital, which for us is a tradeoff between margin versus product programs. You know, a half-a-billion 

dollars of margin could be a very significant new product from the 

standpoint of our ability to stay competitive, not only domestically, 

but against foreign competition. So I think there is a cost of that 

capital and an alternative use for that capital that is very important for us. 

As you get into defining end users, and I recognize the problem 

that you all face, because everybody is going to be here talking 

about why they need exemptions, and end users all have a different 

flavor for why they need it, our—and the problem that we all have 

is that we are a very small piece of the market from the standpoint 

of the overall over- the-counter market, and there have been studies that we make up something about ten to 15 percent of the overall market. 

The end users from our perspective, or from Ford’s perspective, 

clearly will center around who are the market makers versus who 
41 

has the underlying business risk. We use over-the-counter derivatives to hedge an underlying business risk that is generated from 

either selling of cars made domestically and shipped foreign or 

vice-versa, interest rate hedging from a standpoint of our ability to 

continue to fund our customers and our dealers. So there is an underlying business risk that if we aren’t able to hedge or aren’t able 

to hedge effectively, we are making a risk tradeoff from the standpoint of our overall business. 

So I think those are our two points very specific to Ford from the 

standpoint of both end user as well as cost. 

Mr. BOLING. To answer your questions in kind of reverse order, 

Southwestern hedges its natural gas price risk using two different 

types of derivative instruments, over-the-counter swaps and 

costless collars. And both of those instruments require no initial 

net investment payment up front to Southwestern. 

With respect to what would happen if the clearinghouse requirements were in place as has been proposed by some legislation, we 

did our own internal estimates, and if you estimated if they were 

in effect June 30, 2008, if the clearinghouse margin requirements 

had been in place, we would have been required to post $740 million in cash margin. But by the end of the year, that would have 

changed because of the volatility in prices down to $118 million at 

year end 2008. 

And just to put these numbers in context, as of December 31 of 2008, our company’s total debt outstanding was $735 million. So 

these clearinghouse requirements and the margin requirements 

would have required us to come up with additional money somewhere of $740 million. 

Mr. BILLINGS. On the cost issue, and our hedging is very much, 

as the other gentlemen here have described, we are hedging future 

gas costs for our municipal members and ultimately their customers. We deal primarily in the over- the-counter market. We also 

have no collateral arrangements, and so not required to post collateral when we hedge. 

As far as the costs go, a couple of things. Chairman, on your 

point about bid-offer spreads, I don’t know that I have seen anything—it sounds good in practice, but I don’t know that I have seen 

anything to convince me, anyway, that we are going to see a big 

change in bid-offer spreads just because we force everything to 

clear. It is possible. 

From a cost standpoint, when we go out to do a hedge— and I 

am in these markets every day—when we go out and do a hedge, 

I may pay a half-a-cent or a cent per MMBtu over the stated bid 

or offer on the exchange to trade over-the-counter. That is a very 

minor cost for us. We are very comfortable with that cost. We have 

several counterparties we deal with. I can try to work that cost 

down through competition. 

On the other side, now, if I am forced to clear everything, we are 

going to have a large line of credit in place. We don’t have a large 

amount of cash on hand. This really is going to change what we 

are doing, and so we are going to have to go out and get a big line 

of credit. Our estimate, we weren’t exactly sure what standardized 

meant, so I took a look at if we had to clear every swap that we 

have on our books and had to have enough cash on the side for 
42 

maintenance margins, we estimated we could have possibly up to 

a $500 million line of credit that we would have to have. Just having the line of credit, 50 to 75 basis points. Using it, and then we 

are talking about, as Mr. English said, five percent, those dollars 

add up quickly. We estimated it could be as much as $10 million 

per year of additional cost. 

So for me, it is very simple. The cost of having a line of credit 

far exceeds anything that I could see in improvements in the bidoffer spreads. 

And then we also—we are concerned that having to put a big additional debt on our balance sheet could impact our credit rating, 

so it could have trickle-down effects in other things that we do, if 

we are trying to do infrastructure updates or help a system reach 

a new customer. Anything where we have to issue debt, if the rating of that debt is impacted by this large line of credit that we 

might have to have, there are other impacts to our systems that 

we are very concerned about. 

