[House Hearing, 110 Congress]
[From the U.S. Government Printing Office]

                      ON CITIES, TOWNS, AND STATES



                               BEFORE THE


                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION


                             MARCH 12, 2008


       Printed for the use of the Committee on Financial Services

                           Serial No. 110-99

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                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma                  KEVIN McCARTHY, California
                                     DEAN HELLER, Nevada

        Jeanne M. Roslanowick, Staff Director and Chief Counsel

                            C O N T E N T S

Hearing held on:
    March 12, 2008...............................................     1
    March 12, 2008...............................................    91

                       Wednesday, March 12, 2008

Blumenthal, Hon. Richard, Attorney General, State of Connecticut.    17
Dillon, Terry, Chief Executive Officer, Atlas Excavating, on 
  behalf of the National Utility Contractors Association.........    52
Dinallo, Hon. Eric R., Superintendent of Insurance, Department of 
  Insurance, State of New York...................................    16
Jain, Ajit, Chairman, Berkshire Hathaway Assurance Corporation...    65
Levenstein, Laura, Senior Managing Director, Global Public, 
  Project and Infrastructure Finance Group, Moody's Investors 
  Service........................................................    69
Lockyer, Hon. Bill, Treasurer, State of California...............    43
McCarthy, Sean W., President and Chief Operating Officer, 
  Financial Security Assurance, on behalf of the Association of 
  Financial Guaranty Insurers....................................    67
Newton, Mark, President and Chief Executive Officer, Swedish 
  Covenant Hospital..............................................    50
Reeves, Hon. Tate, Treasurer, State of Mississippi...............    48
Sirri, Erik R., Director, Division of Trading and Markets, U.S. 
  Securities and Exchange Commission.............................    11
Vogtsberger, Martin, Managing Director and Head of Institutional 
  Brokerage, Fifth Third Securities, Inc., on behalf of the 
  Regional Bond Dealers Association..............................    71
Wiessmann, Hon. Robin L., Treasurer, State of Pennsylvania.......    45


Prepared statements:
    DeLauro, Hon. Rosa L.........................................    92
    Blumenthal, Hon. Richard.....................................    94
    Dillon, Terry................................................    98
    Dinallo, Hon. Eric R.........................................   103
    Jain, Ajit...................................................   109
    Levenstein, Laura............................................   115
    Lockyer, Hon. Bill...........................................   132
    McCarthy, Sean W.............................................   140
    Newton, Mark.................................................   195
    Reeves, Hon. Tate............................................   198
    Sirri, Erik R................................................   202
    Vogtsberger, Martin..........................................   210
    Wiessmann, Hon. Robin L......................................   217

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    Chart entitled, ``Sectoral Breakdown of Moody's-Rated Issuers 
      and Defaulters: 1970-2000..................................   224
    Washington Post article, ``Tax-Exempt Funds Yield a 
      Surprise,'' dated March 11, 2008...........................   225
Bachus, Hon. Spencer:
    Statement of the Municipal Securities Rulemaking Board.......   227
Kanjorski, Hon. Paul E.:
    Letter from the Government Finance Officers Association, the 
      National Association of Counties, the National Association 
      of State Auditors, Comptrollers and Treasurers, the 
      National Association of State Treasurers, the National 
      League of Cities, and the U.S. Conference of Mayors, dated 
      March 11, 2008.............................................   244
    Letter to the House Ways and Means Committee from various 
      Members of Congress........................................   253
Shays, Hon. Christopher:
    Letter to former SEC Chairman Christopher Cox from Hon. 
      Spencer Bachus, dated January 23, 2007.....................   258

                      ON CITIES, TOWNS, AND STATES


                       Wednesday, March 12, 2008

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:04 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, Waters, 
Watt, Sherman, Moore of Kansas, Capuano, McCarthy of New York, 
Lynch, Scott, Green, Cleaver, Moore of Wisconsin, Perlmutter; 
Bachus, Royce, Shays, Feeney, Hensarling, and Campbell.
    The Chairman. The Committee on Financial Services will come 
to order.
    I am pleased to see that the representative of the 
Securities and Exchange Commission passed security. I don't 
know about your exchanges, but you're okay on security.
    And this is as important a hearing as we are going to have.
    Earlier this year, when we began to talk about a stimulus 
package, there was a lot of pressure on Speaker Pelosi, who had 
been one of the leaders in the recognition of the need for a 
stimulus, to get into infrastructure, and it's a very widely 
supported goal among Members of both parties, especially many 
    The speaker quite courageously, and I think thoughtfully, 
said no, we're going to do something that can be spent quickly 
and infrastructure doesn't meet that, but she gave her 
commitment that we would be working on improving infrastructure 
financing, because there is an admitted need in this country 
for bridges and highways and schools and sewer facilities, 
etc., all of which have to be paid for by the public sector.
    Today, we are here playing defense because due to grievous 
misjudgments made by elements in the private sector, the public 
sector in this country now faces unfair excessive costs as they 
try to meet those infrastructure needs.
    We are all, in America, capitalists today. We understand 
the value of the free market system. People on this committee 
understand the importance of the financial system as 
intermediaries in our system.
    But those who have argued that the private sector should be 
left essentially alone, and that public sector intervention 
would do more harm than good, have nowhere been more decisively 
refuted than in the situation in which the municipalities and 
the States find themselves.
    In yesterday's Washington Post, and I ask unanimous consent 
to put this into the record, Alan Sloane notes that he 
discovered to his surprise that a tax exempt money market 
mutual fund is now paying a higher absolute rate than a 
Treasury fund, even though the one paying the higher rate is 
taxable and the Treasury fund is tax exempt.
    Here is the situation: Municipalities have been unfairly 
treated by the private sector for some time. I will be giving 
out this chart, ``Sectoral Breakdown of Moody's Rated Issuers 
and Defaulters: 1970 to 2000.'' Under ``General Obligation,'' 
there it is. Number of Issuers: 14,775. Number of Defaults: 0. 
Despite that, there has been pressure on issuers to buy 
    Now, to begin, the insurance for full faith and credit 
general obligation bonds has been unnecessary.
    Requiring general obligation issuers of full faith and 
credit bonds, where the taxing power of the entity stands 
behind them, requiring them to buy insurance is, as I said 
yesterday--it occurred to me, and I was fond of it, so I will 
say it again--like asking a vampire to buy life insurance, 
because nobody is going to ever have to pay off.
    The problem is that in this situation, the bloodsucking 
seemed to have gone in the opposite direction, because the 
vital substance of these municipalities has been sucked away, 
and what happened?
    Mr. Callen from Ambac had an interview in the Wall Street 
Journal, and he said, well, the premiums paid by the 
municipalities were golden. They were AAA and better sources of 
revenue, but it was kind of slow growth.
    So what some of these insurance companies did was, they 
took the insurance premiums from issuers that shouldn't have 
had to pay premiums in the first place, and invested them in 
sophisticated instruments, and did it badly, and as Mr. Callen 
said, when we got into CDO squared, we were a little beyond 
what we understood.
    What happened? These private investments went bad. And who 
is paying the price? Among others, the municipalities.
    It is an odd situation in which issuers are now being 
charged higher interest because they are hurt by their 
insurers. They are better propositions than their insurers.
    We have had problems with rating agencies. There have been 
two scales. Rating agencies have had a separate scale for 
municipalities than for corporates.
    Why? Because if you rated municipalities, and again, I'm 
talking particularly about general obligations, although you 
can see it's a pretty good ratio with some of others as well, 
if you rated municipals the same way you rated corporates, it 
would be boring, because everybody would get super duper triple 
A. And how do you make a business out of saying everything is 
perfect? So they get subjected to this separate rating system.
    This is not a minor technical matter. The cost of schools 
and highways and sewer treatment facilities and bridges and a 
number of other important facilities now costs the public more.
    There are areas where we have made mistakes in the public 
sector. This is an area where the private sector, left to its 
own, has made the great bulk of mistakes and the public sector 
is paying the price.
    So I want to send a message very clearly from myself as 
well as, I believe, the majority of this committee, and I have 
also had some bipartisan conversations on this. This has to be 
    We cannot tolerate a situation in which elected officials 
trying to build schools and comply with mandates from the 
Federal Government to improve the treatment of sewage, to build 
highways, and to do other important things are charged much 
more than they should be charged, partly because of an initial 
undervaluing of their credit, and then compounded, adding 
injury to injury, by the fact that people took their premiums, 
and since they never had to pay any of those claims, had all 
the money to go invest, invested it badly, and inflicted damage 
on the public sector.
    I have to say, I mean, I am not one of those who invokes 
religion in the public sector. People are free to do that, but 
it is not something that I generally do. But for me, it is the 
time of year when we celebrate the exodus from Egypt, and I 
have to say now as an elected official who is a partner in 
governance with the cities and States, I want to say to the 
private sector that has enmeshed them in this set of 
circumstances in which they're being unfairly penalized when 
they sell bonds, ``Let my people go.'' This is a time to cut 
them loose. And if we have to part the ``red ink sea,'' we will 
do that.
    But I do not think we can tolerate, as a society, this 
situation where people are being required to pay so much.
    Now, this has not been a traditional Federal role. 
Insurance has been State regulated. That is why we have one 
Federal regulator here and two very able State regulators. But 
that is not going to continue. I think the Federal Government 
has to be a partner with regulators such as we have here who 
have been stepping forward.
    And we intend to listen today, but I am submitting an 
invitation now: Give us solutions to this. We are determined, I 
believe the majority of this committee, and I think the whole 
Congress, to deal with this.
    Let me make one other statement, now. It's a personal 
statement. But we spent a lot of time on the ethics rules 
yesterday, and it was very controversial.
    I will say this. I intend fully to comply with the ethics 
rules, so let me take this occasion to tell everybody, no, I'm 
sorry, I can't have dinner with you and we can't have 
breakfast, and if you see me sitting there, you have to leave 
me alone to read the paper and not buy me a cup of coffee, and 
that's the new ethics rules, and I can live with them.
    But I plan today to buy some municipal bonds from the State 
of Massachusetts. I wish they weren't being forced to pay such 
a high rate, given that they are for me double tax exempt, but 
given that they are, me as well as anybody else ought to buy 
them, and I really say that, my advice to people, I don't 
usually do this, you get a great buy in municipal bonds right 
    I didn't want to say this before the hearing. I don't want 
to be accused of sort of influencing, you know, and buying 
    But this is an intolerable situation. Some things are more 
complex than others. This one is clearcut.
    We have to have a situation in which those numbers--I'm 
told there has been since 2000 one default in a general 
obligation. It was a default where they were not in full 
compliance with the covenants, and in fact nobody lost any 
money, everybody got paid off. So we have to restore some 
rationality here.
    And this is one where the market has got it wrong. The 
market is a wonderful instrument, and it creates a lot of 
wealth, but it's not a perfect instrument, and this is a case 
where if this doesn't get corrected, we will have to intervene.
    The gentleman from Alabama.
    Mr. Bachus. Thank you, Mr. Chairman. I appreciate you 
holding today's hearing on the ongoing turmoil in the bond 
markets and the problems that cities and counties are facing in 
trying to issue, refinance, and price their municipal debt.
    This is the committee's first hearing on the $2.6 trillion 
municipal securities market. We did have a hearing on bond 
insurers, at which time Mr. Dinallo testified, and I'd like to 
acknowledge at this time both the difficult and important work 
that you're doing with the monoline bond insurers in preserving 
liquidity, which is very important to our municipal bond 
market, as we all know.
    Our hearing unfortunately comes at a time when that market, 
which I think the chairman, by his chart showed, has 
traditionally been known for its safety, security, and rate of 
return, presently is under severe stress.
    Constituents in my congressional district are being 
particularly hard hit by the crisis. In my home county of 
Jefferson County, Alabama, the breakdown of the secondary bond 
markets has forced the county's interest rate payments on local 
sewer bonds to skyrocket from 3 to 10 percent, a more than 
triple increase.
    Most of these are revenue bonds, and these higher costs 
will ultimately have to come out of the pockets of the users, 
the water and sewer system there, or there will have to be a 
reduction of services, or, as I said higher fees.
    We need to act swiftly and responsibly to determine whether 
there's anything we can do as a Congress to get these markets 
on track before too much more damage is done, although at the 
same time, I'm not sure what that will be, other than perhaps 
the SEC's proposal.
    I would respond to the chairman that I'm not as convinced 
as he is about not having a need for bond insurance.
    I could see that, on occasions when you have an entity like 
maybe the port authority or you had a well-known entity, a 
State, but when you are dealing with particularly local 
governments or water boards that investors know nothing about, 
I would think that the insurance would almost be necessary to 
market the bonds.
    Local governments across the country are facing a hostile 
environment in which to raise funds, with new issues plummeting 
and many municipalities forced to pay significantly higher 
interest rates to attract investors.
    The downgrading of bond insurers and the constriction of 
the credit markets as results of the subprime mortgage problems 
have forced banks and hedge funds to dramatically reduce their 
municipal debt risk exposure.
    I think this reduction of risk we're seeing in our economy, 
of people not willing to take as much risk, is probably a good 
thing. There has been too much risk in the past, and people are 
repricing that risk, and I don't think there's anything 
unnatural about that.
    The extent of its impact on the municipal bond market, the 
municipal securities market, is however a problem, which I am 
still hopeful may be transitory.
    As the economy picks up and liquidity improves, I think 
we'll see a lot of improvements in this regard, although I'm 
not sure we'll ever see the auction rate securities come back.
    But the resulting collapse of the secondary bond markets 
has further impaired the ability of local governments to manage 
their debt exposure, and this is a serious problem.
    Until the recent crisis, the secondary bond markets had 
ample liquidity, but auctions have been failing since the end 
of last year as the investment markets pulled back.
    On March the 5th, Bloomberg reported 536 unsuccessful 
auctions in the market for floating rate securities. That is a 
failure rate of 68 percent of all auctions.
    According to Bank of America, the rate of failures reached 
87 percent on February the 14th, and has since ranged from 61 
to 69 percent. These are sobering statistics.
    Fortunately, this committee does have possible solutions 
available to better protect both local governments and 
    SEC Chairman Cox presented a vision last year for 
increasing integrity, transparency, and accountability in the 
municipal securities market. Chairman Cox's initiative would 
require meaningful public disclosures that are current and 
understandable with a full accounting of all material 
information at the time of a new municipal bond issuance.
    Chairman Frank has agreed, at my urging, to invite Chairman 
Cox to appear before the committee later this year to formally 
consider his proposal.
    In addition to considering Chairman Cox's proposal for 
greater disclosure and transparency, the committee will also 
need to examine the dual credit rating scale used by the rating 
agencies that appears to arbitrarily assign municipalities a 
higher risk rating than other debt issuers.
    This creation of risk perception has forced many 
municipalities to purchase insurance that, as the chairman 
said, may not have been otherwise necessary.
    More business is created for the rating agencies who 
analyze the bond insurers' offerings, but it's the local 
taxpayers who end up paying the increased cost.
    Not surprisingly, it has been the non-municipal debt that 
rating agencies severely under-assessed for risk, with 
investors in secondary markets absorbing huge losses as the 
result of a fundamentally flawed system of risk analysis.
    In conclusion, Mr. Chairman, the municipal bond markets, as 
you said, finance the development of roads, bridges, sewer and 
water systems, hospitals, universities, and other critical 
infrastructure upon which local residents rely.
    Efficient and liquid municipal finance markets are critical 
to keeping our economy moving forward and must be restored to 
working order as promptly as possible.
    Thank you.
    The Chairman. We have a vote; I believe it is to table the 
notion of requesting a privilege. But I think we can get some 
more opening statements in, and it usually takes about 20 
minutes. So I apologize, but I think that will be the only vote 
for a while.
    The gentlewoman from California, the chairwoman of the 
Housing Subcommittee.
    Ms. Waters. Thank you very much, Mr. Chairman.
    The need to hold this hearing reflects the growing impact 
of the subprime and home mortgage loan market crises across the 
domestic and global economy.
    Hedge funds, along with large commercial and investment 
banks, continue to take hits to their balance sheets as a 
result of their substantial investments in mortgage-backed 
securities of uncertain or clearly declining value.
    As a result, they have been flooding the market with bonds 
in a rush to sell assets. This has had a dual effect.
    First, demand for bonds has dropped over the past few 
weeks, putting upward pressure on yields and the cost of 
borrowing for bond issuers such as municipalities.
    Second, it has meant that large commercial and investment 
banks have not been willing to step into their traditional role 
as a backstop in the municipal auction rate securities market 
when these auctions have begun to fail.
    This has, of course, had disastrous results for municipal 
bond insurers, which have seen their costs of borrowing 
    Simultaneously, the municipal bond market has been 
operating under the spectre that one of the bond insurance 
agencies could face a ratings downgrade.
    Currently, many municipal bond issuers purchase bond 
insurance primarily to take advantage of the higher rating the 
insurance confers on their bonds, even though the risk of 
default, even on municipal bonds rated below AAA, is 
statistically insignificant.
    Without access to bond insurance or revisions to the 
municipal bond, we need a way out of this bind if the 
absolutely essential $2.6 trillion tax exempt municipal bond 
market is to return to smooth functioning.
    I look forward to hearing from today's witnesses, including 
my former colleague, now the treasurer of the State of 
California, Mr. Bill Lockyer, about potential solutions to this 
    I yield back the balance of my time.
    The Chairman. The gentleman from Alabama has a unanimous 
consent request.
    Mr. Bachus. Thank you, Mr. Chairman. I ask unanimous 
consent to submit for the record a statement from the Municipal 
Securities Rulemaking Board.
    The Chairman. Without objection, it is so ordered.
    The gentleman from California, Mr. Campbell, is now 
    Mr. Campbell. Thank you, Mr. Chairman.
    I agree with many of the comments the chairman made in 
opening this hearing, but I think there's another factor at 
work here, which I hope we, in all three panels today, will 
discuss, and I hope the chairman would consider, as well.
    Clearly, the risk premiums that exist now on municipal 
bonds, and I have personally taken some of the same actions in 
my home State of California that the chairman just described in 
his of Massachusetts, that risk premium appears to be 
unjustified at the moment.
    But I do believe that there are risks out there which we 
can't tell what they are, and that's part of what is driving 
    In my home State, there have been several bankruptcies of 
governmental units, including my home county of Orange, in the 
last couple of decades, and there is at least one city 
municipal bankruptcy being threatened in California today.
    And these bankruptcies and these fiscal problems usually 
occur from one of two things. Either they take their investment 
funds and invest them in risky investments which then don't 
turn out, and the municipality or civic organization loses 
money, or, and this is the great threat, I think, going 
forward, there is substantial, in many cases, unrecorded and 
unfunded liabilities largely for pension and health care and 
other union obligations, which are out there, which appear to 
be completely unsustainable, but they're not shown on the 
    So I'm a CPA, and this kind of stuff, as you can imagine, 
drives me nuts, and so one of the things I think we need to 
look at in this whole process is transparency, so that 
investors and potential bond insurers can see what is really 
going on in that municipality.
    If there are substantial pension obligations, they first of 
all shouldn't be unrecorded, and they probably shouldn't be 
unfunded, but they absolutely should be disclosed and discussed 
and put in as part of the risk factor.
    And my concern is that we do have potential failings of 
municipalities down the road if we don't start exposing and 
dealing with all these things now.
    And so I do think that that is a part of the equation that 
I hope this panel and the subsequent panels will discuss and 
that we will have a part of the conversation, Mr. Chairman.
    The Chairman. Thank you.
    We have 5 minutes left, so we are going to break and vote. 
When we come back, we will have an opening statement from the 
former mayor of the city of Somerville, my colleague from 
Massachusetts, Mr. Capuano, and then we will get to the 
    The Chairman. Please be seated. We want to move as quickly 
as we can.
    Please be seated.
    We will resume, and we will now turn to the gentleman from 
Connecticut for 3 minutes for an opening statement.
    Mr. Shays. Thank you very much, Mr. Chairman.
    I want to align myself with the basic thrust of your 
comments. I might take off a little of the rough edges, because 
you're pretty emphatic about it. But I do buy into your 
    And I do want to say, in particular, I want to welcome the 
attorney general from Connecticut, Richard Blumenthal. I read 
his entire statement, and I agree with it almost in its 
entirety. I commend it to all the members to read.
    And I just, I am ending up, for me, what I wrestle with is 
why shouldn't--why not just have the Federal Government insure 
    Because in the end, it's really going to be the same 
taxpayers, and it does seems to me, however, small the fee is, 
the premium is, it seems like a premium that one should not 
have to pay, number one.
    And number two, given that the insurance companies are the 
ones that have gotten themselves in trouble, it seems unfair 
to, basically, the taxpayers, that they have to pay the 
    I almost feel like municipalities should insure insurance 
companies, rather than insurance companies insure 
    I thank you for the time, and I welcome all our witnesses, 
but particularly my colleague from Connecticut.
    The Chairman. Thank you. And from time to time, we in 
Massachusetts are glad we have our suburban neighbors to clean 
up our act a little bit. As long as we're in general agreement, 
it's okay.
    The former mayor of the city of Somerville, the gentleman 
from Massachusetts, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman.
    Mr. Chairman, I want to start my remarks by stating right 
from the outset that I do not enter this issue as a neutral 
observer. I am a former mayor. I am not neutral on this issue. 
I have very strong opinions. And I think what I'm about to say 
is on behalf of every single mayor and governor and government 
official who currently serves and doesn't have the freedom to 
say what I'm about to say.
    The monolines started to back up some questionable 
municipalities. They're no longer monolines. They're now bond 
insurers. And they really use the municipal and State bonds to 
shore up their other risky investments. They're completely 
upside down.
    But I don't want to blame them alone. They're in business 
to make money. They can't do it alone.
    Even though the State municipal bonds are the safest 
investments in bonds you can make, they need the help of the 
credit rating agencies to basically hold hostage cities and 
towns and States across this country until they pay them a 
    Now, they call those ransoms nice little things, like fees 
or bond enhancements, but it's still a ransom: ``Until you pay 
us, we're not going to rate you in the way you deserve, the way 
your taxpayers deserve, and when we do, we're still going to 
shake you down, because we're going to make you get bond 
insurance that you don't need.''
    To me, as I've said before, and I will continue to say, 
this is nothing more than legalized extortion.
    But even they didn't do it alone. They had the help, or the 
acquiescence, if not the active help, the benign neglect of 
most Federal regulators, and many State regulators. They sat by 
and said, ``Well, what's the big deal?''
    This fell particularly heavily on poorer cities and towns 
who didn't have the negotiating power of some of the larger 
bond issuers.
    The rating agencies, the bond insurers, and those compliant 
regulators effectively, in my opinion, stole billions, if not 
trillions of taxpayers' dollars to put in their pocket.
    When people in my position, my former position, were not 
able to hire police, firemen, teachers, or sanitation workers, 
or to improve their cities and towns, we had to pay them their 
ransom, their extortion. And I will tell you that, 
unfortunately, I'm not--there are mixed emotions.
    I'm not happy we're here today, because my friends who are 
still at the city and town level are still being held hostage 
and are being hurt even more today because of the neglect and 
the malfeasance and misfeasance of people who have been doing 
this for years.
    I can't tell you how much I will do to do my utmost to make 
this legalized extortion stop, to give the cities and towns and 
States their due, to let their taxpayers have their money back, 
and to stop this stealing from people whose money you don't 
deserve to have.
    Mr. Chairman, I yield back whatever time I might have, 
unless you want to give me another 5 minutes.
    The Chairman. No, because it's going to take 3 minutes for 
Mr. Shays comment on you now. But that's fine.
    Mr. Shays. I would align myself with my colleague--[off 
microphone]--rough edges.
    Mr. Capuano. Mr. Chairman, without the rough edges, they 
don't hear it.
    The Chairman. And you wouldn't be yourself.
    The Chairman. The gentleman from Pennsylvania, the chairman 
of the Subcommittee on Financial Institutions, who has been 
taking the lead for us in dealing with some of the related 
issues here, such as the rating agencies, and who had a related 
hearing on this, Mr. Kanjorski.
    Mr. Kanjorski. Thank you very much, Mr. Chairman.
    Mr. Chairman, I want to congratulate you for convening this 
hearing of the full committee on this important subject, 
because certainly it is a major part of what I think is a 
crisis of confidence in the credit markets of not only the 
United States, but indeed, the world.
    We must recognize the seriousness of the problem and the 
need for fast, pragmatic solutions. Even though some of these 
solutions will not always work, they must be tried, because the 
failure to try and the failure to stem the whirlpool that is 
occurring out there in the credit world could be catastrophic 
for the American economy and the world economy.
    I think it is so important in the bond insurance market to 
see the ramifications of what can happen when there is a 
disqualifier of losing a certain rating that is necessary and 
required of trustees of various funds who are purchasers of 
municipal bonds, that it can destabilize. Although a very small 
part of the premium world of insurance, the municipal bond 
market is a $2.6 trillion market, and it could be tremendously 
destabilized by the credit crunch that is prevailing today.
    But I may say, it does not only apply to the municipal bond 
market. It applies to the student loan bond market. It is now 
starting to spread into so many other fields. So we have a 
metastasizing that is occurring in the credit markets of the 
    So this committee has the chief jurisdiction to put the 
effort forward to make the stops, and for that, I am pleased to 
see that we are going to have the treasurer of the Commonwealth 
of Pennsylvania, Robin Wiessmann, as one of our witnesses. I 
look forward to her testimony.
    And I look forward to what we are going to turn out here as 
a product, eventually.
    I ask, Mr. Chairman, that two letters, one to the Ways and 
Means Committee and the second letter from the Governor of 
Finance Officers Association, the National League of Cities, 
and the National Association of State Treasurers, the National 
Association of State Auditors, Comptrollers, and Treasurers, 
the National Association of Counties, and the U.S. Conference 
of Mayors be submitted and entered in the record with 
suggestions of some of the things that can be done.
    Thank you, Mr. Chairman.
    The Chairman. Without objection.
    And with the consent of the committee, I'm going to go to 
one more speaker, because we have another former mayor of one 
of our large cities, and we did want to get his input, the 
gentleman from Missouri, Mr. Cleaver, and then we'll go to our 
    Mr. Cleaver. Thank you, Mr. Chairman.
    I want to associate myself with the statements of Mayor 
Capuano, both in tone and content.
    I served as the mayor of the largest city in the State of 
Missouri, and in the State of Missouri, State law prohibits any 
city or municipality from spending into the red, which means 
that every city in the State, at the end of its fiscal year, is 
debt free with regard to overspending. There's no deficit 
    And so we don't have either a debt, other than the bonds 
that we are paying on, but we have no debt, and no deficit.
    And in spite of that, we end up getting the roughest 
treatment from the bond insurance companies, and yes, the 
roughest treatment comes to the cities, even if they have the 
highest rating possible.
    We can't get a AAA bond rating in Kansas City, Missouri, in 
spite of the fact that we have AAA status.
    Now, the State can get it, the State of Missouri can get 
it, but the municipalities--neither St. Louis nor Kansas City 
can get it, and we don't have any deficit spending.
    Wilbur Ross, the billionaire, just bought $1 billion in 
municipal bonds. This is not some stupid guy playing the stock 
market. He knows what he's doing.
    And if we can invest in municipal bonds $1 billion, and 
then have J.P. Morgan and Chase Company and Lehman Brothers 
recommend that debt, it seems to me that it's safe.
    We have had one little piece of a default in almost 4 
decades, 4 decades, and then we still get ripped off.
    And so I'm here today--and I'm not going to leave--because 
I want to hear every single word that comes out of your mouths 
with regard to what is happening to cities, because I want to 
be able to translate this, not only to my home of Kansas City, 
but to the U.S. Conference of Mayors and the National 
Conference of Black Mayors, with whom I used to be affiliated.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    I would point out that there are some seats there. I know 
they say ``staff,'' but if staff comes, you can get up. If 
people want to sit, they should sit.
    We will now go to the witnesses, and we will begin, and as 
I said, this is an area--we have to vote, but we'll get in one 
statement, and I think that we'll be okay after this for a 
    Historically, this has been State regulated, but there is a 
Federal role, as well. So we will begin with Erik Sirri, the 
Director of the Division of Trading and Markets of the SEC. He 
is a regular witness, and we appreciate, Mr. Sirri, your 
continued cooperation with us.
    Please go ahead.