Chairman LINCOLN. Dr. Johnson. 

Mr. JOHNSON. First of all, let me start by saying that I am much 

less intimately familiar with the individual businesses of each of 

the gentlemen to my right. So I don’t think—to dispute them regarding the individual costs, I just have no basis for that. 

As I say in my written testimony, I do believe that we have had 

a system that has been reliant upon the guarantees of the taxpayers via the marketplace that was the ‘‘too big to fail’’ institutions, and we have had underpriced insurance. And as each of 

them discusses, the change to an exchange or to a clearinghouse 

would in all likelihood entail—the process of obtaining that insurance would be more costly for each of them. It would be more costly 

in the cash management realm. Some would go without insurance 

and the consequences would likely be diminished profits in their 

sector or at their firms and it would also likely be the case that 

their pricing, they would pass through to their customers and they 

would bear some of that burden. 

But philosophically, what I am saying is that is a removal of a 

subsidy, and it might have even been what you might call an implicit design, not something that we all sat down and said, we want 

to subsidize this credit. We just have revealed in light of episodes 

that that is the case. 

I would anticipate, if you moved to exchange trading, that we 

would experience a narrowing of bid-ask spreads, more transparency of market prices, and an integrity of the system, which 

would also diminish the contingency of a big wipe-out-like crisis 

that we just had, and that indirectly should be factored into their 

costs. The collapse of demand, the layoffs, and all of the other 

things that all of our firms and our society are adjusting to right 

now, in my opinion, dwarf the kind of calculations that we are talking about today, however real they happen to be. 

Chairman LINCOLN. Thank you. 

I have to apologize. I have gone way over my time and I need 

to defer to my colleague, Senator Chambliss, to move on. Thank 

you. 

Senator CHAMBLISS. All of you have heard the previous discussion we have had about transparency and moving towards a dif-
43 

ferent form of reporting requirement. Whether it is a clearinghouse 

for all transactions or not obviously is still going to be up for debate. But from the standpoint of each of you four, if we required 

full transparency of all transactions, irrespective of whether you 

have an exemption or not, is there any issue with doing that? I 

mean, are all of you willing to be fully transparent about the swaps 

and derivatives that you enter into? Glenn? 

Mr. ENGLISH. Yes. 

Mr. SCHLOSS. Absolutely. 

Mr. BOLING. Yes. 

Mr. BILLINGS. Yes, without question. We have been in favor of 

more transparency for many years. 

Senator CHAMBLISS. All right. The question that I was getting to 

with Chairman Gensler, I think I finally understood his answer, 

and that is as each of you deal with the respective financial institutions or sellers of products or whatever it may be, if you have the 

benefit of the full transparency of all of their transactions prior to 

your engaging them in a swap or a derivative, would the information that you could glean as a result of knowing their financial position and their capital position affect your ability to make a decision on whether or not it would be a prudent investment for you 

to engage with that company? Glenn? 

Mr. ENGLISH. Yes. 

Mr. SCHLOSS. I think to the extent that we could get more transparency into the credit charges, I think that would be a help. The 

market itself is pretty transparent already. There are plenty of 

market screens from a standpoint of knowing where transactions 

trade. The difficulty will come when you have a very specialized 

trade, in our case, the securitization world, which takes on a very 

unique piece of the asset. Transparency in those transactions, even 

if everything was reported, I am not sure would add a whole lot 

of value. 

Mr. BOLING. Our company has a formal commodity risk management policy, and as part of that policy, we engage in analysis, credit analysis of all the counterparties that we use, which at this time 

is, I believe there are 13 different counterparties. So that is an ongoing thing for us because we are concerned about their particular 

credit exposure in making sure it is spread across a number of different counterparties, as well as making sure of the financial integrity of each counterparty. So anything that would allow us to do 

that job more effectively, we would support. 

Mr. BILLINGS. I really agree with Mr. Boling, that anything that 

helps shed light on potential red flags—we talked about AIG earlier—anything that would throw off concern that one of our 

counterparties was undercapitalized would certainly help us on the 

front end make decisions about whom we are trading with, so very 

much so. 

Senator CHAMBLISS. Well, Dr. Johnson makes a good point about 

they fact that we need to make sure that there is security in the 

market, and it is like buying an insurance policy. I think that is 

a pretty good analogy that has been used several times today. 

But what I am concerned about is the practicalities, having been 

in business myself, the practicalities that each one of you have alluded to. In fact, you, Mr. Billings, have indicated that there are 
44 

no liquid assets that your members could put up basically to provide for security or non-cash collateral assets or cash collateral assets. And even if you had to put up cash, it is going to severely 

hamstring you. 

But when we modernized the CEA in 2000, we thought we were 

doing the right thing, and I think we did do the right thing, to put 

more flexibility in the marketplace. But what we didn’t anticipate 

was the ability of the players in the market to package CDSs, for 

example, and do it the way that, say, AIG did it. And where I come 

down on Dr. Johnson’s side is just trying to make sure that as we 

move forward with whatever legislation we wind up with, that we 

don’t create an opportunity for additional CDSs to collapse the 

market ten years from now. So I think that is what we have got 

to be careful of. 

I am not concerned about any of the full review. You all have got 

folks you have got to answer to and you have got smart people 

doing your business. But the folks who caused this collapse were 

out there getting greedy and making a lot of money and trying to 

make more money, and they weren’t going to make it off folks like 

you all, but they are going to make it off of some people who are 

not as savvy or not as sophisticated as the four entities we have 

got here today. 

So I think our job is going to have to be where do we find that 

middle ground without requiring, Mr. Boling, you put up as much 

for a line of credit as you have in total outstanding debt. That 

makes no sense at all. But yet, we need to make sure that there 

is that security in the marketplace for that operator down the line 

who may be third or fourth removed from you as an ultimate customer to make sure that there is no collapse in the intervening 

transaction that is taking place. 

That is why this is such a complicated issue and why I am really 

glad that the Chairman has held this hearing today, because I 

think all of you provided valuable information that we are going to 

have to take back and digest and see if we can’t find that common 

ground that is going to allow you to continue to operate. 

And Glenn, I guess I am more familiar with your folks than anybody else because I know your members are all nonprofit and they 

are made up of farmers and ranchers and small business people, 

primarily, who can’t afford the kind of cost that is going to be put 

on them from the standpoint of having to secure all of these transactions. And since I am a consumer of yours, too, I don’t want my 

utility bill going up. 

And the same thing with Mr. Billings there. He is serving Georgia. 

But all of you have provided very valuable practical information 

for us to digest and I thank you for being here and giving us that 

testimony today. It is going to help you through this period. We 

look forward to staying in touch and dialoguing with you about the 

issues that we are going to continue to see develop as we go 

through this process. Thank you. 

Chairman LINCOLN. Senator Conrad. 

Senator CONRAD. Thank you, Madam Chairman. 
45 

First of all, let me say this is an excellent panel, really five outstanding witnesses. All of you have contributed to the work of this 

committee in a very positive way and we appreciate that. 

What strikes me about this conversation is transparency, as I see 

it, is necessary but not sufficient. In the case of AIG, as my memory serves me, one of the big financial houses wanted to go from 

ten-to-one leverage to 30-to-one leverage. They knew there was inherent risk in moving to that kind of leverage. If everything is 

going well, you make a lot more money. If things are not going 

well, you lose a lot more money. 

And so they recognized the need for an insurance product and 

they went to AIG and convinced them to write such insurance 

products, and AIG saw a gift horse and said, oh, yes, we can make 

a lot of money on this deal. What they forgot about is having the 

resources to cover against the down-side risk of these transactions. 

And when the down- side risk occurred, here we go. Taxpayers 

were the ultimate funder of the liability. That, we cannot permit 

to happen again. 

Dr. Johnson, thank you for your testimony. I think it was very 

clear and compelling. 