    Mr. Sirri. Chairman Frank, Ranking Member Bachus, and 
members of the committee, thank you for inviting me here to 
testify on behalf of the Securities and Exchange Commission 
about the current turmoil in the municipal bond markets, its 
impact on cities, towns, and States, and the Commission's 
    There's no question that the recent dislocations in the 
muni bond market have created unanticipated hardships for 
municipal issuers, and in some cases, have dramatically 
increased borrowing costs.
    Today, I'd like to discuss some of the current problems in 
the bond markets, with particular attention to problems that 
have developed in the market for certain short-term municipal 
securities known as auction rate securities.
    Auction rate securities are municipal bonds, preferred 
stocks, and other instruments with interest rates or dividend 
yields that are periodically reset through auctions, typically 
every 7 to 35 days.
    Auction rate bonds are usually issued with maturities of 30 
years, but maturities can range from 5 years to perpetuity.
    Auction rate securities were first developed in 1984, and 
the market has grown to over $325 billion of securities, with 
State and local governments accounting for about $160 billion 
of the outstanding auction rate debt.
    As you know, hundreds of auctions for auction rate 
securities issued by municipal issuers recently have failed to 
obtain sufficient bids to establish a clearing rate.
    Consequently, issuers who decided to use this type of 
financing to obtain favorable short-term interest rates are 
instead paying what are known as ``penalty'' interest rates, 
which can be as high as 20 percent, at least until the next 
auction. In addition, investors cannot sell their holdings 
through the auction process until the next successful auction.
    The Commission has received many requests to address this 
market dislocation from municipal issuers, conduit borrowers, 
dealers, and investors.
    For a variety of reasons, including the current lack of 
dealer support for auctions and frequent auction failures, many 
holders of auction rate securities now want to sell them. 
Recent downgrades of bond insurers have caused many holders to 
desire to sell bonds insured by companies who recently have 
been downgraded or soon may be.
    In addition, many holders of bonds insured or supported by 
the credit of insurers whose ratings have not been threatened 
may now also wish to sell, which may be due to a general loss 
of confidence in the muni auction rate market.
    As a result of these factors, among others, we understand 
that sellers of muni auction rate securities have often far 
exceeded buyers in auctions, resulting in auction failures.
    Estimates of the value of recent failures for auctions of 
muni auction rate securities exceed $80 billion.
    Prior to the current disruption in the auction rate market, 
participating dealers retained to solicit bids for the auctions 
generally supported the liquidity of the auction rate 
securities by placing proprietary bids as necessary in order 
that the auctions not ``fail,'' and disclosed the fact that 
they might do so.
    However, in recent weeks, for a variety of reasons, 
including liquidity concerns and uncertainty surrounding the 
monoline insurers, participating dealers have ceased to 
intervene proprietarily in auctions, with the result that 
hundreds of auctions have failed.
    Due to these failures, and the resulting higher borrowing 
costs, we understand that some muni issuers and conduit 
borrowers would like to, and in many cases have begun the 
process to convert their auction rate bonds into variable rate 
bonds backed by letters of credit or other type of credit 
enhancement or fixed rate bonds.
    However, the ability to convert auction rate securities may 
be slowed due to heavy demand for such substitute instruments 
and further overall concerns about the credit markets.
    We also understand that certain participating dealers may 
be unwilling to accept bids from issuers in an auction because 
of questions about the scope of a settlement in a past 
enforcement action.
    The Commission has received several requests to consider 
ways to assist issuers with an orderly exit from current market 
    On February 28th, the leadership of this committee asked 
the Commission to clarify for the market as quickly as possible 
that issuers can, within the bounds of applicable laws and 
regulation, participate in auctions for their own securities. 
The staff is developing approaches to providing further 
guidance in this area in light of market developments and the 
    Due to the severity and immediacy of the auction rate 
market decline, and the implication for investors, Commission 
staff is developing appropriate guidance to facilitate orderly 
markets and continue to protect investors.
    This guidance would be designed to clarify that, with 
appropriate disclosures and compliance with certain other 
conditions, municipal issuers can provide liquidity to 
investors that want to sell their auction rate securities 
without triggering market manipulation concerns.
    This may also have the secondary effect of easing the 
substantial financial burden on muni issuers and conduit 
borrowers from unusually high interest rates.
    It should also facilitate an orderly exit from this market 
by municipal issuers and conduit borrowers who seek to do so.
    We hope to have such relief prepared by the end of this 
    The Chairman. Mr. Sirri, I'm going to interrupt, just 
because this is a very important subject.
    When you use the phrase ``municipal'' there, is that in the 
broadest sense of the other tax exempts, as well?
    Mr. Sirri. Yes.
    The Chairman. Thank you.
    Mr. Sirri. Enhanced transparency would be a key component 
of this guidance, as it is to the auction process.
    For example, if municipal issuers or conduit borrowers want 
to bid in auctions, they must disclose, among other things, 
certain facts related to price and to quantity.
    Of course, issuers have to comply with their disclosure 
obligations under the Securities Act of 1933 and the Securities 
Exchange Act of 1934, as applicable.
    Staff anticipates that this guidance should remove any 
hesitancy on the part of broker-dealers and auction agents to 
allow municipal issuers to bid at auction.
    Of course, this guidance cannot modify the terms of 
contracts between buyers and sellers or contracts between 
issuers and bondholders, and so municipal issuer bidding could 
only take place if consistent with the terms of the auction 
rate securities as reflected in their respective indentures and 
governing instruments.
    The guidance does not address the amendment of the terms of 
any auction rate securities in accordance with their governing 
    I also should note that the Commission staff is closely 
monitoring the potential effects of the developments in the 
muni auction rate securities markets on mutual funds, including 
money market funds, and on closed-end funds.
    Tax-exempt money market funds, with $465 billion under 
management, are key investors in muni securities and part of 
the $3.3 trillion money market industry. Money market funds 
typically have as their investment objective the generation of 
income and the preservation of capital.
    To help meet this objective, they are required by Rule 2a-7 
under the Investment Company Act of 1940 to limit securities in 
which they invest to high-grade, short-term instruments that 
the funds' advisers determine also involve minimal credit 
    As part of this rule, Rule 2a-7 employs NRSRO ratings to 
determine whether funds may purchase a security.
    As much as 30 percent of the muni securities currently held 
by tax-exempt money market funds are supported by bond 
insurance issued by monoline insurance companies. Some of the 
securities may be eligible for investment by money market funds 
because of the insurance that monoline insurers provide.
    Given the importance of money market funds as investors in 
muni securities, some have raised questions regarding the 
effect of credit rating conditions in Rule 2a-7 on the funds' 
ability to purchase and hold muni securities affected by 
downgrades of monoline insurers.
    The Commission staff recognizes that a significant 
downgrade in a monoline insurer's rating could result in the 
securities becoming ineligible under Rule 2a-7 for investment 
by money market funds.
    The credit rating conditions only create a ``floor'' below 
which funds may not invest, however, and constitute one among 
several risk-limiting conditions of Rule 2-a7.
    Since its adoption in 1982, this rule has continued to 
serve the purposes that the Commission intended. It is notable 
that, despite the current liquidity crisis, money market funds 
and their sponsors have not asked the Commission for any 
changes to the risk-limiting conditions of Rule 2a-7, including 
the credit rating floor.
    The Chairman. Mr. Sirri, I'm going to stop you here. We're 
going to come back to you. This is a very important subject. I 
don't usually do this, but I don't want you to be rushed. This 
is very important, so we are going to go vote, and then we will 
come back.
    I have nothing to do until 3 o'clock. I hope the rest of 
you don't, either, because we're going to do this hearing. It's 
as important a subject as we get.
    I appreciate the clarifications you have already given on 
this. We will be back as soon as we can.
    The Chairman. Let's take our seats.
    Sit down, please.
    We will resume, and Mr. Sirri, I apologize for interrupting 
you, but this is a hearing where we don't want anyone to feel 
rushed, so please continue where you left off, and would other 
people please take their seats and be quiet.
    Mr. Sirri, go ahead.
    Mr. Sirri. I believe we were talking about Rule 2a-7, so 
let me continue.
    The Chairman. Yes.
    Mr. Sirri. There are also some other possible effects that 
a significant downgrade in a monoline insurer's rating could 
have on money market funds. The municipal securities they hold 
include variable rate demand notes and tender option bonds that 
typically have liquidity backstops, or puts, that are provided 
by a financial institution.
    The Chairman. Excuse me. Hold on.
    All right, let's get in here in a hurry or get out. I'm 
sorry for this, but we're not going to add to the inescapable 
problem of the votes, so people, either stand or sit.
    Mr. Sirri, I apologize. Please continue.
    Mr. Sirri. These liquidity features serve to provide a 
source of cash to satisfy redemptions by fund shareholders, and 
also to shorten the muni bonds' maturities and make them 
eligible investments for a money market fund.
    A significant downgrade could terminate the put, and thus 
result in money market funds holding long-term securities that 
would be inappropriate for funds maintaining a stable net asset 
    The Commission staff has been in regular contact with fund 
management companies, which are aware of these risks and have 
taken steps intended to protect funds, and thus fund investors, 
from the loss of these puts.
    Now that I've discussed mutual funds and other investment 
companies as investors in municipal auction rate securities, 
it's important to also understand that closed-end funds are 
also issuers of a particular type of auction rate security, 
called an auction rate preferred security. The general loss of 
confidence in the auction rate market has spilled over into 
this market, and many of these auctions have failed, as well.
    There are important differences in how auction failures 
have affected municipal and closed-end fund issuers.
    Although closed-end funds also issue auction rate 
securities to obtain financing, they use the financing to 
leverage their investment in portfolio companies in order to 
seek higher dividends for the funds' common shareholders.
    Also, although the funds have been paying penalty rates to 
their preferred shareholders to compensate them for the 
illiquidity, the rates generally are much lower than those paid 
by muni issuers.
    One effect of the respectively lower penalty rates is that 
the rates are generally not as detrimental to fund issuers.
    As long as the amount they pay to their preferred 
shareholders through penalty rates is less than the returns 
they generate from converting the proceeds of the financing, 
the underlying mechanics continue to work as intended and the 
funds have positive carry.
    This does not mean that the current status of auction rate 
preferred securities will continue, however.
    Although the closed-end funds pay the preferred 
shareholders the penalty rate, failed auctions mean that these 
shareholders may have to continue to hold the securities, which 
are perpetual, or attempt to sell them in a secondary market at 
what may be a heavy discount.
    Preferred shareholders have pressured closed-end fund 
companies to find solutions to the failed auctions, and the 
companies have recently begun to contact the SEC's Division of 
Investment Management for guidance.
    Due to the special issues raised by the auction failures in 
the auction rate preferred securities market, such as those 
raised by the fiduciary duties owed by funds to both preferred 
shareholders and common shareholders, the staff guidance in the 
muni auction rate securities market may not extend to the 
closed-end funds issuers.
    The Division of Investment Management continues to asses 
requests for guidance, however, and to monitor the developments 
in this area closely.
    Thank you for the opportunity to testify in front of you 
today. I'd be happy to answer any questions you may have.
    [The prepared statement of Mr. Sirri can be found on page 
202 of the appendix.]
    The Chairman. Thank you, Mr. Sirri. That was very useful, 
and we will get back to it.
    Next, we will hear from Eric Dinallo, who is the 
superintendent of insurance for the State of New York.
    Mr. Dinallo.


    Mr. Dinallo. Thank you, Chairman Frank.
    It's good to be back before you. It's an honor to testify. 
And I thought I would take a few minutes and update this 
committee on what has gone on since I testified in front of the 
subcommittee just about a month ago.
    I think substantial progress has been made in seeking 
company solutions in the monoline or bond insurance industry in 
helping facilitate market stabilization and beginning to define 
the future regulatory landscape for these activities.
    I hope our role reflects a proactive approach by the 
regulator here. I think that's the proper approach here. I 
think we need to be facilitators, we need to be catalysts when 
we see something that has to be jump-started.
    I think doing nothing here would have been a grave error, 
and although we took some risk by getting involved, I think 
prudential risk in times of what has been described as a crisis 
is better than doing nothing, which is still a choice of doing 
something, you're just not actually doing anything, you're 
instead accepting the status quo.
    We began a three point plan in the fall. The three point 
plan consisted of:
    Number one, bringing new capital and capacity into the 
monoline insurance area;
    Number two, to begin to begin to deal with and prepare for 
chronically distressed bond insurers; and
    Number three, to begin to rewrite the rules of the road and 
develop new regulations and statutes in this area.
    I thought I would just take a minute and go over where we 
are in those three areas, and that will be a description of at 
least what our role has been to date.
    First, in the area of capacity and capitalization, we have 
created or facilitated conditions that have attracted 
approximately $7 billion of capital injections and a total 
overall capacity, including the Berkshire Hathaway offer of $12 
billion in total that have helped insure the ratings of the two 
publicly traded companies, kept the market fairly competitive, 
and helped to stabilize that market.
    Those activities include inviting Ajit Jain of Berkshire 
Hathaway into the industry and helping facilitate the licensing 
of Berkshire Assurance Corporation in record time, and working 
with the other States in facilitating the licensing by 30 
States in approximately a month, also receiving a bid on the 
municipal book for FJIC, Ambac, and MBIA from Berkshire.
    Second, we approved and facilitated MBIA's capital raising, 
which led to $2- to $3 billion of additional capital into that 
    And as you're well aware from when I was here last time, we 
fostered and helped create the consortium behind Ambac that 
resulted in the capital raise that occurred just about a week 
    We worked with Wilbur Ross and spent a lot of time speaking 
with private equity, and between his purchases of bonds and 
injection in Assured, there's a billion into the system, and we 
will be seeking out other capital, including other private 
equity on investors' sovereign wealth, and some bulge bracket 
investment banks have sought licensing through the Department 
of Insurance.
    In the second category, concerning dealing with distressed 
companies, we have done the capital raising activities that we 
just discussed--
    The Chairman. Mr. Dinallo, we're going to run out of time, 
and that's in your written statement. If you could get to some 
of the forward-looking things, I think that might be more 
    Mr. Dinallo. Okay.
    The forward-looking ideas here are to facilitate 
reinsurance and support of the markets, to engage in the 
possibility of a rehabilitation or restructuring of the 
companies that would be done by the government, including the 
good book/bad book scenarios that have been talked about, the 
Citibank concept of an optionality built into such a situation.
    I have also spoken to this committee about the potential 
for a Federal backstop, which we could discuss, and I would 
explain what that would look like, if you have questions about 
    The third category is around new regulations. We have done 
a serious research and discussion with experts of what new 
regulations would look like. We have drafts of those.
    Basically, we're considering the requiring of more capital 
to be engaged in this industry, the elimination of certain 
guarantees of structured products, such as CDO squares, which 
you have discussed, the possible segregation of the businesses 
of structured municipal and possibly project finance, and 
finally, the prohibition of insuring credit default swaps and 
other instruments that cause events of default or acceleration, 
which is generally not regarded as a good thing for insurance 
book, because you can't manage the claims if the worst-case 
scenario arises.
    And on the reinsurance, the Federal backstop, because I 
know that you're seeking solutions that Congress could 
facilitate, my view is that a lot of the offers that we have 
received from private equity and from Mr. Buffett are 
essentially reinsurance transactions, and it seems to me that 
the Federal Government could rather inexpensively, in a certain 
sense, guarantee and reinsure the municipal sides of these 
    That would actually, ironically, free up capital to put the 
structured side in the best possible position going forward, so 
their policyholders were as protected as possible, and for the 
Federal Government, it would at least be just a backstop. It 
would be simply a guarantee against the book that, as your 
statistics showed, was already proven to be a fairly safe bet.
    [The prepared statement of Superintendent Dinallo can be 
found on page 103 of the appendix.]
    The Chairman. Thank you, Mr. Dinallo, and we're going to 
pursue some of these. That's exactly what we were hoping for.
    Next, we will hear from Attorney General Blumenthal.