The one thing that strikes me is, as legislators, we have got an 

obligation to differentiate those places that are contributors to systemic risk, those that are not, and somewhere in between, because 

if we try to impose a regime on everyone and some of them are in 

a different category, we won’t get anything done. I would say that 

to you. That is the trick of legislating. 

As I listened to the first four witnesses, I have high regard for 

Congressman English. He was the Chairman of a subcommittee in 

the House Agriculture Committee when I chaired the comparable 

committee on this side. I can tell you, he is one of the smartest and 

tough negotiators I ever dealt with around here. No, I said that 

wrong. I said smartest and toughest. Toughest and smartest. 

[Laughter.] 

Senator CONRAD. When I listen, he is a smart guy. I don’t think 

those kind of transactions contribute much to systemic risk. 

Mr. Schloss, as I listen to your description, that does not strike 

me as in the same category at all of what the hedge funds were 

doing or what certainly AIG was doing, which I believe was criminal. I believe some of those people ought to go to jail. 

Mr. Boling, I thought you were very persuasive. Mr. Boling, you 

used a phrase there on exemptions. You used language there about 

hedging transactions. I would like to go back and have you just 

reread that specific language, where you were proposing an exemption. For those who are hedging transactions, people who are hedging real business transactions, I think is what you were getting at, 

rather than, you know, speculation. Do you have that? Can you—— 

Mr. BOLING. I believe I can identify—I believe it was under the— 

was it at the beginning of my remarks or at the end where we were 

making recommendations? 

Senator CONRAD. You were making recommendations and you 

were proposing where you would draw a line with respect to exemptions—— 

Mr. BOLING. Yes. 
46 

Senator CONRAD. and you were describing that. I don’t have all 

the words. I wrote down, hedging actual transactions. 

Mr. BOLING. Yes. I believe the language is Southwestern believes 

the solution to these problems would be to provide an exemption 

from the clearing and margining requirements for bona fide hedging transactions where at least one party involved is a company 

that produces, owns, and sells, or purchases and consumes, the 

commodity, and the transaction is directly related to managing 

commodity pricing risk inherent to that company’s operating activities. We believe these transactions are easily distinguishable from 

those that are purely speculative, which appears to be the primary 

focus of the proposed derivatives legislation. 

Senator CONRAD. In a nutshell, to me, you summed it up with 

that statement. And it seems to me that that is something we have 

got to try to capture here, and I would ask Dr. Johnson—and Mr. 

Billings, thank you for your testimony. It was very clear. You are 

in a situation, you don’t have a lot of cash. Whether it is $500 million or $250 million doesn’t make that much difference. The point 

is, you would have to, if you are running it through clearing, come 

up with additional money that you would have to finance somehow. 

Clearly, that would add to cost. 

Dr. Johnson’s point is, yes, but there is risk in any of these, and 

certainly there is risk. I mean, we have to acknowledge that, not 

nearly the risk in these transactions that I see in what I saw hedge 

funds doing, what I saw AIG doing. Would you acknowledge, Dr. 

Johnson, there is a difference between what some of the hedge 

funds were engaging in, what AIG was engaging in, and what 

these companies have been doing? 

Mr. JOHNSON. Well, first of all, Senator, there clearly is a difference, and to echo Chairman Lincoln’s comment earlier about 

how to construct an exemption, I was trying in my testimony to 

warn against creating hard and fast rules that then we might say 

lawyers can navigate around and leave us where Senator Chambliss talked about with AIG, which was with a disaster that was 

never the intention of the committee in the year 2000. So what I 

would recommend is to see someone like Chairman Gensler as the 

referee, as the arbiter. 

The gentleman sitting to my right, Mr. Billings, talks about the 

various cash flow problems, and no one has any intention to drastically impair his business. That is not healthy. So the kind of exemption that he would seek is something that someone with expertise who could differentiate between a hedge fund and his type of 

risk and his type of business structure could make a determination 

that it was in the public interest. 

And while—how would I say—I characteristically am more in 

favor of rules that are clearer than in allowing regulatory interpretation, because, as you know, the nature of who is in that regulatory chair changes, and that creates a volatility that these men 

probably don’t appreciate. 

Senator CONRAD. Sure. 

Mr. JOHNSON. But I think in this instance, because of the complexity of derivative markets, I would opt for the exemption arbiter, 

if you will, to be the Chairman of the CFTC. 

Senator CONRAD. All right. Thank you. My time has expired. 
47 

Chairman LINCOLN. Senator Lugar? 

Senator LUGAR. Dr. Johnson, let me go back to the question I 

raised with Chairman Gensler about AIG and the insurance that 

was being sought by the banks that had finally packaged together 

all these residential loans. I gather from your testimony, AIG could 

have charged a higher fee to these banks for the insurance they 

were seeking. If I listened to you carefully, AIG was offering a subsidy, of sorts. The subsidy ultimately was paid for by the American 

people in the collapse of the system. In other words, by offering 

these derivatives for lower costs than really the type of insurance 

that was required, and AIG not having the resources to pay, should 

they collapse, this huge subsidy, ultimately caused this catastrophe 

that we continue to go through with all of the rescue efforts. 

In this particular situation, how do we require AIG to charge the 

proper amount? In other words, where is the market? Is this something up to Mr. Gensler, as the referee, saying you are underpricing this derivative. It ought to be much higher, or all of us are 

likely to have systemic risk. 

At the other end of the situation, as you listened to the other 

four on the panel, you said you understand they have cash problems, and these are small situations in comparison to what we 

were talking about with AIG. Trying to find an exemption as to 

who comes underneath this—after all, someone at AIG or some 

equivalent company may be clever enough, to sneak underneath 

the tent with those who are being exempted now. You are saying 

perhaps the response we ought to have is not to try to do in legislative language the precise exemption, but to have Mr. Gensler or 

somebody like this as a referee, or as an arbitrator, who has the 

expertise, who has the staff, who says, ‘‘no, you folks really don’t 

qualify as agriculture cooperatives or natural gas firms or so forth. 

You are something else.’’ 

I am just trying to figure this out, because I like your idea that 

somebody pays ultimately. If we had no exemptions, then the small 

businesses here today could say, ‘‘if we are going to hedge on behalf 

of our customers and so forth, this is going to cost money. We don’t 

have a whole lot of cash. It ultimately has to be passed on to the 

customers.’’ But if it is not passed on to the customers and risks 

are taken, then the customers are getting a subsidy in terms of 

what they ought to be paying to begin with for the natural gas or 

for whatever else they are buying for. 

We are more sympathetic with householders and so forth as customers than we are with large entities who are getting the subsidies from AIG. I am curious, how do we construct this legislation 

so that the subsidy, if it is there, and is clear, how do we extract 

the subsidy out of it? Because at the end of the day, why, none of 

us really are thinking of subsidy. We are thinking now of the bailouts of the stimulus package, and how are going to pay for it forever, even if we are very small individual consumers given the billions and trillions that we are borrowing. That is going to be the 

ultimate result of this if it is not done right to begin with. 

How do you spot the subsidy and how do you make sure it is not 

a part of the process? 

Mr. JOHNSON. You ask me easy questions. 

[Laughter.] 
48 

Mr. JOHNSON. I think that in the case of AIG—I will start with 

where you started—what was fundamentally missing was an equivalent of a supervisor or a regulator that understood that they were 

providing what I will call mirage capital. They were providing assurances through the credit default swap market to the other ‘‘too 

big to fail’’ institutions, as well as others, but it was a mirage in 

the sense that they were not setting aside the resources to be able 

to meet those claims contingent on an event called a default. 

Senator LUGAR. Is this fallibility, then, of the President or whoever appoints these regulators? How do we know that the person 

that is appointed is going to be bright enough to understand? 

Mr. JOHNSON. Well, that was the next stage, which is the first 

piece you need is for them to be regulated. We have insurance companies that are dealing in these actuarial odds regarding property, 

casualty, life insurance, and other things, earthquakes and what 

have you. You are never sure what the odds are. The past is not 

always prologue, and we had an extreme outlier in this episode. 