    Mr. Blumenthal. Thank you, Mr. Chairman, and members of the 
    Thank you, first of all, Mr. Chairman, for having this 
hearing, and I want to join in saying how important it is, and 
say how pleased I am to be here with Superintendent Dinallo, 
who is doing great work, as the regulator in New York, in 
attempting to address many of these problems, and working very 
closely with the folks at Berkshire Hathaway Assurance 
    I am also pleased to be here with them, and particularly 
with Ajit Jain, and want to say that I'm going to try to avoid 
the rough edges, but I feel as deeply as anyone in this room 
about the cost of this system on the towns and cities and 
States around the country.
    The cost of insuring these bonds per year is about $2.3 
billion. That's money paid by everybody in this room and the 
people whom you represent.
    They are costs that are unnecessary and avoidable. They 
fall directly on taxpayers, and they inhibit infrastructure 
improvement and upgrading. That is exactly what the chairman 
mentioned at the outset of this proceeding.
    The cost is not just on them, but it's also on investors, 
because the current dual system, the double standard that 
disadvantages municipalities and inhibits their use of public 
debt, is one that also confuses investors. It makes the market 
less transparent, and it restricts competition.
    I have an investigation ongoing into potential violations 
of law. This system is not just unfair and unwise as a matter 
of public policy; it is also, in how it has been perpetuated 
and sustained, quite possibly illegal under our Federal and 
State antitrust laws.
    My investigation is ongoing and active. It focuses on how 
this system started and how it was perpetuated, and I will say 
to you that our findings so far are very, very deeply 
    We know there was a concerted effort among supposed 
competitors to maintain the dual rating system and kill 
attempts at reform.
    There were discussions among bond insurers aimed at 
retaining this dual rating system, when at least one of the 
rating agencies suggested modifying or eliminating it.
    And the net effect of these activities was clearly to 
maintain prices and prop up the market for bond insurance.
    This misuse of market power and restraint of competition is 
plainly anti-competitive and anti-taxpayer, causing direct harm 
to municipal and State customers--
    The Chairman. Mr. Blumenthal, hang on one second.
    That is another motion to adjourn. I do not plan to make 
that vote. I would advise other members, if you want to go and 
come back to do so, but I am going to keep going.
    Go ahead, Mr. Blumenthal.
    Mr. Blumenthal. Thank you. I will be brief, and I would ask 
that my full remarks be included in the record, but just to 
    The Chairman. Don't feel rushed. This is too important. You 
know, the chicken scratchings can go on without us.
    Go ahead.
    Mr. Blumenthal. Thank you.
    We have found no legitimate business reason for this dual 
standard by itself. Just as one example, a triple B municipal 
bond, according to Moody's ratings, is one-fourth as likely to 
default as a triple A corporate bond. A municipality in that 
situation either has to buy bond insurance--and as I have 
described, we have documented how discussions perpetuated this 
system, involving the bond insurers as well as the rating 
agency--or a municipality has to pay higher interest rates for 
the debt that is issued.
    Either way, taxpayers and citizens pay more, $2.3 billion 
more every year to insure that debt than they would otherwise. 
And this dual rating system, so far as we know, has no 
justification. I will be interested in whether any is presented 
later in the day when you have at least some of the rating 
agency representatives before you, and I would suggest, with 
all due respect, that you put this question to them and request 
them to justify how the dual system can possibly be justified.
    Let me just close by saying that I am here to urge you to 
abolish it and prohibit it. It should have been prohibited in 
the 2006 Act, the Federal Credit Rating Agency Reform Act. In 
my view, arguably, it was prohibited because it is an unfair 
and anticompetitive practice. But, obviously it should be 
specifically prohibited under law, and I would ask that the 
United States Congress do that. It may well result, in any 
event, from voluntary actions by the rating agencies themselves 
because it is so contrary to the globalization of our credit 
markets that eventually it will probably fall of its own 
weight. But in the meantime, we are paying billions of dollars 
in unnecessary and unwise cost.
    Thank you, Mr. Chairman.
    [The prepared statement of Attorney General Blumenthal can 
be found on page 94 of the appendix.]
    The Chairman. Thank you. This has been very useful and very 
much in point. Mr. Sirri, let me express my appreciation, and 
please convey to the Chairman and the other members of the 
Commission, few though they may be these days, that what you 
have done has been very responsive, and the way you have 
explained it has been very helpful.
    On Rule 2a-7, I guess what you're saying is that nobody has 
raised that of course. What we would hope to do is fix the 
ratings, or have the ratings fixed so that it wouldn't come 
into play, that people would not be--and I agree with you. I 
don't want to accommodate an inequitable and inaccurate rating 
    Mr. Dinallo, you listed some very useful things we could do 
in terms of the regulations that would apply. Obviously under 
the current system in America, those are within the 
jurisdiction of the States. But would there be any 
Constitutional obstacle to our also doing them under Federal 
jurisdiction? I know many of us are reluctant to have 
preemption, but in some cases, there is some argument for 
uniformity. We could do a kind of regulation that would not 
preempt the State's ability to go beyond that.
    And Attorney General Blumenthal, I would ask you as well. 
Would there be any Constitutional or other obstacles to our 
doing some of those things as a floor, for example, on the 
national level? Mr. Dinallo?
    Mr. Dinallo. I don't think there would be any 
Constitutional objection to it. I am not such a staunch 
objector to a Federal regulatory system for insurance. But I 
would point out that I am fairly against an optional Federal 
charter, because I think you end up with a regulatory arbitrage 
    The Chairman. We're not talking about that.
    Mr. Dinallo. But I think you could have--here you could 
have sort of a Federal floor on this. It is true, as 
Congressman Kanjorski said, that it was sort of shock and 
surprise at how much of the national and the global financial 
system was hung off of this small part of the market.
    The Chairman. This is separate from the optional Federal 
charter. I mean, that's--
    Mr. Dinallo. I think it's a place where the Federal 
Government should inquire, because it turns out that a big part 
of the economy is driven by this kind of insurance, which--
    The Chairman. You know, and there's direct context, 
connection here. We talk about--and we have all acknowledged 
State and local spending on various infrastructure projects is 
impacted. As you know, there is an intermix of Federal and 
State and local funding there. So, Federal transportation 
policy can be frustrated by excessive charges at that level.
    Attorney General?
    Mr. Blumenthal. I see no Constitutional objection. I think 
that preemption, as you know, Mr. Chairman, is very, very 
frequently used. I think as a State law enforcer, I would 
object to any preemption of State enforcement authority if 
there are--
    The Chairman. That's a very good point.
    Mr. Blumenthal. --criminal or even civil prohibition.
    The Chairman. Well, in fact, let me just underline that. 
Yes. It would be a grave error for us to try to do that because 
even if we were to promulgate some rules, we have no Federal 
enforcement entity for insurance, and it would be--that's a 
very good point that you would have them work together.
    Mr. Blumenthal. Exactly, Mr. Chairman. And I think that for 
all the reasons that Mr. Dinallo has stated so well, there 
might be an argument that more of the bond insurer or that 
aspect of the insurance industry might be federalized so far as 
rules of--
    The Chairman. Let me ask one last question here, and that 
is on the backstop. I would say, the gentleman from 
Connecticut, Mr. Shays, had mentioned that, and others had. And 
I know--and Mr. Buffet has also talked about doing that, and we 
are very pleased to have Mr. Jain here and we have talked to 
Mr. Buffet, and we will deal with that later. And there may be 
a context in which Mr. Buffet and the Federal Government are 
equally attractive alternatives, or maybe these days he might 
have the edge in the minds of some in terms of financial 
    But what about--what are your initial reactions, the two of 
you, to a Federal financial reinsurance?
    Mr. Dinallo. I think I'll just tell you what I learned 
along the way that would maybe inform. When we explored the 
possibility that the investment banks would engage in a 
consortium, one of the very first ideas was whether it would 
just be a line of credit, essentially a backstop. And I thought 
the rating agencies would give it very high credit without 
actual capital being put up. I assume that the Federal 
Government's guarantee would be even more highly rated.
    And so what you do is you put in place a reinsurance 
situation where you essentially guarantee a certain amount of 
capital in case there are defaults. What that does is it lets 
the insurance company release a lot of capital that it was 
otherwise holding to cover on the municipal side. And that 
would go towards a situation that would elevate the ratings 
across the board, including on the structured side.
    But if you were in a situation where you wanted to not have 
to do damage to other policies or establish the worst-case 
scenario of a good bank, a bad bank, that would be 
extraordinarily helpful to releasing capital and coming out of 
what looks like a liquidity crunch situation.
    The Chairman. Attorney General?
    Mr. Blumenthal. I support it strongly, and the reason is 
very simply that it represents the best hope for achieving the 
goal that you stated at the start of the season, to let our 
people go, to free the towns and cities from a tax, a secret 
tax, that is now imposed by Wall Street. Let's face the facts. 
Except for Orange County and a couple of other aberrations, no 
towns and cities and certainly no States cease to exist. They 
continue in business. They almost never default, and the 
Federal Government as a backstop would eliminate the tax that 
currently towns, cities, and States have to pay.
    The Chairman. Well, I appreciate that. I am going to finish 
with this, but it strikes me that as you talk, you mention 
Orange County. There have been a couple of bumps. But in every 
case, it seems to me it was because the issuer got cute and 
tried to get into investments that were over its head, and 
there would be nothing stopping us if we were to do this from 
saying, here, we are the backstop for full faith and credit, 
general obligation, plain vanilla. And if you start getting 
fancy, then you're out of our loop. And I think that might save 
a lot of grief as well.
    Mr. Blumenthal. Mr. Chairman, if I can just add, there is 
another aspect of this whole issue legally, which is that right 
now, the States often function as backstop for the towns and 
    The Chairman. Yes.
    Mr. Blumenthal. In fact, one of the first actions I did as 
Attorney General was to go to bankruptcy court and prevent the 
city of Bridgeport from declaring bankruptcy and defaulting on 
its bonds. So the States will not let--
    The Chairman. Right. Because of the negative effect it 
would have had on everybody else, and in fact the bondholders 
were held harmless, and that may be another problem.
    Mr. Blumenthal. Exactly.
    The Chairman. I would just--we have been joined by our 
colleague from Connecticut, and I just wanted to tell him we 
have been talking about his--the idea he and I had talked 
about, about the backstop, and we will be pursuing that 
    The gentleman from Alabama.
    Mr. Bachus. I thank the chairman. When it comes to the 
municipal securities market, we have functional regulators and 
they focus on different things. The Fed focuses on one part, 
and the insurance commissioners focus on another. You have all 
this, you know, obviously the SEC on broker-dealer matters. But 
are there gaps in that regulation, or is there a need for 
some--for better coordination?
    Mr. Sirri. Well, Congressman Bachus, I think our chairman 
has gone on the record and said that he feels that disclosure, 
in particular in the municipal area, could be stronger. I think 
when you compare disclosure in the municipal area to, say, 
disclosure in the corporate area, some immediate gaps arise. 
And Chairman Cox has stated very clearly, I think he sent 
material up to the Hill that details this very precisely, that 
disclosure could be improved both in its accuracy, its 
completeness, and its timeliness.
    I think issues like accounting, accounting protocols, and 
the independence of certain accounting standard setters, could 
also be improved, so as to bring disclosure and the quality of 
information that investors get more in line with the standards 
we have in the corporate area.
    Mr. Bachus. Okay. Attorney General Blumenthal, you proposed 
prohibiting different rating standards for the corporate 
municipal bonds. Would you--what about municipalities that may 
not be able to pay? I mean, how do you--and would you run 
through that? And you may--exactly how that would work?
    Mr. Blumenthal. Well, I think that goes to the heart of the 
idea, and is obviously a very profoundly significant question. 
I'm not proposing that every municipality be rated triple A, 
but simply that the criteria and the standard be the same for 
the municipality as it would be for the corporation. And there 
are a lot of corporations that don't deserve triple A ratings 
    So, if a municipality has insufficient reserves, is not 
taxing enough, in fact is uncreditworthy for some reason, then 
it should be judged accordingly, but it should be judged by the 
same standard, not a dual standard, but a single, unified 
standard known either as a global standard or the corporate 
standard, call it what you will, it should basically be the 
same for corporations as it is for municipalities, but not give 
either of them a break.
    Mr. Dinallo. May I comment for just a second on the triple 
A rating issue? I think that it's important to note what I 
think the bond insurers did here, because I heard the words 
``extortion,'' etc., and I do think that there is a serious 
issue that has to be looked into. But they did perform one 
important function for small municipalities, water authorities, 
school boards, and hospitals. They essentially commoditized 
their bonds such that they could be traded in and out of triple 
A rated situations.
    Now we know that money markets, Fidelity, even hedge funds 
have triple A tranches that have to be filled with a triple A 
rating. So what I think they essentially did was they took sort 
of a statistical gamble, which has paid off, in that they did 
not in fact examine every one of those authorities. And the 
rating agencies themselves did not rate every one of those 
    I think I would just challenge a bit that it would be a 
very difficult and inefficient and expensive system that would 
have every single municipality, authority, school board, 
hospital, or museum rated by the rating agencies, or, in fact, 
examined by the insurers. But across the whole board, as 
Chairman Frank showed, the gamble is a good, safe gamble, it 
seems. And I think that was the system.
    I don't want to comment on the investigations, but it seems 
to me that approach was a way to let all municipalities come to 
market and be commoditized in a positive way so they could be 
held as they deserve statistically triple A rated. If you begin 
to pluck, cherry-pick out of that system, and I'm sure it's 
perfectly appropriate for Florida and California to want to do 
this, you will create a situation where the lesser 
municipalities, so to speak, which still statistically are good 
bets, will find it much more difficult to come to market. So 
the system will have to change dramatically.
    Mr. Bachus. It does appear to me at least that there has 
been a double standard or there have been harsher ratings on 
the municipal securities, when as you say, they have 
historically been much safer. So, you know, I have not 
understood that.
    Let me ask you this. What about the difference--we talked 
about general obligation bonds. What about revenue bonds? Is 
there a different approach to them? Since the revenue bond is a 
dedicated source. And Mr. Sirri or--well, anyone who would like 
    Mr. Dinallo. I would say that one thing you'll learn this 
afternoon is I would seek answers from the rating agencies 
about how they would go about doing the ratings. I know it 
sounds kind of tautological, but the point is, I think that 
what municipalities do doesn't necessarily fit well into sort 
of the box checking that the rating agencies usually look for. 
They don't have a revenue stream. They don't have a return of 
equity. They don't have capital. It's a very different way of 
judging. What they have is a very secure promise on a risk, on 
an obligation. And I agree with those who have commented it may 
be the most secure of all.
    But in fact I would urge the rating agencies not to 
necessarily rate them the same as corporates, because they're 
not going to be able to be rated the same as corporates. They 
don't have the same structure. But they need to be 
statistically brought in line with corporates under their own 
system. And I think the SEC will work, I assume, with rating 
agencies to try to produce that and get better standardization.
    Mr. Blumenthal. And I would just add, if I may, sir, that 
there are ways to minimize the tasks of the rating agencies in 
looking at either revenue bonds or the school boards and the 
resource recovery agencies or all of the municipal agencies and 
simply say or ask, are there backstops, for example, State 
guarantees? And in many instances, it will be found that the 
reason why their default rates are so low is the State will not 
let them default, period. End of story. And so why are they 
paying insurance? Well, they're paying insurance because they 
have been bludgeoned and intimidated into doing it by the 
markets and by the powers that be.
    Mr. Bachus. Mr. Sirri. Thank you.
    Mr. Sirri. I would just point out that there is a 
difference between general obligation and revenue bonds. 
General obligations are backed generally by the taxing, full 
faith taxing authority of the municipality, whereas with 
revenue bonds, the payments are secured by some particular 
project, whatever it is.
    Much that we have been talking about today about the strong 
credit performance of municipal securities is related to 
general obligation instruments. When it comes to revenue 
instruments, the picture becomes somewhat more cloudy. Not all 
revenue bonds are insured. They're not all wrapped. And in some 
cases, there have been performance issues. And in those cases, 
because the performance is secured by a particular project, you 
can't bring in general taxing authority.
    Mr. Bachus. Yes. And there is some political pressure on 
not raising rates or not raising charges. And sometimes a 
Federal judge has to intervene.
    The Chairman. Thank you. The gentleman from Massachusetts.
    Mr. Capuano. Mr. Chairman, I just want to assure the 
gentlemen at the table that though I wasn't here, I was 
watching from a secure location.
    Mr. Capuano. First of all, Mr. Sirri--
    The Chairman. Excuse me, but that's because he was the 
author of the ethics bill. It has nothing to do with you. 
That's why he had to be hidden.
    Mr. Capuano. Mr. Sirri, I want to thank you and the SEC for 
the report you have done. I haven't read the whole thing yet, 
but what I have seen of it, I like, and what I have heard of 
it, I like.
    However, it's only a portion of the problem that I'm 
interested in. Honestly, I cannot believe that anybody is going 
to look me in the eye and tell me that most GOs have to go to 
auction at all. Most of them don't. Most of them--and those who 
do only go to auction because they're bundled with something 
that's junk. And so--I understand what you're saying and I 
don't disagree with you about the ARS. That's a problem. It's a 
serious problem for the country, and I'm glad you're addressing 
it--finally--but you're addressing it. At the same, it's only a 
portion of the problem.
    Mr. Blumenthal, thank you for being smoother than me, but I 
heard you say almost the exact same stuff I said, just nicer. 
And I would encourage you not--
    Mr. Shays. Much nicer.
    Mr. Capuano. And I would encourage you, though, not to wait 
too long for Congress to act. We tend not to act until way too 
late on almost everything. And if we don't do it, I'm begging 
you to please do it and gather your other attorneys general to 
do it. And I'm also asking you, you know, you have all kinds of 
laws. You have RICO laws, you have all kinds of laws you can 
use on cabals that extort people. Basically, that's illegal, 
and it shouldn't be allowed, and if I can help you in any way, 
that's fine.
    I do have some comments, though, Mr. Dinallo, about some of 
the things you just said. I will tell you that in 
Massachusetts, it's exactly as Mr. Blumenthal said, cities and 
towns have gone bankrupt, but not a single bondholder has been 
unpaid because the State steps in and pays directly. Not one.
    And according to--this was just handed to me this morning. 
This is from Moody's. Source: Moody's Investors. GOs, since 
1970, 14,775, not one default. Not my numbers. Moody's. Not one 
default. They didn't say the big ones, the small ones, the tiny 
ones, the ones that don't matter. You could also have things 
like pooling of issuances. If you have some small community 
that needs a fire truck, you pool it with five other 
communities and issue that bond.
    And if the State of New York doesn't want to step in 
behind, fine, then the State of New York should know that their 
cities and towns are going to pay higher rates. But for those 
States that have the foresight and the wisdom and the desire to 
provide the backup for the municipalities, they should be 
allowed to do so.
    Now, I understand that. And I'm not--I'm hoping that some 
of your commentary is not based on the fact that most of these 
people are there. I also want to make one particular point. 
When I asked the credit agencies to rate my city, I paid for 
that. They didn't come in and say, ``Oh, Mike, we're good guys. 
We're just going to do it for you.'' Not only did I pay for it, 
I wined them, I dined them, I bused them around, I begged them, 
I treated them nice. And I had to keep my mouth shut the entire 
time. I don't have to do that any more.
    Mr. Capuano. So let's not pretend that they're doing us a 
favor. And by the way, I also want to be very clear. The dual 
system is a problem, but it is not the only problem. If we had 
a unified system, they would still rate me, my poor city, lower 
than somebody else who is just as likely to pay back their 
bonds. Corporations go bankrupt every day and walk away. Most 
municipalities don't, particularly those who have States that 
back them up. We're not going anywhere.
    So even with a unified rating system, that's all well and 
good, but it is only one step towards the final process. The 
final process is to treat all bond issuers the same, only 
looking at the likelihood of the bondholders being paid back, 
and that is a fair and reasonable standard. Other than that, 
it's extortion, especially when you have only a handful of 
people making those judgments. I guess I must--I don't know if 
I have a question in there somewhere, but they can--
    The Chairman. Let me just, if the gentleman would yield 
briefly, let me just underline what's been said. Several of us 
here were State legislators, my colleague from Massachusetts, 
and were mayors. Here is the point: No State, no State 
legislators, no governor, can allow any one of its 
municipalities to default because then every other municipality 
would pay through the nose. So that is why this is not just 
some charity here; this is self-defense.
    The particular municipality, you might pity the municipal 
workers there. Services may get cut back. Maybe the trash won't 
get picked up. But we can guarantee you, we have all been 
there, you can't do that. Because if any one municipality 
falters, every municipality in that State would pay, and there 
isn't a State governor and legislature in the country who 
doesn't understand that, and that's why the State guarantee is 
such a good one.
    I'm sorry.
    Mr. Dinallo. No. But if that's the absolute truth, which I 
don't dispute, then you could essentially federalize the rating 
systems for municipalities. It wouldn't be an outrageous 
concept to either socialize the rating agencies completely and 
take out the conflict that the Congressman just recited. That's 
    Mr. Capuano. Sign me up.
    Mr. Dinallo. That has been discussed. You could, on the 
municipal side, essentially federalize that rating system and 
say that the U.S. Government through the States, through the 
municipalities will stand behind all those obligations, and I 
assume it would immediately get the equivalent of a triple A 
rating in those asset management situations that I described 
before. I mean, these are not insane ideas. You just described 
a situation where you're essentially saying, as the chairman of 
the Financial Services Committee, that we just don't let those 
fail, which is probably a good situation for the reasons you 
say, you could change the system.
    The Chairman. The gentleman from Connecticut.
    Mr. Shays. I thank you again, all three of you, for being 
here. I was waiting for that vote that never happened, so I 
didn't hear your statement. I did read yours, Mr. Blumenthal, 
and thought it was again quite excellent.
    I'm struck with a number of different reactions. One is, 
again, it seems to me that local municipalities are better off 
than the insurance companies that were rating them. And I just 
find that, you know, rather curious. And we all have stated 
that you're not going to see defaults, which is fairly obvious. 
I moved to the City of Bridgeport that previously had attempted 
to go bankrupt, and the local community rose up in arms, and 
the State said no way are you going to go bankrupt.
    The only value I see--and then I'm struck by this reaction, 
that, particularly with subprime, the rating agencies have lost 
their brand. They are meaningless, because they have been so 
wrong. They were wrong about Enron. They were wrong about other 
companies, but in particular, they were wrong about the 
subprime market. And so I'm even questioning the value of 
rating agencies now.
    The only thing I am struck with is that there is value in 
having a mayor or governor in fact, have to be held--be given a 
grade as to how they're managing the city. But other than that, 
if I was an investor, I'm struck by the fact that the ratings 
are almost meaningless. Tell me why the ratings aren't 
meaningless. Tell me why a businessman or woman in this day and 
age who is investing would pay much attention to rating 
    Mr. Dinallo. I'll just say, I'll just give a general 
response and defer to Mr. Sirri. I think the credit markets 
need some efficient commoditization that they can rely on. You 
cannot take away all ratings. It would I think result in sort 
of credit market chaos. I think that the municipalities are 
potentially a separate situation. But once again, we're dealing 
with thousands and thousands of companies, and it is impossible 
for credit providers, loan givers and investors to make all of 
those individual distinctions, especially when they're running 
a large asset base.
    Mr. Shays. I hear that, and yet they have been so wrong.
    Mr. Dinallo. They have had some--well to be fair, they have 
had some dramatic wrongnesses, there is no doubt. But I bet if 
we look at it statistically, you would actually give them a 
higher grade than just based on some of their largest so to 
speak mistakes. To be fair. I think that they need to stand up 
on those. They need to get over this inference of a conflict of 
interest, but I don't know that I know a better system. That's 
all that I'm saying.
    Mr. Blumenthal. I would just add that I agree, Congressman 
Shays, and I want to thank you, by the way, for your work on 
behalf of Connecticut's towns and cities in infrastructure and 
credit and so forth.
    Mr. Shays. This is called the quid pro quo that we have 
developed. Thank you, Dick.
    Mr. Blumenthal. But I would agree that--I would agree with 
Mr. Dinallo that in theory there is a need for some objective, 
dispassionate, disinterested agency that evaluates whether 
investors will be paid back. In other words, the likelihood of 
default, the creditworthiness of a corporate bond. In the 
municipal situation where there is the kind of State 
    Mr. Shays. See, that's the irony. That's why I wonder what 
is the value of the rating, because they're going to be paid 
back. They can say that a town is well-run or not well-run, but 
in the end, it's almost irrelevant.
    Mr. Blumenthal. And the problem is that they have no 
business telling Bridgeport or Stamford or Boston or any other 
city whether it is being run well. That's for voters to decide. 
All they should be deciding is will somebody who buys the bond 
receive his or her money. And in the case of most cities, 
there's no question that they should be getting triple A 
ratings, and that's why in my view, a single, unified standard 
would accord many of the towns and cities, and States 
obviously, a triple A rating because of those legal guarantees, 
but also because they're not going anywhere, as Mr. Capuano 
said more eloquently than I could. They're going to be in 
business, and they are not going to default when they have to 
go into the market again and again and again in the future.
    Mr. Shays. Mr. Sirri? Thank you, Dick.
    Mr. Sirri. I think it is interesting to realize how credit 
rating agencies came about. Historically, they came about over 
100 years ago when investors sought to understand the credits 
of, at the time, railroad bonds. At that time, people couldn't 
distinguish between the credits, so they looked at credit 
rating agencies to help them with that. So in that context, 
they were a point of efficiency.
    Fast forward to today, I think you have pointed out quite 
correctly some issues with credit rating agencies, whether it's 
Enron or certain issues in the subprime area. But in some ways, 
this has partially been addressed with the Credit Rating Agency 
Reform Act of 2006. To my reading of that Act, what Congress 
thought to point out to us was that we should let the 
competitive markets determine how useful credit ratings are.
    So to what we're talking about there, a few things have 
happened. We have seen new credit rating agencies enter the 
market that weren't there before. We now have nine credit 
rating agencies where we used to have five. If it's the case 
that these credit ratings aren't useful, then one of two things 
will happen, I believe, in the long run: (a) if they don't 
improve, investors will ignore credit ratings. They'll start to 
be written out of the process; and (b) the second thing I think 
will happen is that credit rating agencies have an incentive, 
given this legislative framework, to improve their act. And I 
believe they will over the long run.
    I think you've seen some steps in that direction. They 
won't happen instantly, and there may be a role for entities 
like ourselves, the Securities and Exchange Commission, to step 
in. Our chairman has indicated that we will engage in some 
rulemaking this year I think that's based on some of the things 
we've observed. But there is this framework under which credit 
rating agencies are governed, and I think this will play out 
over time.
    Mr. Shays. This may seem like a stupid question, but 
wouldn't the best investment be the State that has the worst 
credit rating and therefore the highest interest rate?
    The Chairman. Yes.
    Mr. Shays. Yes. I mean.
    Mr. Blumenthal. And--
    Mr. Shays. So you really want to find the worst. I'm sorry, 
    Mr. Blumenthal. You know, just to put a footnote on the 
point that has been made. You know, the elephant in the room 
    Mr. Shays. Don't use elephant. You can use donkey.
    The Chairman. That's right. We're for diminishing the 
number of elephants in the room.
    Mr. Shays. Give him the microphone and you're dead.
    Mr. Blumenthal. You know, it may well be that there are a 
few more credit rating agencies, but let's face the facts. It's 
a highly concentrated market. You have S&P and you have 
Moody's, and they dominate the market. It is a highly 
concentrated market. And in the long run, Mr. Sirri may be 
right, but it's a very long--
    The Chairman. Can I just--if I could interject. And there 
is also the question--Mr. Sirri is right--we generally like 
competition, but there is some question here about where the 
competitive effects are pulling you. Who's paying? And I think 
there is a question here about how the, you know, where the 
competition, in some cases, the way it is now structured, might 
have had a countervailing effect, and that's one of the things 
I hope will be addressed in the rulemaking.
    Mr. Sirri. There is one other point I'd like to make. We 
have been focusing on credit ratings, but I think it's also 
equally important to focus on market prices, or in this case on 
yields. If all municipalities were as we say, and that none of 
them were ever to default, then those bonds should all trade at 
the same yields, but they don't. The market actually, as it 
trades bonds, prices them at different yields. And that's--
    The Chairman. That's right. And by the way, the market is 
wrong. I mean, it's demonstrably wrong. There would still be 
some different yields but probably because you have different 
State tax structures. For me, the double tax and triple tax 
exemptions would give you one market versus another. But I do 
think this is a case where the market clearly doesn't get it 
    Mr. Sirri. It may be. I mean, it's hard to say. I 
appreciate the point you make, since the default rate is so 
low. But not only do they trade at different yields, but as 
credits change, as municipal credits change, you see yields 
widen on those credit--
    The Chairman. Yes, but again, isn't it--that's because the 
credit rating agencies have been giving different views, and 
that may be changing.
    The gentleman from Massachusetts, Mr. Lynch.
    Mr. Lynch. Thank you, Mr. Chairman. I want to thank the 
members of the panel for helping us. Just to pick up on this 
last point, I do agree with Mr. Capuano and the attorney 
general who have talked about the disconnect between the 
corporate bond rating and the municipals. But I think there is 
value in the rating system for the--principally for the second 
reason that Mr. Sirri raised, which is not all municipalities 
are the same. We need that competitive incentive for 
municipalities to get their act together, as Mr. Sirri said.
    And we don't have to look back very far. The whole change 
in GASB 45 where municipalities now had to lay out in their 
financials the long-term pension obligations and health care 
obligations with respect to their employees over the long term, 
we saw some municipalities handle that very well, others not 
well at all. And so now it's a huge burden on some older cities 
with a lot of public employees.
    So I think relative to a measurement between municipalities 
and States and towns, I think that that rating is an important 
factor for investors to consider. But let me just--aside from 
that, would there be a way, rather than this whole tangled mess 
that we have right now with the rating agencies, would it not 
be possible for the Federal Home Loan banks to step in here? 
The chairman has talked about a Federal backstop. Mr. Shays has 
talked about a Federal backstop. What about the Federal Home 
Loan banks issuing, say, a letter of credit on the bond 
rather--in place of I guess or maybe even belt and suspenders, 
on the bonds themselves? Is that something that could work or 
take the--you know, take this rating agency, and at least the 
double standard, mitigate that somewhat?
    Mr. Dinallo. Well, I was about to comment that on the $236 
billion line of credit that the Fed just created, you could in 
a sense take a small sliver of that and stabilize the bond 
insurance industry overnight. I mean, the stress amounts that 
are at issue there, as I testified to the subcommittee, are 
somewhere in the range of $7 to $10 billion. In other words--
    Mr. Lynch. Just on that thought, if you did it, you know, 
nationally, how do you eliminate the moral hazard of backing up 
someone who's not doing the right thing? Unless you do it on a 
municipality-by-municipality basis? And say here's the 
opportunity. You have to prove yourself.
    Mr. Dinallo. Well, the moral--look, the moral hazard 
problem is a serious problem. I think that is why I sort of 
illuminated that everyone assumes that there really is no 
chance of a municipality defaulting on its obligations.
    If that is really true, then the moral hazard is already 
baked into the system, it seems to me, and you might as well 
save all the money on the wrap and the insurance and the 
Federal Government should just sort of de-clear it, so you will 
have moral hazard, but it seems to me you have just kind of 
annunciated today that the moral hazard is already there. The 
markets do not seem to believe it.
    Mr. Lynch. I appreciate that.
    Mr. Dinallo. If you took it away, you would get at a very 
wealthy truth, so to speak.
    Mr. Lynch. Mr. Blumenthal, any thoughts on that?
    Mr. Blumenthal. I think it is an idea that ought to be 
explored. Certainly anything that relieves costs--the Home Loan 
Bank Board may be a good prospect--should be explored; 
    Mr. Dinallo. I think that the chairman's point is well 
taken. I do have one idea. The way that most municipalities 
have gotten into trouble is on their asset liability match and 
sort of investing in situations to try to boost their returns 
and cover their liabilities.
    If you were essentially guaranteeing their backstop and 
then prevented them, because they would not have to go into 
some of the riskier investments, and sort of take out the moral 
hazard of getting into the situations that we described before, 
you might be able to take out what is the most difficult moral 
hazard, which is the risky investment side.
    Mr. Lynch. Mr. Sirri, do you have anything to add to that?
    Mr. Sirri. No, not in particular. I would just point out 
that any time you issue a guarantee like that, you have to 
manage your liability with respect to the guarantee. As people 
have said, that can be difficult.
    I think the moral hazard issue is a serious one and one 
that has to be thought about.
    Mr. Lynch. Mr. Chairman, I yield back.
    The Chairman. Thank you. Let me just note, by the way, as 
my colleague talked about or somebody talked about, the $236 
billion in the Fed. Apparently, the Fed is by statute currently 
prevented from getting into the longer term municipal bonds, 
and we are in the process of writing Chairman Bernanke.
    I think what the Fed has done this week has been neutral, 
but if they can take AAA mortgage backed securities in the swap 
with treasuries, we are talking about something that has a 
higher value even than that.
    We are going to explore that with the Fed as well. I think 
we are all moving in that general direction.
    The gentleman from Texas.
    Mr. Green. Thank you, Mr. Chairman. I thank the witnesses 
for appearing.
    Let me start by asking if we are in essence talking about 
the auction rate securities and available rate demand notes, is 
that the bottom line here that is creating the increase in fees 
and costs that we are seeing? Is that where we are?
    Mr. Sirri. I think my comments earlier were directed to 
relief that we are aiming to providing in the auction rate 
securities space.
    The variable rate demand obligations space still appears 
for the most part to be functioning well, although there have 
been some capacity issues there.
    Mr. Green. With the monoline insurers, when their credit 
rating is downgraded, the cost of their borrowing increases, 
correct? This impacts the bond issuer.
    It does not impact what we will call the notes that they 
already have in place, the debt that is already in place. It 
does not impact their debt service payments.
    It does impact their payments on new acquisitions going 
forward; is that correct?
    Mr. Sirri. One place--in general, I think what you are 
saying, the answer is yes. One place it can have an important 
effect is the relationship in the variable demand space, 
variable demand obligations.
    If there were to be a sufficient problem with an insurer, 
then these bonds could be put back to a backstop provider. 
Again, the bonds are issued. I just want to point out there 
could be a significant effect there.
    Mr. Green. My intelligence indicates that the cost of 
borrowing increases greatly when the credit rating is 
downgraded. Give me an example of what ``greatly'' really 
means, please.
    Mr. Dinallo. You can take a look at what happened to the 
Port Authority, I guess. One week, they were paying 3 to 4 
percent, and when the wraps sort of fell off and the auction 
rate market went haywire, they were paying 18, 19, 20 percent. 
We are talking about the Port Authority of New York and New 
Jersey, which is about as good of a bet as you can reasonably 
imagine, as Chairman Frank said earlier.
    Mr. Green. Permit me to ask you, if you can, to translate 
that into dollars so I can get a more comprehensive 
understanding--3 percent in dollars and the 18 to 20 percent in 
dollars, please.
    Mr. Dinallo. I cannot quite do that for you. I do remember 
that the week that they had to pay, that one week was, I 
think--it might have been just for the day, it was several 
hundred thousand just for that day. I am speculating a little.
    Mr. Green. Did you say several hundred thousand?
    Mr. Dinallo. Yes, I believe so.
    Mr. Green. We have gone from a few thousand dollars to 
several hundred thousand dollars?
    Mr. Dinallo. If you took what Mr. Sirri said earlier, which 
is on the day we were testifying, 600 or so auction rate bonds 
failed, I think across that list, you are into--I am going to 
speculate--it has to be hundreds of millions of dollars for 
that round of bonds.
    Mr. Green. I was going to get to that, the failure at an 
auction, when you have that, then you have the penalty interest 
rate that you have to contend with.
    Is the penalty interest rate contained within some codified 
agreement? How do we find the penalty interest rate? How does 
it get defined in this process?
    Mr. Sirri. When the auction rate instrument is set up, it 
provides for the eventuality that an auction possibly may not 
succeed. When that happens, there is a maximum rate or penalty 
rate that is set. It could be particularly high. We were using 
the example of 20 percent. It might be lower. It might be 6 or 
7 percent. That depends on the design of the instrument.
    It is part of the set of documents and contracts, the 
auction rate agreements, that constitute the papers supporting 
the issue.
    Mr. Green. The auction rate fails because the company, the 
bonding company, no longer has its AAA rating. All this is no 
fault of the municipality?
    Mr. Sirri. The failure here is defined as having more 
sellers of the bond than buyers. If a group of sellers came and 
wanted to sell 100 bonds but there were only 80 bonds that 
wanted to be bought, that auction would fail.
    Mr. Green. I understand. The reason you do not have the 
buyers is because of the ratings the insurer's have; is that 
    Mr. Sirri. That may be one of the reasons, but there could 
be other reasons, too. Let me give you a concrete example.
    When you start to have some failures in this space, you 
could also have failures in credits that are otherwise 
unaffected, say credits in the student loan space, where the 
underlying credits are perfectly fine. There may be explicit or 
implicit government supports.
    What people anticipate is their auction may fail for 
whatever reason. Knowing their auction may fail and given that 
people who hold this paper have a very high demand for 
liquidity, they view it as a short term money market 
substitute. They do not want to be the last person to get out, 
so they jump for the exits. If people anticipate folks jumping 
for the exits, they all jump for the exits, and thus you see 
good credits where there is not a question of a downgrade, you 
see in those credits failed auctions.
    Mr. Green. Final question. The municipality, in this scheme 
that you just gave to me, is not at fault in this process. 
Nothing has happened with the municipality. It is still there. 
They are still doing the same things they have been doing. It 
is the insurer that has the problem.
    Mr. Sirri. If I can interpret ``fault'' as saying there has 
not been some event at the municipality in terms of its credit 
or its ability to--
    Mr. Green. Let me ask someone else to respond.
    Mr. Dinallo. I think the way to phrase it would be to say 
that the underlying creditworthiness of the municipality had 
not changed, and that instead, there were two events that were 
going on, there was a doubt as to the viability of the 
insurance wrap that you are referring to, the AAA wrap, and in 
general, at exactly the same time, the credit markets were 
starting to withdraw credit and liquidity, so the auction rate 
market, I think, was impacted both by the monoline crisis and a 
general tightening of credit.
    The Chairman. The gentlewoman from California.
    Ms. Waters. Thank you very much, Mr. Chairman. I would like 
to thank all of our panelists for being here today.
    It is very important that we understand what is going on 
and see what we can do to assist in dealing with this economic 
situation we find ourselves in.
    Mr. Dinallo, it strikes me that we have a somewhat odd 
situation here. On the one hand, you have bond insurers having 
started to insure much riskier bond products, such as mortgage 
backed securities. On the other, an entire class of bonds, 
municipal bonds, which seem to have to rely on borrowing the 
bond insurer's AAA ratings, even though their riskiness is 
probably much lower than the municipal bond rating system 
    Am I correct in identifying this duality and if so, how are 
you dealing with it at the State level?
    Mr. Dinallo. I think you are correct in identifying the 
duality and we have spent quite a bit of time talking about it.
    At the State level, I think we have gone in to try to both 
stabilize the markets and infuse capital to make sure that we 
do not at least lose the ratings that were attached to the 
municipality on the structured side.
    What I find interesting is that as presented to the bond 
insurers, the ratings for the structured side were usually 
already AAA rated. In other words, it was the super senior 
tranches of the CDOs and the banks wanted the equivalent of a 
credit default swap to basically assure that no matter how the 
value changed, they had a AAA wrap around that.
    The municipalities, as we pointed out today, ironically, 
many people believe they were woefully underrated or unrated.
    If you were a computer just judging risk, the monolines 
took a riskier bet in uplifting them from no rating or A or AA 
into AAA. It is all very ironic now and clearly not true.
    If you were going in and relying purely on the ratings or a 
lack of a rating, it was the case that you were essentially 
being riskier on the municipality side just from a ratings 
point of view.
    I think there is going to be a large sorting out, which is 
appropriate and should be done quickly, which we are working on 
the new regulations to get there, about essentially separating 
the businesses potentially going forward, assuring the credit 
default swaps are no longer the instruments for securing that 
kind of obligation, and probably prohibiting credit CDO 
squared, which is the sort of recreation from a BBB into a AAA, 
sort of the silk purse out of a sow's ear problem that 
exacerbated it.
    Mr. Blumenthal. Can I add just an answer as well, please?
    Ms. Waters. Yes.
    Mr. Blumenthal. I think the thrust of your question is 
absolutely right. What happened was a great many of these 
instruments, the CDOs, the SIVs, the structured investment 
vehicles, the structured finance securities, were overrated, 
and the municipalities were underrated.
    I ran across a quote. It happens to be from Warren Buffett. 
It is not directly quoted, so I apologize if he did not say it 
or if I am getting it wrong.
    He said: ``It's poetic justice in that the people who 
brewed this toxic kool-aid found themselves drinking a lot of 
it in the end.''
    The folks who brewed the mix are now having to swallow it. 
The point is that we need to change this system so it does not 
happen again.
    Ms. Waters. Mr. Chairman, I thank you very much. Even 
though we do not have time to get into it, I would hope that at 
some time we can really get into understanding the tranches and 
how they were packaged, how it worked, and how they were 
determined to be risky or not.
    That is one area where I just need more information.
    The Chairman. We certainly are going to try hard. I am not 
going to promise anybody that by the end of this year, I am 
going to understand what the derivative of a collateralized 
debt obligation really means. I will just take comfort in the 
fact that nobody else seems to know either.
    The Chairman. The gentleman from Pennsylvania, and then the 
gentleman from North Carolina.
    Mr. Kanjorski. What was it that you did not understand, Mr. 
    My problem is somewhat related to what Ms. Waters has been 
addressing. There are so many bad signs here. I recall about 3 
weeks ago meeting with one of the monoline insurance carriers 
that did not get into as much difficulty as some of the others.
    They showed me a study that they had undertaken of their 
competitors. One of them was the pools of securities that were 
purchased and insured by their competitors, and it showed that 
in one year, in 2007, 18 percent of the first installments on 
the mortgage obligations were not paid.
    The only thing I can relate to is the prior experience I 
had on a board of directors of a small bank that when our 
default rate on mortgages went above one percent, everybody 
seemed to get into a nervous state and started at least 
experiencing the pains that may indicate a heart attack.
    How did we get to an area where 18 percent of the mortgages 
did not even perform on the first installment and why did not 
people know about this? Two, why did it not set off a bell in 
any number of places, from the owners of the securities, the 
purchasers of the securities, the people that made up the 
pools, or for that matter, the insurance carriers that were 
putting their resources into the pools?
    It seemed to me everybody turned a blind eye and should 
have known with even a cursory review of the record that 
something was wrong.
    I will grant one thing. It is practically impossible to 
figure out what is where and what the impact is because there 
does not seem to be any inventory that exists in the public 
realm anyway that you could find out how these securitized 
pools are manipulated and sold off in various configurations.
    Certainly, should not a regulator--and maybe I should 
direct this to you, Mr. Dinallo--is your inspector or auditor 
of these insurance companies able and does he make an in-depth 
analysis of the securities held as collateral to know whether 
or not they are performing, and if they are not performing, 
does he take some action to indicate therefore, they do not 
meet the criteria established by the law?
    Mr. Dinallo. I think that is a great point. There is a 
history here where in fact there is something called the 
Securities Evaluation Office of the NAIC, which is a group of 
100 people who value securities separately.
    We did once, I am told, long before I came onto the scene, 
seek to value hybrid securities, hybrid equity securities, 
differently than the rating agencies, and it created a brouhaha 
because the States in their capacities, regulators, were sort 
of daring to question to not create chaos in the marketplace.
    I am considering sort of juicing that up. It is located in 
New York. I think it is important, but do recall, please, 
Congressman, that our first order job is solvency and I think 
on solvency of policyholders, we have done quite well, frankly.
    People will be paid on their losses it looks like because 
the assets of the insurance companies exceed the most 
aggressive liability projections or losses by someone say like 
Mr. Ackerman.
    I think on that, we have done well. On the AAA rating that 
comes before the insurance company, I will just tell you that I 
have a theory. You asked a question, a rather large macro 
question. I will say that the Congressman who has since 
departed hit on moral hazard.
    There was a day that when you gave a loan as a banker, you 
stood behind that loan. You owned the risks of that loan, and 
you had a book of business that was built on making good 
underwriting, good loan decisions.
    Someone then had an idea that we could securitize that book 
of business and do good things. We could extend more loans to 
people who wanted homes or to buy a car or finance their 
children's education, and so it was securitized, and the banker 
could do more loans.
    That first book of business was excellently built and it 
performed rather well. On the fourth or fifth iteration of 
that, it became a more dangerous undertaking.
    Insurance. We need to be very careful that we do not over 
securitize the underwriting that is going on there, and it is 
something that I am very worried about.
    Mr. Kanjorski. Thank you. You may not be aware that the 
Governor of New York announced his resignation. I suspect you 
are an appointee of the Governor.
    The Chairman. Why are we getting into that?
    Mr. Dinallo. I am.
    Mr. Kanjorski. I would recommend to the new Governor that--
    The Chairman. Let's not get into that. Let's go on.
    Are there any further questions?
    Mr. Kanjorski. No.
    The Chairman. The gentleman from North Carolina.
    Mr. Watt. I thank you, Mr. Chairman. Let me first comment, 
I left the room after Mr. Capuano because I did not want to go 
after him. There was so much passion in his voice. A lot of the 
points he was making, the concerns about this resonated, but 
there is also a side here that is reflected by the chairman's 
comments about lack of understanding here, that may lead to 
some slightly different conclusions on how we proceed.
    I think the value of this hearing is to expose that there 
are a number of irrationalities in this market as we have seen 
in virtually every market recently.
    The first question I want to ask is, who is the prime 
regulator of this market? Whose responsibility as regulator 
would it be to step into the void that you all are describing 
    Mr. Dinallo. I guess that would be me, Congressman, to the 
extent that most of the monoline insurers are either located or 
domiciled in New York.
    Mr. Watt. This is a New York issue, which leads me to one 
of the other irrationalities of this. We are dealing with a 
national market. This reminds me that the first irrationality I 
dealt with in this whole context, in the whole bond issuance 
context, was back in the mid to late 1970's when lawyers in the 
State of North Carolina could not issue opinions on bonds, 
legal opinions on bonds of any kind. It was all done in New 
    Mr. Dinallo. I may not have answered your question 
correctly. If you are asking who is responsible for the rating 
agencies and the ratings of bonds, creditworthiness.
    Mr. Watt. I am asking if there is some regulator who, if a 
problem emerged in this market context, in the bond issuance 
context in general, is there a regulator we could point to and 
say this person has responsibility for it.
    If there is not, then that is the first problem that it 
seems to me we have because everybody then will be pointing the 
finger at everybody else, the same way that everybody has been 
pointing the finger at everybody else on the whole other side 
of the credit crisis.
    Is there a regulator that has super responsibility for 
this? I would have assumed Mr. Sirri would have been the first 
person to answer this question, not somebody at the State 
    I am not trying to influence that. I am just trying to find 
out who the regulator is.
    Mr. Sirri. I took Mr. Dinallo's answer to be for the bond 
insurers, and I think he clearly has responsibility for the 
monoline bond insurers there.
    With respect to understanding your question, when you talk 
about the issuance of the securities, municipal securities are 
by and large exempt securities. The Securities and Exchange 
Commission, which generally oversees the offering of corporate 
securities, not so for municipal securities in the same way 
because they are exempt from the 1933 Act.
    That said, there is a framework in which there are 
    Mr. Watt. So, you are telling me there is no regulator. Is 
that what you are telling me? Does the Fed have the authority 
to step into this and be a super regulator?
    Mr. Sirri. I think what I am saying is we are not a super 
regulator in the sense that we are all encompassing. We have 
various touches on the market, however, with respect to certain 
kinds of fraud that may occur. We have authority with respect 
to the operations of brokers when they trade--
    Mr. Watt. Who would we hold accountable if this thing was 
completely out of whack as it is? Who would we hold accountable 
for that other than the market?
    We all know that the market got out of whack. Was somebody 
supervising the market? I thought this was going to be a simple 
question. Apparently, it is a lot more difficult than I thought 
it was.
    Mr. Sirri. I think the best way I can answer it is there 
are various pieces that are divided between various entities.
    For us, when it comes to credit rating agencies, when it 
comes to the work that brokers do in selling these securities, 
we have authority there. When it comes to issuance, the 
Securities and Exchange Commission does not. When it comes to 
the monoline insurers who wrap these securities, we do not.
    Mr. Watt. Thank you. I yield back.
    The Chairman. The gentleman from Georgia.
    Mr. Scott. Thank you, Mr. Chairman. I would like to just 
ask a question dealing with something that is happening across 
the country, if any of you care to respond.
    There are examples where communities across the country are 
experiencing incredible interest rate increases. I call to mind 
an example, a couple of examples that some of you may be aware 
of, where I recently read that Underwood Memorial Hospital in 
Woodbury, Pennsylvania, my own alma mater, the University of 
Pennsylvania's health system, and the Pennsylvania 
Intergovernmental Cooperation Authority all have had 
outstanding auction rate securities, and have all experienced 
interest rate increases, as much as from 4.5 to 8 percent.
    This is happening in various places throughout the country 
where people are telling us of similar experiences of 
incredible interest rate increases.
    I was just wondering if you think that providing additional 
sources of credit enhancement, such as that which is provided 
by the Federal Home Loan Bank's letters of credit and similar 
ideas are of value in addressing the financing needs of these 
    Mr. Blumenthal. I would say yes. You hit on a point that I 
think is very, very important. Even before this credit crisis, 
the cost of those debt issues were rising in terms of interest 
and also in terms of insurance. The insurance companies, the 
bond insurers, were charging more and more as a percentage of 
what the interest savings could be.
    That is a means that I think we have discussed today to 
reduce or minimize those costs. I think again going back to the 
question that was raised before and I was going to raise it 
when the Congressman was still in the room, clearly, in this 
whole system, there are gaps in terms of regulation. I think 
that is an important point that has emerged today.
    There are gaps and there are some overlapping 
jurisdictions, but there are clearly deficiencies in the law 
that need to be corrected. One of them is the absence, in my 
view, of a provision that prohibits the dual system that again 
disadvantages the health system of your alma mater.
    Mr. Scott. Thank you for that. Let me go to another point. 
With the initial question being whether we need to worry about 
a municipal bond or a muni market melt down, do you believe, 
each of you, that this issue is being overblown, or do you feel 
we have yet another blow to the economy ahead with bond 
    Do you believe it to be true that more and more insurers 
will lose their AAA ratings as Moody's and S&P look as though 
they are ready to lower the grades on more insurers, even such 
names as Ambac and MBIA?
    It appears to be quite worrisome when a firm is downgraded 
to AA, it is most difficult for them to do any more municipal 
    Is this not the case, or is it not the case that many of 
these companies are themselves to blame for the mess that they 
are in after expanding out into the risky securities that some 
say they had no business or experience in insuring?
    Will it not be hard to find investment banks who are 
willing to bail these guys out and will there even be a bail-
out if necessary, or do you believe that investors will simply 
have to take these losses?
    Finally, would an industry-wide bail-out be even a 
legitimate option as getting banks to agree on how much each 
should pitch in to help might prove difficult itself?
    Mr. Dinallo. I think, Congressman, that it is a very 
difficult set of questions to answer that you have asked. I 
think the infusions of capital that you have seen into the bond 
insurers have at least for now maintained the AAA ratings of at 
least four or five of them, and others are going to shake out 
and possibly go to a lower rating.
    If I were to be asked whether these were sufficient capital 
infusions for the absolute long run, I cannot answer that 
because the question is as difficult as answering exactly where 
is the economy going to be in fact several years from now.
    If mortgage defaults continue at a certain rate, then we 
are probably going to be okay, if they are as projected by the 
rating agencies, but if they take off into a worse scenario, 
then the rating agencies will, I presume, require more capital 
as those projections go up.
    Likewise, that could also have a serious pull on the 
municipal side because if there was a tax base erosion, then 
the municipalities could presumably default if permitted to 
default at a higher rate than they otherwise have been.
    It is a question that is linked to the economy. That is why 
I think we should inject capital prudently and it should be 
market based solutions and let the assumptions crisis that we 
are in and the potential liquidity crisis play out a little 
    Mr. Scott. Thank you, Mr. Chairman.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. Thank you, Mr. Chairman.
    Mr. Sirri, my city needs about $1 billion to upgrade its 
storm water sanitary sewers, combination sewers. I stepped out 
a few minutes ago to meet with Mayor Jim Odom, who is the mayor 
of one of the suburban communities in Kansas City, Missouri. 
His City is Belton. He just told me he needed $2 million to 
upgrade their infrastructure.
    The National Service Transportation Policy and Revenue 
Study Commission says that we need $255 billion a year, a year, 
to upgrade the infrastructure around the country. If that is in 
fact true and if municipalities are going to do it, they are 
going to have to access the debt market to do it. No city has 
that kind of money in the city treasury.
    When you add the market volatility, then municipalities are 
in serious trouble.
    Is there something that the SEC can do within its 
regulatory authority to correct not a perceived problem but a 
very real problem with the bond rating agencies that to a large 
degree, and I want to talk to them directly about it, are 
causing the problem.
    Do you see that the SEC has any responsibility for helping 
us out of what I think is a crisis?
    Mr. Sirri. I think there are several things we are doing at 
the moment. The first is, and I referred to this earlier, that 
we are providing some relief to dealers in the auction rate 
area so that municipalities, perhaps such as some of the ones 
you mentioned, would be able to bid for their bonds at auction, 
and be able to have those bids taken.
    That should help in the short run. In the longer run, right 
now, and you brought up the credit rating agencies, as we speak 
right now, we are examining the credit rating agencies for a 
number of issues, most of them related to subprime, but that 
work will continue.
    Our Chairman has asked that we engage in some rulemaking 
where appropriate this year to get at some of the issues that 
we have talked about. I think that rulemaking is still to be 
flushed out as to what it will entail precisely.
    I think we do take very seriously our responsibility, our 
authority over the credit rating agencies is new. The Act was 
promulgated in 2006. It really just came on line in 2007. We 
are barely 9 months into our authority here.
    I think we do not want to do something untoward, to do 
something that is not carefully--
    Mr. Cleaver. Do something what?
    Mr. Sirri. We want to be careful in our use of authority 
here. The Chairman has instructed us to be very measured, to 
think very carefully about what kind of rulemaking we engage 
    The Chairman. That is the Chairman of the SEC.
    Mr. Sirri. I am sorry, the Chairman of the SEC. I am sorry. 
Very good.
    The Chairman. He is more measured than me.
    Mr. Cleaver. I am not suggesting that you do something 
irresponsible. I am not sure it sounded like I was saying that.
    I am asking that the SEC use the responsibility it has been 
given legislatively to deal with the problem. I understand you 
have not had that for a long period of time.
    What I hope to convey to you is that it is a problem that 
is growing daily. It is not getting any better because the 
crumbling infrastructure around this country is not going to 
stop until we deal with this problem.
    Is there something that you can do? Can you tell them to 
    Mr. Sirri. I think with regard to a number of things, we do 
have authority. For example, if in the process of our exams we 
were to find out there was anti-competitive behavior going on, 
and we have had some discussions here at the table about the 
nature of what that anti-competitive behavior may be, our 
authority is very clear there, that we could step in and stop 
    Mr. Cleaver. Do you not think there is anti-competitive 
    Mr. Sirri. I do not want to jump ahead of where our exams 
are. We are looking at--
    Mr. Cleaver. We have nine rating agencies--maybe that 
suggests something is awry.
    Mr. Sirri. It certainly raises that possibility. There are 
possibly some other benign explanations for it, but I certainly 
take your point.
    We started our authority with five. We have had nine come 
in. As I said before, I think some of the cures that are 
provided by the Act will take some time. I certainly appreciate 
there is more urgency there and that we need to be focused on 
the here and now as well as a longer term view.
    Mr. Cleaver. Mr. Blumenthal, if you could write out a 
script for the SEC to address the problem, what would it be, 
    Mr. Blumenthal. On the credit rating agencies?
    Mr. Cleaver. Yes, on credit rating agencies.
    Mr. Blumenthal. What I would like to see is that the SEC 
would require a single unified standard. In other words, I 
believe that under the current statute, it has authority to 
mandate that single standard, but it may be a fair issue for 
them as to whether they feel the statute does provide 
authority, so I am suggesting that there be explicit 
congressional action in that regard.
    I believe that as part of this rule, they can and should 
take that action to make the system fair and eliminate these 
disparities. In effect, the system that we have right now puts 
municipalities in a lesser category of existence.
    I will say to your point about anti-competitive conduct, 
that is precisely the focus of my investigation. It is not only 
on the dual standard and the way it started and perpetuated and 
maintained, but it is a variety of other practices that the 
rating agencies have engaged in doing that raise the cost of 
those ratings, the so-called notching practices, the basketing 
    These terms have meaning and I know this hearing is not 
focused on the details of the rating agencies, but there are 
very, very profound and significant questions under the 
antitrust laws about whether or not they have restrained trade 
or otherwise impacted competition.
    Mr. Cleaver. Thank you.
    The Chairman. The gentleman from Colorado.
    Mr. Perlmutter. Thank you, Mr. Chairman. I am sort of with 
Mr. Kanjorski and Mr. Frank in not understanding some of the 
terminology. I would just like to go to basics for a second.
    I represent an area with lots of school districts, and some 
health and hospital authorities, and they want to issue a bond. 
They have to get some money to build a new hospital or new 
school. Those are the guys, if I understand it, that are going 
to be affected by these higher interest rates.
    Is that right or wrong?
    The Chairman. The court reporter is very able, but she is 
not good at nods.
    Mr. Blumenthal. Yes.
    Mr. Dinallo. Yes.
    Mr. Perlmutter. Thank you, Chairman.
    Let's move the credit enhancement piece aside for a second. 
Somebody who is going to invest or buy these bonds will look at 
a revenue stream that is generated by the township or the area 
of authority or whatever, look at the expenses, and say that 
looks like a good buy for me and I will buy it at 5 percent. 
That is how I look at the risk of this. Is that right?
    Mr. Dinallo. Yes.
    Mr. Perlmutter. There are a bunch of these out there. Some 
of what we have done, the market has done something to try to 
short cut analyzing the revenue stream and whether it is 
legitimate and a solid revenue stream or in the instance of 
some of my neighborhoods where there are lots of foreclosures 
and lots of people who are not paying their property taxes or 
sales tax has dropped, the revenue stream is not as solid as it 
once was. Still have all those expenses.
    Some of these municipalities or authorities then buy down 
the risk; right? They buy down the risk by either getting 
letters of credit from a bank or they find an insurance company 
to buy down the risk, or they get a credit agency, the credit 
agency looks at everything and says this is a good risk.
    Is that how this is working?
    Mr. Sirri. I think you mentioned two different kinds of 
risk there. When you cited the letter of credit, you are 
talking generally about liquidity risk, that is the idea that 
the bond can be re-sold.
    When you talked about a monoline insurer wrapping the bond, 
you are talking about credit risk, the idea that if the 
municipality does not make their timely payments, that someone 
will step in and make it for them.
    In the third instance, when you talk about the credit 
rating agency, you are talking about an opinion of a third 
party about the likelihood that they make timely payments.
    The three of them interact together in the way you say.
    Mr. Perlmutter. To be able to peddle or sell the bond. 
Where is it that we are running into trouble?
    Is it because we do not have insurance any more or because 
the credit agency is saying hey, the markets are very difficult 
out there right now, we are going to tighten down on everybody, 
just like the appraisers and the accountants are tightening 
down, and the regulators are tightening down.
    Is that the problem? Or is it because nobody has any money 
to buy these things?
    Mr. Dinallo. I think Mr. Sirri just helpfully asked me to 
answer that question. I think there are several factors that 
are contributing to the issue. The rating agencies, I think, 
have gotten tougher because they have sensed a certain 
scrutiny, and I think it is appropriate for them to tighten up 
a bit.
    It is the case that the bond insurers that would otherwise 
be giving the wrap have been under pressure and their ratings, 
which are the wrap that you talk about, have gone down or been 
in danger of going down.
    The credit markets that are sometimes the way those 
municipalities come to market, the variable rate markets, etc., 
are very tight as Wall Street and other liquidity providers are 
beginning to worry about their capital requirements and pulling 
away from the lending activity that everyone just kind of got 
used to and maybe overly used to.
    There are several factors that are contributing to it. We 
discussed today one other that is kind of at the heart of what 
you are saying, which is a belief that the rating agencies 
essentially have a two tier system for rating corporate credit 
risk versus municipality credit risk, and that the underlying 
credit decisions around municipalities should be more liberal, 
so to speak, and they should not have to pay as much because 
they ought to be starting off from either a higher rating or 
any rating at all, which some of them cannot even get rated so 
they buy the wrap.
    The Chairman. We have a vote. We can finish.
    Mr. Perlmutter. As regulators, are you seeing any trouble? 
One of the things we have been dealing with is this subprime 
mess here and we are seeing lots of foreclosures.
    Do you see any problem with the revenue side? That 
municipalities really are starting to--
    Mr. Dinallo. In a worst-case scenario, I have two concerns. 
My immediate concern, which I think is clear to everybody, is 
that the mortgage foreclosures and the mortgage defaults will 
definitely put a huge pull on the CDO side of the obligations 
that the monoline insurers have put out, and that will in turn 
put stress on the municipal side of their books.
    Likewise, I do believe that if the economy goes abruptly 
and more so in the wrong direction, you may have underlying 
stress on the municipalities. I think that is where you will 
hear Ajit Jain from Berkshire say that it is not quite as safe, 
the risk, as everyone seems to be saying, that it is a riskless 
investment. I read his testimony.
    Mr. Perlmutter. Thank you.
    The Chairman. Thank you. I am not going to go vote. It is 
an adjournment. I will stay here and we will get to the next 
panel. We will finish with the gentlewoman from Wisconsin.
    Ms. Moore of Wisconsin. Thank you so much, Mr. Chairman.
    I was very fascinated, Mr. Sirri, by your testimony and 
others regarding the auction rate securities and specifically 
want to know more about the Federal backstops that you might 
    I can see that you think that perhaps there is something 
that can be done in the regulatory area. I have heard others 
talk about the Federal Home Loan Bank.
    As people want to get rid of these bonds and switch them to 
variable rate, you said that had been slowed tremendously 
because so many people are trying to do it.
    I noticed in the footnote in your testimony on page four 
that you said some banks have already reached their entire 
yearly capacity for writing letters of credit policies.
    What more can you do or what role could the Fed provide in 
enabling people to make these swaps?
    Mr. Sirri. What we have done specifically here is we have 
made something clear that had been slightly unclear to the 
market. We have a situation where we have issuers of bonds, 
municipalities, who are paying particularly high rates because 
their auctions have failed.
    We have a situation where we have investors in bonds who 
normally would be happy to get those high rates. Of course, 
that is what they like to do at auction, but they also have a 
demand for liquidity. Because the auctions have failed, they 
cannot move their paper.
    What we are striving to do this week is to issue some 
guidance by the staff of the SEC saying that municipal issuers 
can bid through dealers at auction and repurchase their paper, 
take it off the market. First, that is helpful to them, and 
second, by bidding, many of the auctions we hope will not fail. 
Once they do not fail, those rates will come down and the 
issuers' rates that they pay will be more in line with the 
traditional rates they pay for their credits.
    We have provided some guidance there to make it clear that 
will not be deemed ``manipulation,'' and that is one of the 
reasons why dealers have been not willing to accept the bids of 
    Ms. Moore of Wisconsin. Because there would be a huge 
discount to muni's if they bought their paper back?
    Mr. Sirri. There was an enforcement settlement in 2006 
where there was some actual manipulation by dealers. In the 
wake of that settlement, dealers became very conservative. In 
our view, perhaps slightly overly conservative, and that is 
fine that they do so. They do not want to run afoul of the 
securities laws.
    We just want to clarify for them that in this instance, and 
perhaps generally, that when they bid at auction, if they bid 
in a precise way that has good disclosure around it, they will 
not be deemed to manipulate the market.
    We want to be very, very clear, we are not saying anything 
about the contracts around these. There are various private 
issues about the contracts, about the agreements between the 
parties. The SEC is saying nothing about those whatsoever.
    We are just clarifying that the municipalities can place 
bids through dealers and neither the auction agents, the 
dealers, nor the municipalities will be deemed to have 
manipulated under a set of circumstances that has a lot of 
disclosure around it.
    Ms. Moore of Wisconsin. Thank you for that clarification.
    The Chairman. I thank the gentlewoman. I thank the panel. 
The panel is dismissed with our thanks. There are a lot of 
specific things and we will all be back to this.
    We will call our next panel, Mr. Lockyer, Ms. Wiessmann, 
Mr. Reeves, Mr. Newton, and Mr. Dillon. Will you all come 
    I thank the panel. This is a very important subject, and 
while not all of the Members are here, people are watching this 
elsewhere, and there are staff members here on both sides, so 
we will get right to it.
    First, we have Bill Lockyer, the treasurer of the State of 
California. Mr. Lockyer, do you want to go ahead? If you need 
to be excused after your testimony, feel free. Why don't you 


    Mr. Lockyer. Thank you very much, Mr. Chairman, and members 
of the committee. It is the red eye and Ambien on the plane 
that does not seem to work well for me.
    The Chairman. We have about 50 Members in California who 
will not be sympathetic to that.
    The Chairman. None of them are here, so you go ahead.
    Mr. Lockyer. The committee considers upheavals in capital 
markets that dramatically affect governments, taxpayers, and 
investors across the Nation. I commend you for shedding light 
on these issues and appreciate the opportunity to share 
perspectives from California, the largest municipal bond issuer 
in the United States.
    I would like to start by addressing the issue that lies at 
the foundation of much of the turmoil that led to this hearing, 
the system used by major U.S. rating agencies to grade 
municipal bonds.
    If you remember back when we were taking tests in school, 
what if you had aced every test and still received a grade 
lower at the end of the semester than a classmate who failed 
four exams. You would with total justification call the 
teacher's grading system unfair.
    Unfortunately, for American taxpayers, that is exactly the 
same situation faced by governmental entities that issue bonds.
    The agencies hold municipal issurers to a higher standard 
than corporate issuers. There has been considerable comment on 
this by the Chair and others, so I simply point out that 
disparate treatment results in higher payments and that the 
system is fundamentally flawed.
    The rating agencies' own studies substantiate these claims. 
Municipal bonds rated Baa by Moody's have a default rate of .13 
percent while corporate bonds rated Aaa by Moody's have 
defaulted at 4 times that rate or .52 percent, and similarly 
with the other rating agencies.
    S&P, who by the way, of the rating agencies has been the 
one most resistant to considering change, published an article 
last Friday on muni ratings, and focused on unrated bonds, ones 
that do not rely on a government's strength of issuance.
    With regard to the rated municipal bonds at issue in this 
debate, however, the same article contained updated numbers of 
default statistics that support these claims, showing the 
disparity between corporate and municipal defaults.
    California has never defaulted on its bonds, yet, the 
agencies refuse to give the State a AAA rating. It undermines 
the functioning of an efficient and transparent market. It 
misleads investors by falsely inflating the risk of buying 
municipal bonds relative to corporate bonds, and worse from my 
perspective as the State's banker, it costs taxpayers billions 
of dollars in increased costs and bond insurance premiums.
    If the State received the AAA rating it deserved, we could 
reduce taxpayers' borrowing costs by hundreds of millions of 
dollars over the 30 year term of still to be issued bonds that 
have been approved by our voters to finance infrastructure 
development. Billions of dollars more could be saved by 
municipal issuers across the country.
    We have asked the rating agencies to work with us to devise 
a unified rating system based on default risk. We believe that 
reform would make the market more efficient and transparent and 
better serve taxpayers and investors.
    A number of other State treasurers and finance officials 
have signed those letters or written similar letters of their 
own. You will hear from some shortly. That letter is attached, 
Mr. Chairman, to my written testimony.
    The rating issue flows naturally into the question of bond 
insurance. Municipal issuers buy insurance to obtain a AAA 
rating that, in many cases, they already deserved, based on the 
de minimis risk of default.
    Insurers' AAA ratings are then transferred to the issuers' 
bonds. Our policy on insurance is similar to most muni issuers. 
If by insuring bonds we can save taxpayers more money in 
interest than it costs to buy the insurance, we will insure the 
    During the 5 years of 2003 to 2007, California spent $102 
million to insure $9.1 billion in GO bonds.
    Defenders of the current rating system argue that the 
market understands the distinctions between corporate and 
municipal rating scales. I would suggest that argument holds no 
    If investors truly possessed that understanding, our 
taxpayers would have had no need to spend $102 million on 
insurance. The fact that investors placed value on insurance, 
that it is an enhancement of our credit, shows the market does 
not understand fully the distinctions between the two ratings.
    Even though bond insurers almost never paid out a claim 
since muni issurers almost never default, the industry is in 
crisis because of risky bonds they insured in other markets. 
Some monoline insurers are fighting to save their AAA status 
while rating agencies have downgraded others and the AAA rating 
of insured bonds purchased by investors has been lost or is in 
    The effect of these downgrades on municipal issuers differs 
depending on the type of the bond. Most of our State's 
outstanding debt is in fixed rate bonds, but downgrades do 
affect debt service with respect to other bonds, and you have 
talked earlier about auction rate and others.
    The Chairman. Mr. Lockyer, we need you to summarize and 
finish up, if you can, and then we can get to questions.
    Mr. Lockyer. The variable markets have been hit because of 
the insurance difficulties.
    The States are grateful for the fact that the SEC has 
indicated that they may provide rules that will provide 
assurance soon to local entities that if they repurchase, that 
it does not constitute a default or some manipulation of the 
market. Replacing the dual bond system with a unified approach, 
Mr. Chairman, is a needed reform, and we hope that you will be 
able to assist.
    [The prepared statement of Mr. Lockyer can be found on page 
132 of the appendix.]
    The Chairman. Thank you, Mr. Lockyer. We appreciate the 
leadership you have taken. The letter you put together will be 
put into the record as well as anything else people want to 
    Ms. Wiessmann, please go ahead.