The second—but at some level, somebody should have been 

there, calling on AIG and saying, how come you are paying out bonuses and recording this as income and paying dividends and not 

provisioning for these losses? What was called a credit default 

swap to avoid regulation was actually credit default insurance. 

The second thing to diminish that is that I would stop uninsurable risks. People shouldn’t buy insurance on something they don’t 

own. So that is what fomented the speculation there. 

With regard to designing the structure and where the subsidy 

lies, what they call the lemon socialism, the downside is ours and 

the upside is private, it really has been the architecture of the 

banking system and the acknowledgement that the spillovers from 

the banking system can harm the real economy that has been the 

basis for that safety system. So I would return to that ‘‘too big to 

fail’’ regime and the design of the systemic regulator. 

With regard to your specific task—and what I think is really fascinating is that the interaction between derivatives and ‘‘too big to 

fail’’ is going to put you into a joint venture with the Banking Committee, and keeping the derivatives simple, transparent, supervised, and provided for with capital and margin will diminish the 

extent to which they can spill onto the banks. And one thing I 

might recommend in legislation is over in the Banking Committee 

in their ‘‘too big to fail’’ determinations, they are going to speak 

about tier one financial institutions, or systemically significant institutions, and I would very much consider— and I would be interested in each of your thoughts on this— if you go to a tier one classification, your legislation could have an exemption which says—or 

have a provision which says no one is eligible for an end user exemption in any subsidiary, affiliate, branch, or whatever who has 

been designated a systemically significant institution, and that way 

you would avoid this attempt to drive, as I call it, the jet plane 

through the loopholes of language. 

Senator LUGAR. Thank you very much. 

Chairman LINCOLN. Thanks, Senator Lugar. 

Thanks to all of you all for joining us, and I think, actually, Senator Chambliss has one more question. 
49 

Senator CHAMBLISS. Yes. I have one for Mr. Schloss. I want to 

drill down on one particular issue that is important. That is, you 

indicated in your written testimony that your interest rate swaps 

are over-the-counter customized derivatives, and some have 

claimed that interest rate derivatives are an example of standardized swaps that can easily be cleared. Could you describe why you 

consider these to be customized as opposed to standardized? 

Mr. SCHLOSS. Great question, Senator. There are really three 

pieces, or three types of interest rate derivatives that we will use. 

The biggest one by far is the securitization swaps, which are done 

between the securitization trust and the counterparty from the 

standpoint of protecting the underlying investor. And a great example is when we do a retail contract to consumers, those are typically done on a fixed-rate interest rate. We package hundreds of 

thousands of those together and sell them to investors that are 

typically floating rate buyers. So we have to hedge that interest 

rate, but they are amortizing structures and they are very unique 

to the underlying asset class. So that is probably over half of our 

interest rate derivatives are done in that form. 

The other piece is when we do a long-term debt instrument and 

we try to fund the business longer than our assets, so if we do a 

ten-year bond, our assets are three years, we need to match those 

terms of the bond specifically in order to get FAS 133 hedging 

treatment. So those have to be very unique from the standpoint of 

matching the exact same terms of the bonds. 

The other piece of our interest rate hedge are more common from 

the standpoint of taking floating rate to fixed on a more standardized basis. 

Senator CHAMBLISS. And again, I am assuming from your earlier 

answer, even if you had an exemption, there is no problem with 

you disclosing all of the financial transactions involved in those derivatives—— 

Mr. SCHLOSS. No problem whatsoever. 

Senator CHAMBLISS. —to the CFTC. Thank you. 

Chairman LINCOLN. Well, thanks again to the panel. You, as the 

members have said, you have been most helpful to us in the deliberations. We appreciate your testimony and certainly would ask 

that you not go too far because we would love to be able to continue 

the conversation as we move legislation through the committee and 

have deliberations on how to do a good job putting this together. 

I would remind people that we are going to have a second hearing on December 2nd, Secretary Geithner will be on our first panel 

there. 

Thank you all for joining us. We appreciate it. We look forward 

to continuing to work with you to solve the problem. Take care. 

[Whereupon, at 12:25 p.m., the committee was adjourned.] 

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