                        OF PENNSYLVANIA

    Ms. Wiessmann. Chairman Frank and members of the Financial 
Services Committee, thank you for inviting me to testify today 
about the current turmoil in the municipal bond marketplace, 
and what I have termed the collateral damage that is being 
experienced by State and local government entities.
    My name is Robin Wiessmann and I am Pennsylvania's 
Treasurer. My professional experience that is relevant to 
today's hearing includes municipal and State agency 
supervision, 24 years as an investment banker, which includes 
10 years as an owner of a broker-dealer investment banking 
firm, and 15 years of asset management oversight.
    Today's financial market problems are very disturbing to 
me, especially the failure of many auction rate securities and 
the high reset rates on variable rate demand bonds.
    They are imposing extraordinary volatility and stress on 
all municipalities including States, local governments, other 
local political subdivisions, and student loan providers.
    This credit crisis is affecting them through no fault of 
their own, but due to market disruption unrelated to the 
prudent financial management of State and local governments.
    Such market disruptions are costing taxpayers in terms of 
increased expenditures and constrained budgets. Further, the 
potential exists that in an already tenuous financial 
situation, it may worsen and disrupt the provision of basic 
government services, including the availability of student 
loans for the next school year.
    The market is in desperate need of some help, and to those 
who say let the market correct itself, one must recognize that 
the market has been unable to adjust itself.
    While I have great faith in the resiliency of the American 
economy, the market has demonstrated an inability to self 
    While I applaud the Federal Reserve's action yesterday in 
announcing the securities lending facility program, 
nevertheless, the situation in the municipal markets requires 
and demands a more targeted relief for this market.
    I want to speak about Pennsylvania for one moment. The 
current state of the national economy is very difficult and 
challenging, but the real challenge is, as I said, the 
challenge in the credit markets.
    Nevertheless, we in Pennsylvania are relatively optimistic 
about the Commonwealth's economic outlook and debt portfolio. 
Due to Pennsylvania's conservative debt policies and 
conservative investment policies, we are again relatively well 
positioned to weather the current market uncertainties and 
    However, the turmoil does have wide ranging implications 
and my concern extends beyond the Commonwealth's direct debt to 
the agencies, counties, municipalities and school districts.
    I would like to turn now to some very specific 
recommendations. I would like to call on the Federal Government 
to provide liquidity and confidence to the municipal 
marketplace. Encouraging investor confidence in the municipal 
bond market, which will bring in more buyers and result in 
liquidity, is essential, so that market participants can have 
the time to restructure their products, services, and 
    In particular, I would call on the Federal Government to 
consider temporary actions to provide liquidity such as serving 
as a buyer of auction rate and variable rate securities, 
providing liquidity which they have provided to the general 
market with specific direction to maintain the auction rate and 
variable rate market of municipal issuers, and providing short 
term credit enhancements for bonds suffering market failure 
because of downgrades of their bond insurer, so that the bonds 
can resume trading at reasonable interest rates.
    There has been much discussion about credit ratings, and 
based on my years working on Wall Street, I know firsthand that 
the credit of investments is primary. I also know that credit 
evaluations of governmental obligations have withstood the test 
of time.
    However, I do have some observations about the market. 
Since municipals are governed by such challenging standards and 
are monitored very closely, they are, as we have heard many 
times today, seldom in default. Despite the scrutiny and the 
reduced likelihood of default, they are often perceived and 
priced as inferior credits.
    I would corroborate and support many of the statements that 
have been made here today.
    There should be some mechanism for the true 
creditworthiness of governmental debt obligations to be 
recognized. That will only happen when some adaptation of the 
current rating system is made. A credit rating system that is 
analogous to the corporate rating system would serve this 
purpose and make bonds comparable. Specific distinctions could 
provide the differentiation if necessary among municipal 
    Another reason for this is very market driven. Buyers are 
now investing across asset classes based on relative value, and 
this simpler classification might facilitate this crossover 
buying, which in turn will provide greater liquidity and market 
demand for municipal credits.
    Markets change. Guidelines evolve. We need to adapt.
    I would also suggest that there are mechanisms that should 
be put into place to support trading, when disruptions in the 
market occur, as has occurred recently. Just as triggers were 
established in the equity markets, I suggest that the Federal 
Reserve or other Federal agencies offer stop gap temporary 
measures to support and sustain the municipal markets in times 
of psychological or actual crises, such as what we have been 
    Had measures such as these been available in December or 
January, we might not have experienced the cascading effect of 
liquidity and credit concerns which are now impacting fixed 
rates and unenhanced paper.
    Some of the other immediate solutions that I will not go 
into detail on have been cited before, raising the bank 
qualified debt limit from the current $10 million level to $25 
million, permitting an additional advance refunding of bonds, 
altering the rating requirement under Rule 2a-7, and permitting 
Federal Home Loan Banks to offer letters of credit, and 
allowing governments to purchase their own debt.
    I would like to speak just one more moment and speak about 
looking forward and doing better going forward.
    It is clear from our current credit crisis that changes 
need to be made in our approach to the marketing and securities 
    There are three major factors that are necessary in order 
to effectively direct our capital markets: First, a principles-
based code of conduct for business operations, a deliberate 
conscientious decision making process with consideration of 
market ramifications as they relate to consumers, capital 
markets and the economy as a whole, not just the business 
entity itself; second, transparency and complete disclosure of 
financial operations and securities structures; and third, a 
regulatory discipline that accurately reflects the realities of 
today's marketplace.
    Thank you very much for your time.
    [The prepared statement of Ms. Wiessmann can be found on 
page 217 of the appendix.]
    The Chairman. Thank you, Madam Treasurer.
    Next, the Treasurer of the State of Mississippi, Mr. Tate 


    Mr. Reeves. Thank you, Mr. Chairman, for the opportunity to 
be here today. I would ask that my entire statement be entered 
into the record.
    The Chairman. Anything that anybody wants to put into the 
record will be put in, without objection.
    Mr. Reeves. For the record, I am serving my second term as 
the State Treasurer of Mississippi. I am the immediate past 
president of the National Association of State Treasurers, and 
I am currently serving at the request of Treasurer Lynn Jenkins 
of Kansas, our Association's current president, as the chairman 
of the Legislative Regulatory Committee, which has jurisdiction 
over issues that relate to the municipal marketplace.
    Accessibility and affordability of the capital markets and 
the liquidity of those markets is of great importance to your 
Nation's State and local governments. The capital we raise in 
the municipal marketplace builds our schools, hospitals, roads, 
and other vital infrastructure and public projects.
    In times of disaster, municipal issuers are often called 
upon to use public debt to finance recovery efforts. New York 
City's post-9/11 liberty bond program and the Gulf opportunity 
zone bond after Hurricane Katrina are two of the most prime 
examples in recent years.
    My experience as treasurer of a State that bore the brunt 
of the largest natural disaster in the history of our country 
certainly confirms the advantages of tax exempt borrowing.
    Many of the post-Katrina recovery projects in Louisiana, 
Alabama and Mississippi have been and are being aided by the 
Gulf Opportunity Zone Act of 2005.
    The bonds we have been able to issue as a result of 
congressional action have greatly benefitted the recovery 
efforts and the citizens of the affected regions.
    I would be remiss if I did not take this opportunity to 
thank the members of the committee as well as every other 
Member of Congress for your willingness to help my own home 
State in the aftermath of Katrina. Our recovery is far from 
complete, but the financial resources through appropriations 
and tax law changes approved by Congress make possible what 
seemed like a nearly impossible task of rebuilding in late 
August of 2005.
    It is extremely important to remember that what brings my 
colleagues and me before the U.S. House Financial Services 
Committee this morning is the current situation in the 
municipal marketplace, and it is not a general decline in the 
underlying credits of municipal issuers, but a disruption in 
the corporate marketplace caused by the collapse of securities 
backed by subprime mortgages.
    In fact, the current stress in the bond insurance industry 
is not at all caused by the consistent highly profitable cash 
flow derived from insuring municipal debt.
    Instead, the problems with the insurers, and by extension 
the public debt they insured, are a direct result of their 
decision to insure higher risk ventures in the corporate 
securities markets.
    The current loss of market liquidity has affected public 
issuers across the country. The end result is a failed auction 
resulting in dramatic spikes in interest rate costs on bonds 
which have little risk of default. In some cases, the rates 
have jumped to upwards of 20 percent. Obviously, the taxpayers 
foot the bill as the cost of capital increases.
    In our State, we have been more fortunate than many with 
respect to our exposures in today's unstable market. By 
statute, we cannot have greater than 20 percent exposure to 
variable rate debt.
    In practice, we have a well diversified portfolio that 
generally helps position us to weather and even take advantage 
of short term aberrations in the market.
    Of our $3.2 billion debt portfolio, less than $140 million 
currently is held in auction rate mode securities. We have had 
one failed auction, but due to the diversification of our 
portfolio, this failed auction will only contribute an 
additional 2/100 of 1 percent to our overall debt service 
payments in the current fiscal year.
    The following week, our auction was priced at a level more 
in line with our expectations, and although it was and 
continues to be trading at a level significantly above the 
SIFMA index.
    Many of the specific issues that are before the committee 
today as it relates to the present market disruption are, in my 
opinion, short term aberrations caused by the credit crunch. 
Having said that, the issue of bond insurance, liquidity, and 
rating agency scales on municipal bonds are longer term issues 
that must be addressed.
    I am not convinced that Congress necessarily should play a 
role in all of these issues, but to the extent you should, I 
would recommend consideration of the following:
    A traditional role of the Federal Government in past 
financial crises has been to provide short term price stability 
and liquidity to the market during extremely difficult times, 
until the market can find its own footing. Clearly, these are 
extraordinary difficult market conditions.
    The Department of the Treasury, at the request of the 
National Association of State Treasurers and other market 
participants, recently released extremely helpful guidance on 
re-issuance rules for auction rate securities and variable rate 
demand bonds.
    This guidance allows many issuers to convert out of auction 
rate securities into different products, such as fixed rate 
maturity bonds, without having the bond deemed to be re-issued 
which can be costly to our governments. This has allowed our 
issuers to save taxpayers money and limit their exposure in a 
volatile market.
    Some tax exempt bond issuers secure letters of credit from 
strongly accredited financial institutions to achieve lower 
borrowing costs. Letters of credit can be particularly helpful 
as a source of liquidity for small issuers who do not have 
strong bond ratings or large bond issuances. They are also 
useful to issuers of every size as a mechanism to diversify 
access to credit markets through large, well known 
    As has been mentioned today, the Federal Home Loan Bank 
System is not allowed under current law to offer this AAA 
guarantee. Legislation proposed in this Congress would permit 
that, and I personally would like to tell you that I appreciate 
the support of Chairman Frank, Subcommittee Chairman Kanjorski, 
Congressman Bachus, Congresswoman Pryce, and other members of 
the committee who have co-sponsored this legislation.
    Of course, the fact that we have separate scales on 
municipal and corporate debt makes little sense to me and many 
of my colleagues.
    Moody's has indicated that the default rate on investment 
grade municipal bonds from 1970 through 2006 is approximately 
.1 percent, far different from the 2.1 percent default rate 
among all investment grade corporate securities over the same 
    Yet, municipal issuers pay a penalty to the market for the 
different scales which leads to higher costs of capital that is 
borne by the taxpayers.
    It may be that the market will resolve this particular 
concern. I think it is important that Congress be aware of this 
discrepancy, and to the extent that the rating agencies 
voluntarily establish a global rating scale that more 
accurately reflects relative credit risk, the market will be 
better off.
    Of course, the Securities and Exchange Commission treats 
the two rating scales as equivalent under Rule 2a-7, which 
governs qualified investments in money market mutual funds. 
This rule effectively requires that States' money market mutual 
funds must hold investments rated AA or better.
    I believe that a relaxing of Rule 2a-7 requirements would 
benefit both issuers and investors.
    No single solution exists to solve the current market 
turmoil. To the extent possible, Congress, the SEC, and market 
participants all have a role in navigating our financial system 
through this storm.
    The key is to encourage investor confidence in the 
municipal marketplace.
    I will conclude my prepared remarks by reminding you that 
the capital raised through the issuance of debt in the 
municipal markets is vital to our great country. Working 
together, we can continue to ensure a viable efficient market 
which ensures the lowest cost of capital for our State and 
local governments, thereby maximizing the benefit to all of our 
    Thank you.
    [The prepared statement of Mr. Reeves can be found on page 
198 of the appendix.]
    The Chairman. Thank you. Let me just say to the witnesses 
that I am apologetic and I appreciate your staying. If you want 
to get something to eat, you have time. There is a cafeteria 
right downstairs. I know people have been here all day. We are 
going to get to our third panel.
    Let me get right to Mr. Newton.


    Mr. Newton. Good afternoon. Thank you, Chairman Frank. My 
name is Mark Newton, and I am the president and chief executive 
officer of Swedish Covenant Hospital, located in Chicago.
    I offer a ground-level view of this current situation and 
crisis. Swedish Covenant Hospital is a 334-bed urban community 
hospital. We are the largest remaining independent hospital on 
the north side of Chicago, and we serve a very culturally 
diverse community. Over 50 languages are spoken--
    The Chairman. We have a time problem, so I want to get 
right to how--we stipulate that this is a very important 
institution--you were affected by this--
    Mr. Newton. Well, Swedish Covenant is a Federal 
disproportionate share hospital, and as such we represent this 
critical safety net for the uninsured and underinsured. And we 
consider ourselves your partner in serving these communities.
    The cascading nature of this turmoil over the last few 
months indicates that there is no predictable fire break on the 
horizon. And as the president and CEO of a hospital, I'm no 
stranger to responding to these kinds of community health 
risks, competitive market changes, malpractice crises, nurse 
staffing shortages, and possibilities of revenue stream cuts.
    We have been able seemingly to weather each one of these 
risks to the healthcare system while trying to expand our 
infrastructure, and the key to our ability to respond truly has 
been the availability of predictable and efficient capital.
    Let me share some details of our story. Since 2000, when I 
first joined Swedish Covenant, we have had hospitals close in 
our community with over 500 beds removed and 3,000 jobs removed 
from the community. Our best response has been to invest in new 
facilities, services, and technologies, while others have 
downsized and curtailed services. This is not only out of a 
sense of mission, but it is also our view that it is important 
that we strategically invest in health care facilities for our 
    We now find ourselves responding to a crisis that requires 
us to reinvent our balance sheet and rethink strategies of 
capital spending. We are currently in a refinancing process 
that is going to cost over $1 million in transaction fees. This 
amount is being taken directly from patient care. Our monthly 
insurance costs have historically been in the range of $600,000 
a month, that has increased by an additional $350,000 a month, 
an increase that is directly related to failed auctions and the 
result and expectations of bondholders of default rates of 
interest between 10 and 15 percent.
    The Chairman. We are not talking malpractice insurance 
here. You are talking about the bond insurance, correct?
    Mr. Newton. Correct.
    The Chairman. Yes. I just wanted to be very clear that it 
is just the bond insurance. Thank you.
    Mr. Newton. All of this turmoil clearly has lessened the 
confidence in the financial markets. And what we find is that 
we have to be more alert to unintended consequences as we 
restructure our balance sheet.
    Today our debt is approximately $150,000, with 83 percent 
fixed and 17 percent variable, and it is either insured by bond 
insurance or supported by bank letter of credit. We are an 
underlying Triple-B-plus credit. Our fixed rate now is 4.9 
percent. We expect the fixed rate to increase to 6.5 percent.
    After refinancing, we will have to increase the percentage 
of variable debt to about 60 percent. One unintended 
consequence is even greater reliance on bank letters of credit, 
which by nature are short-term. The cost of bank credit 
enhancement as a replacement for traditional bond insurance has 
increased significantly. Credit enhancement capacity has been 
reduced as we look forward in the next 3 months to a massive 
period of debt refinancing by hospitals such as Swedish 
Covenant Hospital. This remains a yet unexplored dimension of 
this ongoing crisis.
    If this crisis is not resolved, hospitals like Swedish 
Covenant will face significant cost increases on our existing 
debt and may have very little capacity for access to new 
capital in the next few years. We would slow down projects 
investments in projects such as implementation of an electronic 
medical record; we would postpone expansion and renovations of 
core infrastructure; and we would conserve other spending to 
maintain needed cash balances as banks tighten other credit 
terms such as higher minimum levels of cash on hand.
    Perhaps my final observation is that organizations such as 
mine truly need a fire break in this current cascading crisis. 
As I noted before, as your partner in providing health care 
services, we really need and want to get back to the basics of 
caring for people. The fabric of an efficient and effective 
health care system depends on access to stable and predictable 
sources of capital.
    I want to thank the committee for the opportunity to 
discuss this important issue, and I welcome any questions.
    [The prepared statement of Mr. Newton can be found on page 
195 of the appendix.]
    The Chairman. Thank you. I'm going to go vote, and we are 
going to come back. I appreciate your indulgence. People should 
feel free, you have 15 or 20 minutes to maybe get lunch. Not 
this panel, because we're going to be right back here with the 
others. But we will get right back to you. And I thank you. Our 
commitment to this issue, I think, justifies all of us doing 
    The Chairman. On behalf of the National Utility 
Contractors' Association, I should note that I spoke with 
Chairman Jim Overstar of the Transportation and Public Works 
Committee because we did want to make clear what the impact of 
this is on services such as health, as we have seen from Mr. 
Newton, and infrastructure in general. And Mr. Overstar 
strongly recommended that we ask someone from the National 
Utility Contractors' Association, so I'm glad that we were able 
to arrange that. Mr. Dillon, please go ahead.


    Mr. Dillon. We appreciate your letting us testify today, 
Mr. Chairman. And I'm going to put a little different kind of 
color to your meeting today, so let's see how this thing goes 
for you.
    My name is Terry Dillon, and I am the owner of Atlas 
Excavating in West Lafayette, Indiana. We have 150 employees 
who work on sewer, water construction, highway, and road 
reconstruction projects throughout the State. My wife and two 
sons are partners in my business.
    My written statement today supports the need for municipal 
bonds and their effect on infrastructure projects. I will leave 
the reading of the statement for you and move on to actual 
projects these bonds are used for, and try to put some color in 
today's testimony. Ten miles south of Lafayette, Indiana, is 
the small town of Stockwell, where about 300 residents reside. 
Three years ago, you could drive through this town and see 
puddling sewage in the streets and in the yards. There was a 
bad sewage stench in the air. The local kids would be riding 
their bikes through the sewage and playing in it; small 
children could be seen playing in the muddy sewage as if 
playing in a sandbox.
    Stockwell residents took control of this issue, and had a 
sewage system designed, financed, and built. Financing was done 
through the SRF program, the OC Grants, and municipal bonds. 
Today residents are painting the houses. They have cleaned up 
their neighborhood, and have taken their community back. It's a 
thriving Indiana town again.
    My company, Atlas Excavating, has done about 30 such 
projects across the State of Indiana. In each one of these 
towns that we have gone into, I have found a dilapidated city 
and a bad attitude, and once these sewage lines have been 
repaired and the city has been cleaned up, the towns thrive 
once again.
    Next, the City of Indianapolis is under Federal mandate to 
clean up its dumping of raw sewage through sewage overflows. 
This is at a cost estimate of around $2 billion, of which these 
are supposed to be done over the next 20 years. Indianapolis 
also has 80,000 septic tanks in the city limits that have to be 
replaced with a piped treatment system, and posted all over the 
City of Indianapolis at ponds and streams are big red warning 
signs where overflow structures dump raw sewage into the 
waterways. The signs say, and I quote, ``Caution, sewage 
pollution. Keep out of the water. People who swim in, wade in, 
or swallow these waters may get sick.'' And it is repeated in 
    Finally in the City of Lafayette, there is a 42-inch 
concrete sewer line that runs from Staley's Corn Syrup Plant 10 
miles to the sewage treatment plant in the City of Lafayette. 
The sewage line goes through woods, creeks, residential 
neighborhoods, back yards, camp grounds, and playgrounds. This 
line is in such bad decay that it breaks 2 to 3 times a year, 
and in the last 10 years, my company has repaired this line on 
most of its breaks. I want you to imagine a 42-inch-diameter 
concrete pipe that has 5-inch wall thickness, with a daily flow 
of 15 million gallons per day. This 42-inch pipe, which was put 
in around 30 years ago, now has paper-thin walls, with a 
maximum thickness of about 1 inch left in the 5-inch-thick 
concrete walls. This pipe is a disaster waiting to happen.
    My most memorable repair to this line was 5 years ago. The 
city engineer contacted me, requesting immediate response to a 
sewer break. Normally you get a call giving you hours to 
respond, but the urgency in her voice sent me driving to the 
site immediately. When I got there, it looked like a crime 
scene. There were fire trucks and emergency vehicles lining the 
roads to get to it, and the site was cordoned off. I ran up to 
the failing spot, and found a 20-foot-long, 5-foot-deep, 12-
foot-wide sinkhole. In the hole, raw sewage was running down 
the broke and exposed pipes at a very rapid rapid rate, 
indicating a high flow and massive surcharging. The swirling of 
the water in the hole was eroding the ground conditions. I 
immediately had emergency crews who were standing there, 
gawking in the hole, get back away from the hole, and at the 
last minute, I grabbed a city official who was standing by the 
hole by the back of his shirt and pulled him back, and said, 
``I said get out of the way.'' At that point in time, the 
ground caved in out from underneath his feet; however, he did 
not fall into the hole due to my pulling him back. Had he 
fallen into that hole, it would have killed him instantly.
    While that is scary, it is not the worst of the day. The 
reason that the emergency vehicles and the fire department were 
there quickly became aware to me when I looked at the 
surroundings. We were in a playground, and two small children 
were playing on a swing set 100 feet away from us. It would 
have been a very bad day if one of those children had fallen 
into that hole. If you fell into that particular sinkhole, your 
next stop would be the grinder pumps at the treatment plant.
    This entire line has now been replaced, largely due to 
municipal bonds. Are bonds important to our infrastructure 
needs? Yes. It is probably the single most important funding 
source that we have, bar none, across the Nation.
    Gentlemen, clean water is to me more important than oil. 
Without clean water to drink, you won't live more than a week. 
We need your help and you need to help take control of this 
bond market and the infrastructure across this country and help 
be responsible for it. I personally believe that you alone, 
with me working in this industry, we are the gatekeepers of our 
infrastructure system, and it is the greatest asset that the 
United States has.
    Thank you for letting me testify today. I will be happy to 
answer any questions.
    [The prepared statement of Mr. Dillon can be found on page 
98 of the appendix.]
    The Chairman. Thank you, Mr. Dillon. That's precisely why I 
consulted with Mr. Overstar, who is our chief infrastructure 
chairman, and why he recommended you. I should note that I 
believe we will be joined on this committee within a few days 
by the new Member of Congress from Indianapolis, Andre Carson, 
who is succeeding his grandmother, and we look forward--
although we regret the circumstances of having him.
    I want to note that Deputy Treasurer Paul Rosenstiel has 
replaced Treasurer Lockyer on the panel. And I want to move 
quickly here. But let me just ask--a number of things that we 
have talked about, merging the dual risk, some other things 
that are clear--I have been struck--a number of witnesses have 
mentioned, Mike--Massachusetts, Mr. Lynch--Federal Home Loan 
Bank. We will be looking at all those things. What about the 
question of a Federal re-insurance for particularly general 
obligation, full faith and credit municipal bonds? Any comment 
on that? Let's start with you, Mr. Rosensteil.
    Mr. Rosenstiel. Well, I think that is the kind of thing 
that can give investors confidence. With the dual rating 
structure, unfortunately investors don't think that our ratings 
are as strong as we think the risk of State general obligation 
and other general obligation and strong revenue bond issues is. 
So I think the Federal Government stepping up and saying, you 
know, ``This is not risky,'' that's a good idea.
    The Chairman. Ms. Wiessmann?
    Ms. Wiessmann. I think if the Federal Government steps up 
to provide assurance in the marketplace, it is a good thing; 
however, actually administering it, there are differences among 
credits introduced in the marketplace. And actually managing 
and administrating the implementation of that, I think, will be 
a challenge.
    The Chairman. Are there real differences among full faith 
and credit general obligation funds, do you believe? Or should 
there be?
    Ms. Wiessmann. Credit and markets are continually dynamic. 
They change all of the time. It's based on facts and 
circumstances at the time. So at different points in times, 
yes, there are differences among them.
    The Chairman. Among full faith and credit general 
obligation? We have the record that none have defaulted, you 
know, since 1970. So what are the differences?
    Ms. Wiessmann. There are varying degrees of strength. I'm 
not disagreeing with the point that they're very, very strong 
and very secure. But they are because they have certain 
operating requirements, reporting requirements. They have 
accounting requirements. And to make sure that the incentive is 
still in place for them to achieve good credit ratings and to 
not have issues requires some administrative--
    The Chairman. Well--the Federal Government could make some 
things conditional. But--it's sort of circular. If they don't 
have a good credit rating because credit rating agencies don't 
give them good credit and because markets undervalue--solidity.
    Mr. Reeves?
    Mr. Reeves. Thank you, Mr. Chairman. I think that I agree 
in general terms with Treasurer Wiessmann. The reality is that 
in the municipal marketplace, relative risk is always going to 
be important, and it's going to be important either relative to 
the way in which rating agencies rate securities, or it's going 
to be important relative to the buyers who are actually buying 
those securities--
    The Chairman. But we are talking about full faith and 
credit general obligation bonds. Are there real differences and 
    Mr. Reeves. Absolutely. There are real differences in risk. 
I mean if you look at the general obligation of the State of 
Pennsylvania, which has a very diversified economic situation 
within the State or my State and the State of Mississippi 
relative to the general obligation of a smaller entity that may 
not have the sort of diversified situations. Now, in terms of--
    The Chairman. Which has never defaulted.
    Mr. Reeves. The default risk is one component of the 
overall risk structure--
    The Chairman. Well, but that's so fulfilling. Yes, if you 
leave it entirely to a market which undervalues the--and to a 
credit rating agency with a dual structure, then those 
differences are built in. The question is, what would happen if 
the Federal Government stepped in and said, ``You know, with 
regard to these, there has been a default. We don't think that 
the way the rating agencies have treated them reflects 
    Mr. Reeves. Well, I agree that the way in which rating 
agencies have treated municipal issuers has not reflected 
reality because when I say ``relative risk,'' I think relative 
risk means not only amongst general obligation credits of 
larger entities and smaller entities. Relative risk also 
includes that of the corporate marketplace as well. And that's 
where the real distinction has been in the past, in my opinion.
    The Chairman. By the way, the record does not show that the 
size of the State makes any difference whatsoever. There is 
simply no difference with regard to defaults with regard to 
State, because they don't default.
    Mr. Reeves. I would agree with that, Mr. Chairman, but I 
would like to just note that when you talk about the entire 
municipal marketplace, you're not just talking about--
    The Chairman. I said, Mr. Reeves, full faith and credit 
general obligation. I understand that. But that's exactly yes, 
there are some differentiations there. But even there, though, 
the market--the market undervalues all of this, but in 
different levels.
    The gentleman from Pennsylvania?
    Mr. Kanjorski. Thank you very much, Mr. Chairman. As I 
understand it, the question in the municipal bond market is not 
that there aren't funds available the people would like to buy 
bonds with; it is the problem of getting to a triple-A rating, 
which is required by many of the entities that invest in 
municipal bonds. So having lost in some instances the value of 
the insurance wrap-around, that because the rating agencies 
were able to sell their wrap-around, triple-A rating to the 
particular municipal bond issuer, these qualified across the 
board to all potential buyers. Now that has disappeared, and in 
some instances the fiduciary relationship of the pension fund 
or whoever buys these bonds is now being forced to divest 
themselves of the bonds because they failed to meet the legal 
requirement of a the triple-A rating. Is that correct?
    We are not talking about having to create an investment 
tool process by which the owners or purchasers of these bonds 
can continue to exist as they have in the past. And since they 
do not know what the rating is, they cannot depend on the 
rating right now, and the insurance companies are either 
incapable because of their draw-down of equity to issue the 
amount of capacity that they had in the past, we no longer have 
that clear triple-A rating.
    Is that basically--do I have it right or do I have it 
    Ms. Wiessmann. In that segment of the market, yes.
    Mr. Kanjorski. Well, so it seems to me that we have about a 
$2.6 trillion market. It has probably been working for your 
friends and associates in the construction industry and in the 
municipalities. It is a question of how do we get back to that 
status, so there isn't an interruption, as there has been?
    And one of the interruptions would be the insurance 
companies. Their equity is being drawn down because they have 
wrapped too many high-risk securities that now they have to 
come forward and show support for that, and that limits the 
amount of equity they have left in their companies to give the 
triple-A guarantee to new issues. Is that about the correct 
    Mr. Dillon. But I would like to say, Congressman, there 
there has been--construction work is slowing and stopping. It's 
being affected immediately right now. And really it just has 
happened in our industry in Indiana probably in just the last 
three to five--
    Mr. Kanjorski. But we could probably cure that if we were 
to decide to pass a very limited Federal financing instrument 
and say that municipal bonds from this day forward may be 
insured by this Federal agency for the next 12 months or until 
other insurance in the private market is obtainable for a 
reasonable price. And that would then jilt the market right 
back to being a very sound triple-A document. Is that correct?
    Mr. Dillon. That is my understanding from our local city 
    Mr. Kanjorski. Right. And we should all be in favor of 
that, finding a way. So now we are in the darkness, trying to 
find the light. The problem that I have is it is quite an 
invasion and disruption of the private market. The question 
that I pose to you, and perhaps the treasurer from 
Pennsylvania: At what point should we worry about invading the 
private market? Is it so pervasive the risk to going on with 
municipal bonds and public projects, that we ought to just as a 
matter of course in good public policy delve into it to solve 
the immediate problem of stimulating the market to begin to 
    Ms. Wiessmann. Well, that goes to the heart of my 
testimony, which is that I do think these are very unusual 
circumstances, and that the increases and the expenses and the 
stress that is being created on States and municipalities and 
entities is something that needs to be obviated. And I have 
called for some intervention, both from a liquidity standpoint, 
and if the Federal Government were to see to having some from a 
insurance standpoint, if the Federal Government found fit to do 
that on a temporary basis, I think it would be justified.
    Mr. Kanjorski. Well, let me follow that reasoning. It would 
take us a considerable length of time to establish a new 
municipal bond government guarantee corporation. From my 
experience standing here, we are probably talking years, 
unfortunately. So that is one of the reasons I came up with the 
argument and the idea a number of months ago to use the Federal 
Home Loan Banks. If we authorize the issuance of letters of 
credit to operate as an insurer of municipal bonds, that could 
be implemented almost immediately. We have it all 
collateralized, and available in all 12 Federal Home Loan Banks 
across the country, and they could be operable almost 
immediately, or certainly within 30 days.
    Ms. Wiessmann. I think you have three State treasurers here 
on the panel, who have all concurred that would be a very good 
    Mr. Kanjorski. So we ought to urge our fellow members on 
the Ways and Means Committee to move as quickly as possible on 
that piece of legislation as a surgical procedure to at least 
restart the municipal bond operation to move projects along in 
the country, is that correct?
    Ms. Wiessmann. In my opinion, yes.
    Mr. Kanjorski. Right.
    The Chairman. Thank you. Next? The gentleman from 
    Mr. Capuano. Thank you, Mr. Chairman.
    I'd like to ask each member of the panel--I notice that 
several of you work with treasuries in one hospital and one 
independent. I just want to make it clear in my own mind. Are 
you all currently, or any of you not currently issuing bonds on 
a regular basis, either for the State, or on behalf of cities 
and towns, or on behalf of the hospital? Are you not in the 
bond market? Oh, you--I'm presuming you are in the bond market.
    Mr. Rosenstiel. We are in the bond market today, selling a 
billion dollars of revenue bonds because of the fact that they 
are not working--
    Mr. Capuano. That's--I just want to know if you were in the 
    Mr. Rosenstiel. Yes.
    Ms. Wiessmann. The Commonwealth of Pennsylvania has issued 
bonds very recently.
    Mr. Capuano. And I assume that you don't issue bonds 
directly, you just benefit from them when you can?
    Ms. Wiessmann. Correct.
    Mr. Capuano. So then it's fair for me to believe that I 
have to be a little wary of everything you say, because if 
you're in the market, you really don't want to get the credit 
rating agencies upset with your State. You really don't want to 
get the bond insurers upset with your State. And I don't blame 
you. I was hostage for 9 years, I had to very nice and very 
professional, so I'd have to tell you that I feel sorry for you 
and I look forward to the day that you are released from your 
hostage situation, and then can speak freely.
    In the meantime, I would like to know, if you can tell me, 
if you feel--again, I would never ask you to hurt your State or 
municipality, so if you have to couch them or just want to 
skip, go right ahead. Does anybody think that the dual-rating 
system is good or fair? Does anybody think that the similar 
treatment that's required by the SEC or the dual-rating system, 
is fair?
    Ms. Wiessmann. I made in my comments, I commented that the 
origination of the ratings, which of course have a long history 
at this point up until now have withstood the test of time. But 
our markets have become much more complicated, and when times 
call for it, changes should be made.
    Mr. Capuano. That strikes me as a very nice and 
professional way to say they're not fair, and you know--
    Ms. Wiessmann. Well, I like to approach things 
    Mr. Capuano. That's fair. I can't tell you how good it is 
to have some freedom. Believe me, when you get it, it's great.
    Mr. Capuano. I'm just curious. I know you each come from 
different States. I assume the three of you can answer; I'm not 
sure if the other two can. If you can, I'd appreciate it. Do 
your States back up municipal bonds? I know in Massachusetts if 
a city or town has trouble, the State will take it from Local 
8. And they come in right away and we have had cities go 
bankrupt, and not a single bondholder has missed a beat. I'm 
just curious, is that true in each of your States?
    Mr. Rosenstiel. There is nothing legislatively that 
requires it, but in fact when there have been problems, there 
has been a history of the State stepping in to--
    Mr. Capuano. So there's a history, a recent history of that 
    Mr. Rosenstiel. Yes.
    Ms. Wiessmann. In Pennsylvania, it also is done on a case-
by-case basis. It's not legislated, but there is often a 
considered moral obligation.
    Mr. Reeves. We have a specific conduit issuer in 
Mississippi, which by the way was very useful in the immediate 
aftermath of Katrina. But we do have a specific conduit issuer 
that on certain issues when requested does all for the moral 
obligation of the State. I will tell you just for the record 
that along with that moral obligation comes additional 
responsibility by the issuers to satisfy the members of the 
board that sits on that conduit issuer, including myself. Yes, 
we do have a conduit issuer.
    Mr. Capuano. Good. And can you answer me relative to 
Illinois? Do you know?
    Mr. Newton. I can answer relative to my institution.
    Mr. Capuano. Okay. That's fair. What is the answer for your 
    Mr. Newton. We're totally dependent on ourselves and our 
own performance.
    Mr. Capuano. Okay. And do you know--again I don't expect 
you to know, but I figured you might--
    Mr. Dillon. No, I don't. I don't.
    Mr. Capuano. Okay.
    Mr. Dillon. If you want to know how to put pipe in the 
ground, I'm your guy.
    Mr. Capuano. We're doing that right now in my city. As we 
had a brief discussion, my city is currently in the middle of 
doing a major sewer project that has been put off for 20 years, 
and had I been able to save all the money I had to waste on 
bond insurance, I could have done it years ago, and a lot of 
people's homes and businesses would not have flooded.
    In that case, I appreciate you being here. I don't have any 
real questions for you. I can only tell you that if you have 
heard us say anything here that you think has been wrong, then 
I would suggest if you haven't, then talk to your local cities 
and towns, your mayors, and in particular your county 
commissioners. Whomever issues the bonds, in particular, GO's 
and revenue bonds, and see if they think it's wrong. And again, 
when the time comes when you are no longer in the market, I'd 
love to have a further discussion with you to see what your 
personal experience has been. In the meantime, I would like to 
say to the credit rating agencies and the bond insurers in the 
market in the room tonight, this afternoon, please don't hold 
against them what I have said.
    The Chairman. The gentleman--I was sorry but not surprised 
to hear your report that this has already begun to affect a 
slowdown. Anything that your association wanted to send to us 
along those lines, we would be glad to put in the record, 
because I think it is important to show that, as I said, we're 
not talking about some narrow technical matter, but some real 
problems that will slow down the rate of needed physical 
    The gentleman from Texas? Oh, I'm sorry, the gentleman from 
    Mr. Shays. Yes. Thank you, Mr. Green, as well. Just on 
behalf of Ranking Member Spencer Bachus, I'd like to enter into 
the record a letter that Mr. Bachus sent to Securities and 
Exchange Commission Chairman Christopher Cox on January 23, 
2007, not 2008, more than 14 months ago, long before the issues 
in the municipal securities market that we have been discussing 
here today. The letter states concerns that Mr. Bachus had 
about the oversight of the municipal securities market and the 
situation particularly in Jefferson County, Alabama. So if I 
could submit--
    The Chairman. Without objection, that will be part of the 
    Mr. Shays. Thank you.
    The Chairman. And the gentleman from Texas is recognized.
    Mr. Green. Thank you, Mr. Chairman. And I thank the members 
of the panel for appearing. It appears to me that we are 
talking to a great extent about the monoline market. Is there 
anyone who is of the opinion that this market should be 
regulated at the Federal level? Or if you're at liberty to say, 
and perhaps I should start with Mr. Newton. Mr. Newton, should 
this market be regulated?
    Mr. Newton. I don't know if I can give you a specific 
direct opinion on regulating the monolines. What I can share 
with you is that what really precipitated this was the failure 
in the auction market. And to the extent that there is 
oversight of the auction market, and to the extent that we can 
have available to us other options for credit enhancement, that 
would be a wonderful thing.
    Mr. Green. The failure in the auction market is due in 
great part to the way the mono insurers conducted themselves, 
is that correct?
    Mr. Newton. That's my understanding. Correct.
    Mr. Green. So regulating that market would mean that we 
would again get back to the monoline market. I don't know how 
we get away from that. Maybe you can help me to understand how 
we get away from it.
    Mr. Newton. Well, what really makes health care work is 
having this predictability and capacity of capital. And when we 
run up against things that frankly--I, like you, don't 
understand all of the arcane science of how these markets may 
choose to work, what I would be greatly in favor of is if 
transparency and visibility and greater understanding of the 
kind of debt instruments that are involved, that would be very 
helpful, if that helps clear the market.
    But what we're facing is a bolus in the market of this 
refinancing, and that to me on a looking forward basis is 
really my greater concern. The past is past. I mean I can't 
really give some more in-depth conversation about how it really 
got this way.
    Mr. Green. Well, Mr. Dillon, do you have a comment on it, 
    Mr. Dillon. No. I really can't advise you on that.
    Mr. Green. Do you think that we should, the feds should 
regulate the monoline market in any way?
    The Chairman. Well, let me just say in fairness to the 
witness, he was invited here to give his information about what 
the impact of this crisis has been on the industry he 
represents. He was not asked to be prepared on the--
    Mr. Green. Thank you, Mr. Chairman. I appreciate it. Well, 
let me ask this question. Would regulation--and if this is the 
wrong panel to ask a question of, my apologies again--but would 
regulation have been of benefit, any kind of regulation in the 
monoline market have been of benefit to us in terms of 
preventing the failures that we're talking about?
    Ms. Wiessmann. I would just suggest that the insurance 
companies would respond today that they are regulated; they 
just happen to be regulated by different States. And one thing 
that I have been struck with about this is how different the 
different insurance companies are. So I do think it would be 
beneficial for there to be some uniformity of standards as it 
relates to the marketplace that they're operating in, so that 
there is a greater understanding of how they are conducting or 
managing their risk relative to this very important market 
    Mr. Green. Thank you, Mr. Chairman. I'll yield back.
    The Chairman. The gentleman from Missouri.
    Mr. Cleaver. Mr. Chairman, I have one question--I'm anxious 
for the next panel--uniform standard. I mean insurance 
companies, Ms. Wiessmann, you said would argue that they are 
regulated--if there is a regulation supposed to be at the State 
level. And so I guess I'd like to know if you know of any kind 
of regulatory control over an insurance company that has 
addressed any of the issues that we're raising today? The dual 
standards, student loans. I don't know if Mr. Dillon talked 
about the problems with student loans.
    Ms. Wiessmann. Well, I think there are a number of factors, 
here. The dual standards I think are generally referring to the 
rating agencies in terms of all of that.
    Mr. Cleaver. Yes.
    Ms. Wiessmann. It is a complex mix. It's an interplay of a 
number of different factors. When I said that I thought that it 
would be useful to have some uniform standards, if there are 
particular criteria that Congress or other interested parties 
think need to be put into consideration when insuring municipal 
bonds, I think you could develop those. So I think there is 
something that you can do. I think we do have to do it, to say 
wholesale regulation is--I'm not really in a position from a 
jurisdictional standpoint to argue that. But I certainly think 
that there's a lot to be done to improve the information we 
have as well as knowing how the risk is allocated.
    Mr. Reeves. I'd like to just touch on that. The regulation 
of the insurance industry has been an issue handled by the 
States for a long period of time as to whether or not that's 
the right approach or not that's not something I should 
necessarily comment on, because again, as the treasurer said, 
it's not under my jurisdiction.
    But what I would like to say, and I think this is extremely 
important, is that the fact that the insurers have had the 
complications that they've had, and that they've lost their 
credit ratings really speaks to--as it relates to the 
challenges that we face today, speaks to a larger issue, and 
that is the lack of liquidity in the market. The real 
challenges that we have in the auction rate securities market 
is due to lack of liquidity. The reason that the insurers 
losing their triple-A ratings, at one reason, has really 
exacerbated the problem is because of the Rule 2a-7 
requirements. Okay? So in essence, when the insurers lost their 
triple-A ratings, many of these securities were no longer 
eligible under Rule 2a-7. The chairman earlier mentioned his 
sensitivity to the private marketplace. My opinion is that the 
least invasive solution in the short run is actually a relaxing 
of the 2a-7 requirements for municipal bonds. Because the 
reality is it makes no sense that a 2a-7 fund can purchase a 
double-A corporate and not a single-A muni, when in fact the 
reality is and the facts show that that single-A muni has less 
of a default risk than the double-A corporate. So in my view, 
the least invasive solution in the short run is that relaxation 
and as the chairman mentioned earlier, secondarily, an 
additional possibility which again requires legislation, which 
takes time, is the allowance of the Home Loan Bank to offer 
letters of credit again, which would infuse liquidity.
    Mr. Cleaver. Thank you, Mr. Chairman.
    The Chairman. Again, what we stress is the case where the 
low rating of the insurance drags down the entity it is 
insuring. This is the lead life preserver. You would be better 
off without the life preserver and floating on your own.
    The gentleman from Colorado?
    Mr. Perlmutter. Thanks, Mr. Chairman. And I guess, I have 
so many questions, I don't know where to begin but just basic 
question to the treasurers: Why do you have to go through 
Moody's if you are California or you are Pennsylvania or 
Mississippi, why cannot you just go straight to somebody who 
buys bonds and not have to go through any of this stuff?
    Mr. Reeves. Well, one of the main reasons is that among the 
biggest buyers of municipal bonds are mutual funds, and they 
require the ratings. That is in their bylaws for each of their 
funds, that there have to be generally two ratings.
    Mr. Perlmutter. Okay, so the mutual fund before it buys 
says we have to have something from Moody's?
    Mr. Reeves. That's correct.
    Mr. Perlmutter. Or we have to have insurance?
    Mr. Reeves. We have to have certain rating levels from 
usually at least two rating agencies.
    Mr. Perlmutter. Is there anything in the law that says that 
they have to have that?
    Mr. Reeves. I don't believe so, but I am not an expert on 
their law.
    Mr. Perlmutter. So if you went to a mutual fund, and I have 
represented for instance Pennsylvania Higher Education 
Authority, which apparently is struggling to make some loans 
because it cannot borrow any money or sell bonds, but your 
Pennsylvania Higher Education Authority. And you say, ``But we 
are a good credit risk, and we can put on the dog and pony show 
to any bond buyer out there and prove to you that we are worth 
5 percent interest, and that is a good risk for us. Why don't 
you do that?'' They just say, ``Sorry, you have to go through 
Moody's,'' or some other?
    Mr. Reeves. There is that and there are other buyers who 
buy the bonds and then turn them into variable rate bonds and 
2a-7 requires the ratings and just in general I think 
investors, individual investors, get a sense of security. The 
ratings have provided an important function in our market.
    Mr. Perlmutter. But, Mr. Treasurer, listening to Mr. 
Lockyer, I am going wait a second, California has issued $9 
billion worth of whatever, it has paid $100 million to 
insurance companies and to the credit rating agencies, you 
could have taken that $100 million and gone to Leonard 
Perlmutter and say, ``Hey, we are good credit risk, will you 
buy $100,000 worth of our bonds?'' Why do you not do that?
    Ms. Wiessmann. The short answer is that you rely on the 
negotiation of the credit markets, which are far larger than 
anything a State or a particular entity could access. When you 
talk about Pennsylvania student loans, there are securities on 
loans of $7 billion. We would have to find a lot of one-on-one 
placement in order to fulfill that type of liquidity 
requirement, which it brings us back to the point that it 
really does--rating agencies have provided an objective, a 
perceived objective standardization in the marketplace, just as 
the insurers have been up to this point have been perceived as 
creating a marketability for these.
    The Chairman. Will the gentleman yield?
    Mr. Perlmutter. Certainly, yes.
    The Chairman. There is nothing objective. I understand that 
you were held hostage by this, but I do not understand why you, 
the victims, would defend a rating system that has totally 
undervalued you, that has cost you a lot of extra money. There 
is just no validity to this. They are drawing distinctions 
among bonds that never default. So I understand why you are 
forced into it, but frankly now some of them come in, I have to 
tell you at this point, and I have said it before, the ratings 
agencies worth--I have said about editorial writers, they come 
down from the hills after the battle is over and shoot the 
wounded. So they are never there to help anybody in advance, 
but I do not understand how you can talk about them as being 
    Ms. Wiessmann. I just want to qualify, number one, I do not 
feel held hostage to them at all. I feel quite independent in 
fact, but--and I do not think that what I say here today is 
going to affect the credit rating of Pennsylvania.
    The Chairman. But I am saying this, as the gentleman from 
Colorado said, we have bonds that never default and you were 
all held hostage, what you are saying is if you did not go and 
subject yourself to the rating agencies and to this insurance, 
which is dragging people down because it is lower rated than 
you ought to be, you could not sell.
    Ms. Wiessmann. I just want to say I mentioned before that 
markets change. The sophistication of buyers, the 
sophistication in America in terms of what municipal bonds are 
is quite different from when rating agencies were first added.
    The Chairman. But now you are worse off, is that what you 
    Ms. Wiessmann. And they provided market access.
    The Chairman. I'm sorry, I want to get back to the 
gentleman from Colorado, but I do not think that is the case 
because you are now paying more than you used to, so if they 
are more sophisticated, that must mean that you are worse than 
you used to be as a credit risk, and I don't think you are. The 
fact is if they were so sophisticated, you would not be in the 
situation of having rates go up when there is no valid reason 
for it.
    The gentleman from Colorado?
    Mr. Perlmutter. And I will just cut it off at this. I can 
understand why the hospital authority or something else needs 
to go through a middleman, Moody's or have to have some backup 
from an insurance company because the marketplace or the Smith 
Barneys or the Goldman Sachs or whoever buys these bonds does 
not really understand you, but California, Pennsylvania, 
Mississippi, for goodness sakes, it really does not make sense 
to me how this process works.
    Ms. Wiessmann. Unfortunately, we just respond to the 
market. We are trying to change the market. We are trying to 
educate people that we are better credits, but we are in the 
market today with $1 billion worth of bonds, and we bought bond 
insurance on them.
    Mr. Capuano. Will the gentleman yield for a second?
    Mr. Perlmutter. Certainly.
    Mr. Capuano. I appreciate your trying to educate them. Why 
would they get educated when they make money by being--well, 
    Ms. Wiessmann. What I mean is the investors.
    Mr. Capuano. Why would the investors do it when they get a 
higher rate of return?
    Ms. Wiessmann. That is a very good point.
    Mr. Capuano. If you are telling me that you are going to 
educate me, and when I am educated, I am going to get 5 percent 
back on my bond as opposed to 8 percent on my bond, guess what? 
I will stay stupid.
    Mr. Capuano. So therefore, how can you educate the people 
who are making money on the backs of your taxpayers?
    Ms. Wiessmann. You are defining part of our problem, but 
there are also a lot of investors, especially we had at other 
times in the market, as recently as less than a year ago, many 
of our bonds were bought by hedge funds. They put in a great 
bid for our bonds. They drove our interest rates down, and the 
reason they did that is they then put it into trust and they 
sold variable rate bonds. They now have had to unwind those 
trusts because of the problems of the bond insurers. That has 
been one of the problems.
    Mr. Capuano. Because they were bundled with risky bonds. 
They were not sold individually.
    Ms. Wiessmann. They put into the trust insured bonds, and 
when the insurers were downgraded, the bonds--
    The Chairman. Right, the insurers downgraded because they 
went into other things and not your bonds.
    Ms. Wiessmann. Yes, that is exactly right.
    The Chairman. We are going to have to break now, but we 
have Stockholm Syndrome here, where you start thanking the 
    The Chairman. People need to be much less accommodating 
intellectually to a system that has just mistreated you. We 
have to go and vote.
    Mr. Capuano. Mr. Chairman, just one point?
    The Chairman. Yes?
    Mr. Capuano. Just one point. I need to remind everybody 
that even Patty Hearst said good things about her captors.
    The Chairman. Yes, they talk about that. Anyway--
    Ms. Wiessmann. We would not be on this panel if we did not 
think there should be changes to be made.
    The Chairman. I understand, but you have to make the 
arguments for the changes, not by defending the objectivity of 
the existing system. That is not going to help us. I want to 
say to the next panel that we will be back. It may take us 
about a half-hour. There are a couple of votes. I apologize but 
your testimony will be valuable. Let's take a little break. We 
will be back in about 45 minutes. If you can stay, I appreciate 
it, and we will get to you.
    Mr. Cleaver. [presiding] We apologize for how often we have 
to leave, and I wish I could tell you that this was unusual, 
but we are going to proceed and Chairman Frank will join us 
shortly. We are going to move on with the third panel, and we 
will begin to receive your testimony. By the time the chairman 
returns, hopefully we by then can become ``dialogical.'' We 
will begin with Mr. Jain, Berkshire Hathaway Assurance 
Corporation. Thank you for being here.


    Mr. Jain. Thank you to the members of the committee. It is 
my privilege to appear before you today. My name is Ajit Jain, 
and I am with Berkshire Hathaway. Recognizing the value of your 
time, I will get right to the three issues you have asked me to 
address, which are: One, the circumstances that prompted us to 
form Berkshire Hathaway Assurance Corporation, a new bond 
insurer, and the offer we made earlier this year to protect the 
municipal bond portfolios of the insurers. Two, the value of 
bond insurance to bond insurers and investors. And, three, what 
I think the future looks like for the bond insurance industry.
    The first issue then is our decision to enter into the bond 
insurance industry. This was prompted by a phone call from the 
New York Superintendent of Insurance. I confess that when I was 
told that a regulator was calling, I was prepared for a 
complaint. Instead, he was calling to discuss a business-like 
approach to solving a problem, involving us to create New York-
based insurer. Clearly, flattered by the phone call, we wanted 
to reciprocate by helping address a problem of national 
    At about the time the superintendent called us, we felt 
there was a real possibility that the bond insurance industry 
would undergo a structural and permanent shift. For almost 20 
years, we have been considering entry into this business. With 
our triple A ratings and excess capital position, this segment 
was always a natural for us. The attractive macro-features 
notwithstanding, when we analyzed the risk/reward 
characteristics of a typical transaction, we concluded that the 
pricing did not adequately compensate the capital provider for 
the risk, especially the tail risk. By ``tail risk'' I mean a 
black event defined as a random, difficult to predict event, an 
event that may have never happened and therefore is unlikely to 
happen. But when it does happen, it has a huge impact.
    In about October of 2007, with the advent of the subprime 
crisis and the increased awareness of the financial losses it 
could bring, we hypothesized that risk in general, and 
financial credit risk in particular, would no longer be 
underappreciated and underpriced. Pricing going forward would 
reflect an expectancy of loss plus a reasonable return to the 
risk bearer.
    In addition, we believe that the franchises of the existing 
industry leaders could be mortally wounded by the subprime and 
structured finance exposures. Whether or not these companies 
would raise additional capital, we believe there is a good 
chance that they could no longer maintain their all important 
triple A ratings. If that happened, there would be an opening 
for us in the business.
    As for our offer to reinsure the municipal bond business of 
existing insurers, here again the New York superintendent gets 
the credit. He forced us to consider how our capital could be 
deployed to help alleviate the increasing pressure on the 
existing players and their policyholders. A comprehensive 
solution, including the structured finance and the municipal 
obligation, was everybody's first priority. However, we could 
not untangle the complex financial transactions that made up 
the structured finance portfolios. While we continued to feel 
that historical pricing on the municipal bond business was 
inadequate, we could at least take on that risk with a price 
adjustment, which we made in our offer to reinsure the 
company's municipal bond business.
    I would like to briefly explain why we believe the offer 
had the merits from several perspectives. First, from the 
municipality's perspective, having a solid, triple A insurer 
backing their bonds would almost certainly have avoided the 
steep increases in interest cost that we have seen in the 
variable and auction rate securities. Similarly, for the bond 
investors, our protection may well have avoided the steep price 
decreases in the value of the bonds that they witnessed 2 weeks 
ago. Furthermore, by releasing capital from the municipal side 
of the business, the structured finance policyholders could 
have had more capital available to pay for their losses. 
Finally, the shareholders of these companies, having shared the 
30 year municipal bond obligations, the companies could then 
negotiate with their counterparties to terminate their 
structured financial obligations and ultimately return capital 
to the shareholders. This might have been the best outcome for 
the shareholders given where the shares of these companies were 
trading then and are trading now. Despite these benefits, also 
it was clearly not in the best interest of the management of 
these companies, whose interest appeared to have trumped the 
combined interest of the investors, issuers, policyholders, and 
    The second issue I have been asked to address is the 
benefit of bond insurance to issuers and investors. On this 
point, I can add almost nothing to what has already been 
spelled out by so many others. Historically speaking, the cost 
of a financial guarantee insurance policy was more than 
justified by the reduced interest that the municipalities paid 
investors for the funds being borrowed. Speaking historically 
once again, the rating enhancements of the insurance was good 
for investors because it helped maintain a stable and liquid 
market for bonds.
    Given where we are today then, I can well understand the 
committee's interest in the large issue I am to address, which 
is where are we going with all of this? What my answer lacks in 
helpfulness, it makes up for in honesty: I do not know. There 
is a great deal of uncertainty. For our part, we are tiptoeing 
into the water and while we are writing business at pricing 
levels that are economically attractive to us, I remain very 
concerned about the long-term viability of the business in 
general and for us particular.
    There are several reasons for my concern: First, as is true 
in all insurance, the product that is being sold is nothing 
more than a future promise to pay. With recent headlines of 
municipalities having to pay as much of 20 percent on auction 
rate securities and some insured municipal bonds selling at 
higher yields than corresponding uninsured bonds, buyers have 
every right to question--
    Mr. Cleaver. Mr. Jain, I notice you have a couple more 
pages, three more pages, if you could summarize that for us.
    Mr. Jain. Okay.
    Mr. Cleaver. And perhaps during the question and answer 
period, you will be able to respond to questions on that.
    Mr. Jain. Sure. The buyer has every right to question the 
value of the bond insurer's promise to pay. This concern about 
the integrity of the product is further reinforced by the 
``good bank,'' ``bad bank'' talks that are being discussed 
these days.
    I will end there given that I have run out of time, and I 
want to thank you for giving me the chance to address you.
    [The prepared statement of Mr. Jain can be found on page 
109 of the appendix.]
    Mr. Cleaver. Thank you very kindly.
    The next witness is Mr. Sean W. McCarthy, president and 
chief operating office, Financial Security Assurance, on behalf 
of the Association of Financial Guaranty Insurers.
    Mr. McCarthy?


    Mr. McCarthy. Mr. Chairman, Ranking Member Bachus, and 
other members of the committee, I am Sean McCarthy, chair of 
the Association of Financial Guaranty Insurers, AFGI, and the 
president and chief operating officer of Financial Security 
Assurance Holdings, Ltd., and its monoline, Financial Security 
Assurance, FSA.
    AFGI is an association of 11 monoline primary insurers and 
re-insurers. Established in 1971, the monoline bond insurance 
industry has generally been a triple A-rated industry. It was 
initially founded to provide bond insurance to the U.S. 
municipal bond sector and today serves the municipal public 
infrastructure and asset back markets globally. As monolines, 
we provide financial guarantees and related products only. We 
do not provide other forms of insurance, such as property and 
casualty, life, auto, or health insurance products.
    It is a highly regulated and transparent industry with few 
exceptions. The monolines are required to be licensed in States 
and/or countries in which they operate. For example, the 
monolines are regulated by the New York State Insurance 
Department and in the UK, by the Financial Service Authority. 
Of the six companies providing primary guarantees, three are 
public companies and three are privately held. All are subject 
to or voluntarily provide disclosure, consistent with the 1934 
Act reporting requirements. The rating agencies also require 
ongoing information.
    The industry's practice is to underwrite at least 
investment grade risks, meaning investment grade or better, 
with low severity of loss when default does occur. In addition 
to providing financial guarantees, monolines also provide 
surety bonds and credit derivatives, whose terms exactly mirror 
a financial guarantee. All of these policies have pay-as-you-go 
settlement terms, and there is no requirement to post 
collateral if the underlying credit deteriorates, thus 
minimizing liquidity risk.
    Over the past 5 years, monolines have insured more than $1 
trillion of U.S. funds to fund essential public projects, 
almost $82 billion of the funds to fund infrastructure outside 
of the United States, and more than $1 trillion of asset-backed 
bonds globally to lowering funding costs. The issuers do not 
pay more for bond insurance. The premium paid for the guarantee 
allows them to lower their overall cost of funding. 
Additionally, bond insurance provides for a larger, broader 
public finance market because it increases investors' capacity 
for individual credits.
    For investors, bond insurance provides protection against 
default of principal and interest, built in analysis, 
surveillance and remediation so that problems can be worked out 
before a default. Bond insurers do not guarantee market value. 
As a result of conservative underwriting, the industry has up 
until now had a low loss record of three basis points on net 
debt service. This contrasts with the banking industry's 
weighted average annual charge-offs on principal of 60 basis 
points from 1992 to 2006.
    What has happened lately? The crisis originates from a 
specific type of security: collateral debt obligations of 
asset-backed securities, referred to as CDOs of ABS, or another 
form, CDOs of CDOs. These contain large amounts of U.S. 
subprime residential mortgages in concentrated forms. While 
home equity lines of credits, securities called HELOCS, and 
subprime mortgages may also generate claims for the financial 
guarantors, they will not be of the magnitude to imperil the 
company's credit ratings. Thus, some companies made a mistake 
in a single asset type class. This does not represent a 
systemic failure nor does the industry request a Federal 
bailout. Going forward, industry members who have been degraded 
will do whatever possible to get back to a triple A level. We 
also expect the rating agencies to recalibrate their models 
with more conservative assumptions on all forms of asset-backed 
transactions, including the oversight of the monolines. The 
monolines will respond accordingly.
    Even if a bond insurer goes into run-off, it can renew its 
capital reserves through investment income and freeing up of 
reserves if the bonds it has insured mature or are called. 
AFGI, as an association, does not take a point of view on how 
monolines are structured. I will say from the perspective of my 
company, FSA, it does not make sense to require companies to 
split into municipal and structured finance units, as the model 
works appropriately now if correctly applied with conservative 
    I would also like to add a perspective on the causes of the 
recent option rate failures, which, while due in part to credit 
concerns about the bond insurance industry for sure, were also 
driven by dealers backing away from an implied obligation to 
provide liquidity and to credit liquidity concerns in general. 
In most cases, bond insurers will work--we certainly are 
working with issuers to convert auction rate to either fixed or 
variable rate bonds.
    One further point: We believe that unrealized marks that 
insurers are required to take through the income statement on 
insurance policies issued in a credit default swap form under 
US GAAP are obscuring the true performance of the industry. 
Absent any claims under the guarantee and given the insurer's 
intent to hold these contracts until maturity, decreases or 
increases to income due to the marks will sum to zero by the 
time each contract has matured, eliminating any economic 
impact. These contracts are functionally identical to the 
financial guarantee policy and are not inherently more risky. 
Therefore, we can submit the fact that CDOs of ABS were insured 
in the credit default swap form have nothing to do with the 
economic loss that will be taken on these structures, it is the 
assets underneath them.
    I thank you for taking the time to listen to me, and I 
would be happy to answer any questions.
    [The prepared statement of Mr. McCarthy can be found on 
page 140 of the appendix.]
    Mr. Cleaver. Thank you very much, Mr. McCarthy.
    We will move now to Ms. Laura Levenstein, the senior 
managing director of Global Public, Project & Infrastructure 
Finance Group, Moody's Investors Services. Thank you very much 
for being here.

                       INVESTORS SERVICE

    Ms. Levenstein. Thank you. Good afternoon, Chairman Frank, 
and members of the committee. I am pleased to be here on behalf 
of my colleagues at Moody's Investor Service to discuss our 
rating system for municipal bonds and how that system is 
designed to address the attributes of the municipal market. I 
will also describe some of the more recent changes we have made 
to our municipal rating system as a result of our ongoing 
dialogue with issuers, investors, and other market 
participants. I should note that more than 35 percent of the 
municipal bond issuances are not rated by Moody's or any other 
credit rating agency. Therefore, the information contained in 
my testimony is based on the securities that Moody's has rated 
in the municipal market and our comments should not be 
construed as being applicable to the entire universe of 
municipal issuance.
    Moody's first began rating municipal securities in 1918. 
Today, our U.S. municipal rating system is used for rating 
securities issued in the U.S. tax-exempt and taxable bond 
markets by State and local governments, nonprofit 
organizations, and related entities. This system is different 
from our global rating system, which is used for rating issuers 
and issuances of non-financial and financial institutions, 
sovereigns and sub-sovereign issuers outside of the United 
States as well as for structured finance obligations.
    Our municipal rating system grew out of and reflects the 
unique dynamics and needs of the municipal bond market and its 
participants. There are two aspects of the municipal bond 
market that have historically been particularly important. 
First, while it should be noted that the loss experienced from 
non-rated municipal issuers has been higher than that for the 
rated universe, municipal securities rated by Moody's have had 
relatively low credit risk when compared to rated corporate or 
structured finance obligations. This low credit risk is 
primarily the result of the special powers and the role of 
municipalities as public entities. These include their ability 
to levy taxes and the likelihood that in the event of financial 
distress, municipalities or other public entities will receive 
support from a third party, such as a State government. Because 
of these and other factors, the municipal market has had 
limited default and loss experience and our municipal rating 
system reflects that reality.
    Second, investors in municipal securities have 
traditionally had different perspectives and risk advertised in 
corporate bond investors. Municipal investors generally have 
been more risk averse and less diversified in their investment 
portfolios. They typically have been more concerned about the 
liquidity of their investments and, in the case of individuals, 
more dependent on debt service payments for income. They have 
typically been highly intolerant of seeing their investment 
portfolios experience diminished value or reduced liquidity, 
which can occur as a result of an issuer's financial distress, 
even if the bonds do not ultimately default.
    In response to these market characteristics, are municipal 
ratings more finely distinguished among municipal securities 
than do our corporate ratings? Because the risk and potential 
severity of loss is low, our ratings focus primarily on the 
risk that an issuer will face financial distress. This can 
result in delayed payments and reduced liquidity.
    If municipal bonds were rated on a global rating system, 
the majority of the ratings would fall between just two 
categories: triple A and double A. This would eliminate one of 
the primary values municipal investors have historically sought 
from our ratings, namely, the ability to differentiate the 
relative credit risk among various municipal securities. We 
have been told by many investors that not providing that 
differentiation would make the market less transparent, more 
opaque, and presumably less efficient for both investors and 
    Nonetheless, Moody's recognizes that the municipal bond 
market has evolved in recent years, and we have taken steps to 
respond to the changing needs of investors and issuers. For 
example, in 2002, to accommodate the trend we saw of some 
taxable bonds being placed outside the United States, we began 
offering entities issuing such securities the opportunity to 
request a global rating. We also began providing broad guidance 
on how our municipal ratings would translate into global 
ratings. In 2006, we conducted extensive surveys of market 
participants. As a result of that feedback, in 2007, we 
announced that when requested by issuers, we would assign a 
global rating to any of their taxable securities regardless of 
whether issued within or outside the United States. We also 
published a conversion chart that allows the market to estimate 
a global rating from a municipal rating.
    Finally, since our last formal outreach to market 
participants in 2006, we believe that the market has continued 
to evolve. As a result, we plan to assign global ratings at an 
issuer's request to any tax-exempt bond, including previously 
issued securities, as well as new issues beginning in May 2008. 
We are also re-evaluating the overall market use and 
understanding of our municipal ratings and will be issuing a 
request for comment this month.
    Moody's has always maintained an active dialogue with 
investors and issuers to understand what would help make our 
municipal rating system most useful, and we welcome additional 
market feedback on measures that would improve the overall 
transparency and value of our rating systems.
    Thank you.
    [The prepared statement of Ms. Levenstein can be found on 
page 115 of the appendix.]


    Mr. Vogtsberger. Good afternoon, Chairman Frank, and 
members of the committee. Thank you for the opportunity to be 
here today. State and local governments depend on a smoothly 
functioning municipal market to finance schools, roads, 
hospitals, water and sewer systems, and other vital 
infrastructure. This is a timely and important hearing, and I 
commend you for your attention to these issues.
    My name is Martin Vogtsberger. I am a managing director and 
head of institutional brokerage at Fifth Third Securities, a 
regional broker-dealer, which underwrites fixed rate municipal 
bonds and variable rate demand obligations. Like most regional 
broker-dealers, we have not been active in the auction rates 
securities market. But I am here today representing the 
Regional Bond Dealers Association, of which my firm is a 
member. The Regional Bond Dealers Association is a new 
association that represents securities firms active in the 
municipal bond markets. Many of our members, including my own 
firm, are active in the municipal market.
    One of the things that makes the municipal market unique is 
that it is dominated by many thousands of State and local 
entities that issue bonds in relative size issue sizes. In many 
cases, these small issuers do not attract the attention of 
large global securities firms, so the municipal market depends 
on the participation of regional firms to function smoothly.
    The disruptions we have recently seen in the municipal 
market are the result of a perfect storm of negative events 
starting last summer. Sparked by the deterioration in 
residential real estate and especially subprime mortgages, 
credit markets began to freeze up. Investors retreated from the 
credit markets, liquidity dried up, and prices fell. While 
municipals were not as affected as other asset classes at the 
time, they were not spared. Hedge funds and arbitrage funds, 
who have become increasingly active participants in the 
municipal market, faced margin calls and began selling assets.
    Finally, it became clear that some of the bond insurers who 
provide credit enhancement to more than half of the outstanding 
municipal bonds were suffering from their exposure to subprime 
mortgages, structured credit products and other assets, but 
notably not from their municipal bond exposure. These events 
together caused stress on the municipal bond market similar to 
what other sectors of the credit market experienced last year. 
The disruption was felt most in markets for products that are 
designed to mimic money market instruments, including auction 
rate securities and to a lesser extent, variable rate demand 
obligations and tender option bonds.
    The most frustrating aspect of the current market 
disruption is that it is occurring despite the fact that the 
underlying fundamental credit quality of State and local 
governments has not eroded over the last several months. To be 
sure, the credit ratings of many thousands of bond issues have 
been lowered, but that occurred not because of weakening 
financial positions of States or localities but because of 
downgrades of some of the monolined insurers.
    State and local governments have suffered in several ways 
as a result of the current market stress. First, some of the 
auction rate securities are now paying owners penalty rates on 
auction rate securities whose options have failed. Often, these 
penalty rates are well above market rates. Many issuers are 
trying to refinance out of auction rate securities into more 
economical forms of financing. In some cases, however, this is 
difficult because of lack of asset to credit enhancement. In 
addition, issuers who have come to market with traditional, 
long-term, fixed rate bonds have had to pay higher financing 
costs than they otherwise would have because of lack of credit 
enhancement and a general loss of market liquidity.
    One question that has received significant attention in the 
context of the current market disruption is the rating scale 
used by bond rating agencies from municipal bonds, which 
differs significantly from the scale used by other debt 
securities. The separating scale of municipal bonds cost State 
and local governments money when they issue bonds, either 
because they have to issue bonds at a lower rating or because 
they have to buy bond insurance to issue at a higher rating. A 
strong argument can be made for encouraging rating agencies to 
rate municipal bonds on the same scale as other debt 
    Although important segments of the municipal market have 
experienced significant stress in the last several months, the 
core of the market has remained relatively strong. Issuers of 
traditional, long-term, fixed rate securities have still been 
able to access the market to finance new public investment. 
This is attributed to the strength of municipal bonds as an 
asset class and is hopefully a sign that the market's distress 
will not have long-term negative implications for States and 
    Thank you again, Chairman Frank, for the opportunity to be 
here. I look forward to your questions.
    [The prepared statement of Mr. Vogtsberger can be found on 
page 210 of the appendix.]
    The Chairman. Thank you. I apologize for being a little 
late, but again this is very important, and I appreciate all of 
you staying here. Let me start with Mr. Jain. And you 
reiterate, and we appreciate, we had a chance to talk with Mr. 
Buffer, and we appreciate your being here, you reiterate that 
you still think that going into the municipal only insurance 
business would be a very good deal?
    Mr. Jain. At current pricing levels, we certainly feel 
there is an attractive opportunity for us.
    The Chairman. Meaning that you could get--there would be a 
very low default rate, so a fairly low premium structure and 
you could make some money?
    Mr. Jain. That is correct.
    The Chairman. Well, of course, we are also thinking one 
possibility of course--well, I guess two things. There is a 
question about whether, and I apologize, I just tried to read 
your statement, you have made that offer but no one has taken 
you up on it, is that right?
    Mr. Jain. On the re-insurance for the existing municipal 
    The Chairman. Have you thought about just going to that 
business and saying to the municipal issuers, ``Here we are, 
come and be insured?''
    Mr. Jain. We are doing that as we speak. Over the last 2 
months now, we have insured about four billion-plus of 
secondary market transactions and have written premiums.
    The Chairman. What about primary, have you thought about 
doing it for the primary?
    Mr. Jain. Absolutely. We are in the process of trying to 
get ready, but you need a license in each and every State 
before you can write a primary transaction.
    The Chairman. Unless the Federal Government were to pass a 
statute that licensed this. I can't think of any obstacle to 
our doing that constitutionally. It could be a specific 
license. The Federal Government could license you to do that 
for municipalities only, you know, for municipal bonds. If the 
Federal Government were to pass such a license, would that 
facilitate your efforts?
    Mr. Jain. We are, since we made our application to the 
NAIC, through the NAIC to the individual States, we now have 31 
licenses already.
    The Chairman. All right. I'll tell you how to get 19 
licenses in a hurry. We'll file a bill for a Federal license. 
You'll get 19 more licenses in about 4 hours.
    Mr. Jain. Thank you.
    The Chairman. Now I do want to get to the issue of the 
duality. And I understand, Ms. Levenstein, your argument, but 
it seems to be somewhat circular. Well, first of all, I was 
struck with what Mr. Jain says in his statement. If the rating 
agencies had just one rating, there would be little need for a 
financial guarantee insurance marketplace because much 
municipal debt on a stand-alone basis wouldn't require the 
enhancement. So he's arguing against interest, and we 
appreciate the honesty of your doing that. But--and then, Mr. 
Vogtsberger, as I understand it, you're saying you think 
there's a strong argument--let me put it this way. Ms. 
Levenstein is, it seems to me, arguing, if I read correctly and 
listened to your statement, that the reason for the dual track 
is consumer demand; that the people who want to buy municipals 
because they are less--they are more risk-averse, they want a 
separate rating system. Is that essentially what you are 
    Mr. Vogtsberger. Right. I think when you add mutual funds 
as proxies to households, roughly 70 percent of the municipal 
    The Chairman. And they want a separate rating system?
    Mr. Vogtsberger. --are households, and they rely on ratings 
    The Chairman. Well, but, why do they--I understand that. 
But that's not the question. Please, let's stipulate. We'll get 
to whether or not there should be ratings in entities that 
never default. One default that was fully paid off since 1970. 
But why two ratings systems? That is, I understand they want 
ratings. But why--I mean, what we're being told is this. You 
know what? If we rated municipals the way we rated everything 
else, they'd always get 100. It would be boring. So, therefore, 
it wouldn't be good enough. That's the tail wagging the dog. 
That's the cart before the horse. That's all those metaphors. I 
mean, our--do investors demand a separate rating system from 
municipals because municipals don't fail enough to make the 
current--to make it interesting? I mean, let me ask you, Ms. 
Levenstein. Do investors in your view demand a separate rating 
    Mr. Vogtsberger. No. They demand a rating.
    The Chairman. All right. Mr. Jain, you say if we had a 
separate rating system, it would just show that everybody was 
solid. Ms. Levenstein, your argument appears to be that while 
you're meeting the needs of investors by a separate rating 
system, what's the evidence for that?
    Ms. Levenstein. We have been rating based on this scale 
since 1920.
    The Chairman. No, that's simply that you've been doing it. 
But the fact that you've been doing it doesn't mean that 
there's an investor demand that you keep doing it. So, what 
makes you think--
    Ms. Levenstein. But we've queried--we have queried the 
market many, many times, and the--
    The Chairman. In what sense? You've done a survey? Have 
    Ms. Levenstein. We've reached out and had one-on-one 
meetings. We've had briefings. We've done publications. We've--
    The Chairman. And they have told you that they insist on a 
separate rating system, even though they know that there's no 
    Ms. Levenstein. Yes.
    The Chairman. All right, I'm going to tell you, I'm 
skeptical. Sometimes--I'm sure you're being honest with the 
results, but I don't know how these things are done. I mean, 
let me put it this way. You say, well, in general, you talk 
about likeliness of default, but you're saying that when people 
buy municipal bonds, they're not interested in likelihood of 
default. They're interested in financial stress on the entity, 
even though your own evidence is that financial stress on the 
entity appears to be unrelated in any statistically significant 
way to default. I mean, is that a rational basis for the market 
to do this?
    Now, I do understand the argument that, well, no, but 
they're not as tradable. Right. They're not as tradable because 
of your rating system. It seems to me that's very circular. So 
why would people wanting to buy bonds not be influenced by 
whether or not they were going to default? And why is that 
relevant for corporate and not for municipal?
    Ms. Levenstein. Well, I think they are influenced by that. 
But ratings have multiple attributes. Ratings don't measure one 
aspect or one metric. Ratings are meant to provide relative 
rankings as well as--
    The Chairman. Well, but relative rankings, one in ten 
million versus one in a million? Relative rankings of what?
    Ms. Levenstein. Relative ratings of likelihood of default.
    The Chairman. Okay. And what is the likelihood--so, why 
don't you then put municipals in with everybody else and let 
them take the relative ranking of likelihood of default? Why 
can't you rate municipals like everybody else on the relative 
likelihood of default?
    Ms. Levenstein. Well, on a forward basis, as I've stated in 
the testimony, we are going to do that. We are going to offer 
at the issuer's request to rate both--
    The Chairman. I'm sorry. I didn't realize. So from now on, 
if an issuer wants to be rated the same was a corporate--
    Ms. Levenstein. That's correct.
    The Chairman. So the investor demand apparently--
    Ms. Levenstein. --of this year.
    The Chairman. --wasn't so strong after all?
    Ms. Levenstein. I'm sorry. Excuse me?
    The Chairman. Do you expect investors now to stop buying 
    Ms. Levenstein. No, I don't. But I do expect investors to 
still want to know what the relative ranking is, as well as the 
absolute likelihood of default of default.
    The Chairman. Relative ranking of municipals and corporates 
    Ms. Levenstein. Relative ranking of municipals amongst 
municipal securities, and then the likelihood of default across 
the whole spectrum.
    The Chairman. Well, let me ask you, you are all sort of 
market experts. If there is no--do I really care whether it's 
one in a million versus 1 in 900,000? I mean, why is that 
important information for me to have?
    Ms. Levenstein. Because risk premiums are based on relative 
rankings, not--
    The Chairman. Yes, but, then why--they're not absolute? 
They're relative?
    Ms. Levenstein. Yes.
    The Chairman. Is that rational--I mean, you would pay more 
for one in a million than for 1 in 900,000?
    Ms. Levenstein. I don't know if those are--
    The Chairman. You know, I mean, I've been listening for 
years people tell me you politicians, you act emotionally, you 
act irrationally. We, the market, are lucid. Based on today, 
not so much.
    The gentleman from North Carolina.
    Mr. Watt. Mr. Jain, you were about to make three points at 
the end of your testimony that you didn't get a chance to make. 
I'm going to give you the opportunity to make those three 
points quickly, if you can do it.
    Mr. Jain. The three points I was going to make was in 
relation to the outlook of the industry and why I felt the 
outlook of the industry was uncertain in general and our role 
in particular. And the reasons I have concerns for the outlook 
for the industry. Firstly, as we talked about, in insurance, 
the product that we are selling is a promise to pay. And buyers 
have rightly so have started to question what the value--
    Mr. Watt. And when you say industry, are you talking about 
the insurance of these bonds, or are you talking about the 
bonds themselves?
    Mr. Jain. I'm talking about the bond insurance industry.
    Mr. Watt. The bond insurance industry, not municipal bonds 
in general?
    Mr. Jain. No.
    Mr. Watt. Okay. So you're talking about the insurance, and 
I guess if there weren't two rating systems, a triple A and a 
double A, as I understand it, there wouldn't be any insurance 
would there?
    Mr. Jain. There would be less of a need for bond insurance. 
If a number of the--
    Mr. Watt. What does that insurance do, other than provide 
an absolute guarantee of payment in a market in which there is 
a one in one million absolute guarantee of payment anyway?
    Mr. Jain. The insurance certainly provides peace of mind to 
somebody who cannot really assess what are the true odds of the 
loss, to be able to get--
    Mr. Watt. But isn't that what the triple A rating, or 
that's what the rating would do anyway, isn't it?
    Mr. Jain. Right. But--
    Mr. Watt. So you are--the insurance adds an extra layer on 
top of the rating?
    Mr. Jain. Extra layer of protection in the event of 
    Mr. Watt. But do people understand that there hasn't been 
any default anyway?
    Mr. Jain. I am not sure--
    Mr. Watt. Historically?
    Mr. Jain. I am not sure about that. A lot of the product is 
sold in the retail market, and I'm not sure if the retail 
investors are sophisticated enough to be able to analyze 
individual credits. What they do rely upon are the ratings of 
the underlying municipality and--
    Mr. Watt. That's what Ms. Levenstein does, right?
    Mr. Jain. And the bond insurance protection--
    Mr. Watt. Which is what you do? So you are--I mean, people 
are really paying a premium for both of those things, both of 
which do, as I understand it, essentially the same thing.
    If you--if you give a triple A rating, Ms. Levenstein, 
isn't that a virtual guarantee that there's going to be 
payment? Historically, hasn't that been the case?
    Ms. Levenstein. Historically, that is the case, but--
    Mr. Watt. Okay. All right.
    Ms. Levenstein. --I think you could step--
    Mr. Watt. And if he gives an insurance premium, then does 
that do anything other than charge me an insurance premium to 
get the same historical guarantee? But I guess it gives me that 
assurance going forward. I'm not relying on history any more. 
I'm relying on his policy?
    Ms. Levenstein. Can I just provide a little bit of 
background that may be helpful?
    Mr. Watt. Absolutely.
    Ms. Levenstein. I don't think that price or yield is driven 
only by the rating. I think it's driven also by the size, name 
recognition, amount of disclosure that's available. There are 
other factors.
    Mr. Watt. Insurance premiums are driven by that, too?
    Ms. Levenstein. Insurance premiums. Sean should answer 
    Mr. Watt. Mr. Jain?
    Mr. Jain. The insurance premium is, as far as we are 
concerned, is driven first and foremost by what our expectancy 
of loss is.
    Mr. Watt. Okay. Well, let me ask this question, Mr. Jain. 
You say you're getting, if you get these other 20 States or so, 
you're going to get into the primary market. Are you going to 
require in that primary market, are you going to require 
    Mr. Jain. We are providing the insurance, so, you say will 
I require?
    Mr. Watt. You'll be playing on both sides, as I understand 
it, at that point. You'll be in insurance, and you'll be a 
purchaser of the bonds?
    Mr. Jain. No. No. We are not talking about us and our role 
in terms of purchasing the bonds. We will be the risk bearer 
taking on the insurance risk of the default of underlying 
    Mr. Watt. And you will be what else?
    Mr. Jain. That's it.
    Mr. Watt. Well, what are you now?
    Mr. Jain. We are a bond insurer.
    Mr. Watt. Okay. And once you get in on the next level after 
you get all these licenses, what will you be?
    Mr. Jain. We will be a bond insurer.
    Mr. McCarthy. I think perhaps the point that he was making 
is that right now, Berkshire Hathaway is participating in the 
secondary market.
    The Chairman. It's secondary and primary. The license is 
what is primary. Is that the--
    Mr. McCarthy. --I think he's making is that once he obtains 
all of the licenses, he will participate in the primary market.
    Mr. Watt. Okay. Well, and the question I was asking is, 
once you do that, will you require insurance also, or will you 
    Mr. McCarthy. No. He'll be--
    Mr. Jain. We will be--let me explain what I meant by the 
role we are playing right now. A number of bonds come into the 
market without any insurance whatsoever. These bonds end up 
with traders or with retail investors. At some point, these 
traders or these retail investors come to us on these uninsured 
bonds looking for insurance protection. We write insurance 
protection for these bonds on a secondary market basis, as 
opposed to negotiating with individual issuers, which is a 
primary basis.
    Mr. Watt. I think I--
    Mr. Jain. So in both cases we are playing the role of an 
insurer only.
    Mr. Watt. I think you've confused me sufficiently.
    Mr. Jain. I'm sorry.
    The Chairman. Let me just--I want to go back to Ms. 
Levenstein again. Somebody just suggested, and you said, and 
I'm glad to hear that, that you're going offer the municipal 
issuers the choice. Will there be a price difference in what 
they're charged?
    Ms. Levenstein. We haven't decided yet, and that's still 
under discussion. If there would be any incremental price, it 
would be an ongoing monitoring price. I should point out also 
that we currently--
    The Chairman. You would charge an ongoing monitoring price 
to the corporation--I mean, different than--I don't understand 
that. Why should they--
    Ms. Levenstein. Because there is additional work that we 
need to do in order to translate the ratings. But I would like 
    The Chairman. Well, no, no. So that's really taking back 
what it said in your opening--if they're in the same rating 
system as the corporations, why should--are they paying twice 
for this? I don't--
    Ms. Levenstein. No. We're providing a municipal scale 
rating or a rating under the municipal system, and we are going 
to effectively translate that to the equivalent of a corporate 
rating or a--
    The Chairman. Why don't you just rate them in the first 
place? Oh, so you're going to charge--so a municipality that 
wants to be rated as a corporate might have to pay more because 
they'll be first rated as a municipal issuer and then they have 
to pay a translation fee?
    Ms. Levenstein. I think that hasn't been determined yet, 
but they will be first rated under the municipal system and 
then we will apply the--
    The Chairman. Well, what if they just said, I'll skip the 
municipal system. Just rate me like anybody else right away?
    Ms. Levenstein. That's not what we're planning to do right 
    The Chairman. I find that, from our public policy 
standpoint, unacceptable, and we would certainly try to 
legislate against that. To charge them double to be treated 
like anybody else--
    Ms. Levenstein. No, we're not charging them double.
    The Chairman. Yes. That's what you're saying. You'll charge 
them to be a municipal--
    Ms. Levenstein. No.
    The Chairman. You'll charge them for the separate rating 
when they don't want a separate rating and then charge them 
again to get the same rating as everybody else.
    Ms. Levenstein. We're providing a municipal system rating 
which will allow for the sort of differentiation and relative 
ranking, which is valuable to the market. We're also providing 
or will provide upon request, only upon request, a global 
    The Chairman. I must say, I misunderstood what you said. 
When you said you were going to offer them a choice, what 
you're going to offer them is a second item for which you can 
charge them. And I think you will be continuing to be abusive 
of them in that regard.
    Ms. Levenstein. Again, I--
    The Chairman. You're going to charge--they have to--get 
rated like anybody else, they have to pay for two ratings.
    Ms. Levenstein. No. That is incorrect.
    The Chairman. You just said that. They're going to be rated 
as municipal whether they want to or not, and then if they also 
want the global rating, there's an extra charge for that.
    Ms. Levenstein. What I said is we hadn't determined it yet.
    The Chairman. No, but--well, if you do--if you don't, then 
I withdraw my comment. But if you do, then you're charging them 
double. And when you suggested to me that they'll have a 
choice, yes, I have a choice. I can buy--pay for two or I can 
pay for one. But that's not what I usually mean by a choice.
    Ms. Levenstein. But the other thing I should point out, it 
wouldn't be double. But the one thing I would like to point out 
is that we have offered global scale ratings or global system 
ratings since 2003 for any taxable issues, and it is 
interesting to us that we've only had 18 issuers--
    The Chairman. Do they pay extra for that?
    Ms. Levenstein. They do.
    The Chairman. Okay. Well, surprise, surprise, they don't 
want to pay extra for it. Secondly, taxable is different than 
tax exempt.
    Ms. Levenstein. I don't think that's--
    The Chairman. The fact that people may not want to pay 
extra doesn't mean that they wouldn't make the choice if they 
didn't have to pay extra.
    The gentleman from Massachusetts.
    Mr. Capuano. Thank you, Mr. Chairman. Mr. Chairman, I beg 
to differ with what you said earlier. The investors are very 
lucid. Why would they want to do the right thing in order to 
get a lower return? They love the system they have now because 
they get eight points back when they should be getting five. 
They get seven points back when they should be getting four. 
Why should they change it? Why would any of these people at 
this table change the system when with a good system they'd be 
out of business? We wouldn't need you. So I think you're 
investors, and you are very lucid. You got it right. You have 
them by the short hairs. Keep them screaming. Don't worry about 
    Mr. McCarthy, I beg to differ when you saved us $40 
    Mr. McCarthy. Correct.
    Mr. Capuano. That's like the local gang coming into my 
little corner store and saying we saved you $100,000 because 
your place didn't burn down last week. We gave you protection. 
You didn't save anything. You saved it because you have the 
system rigged so that cities and towns can't get the ratings 
they deserve due to their default rates, their lower default 
rates. You didn't save anything.
    How can you possibly be shocked that they're now attempting 
to pretend to do the right thing and going to charge us for it? 
But I'm supposed to say thank you? When I was a mayor, I would 
say thank you. Have another croissant. I don't have to say that 
anymore. Getting double charged for doing what you should be 
doing in the first place, I don't have to say thank you. I can 
call it what I've said it is. It's extortion. All I see is the 
rate for extortion is going up.
    I do want to ask one thing. On the historic default rates, 
am I wrong? Is my information incorrect that corporate double A 
bonds that are rated by Moody's have defaulted at a rate 43 
times higher than double A rated munis?
    Ms. Levenstein. No, I don't believe you're wrong.
    Mr. Capuano. Yet they get a better rating. How is that 
defensible? If you're going to do this, then stick with the 
dual system. Just change how they get done. Why? Keep the dual 
system. Give the munis a better rate. They're a better deal, 
according to your own dual system. And I understand fully well 
that somehow I must be mistaken here in the documents you gave 
and the written testimony you said that you used analytical 
methodologies. Okay. That sounds very complicated, very 
mathematical, very precise. But then I just heard you say the 
reputation or the name recognition of the community. So if you 
don't know where my community is, though my community has never 
defaulted, just because you don't know where it is, I have to 
pay more?
    Ms. Levenstein. No. That wasn't--
    Mr. Capuano. That's obscene. That's offensive.
    Ms. Levenstein. That wasn't what I was saying. What I was 
saying is the way the market prices things sometime depend--
    Mr. Capuano. If the market knew that I was going to pay 
them back, they would price--I have no problem with ratings. I 
just want to be rated on a fair and equal footing. I have no 
problems with ratings, and I do understand that rateds is 
different than unrateds. I understand that within rateds--I 
accept all that. That doesn't bother me.
    But put me in the category, put us in the category that we 
have earned. You didn't give it to us. We earned it by paying 
our bills. We've done what we were asked to do. We have done it 
better than corporations, and yet you still punish us because 
we have been silent. I'm not being silent today. And I don't 
expect to be silent ever again because I now have this new 
freedom that I am finding very good.
    Simply treat us fairly, and there would be no problems. You 
can continue making a few bucks. You can continue insuring 
those issuances that need insurance. Everybody goes on. 
Everybody's happy, everybody makes a few dollars. The cities 
and towns get to do what they need to do. My sewers get fixed. 
My cops get hired, and you're still in business. Stop sticking 
it to us because you can. Otherwise, we will find ways to stop 
    Mr. Chairman, I yield back.
    The Chairman. I thank the gentleman. I would note Mr. 
Jain's comment that if in fact the municipal issuances, the 
municipal bonds were rated the same as any other, there 
wouldn't be any insurance business because they would all do 
well. Mr. McCarthy?
    Mr. McCarthy. Just one point. I think--
    The Chairman. Your microphone is not on.
    Mr. McCarthy. I'm sorry, Mr. Chairman. One of the functions 
of the insurance business in the municipal area is that we 
quote a bid in the market for every particular bond, and there 
are thousands and thousands of municipal credits. We have a 
very, very large staff that analyzes municipal bonds, and 
really the value we're bringing to, as an industry, to the 
municipal investor is that first we're putting our capital up 
so that to the extent that something does happen, whether 
there's a payment shortfall or something else, we stand by 
    I think the chart that the chairman produced earlier is a 
Moody's chart that actually excludes defaults that might be 
taken by the model lines. So the model line--
    The Chairman. No. No.
    Mr. McCarthy. It's not?
    The Chairman. No. There were just no defaults. These 
weren't defaults that were paid by somebody else.
    Mr. Capuano. Mr. Chairman, I want to be clear. I don't 
think that you have no role in the marketplace. I think you do 
have a role. But I want you to market my bonds on the basis of 
the likelihood of me paying them back. And you can't do that 
without Moody's giving me an appropriate rating.
    Mr. McCarthy. Right. We're not the arbiter of whether we 
get used or not.
    Mr. Capuano. Oh, I understand that.
    The Chairman. But I also would have to add--
    Mr. Capuano. Because you're the beneficiary of it.
    The Chairman. I would also add while that's a nice model, 
in fact the way it's worked out for many municipal issuers, 
they have been carrying their insurers. They have in fact been 
rated higher than their insurers, and the insurers have dragged 
them down, and they have had to pay more money because of the 
low rating of their insurers, who improvidently invested the 
    Mr. McCarthy. Well, some--in the model line insurance 
    The Chairman. Yes.
    Mr. McCarthy. --there are several companies, thank 
goodness, FSA, which I represent--have maintained their triple 
A's from all three rating agencies in our State.
    The Chairman. But let me say this. I don't know anybody who 
had to pay more for his car because his car suddenly became 
worth more than his insurance agency. You're saying it only 
happened with some insurance agencies--
    Mr. McCarthy. No, no.
    The Chairman. Some insurers and not others.
    Mr. McCarthy. No.
    The Chairman. Where the lousy performance of their insurers 
cost them money.
    Mr. McCarthy. Well, the financial wellbeing of the 
companies, if you think of it this way, as I said in the 
testimony, if you look at the CDOs of ABS, different model line 
companies were exposed to a single asset class which have very 
large losses and severe losses, and that single asset class--
    The Chairman. Which asset class is that?
    Mr. McCarthy. CDOs--
    The Chairman. Okay. Excuse me. You say were exposed to. Now 
does that mean they were walking down the street and it wafted 
in and they caught it like pneumonia?
    Mr. McCarthy. No.
    The Chairman. They didn't--they weren't exposed to it. They 
took the profits from the municipals and went out and bought 
it. They weren't exposed to it.
    Mr. McCarthy. No, I don't that's--I think the way it 
actually works is that each company has capital--
    The Chairman. Excuse me, Mr. Callen said in the Wall Street 
Journal from Ambac, we took the profits, which were very good 
and very secure, and we went and invested in things, and we 
invested in things we didn't fully understand, CDOs. He wasn't 
exposed to it. He jumped in.
    Mr. McCarthy. I would speak--
    The Chairman. Well, but, that's one of the big companies.
    Mr. McCarthy. I can speak for the industry generally, I can 
speak for FSA specifically.
    The Chairman. Well, then, don't talk about it, but the fact 
    Mr. McCarthy. But Mr. Callen I can't speak for.
    The Chairman. But you weren't exposed to it. These other--
    Mr. McCarthy. No. We didn't underwrite that--
    The Chairman. I understand that. But the point I'm making 
is, you know, the passive voice probably ought to be banned 
from the English language. It's the great excuser. Oh, we were 
exposed to it. No, they weren't exposed to it. They tried to 
make some money and made a bad guess.
    Mr. McCarthy. Well, they underwrote it, meaning that those 
transactions that with a triple A--
    The Chairman. But they volunteered to go and underwrite it 
because they thought they'd make money.
    Mr. McCarthy. That's correct.
    The Chairman. They were--yes. All right.
    Mr. McCarthy. That's correct.
    Mr. Capuano. Mr. McCarthy, if my city had gotten the rating 
I deserved according to these charts, I would have been triple 
A from day one and I wouldn't have needed bond insurance, so I 
wouldn't have been exposed to anything, because I wouldn't have 
had to get bond insurance.
    Mr. McCarthy. We would--well, I'm not sure. We will still 
    Mr. Capuano. And I would say thank you very much, no thank 
    Mr. McCarthy. And investors may or may not decide--
    Mr. Capuano. And by the way, even when I needed bond 
insurance, I was never any lower than a B.
    Mr. McCarthy. Right.
    Mr. Capuano. And guess what? I didn't want to be put in 
with junk bonds.
    Mr. McCarthy. Right.
    Mr. Capuano. The people who did the CDOs, they chose to 
throw me into junk bonds. They were using my good credit to 
cover their lousy choices. I didn't get exposed by voluntary. I 
didn't ask, oh, gee, please throw me in with the junk bonds.
    The Chairman. We're going to move on.
    Mr. McCarthy. I think it's important to note that each of 
the companies that have experienced distress, MBIN Ambac, for 
example, have raised significant amounts of capital.
    The Chairman. They didn't experience distress. They made 
lousy investment decisions. These were not--you know, they 
didn't experience distress. They made bad investment decisions.
    Mr. McCarthy. You're exactly right.
    The Chairman. Okay. Thank you. The only question I had was, 
my colleague from Somerville, I don't know if you know 
Massachusetts, but did you go to Cambridge to get those 
croissants you were giving people when you were mayor?
    The Chairman. I didn't think they had croissants in 
Somerville. All right. I'm sorry. The gentleman from Missouri.
    Mr. Cleaver. Thank you. I hope you understand, and I feel 
very similar to my colleague. As a former mayor, we have--for 8 
years, I had to tiptoe around with the rating organizations--
agencies, because we didn't--you know, the lawyers said, you 
know, you can't irritate them, you know. We have a double A 
rating with perfect payments with regard to the general 
obligation bonds, and so you have to play nice.
    And so, like my colleague, I'm irritated, because I don't 
have to play nice now. You know, I guess maybe the mayor in 
Kansas City is afraid. I'm curious, Mr. Vogtsberger, or you and 
Ms. Levenstein, how much money have you had to pay out in 
municipal bond defaults in the last 10 years?
    Mr. Vogtsberger. As a bond underwriter, we don't pay any 
money out for municipal bond defaults. We buy bonds and then 
remarket them.
    Mr. Cleaver. Well the truth is, nobody pays anybody off in 
municipal bonds, because there haven't been any defaults.
    Mr. Vogtsberger. There have been defaults in municipal 
bonds, not general obligation bonds, but--
    Mr. Cleaver. Where?
    Mr. Vogtsberger. Hospitals, for example, private colleges, 
industrial development revenue bonds. Those are all municipal 
bonds that from time to time--
    Mr. Cleaver. I'm talking about municipalities.
    Mr. Vogtsberger. Municipalities, very few.
    Mr. Cleaver. One?
    Ms. Levenstein. But that's of the rated Moody's universe. 
There may be others that are unrated. I simply don't know.
    Mr. Cleaver. Okay. But you can't name one?
    Ms. Levenstein. I only know of one that was within our 
rated universe, that's correct, of a GO--
    Mr. Cleaver. A municipality. I'm not talking about a--
    Ms. Levenstein. A general obligation pledge from a 
    Mr. Cleaver. On the full faith and credit of that city?
    Ms. Levenstein. Yes. They defaulted. There would have been 
others--there were others that were different types of revenue 
    Mr. Cleaver. One out of how many?
    Ms. Levenstein. One out of about 28-, or 29,000.
    Mr. Cleaver. Don't you think that the cities need a rebate 
now? This is a serious question.
    Ms. Levenstein. No I don't.
    Mr. Cleaver. Why not?
    Ms. Levenstein. Because, again, I think we provided to the 
    Mr. Cleaver. What?
    Ms. Levenstein. --what the market wanted, what was usable.
    Mr. Cleaver. What did you provide Kansas City?
    Ms. Levenstein. We provided ratings that provided relative 
    Mr. Cleaver. I'll tell the people when I go home this 
    Ms. Levenstein. That's what the market told us they--
    Mr. Cleaver. --because all they know is that they're having 
to pay, that our city is having to pay high insurance, no low 
interest, and there's no--there's such a minute change that 
we're going to go into default, that it's almost absurd that we 
have to do it. And you're saying you don't think anything has 
gone wrong there?
    Ms. Levenstein. I think the market is pricing what they 
perceive to be the risk.
    Mr. Cleaver. So everything is fine?
    Ms. Levenstein. All we're doing is providing an opinion of 
the relative credit ranking, and that's what we have done.
    Mr. Cleaver. So everything is fine? You don't see a problem 
    Ms. Levenstein. What has changed is that there is more of a 
crossover market and the market appears to want, as well as the 
municipal rating system, the global system. And that's why 
we're offering it on a forward basis.
    Mr. Cleaver. When did you discover this as the point, I 
    Ms. Levenstein. We first started to talk to the market 
about this in 2001, and we talked to the market in 2001. We 
talked to over 100 participants in the market. The feedback 
that we got at that time--
    Mr. Cleaver. What--who--
    Ms. Levenstein. --that for a certain segment of the market, 
global ratings would be helpful.
    Mr. Cleaver. Did you talk to the--
    Ms. Levenstein. Only that segment.
    Mr. Cleaver. --the U.S. Conference of Mayors, the National 
Conference of--
    Ms. Levenstein. We talked to issuers. We talked to 
investors. We talked to intermediaries.
    Mr. Cleaver. But you didn't--you never talked to any of the 
mayors or the organizations representing mayors?
    Ms. Levenstein. We talked to issuers, so we did talk to--
    Mr. Cleaver. Who?
    Ms. Levenstein. --who were representatives of mayors. I 
don't have the list. But we did talk to over 100 
    Mr. Cleaver. And they didn't go off?
    Ms. Levenstein. No, they did not.
    Mr. Cleaver. Boy, I'd like to see them.
    Ms. Levenstein. In fact, the overwhelming opinion was to 
keep things the way they were, and that's what we did, except 
for the small segment of the market that was taxable issuance 
outside of the United States or swap obligations. And so 
between 2003 and 2007, we offered global system ratings to that 
segment of the market.
    Now as I've said earlier, it is clear that there's a 
change, and it is clear that there would be value to the market 
of global system ratings. So we will provide those on a forward 
basis to any issuer who wants them.
    Mr. Cleaver. The State government of Missouri has a triple 
A rating.
    Ms. Levenstein. Yes.
    Mr. Cleaver. I think there are only five States with triple 
A in the United States. Our creditworthiness is higher than the 
State, and we have a double A. How do you explain that?
    Ms. Levenstein. Well, I'm not in a position today to 
discuss the difference between your city and the State of 
Missouri. But certainly we could get back to you if you wanted 
to have that discussion.
    Mr. Cleaver. I do.
    Ms. Levenstein. But clearly, we think on a relative ranked 
basis, but that's not the case.
    Mr. Cleaver. I'm sorry?
    Ms. Levenstein. If you were to relatively rank the city 
versus the State, we think the State is stronger. But if you 
would like to talk about the specifics of that, we can--
    Mr. Cleaver. I want to talk about a rebate. When can we 
meet to talk about a rebate?
    Ms. Levenstein. I don't think that's warranted.
    Mr. Cleaver. I'm sorry?
    Ms. Levenstein. I don't think that is warranted.
    Mr. Cleaver. If we have a vote, it would be.
    Mr. Capuano. Mr. Chairman, if the gentleman would yield for 
one minute.
    The Chairman. Go ahead.
    Mr. Capuano. As I understand it, the people that you were 
talking to are the very people who make money at this business. 
So you basically ask people, do you want to continue making 
more money than you would otherwise make if we make the system 
right? And you also talk to maybe a few hostages, people who 
didn't have the freedom to tell you what they really wanted. Or 
did you talk to anybody who had been a former mayor or a former 
issuer of bonds when you asked the market participants?
    Ms. Levenstein. I don't know if we did or not.
    Mr. Capuano. I mean, my expectation is market participants 
means either the people who are making the money, and you 
basically ask them, do you want to make less money? And they 
said no. And then you might have asked a few people who are 
hostages, would you like us to change it so you can save some 
money? And they said, oh, no, please don't do that, because if 
you do that, you're going to lower our rating. That's not the 
market participants that mean anything to me. Those are 
hostages, and those are people who are making money on the 
backs of my taxpayers. Their interest is no interest.
    The Chairman. And I think you have a feedback loop here 
between the rated and then people who were asked. But let me 
ask you this. You said the State versus the city. What about if 
there were other instances--
    Ms. Levenstein. There are instances. We do rate a number of 
intercept programs and other types of bonds.
    The Chairman. Straightforward question.
    Ms. Levenstein. Yes?
    The Chairman. If the State stands behind the cities, are 
there still differences in the ratings?
    Ms. Levenstein. It depends on the mechanism that the State 
uses to stand behind the city. If the State stood completely 
behind the city and it was effectively a guarantee, then there 
would be no difference.
    The Chairman. Thank you, that was the question.
    The gentleman from Colorado.
    Mr. Perlmutter. I was never a mayor, and I don't have that 
sense or hostility that my two friends have shown, but I have 
done Chapter 9 bankruptcies, and so I do recognize that there 
are risks. I don't know whether these were Moody rated. I don't 
know whether there was a lot of underwriting or bond insurance 
behind it, so I recognize something here, but I have just some 
very basic questions again. First, who pays Moody's to do a 
credit rating, the buyers of the bonds or the issuers of the 
    Ms. Levenstein. The issuer does.
    Mr. Perlmutter. The issuer does. Who pays, Mr. Jain, I kind 
of heard that it could be an investor wanting to protect the 
investment or it could be the issuer could buy the insurance, 
the issuer, is that right?
    Mr. McCarthy. The issuer in a primary market and an 
investor in a secondary market position who owns the bonds 
    Mr. Perlmutter. Now, I asked the last panel, is there any 
law that says State, Federal, that requires Denver Health and 
Hospitals, who I spoke to a half-hour ago, to get rated by 
Moody's or to buy insurance before they issue bonds and sell 
the bonds, is there any law?
    Ms. Levenstein. No, there is not.
    Mr. McCarthy. No, there is no law.
    Mr. Perlmutter. Okay, how many ratings agencies are there?
    Ms. Levenstein. There are nine recognized rating agencies.
    Mr. Perlmutter. Nine recognized for municipal or government 
    Ms. Levenstein. Nine recognized by agencies, there are 
    Mr. Perlmutter. And not to pick on Moody's but since you 
are here, how much of that market, of those nine agencies, how 
much of the rating business do you do, does Moody's do?
    Ms. Levenstein. I do not think that I know how much we do 
relative to the other rating agencies.
    Mr. Perlmutter. Alright, so but the real reason we are here 
today, and the two mayors really and the chairman are talking 
about some structural things as to why people do not get better 
rates, the purpose of our hearing today though was here we were 
going along merrily, people are doing their--selling their 
municipal bonds, everything is honky dory until we hit February 
and all of a sudden it goes from 4 percent to 20 percent for 
the Port Authority in New York.
    Mr. McCarthy. Right.
    Mr. Perlmutter. And there has not been any testimony that 
the Port Authority of New York became any greater credit risk 
in February than it was in January or that the Denver Health 
and Hospitals are any greater credit risk--
    Mr. McCarthy. That is correct.
    Mr. Perlmutter. --than they were. What happened?
    Mr. McCarthy. Well, what happened, I tried to cover, and 
not well, in my testimony. Essentially, auction rates, if I can 
give you just a one minute history of the floating rate market 
at the municipal area. Going back 25 years ago, which is when I 
had a lot more hair, the first floating rate transactions that 
were done were called ``upper floaters.'' Cleveland Electric 
did the first transaction, and essentially they were just like 
auction rate deals today, meaning that there was a promise for 
the investment banker to re-market these bonds on a periodic 
basis and find new investors, okay. Then those bonds in the 
1980's, right after they got formed, failed to actually clear 
the market.
    Mr. Perlmutter. There were not any buyers?
    Mr. McCarthy. There were not any buyers because they 
couldn't because there was again a market stress environment, 
if you remember back then, municipal long rates were 15 percent 
and the issue that happened there was that the community 
decided to attack real bank liquidity to these transactions 
such that if there was a put, that it was a bank who really is 
in the business of providing their liquidity to these 
transactions. That is the way that market operated for 20 
years. Three years ago, all of a sudden investment bankers 
said, ``You know what, we don't really need the liquidity 
provider. What we can do is we can re-market it for you and you 
will save 10 basis points instead of paying a liquidity 
provider some. We will charge you a little bit more for the re-
marketing fee, but we will promise that we can make that 
    Now, I will tell you that part of the problem was that 
stress or the downgrade issues that have happened in the 
monoline area started people being nervous about owning option 
rate bonds that did not have liquidity. And no option rate 
bonds have liquidity attached to them, so they started to put 
them to the investment banks. Well, that is not really what 
they do. So they tried their best to re-market them.
    Mr. Perlmutter. Just a basic question, option rate bonds 
does not have liquidity behind it but it does have a revenue 
stream behind it?
    Mr. McCarthy. It does not. They have to clear the market. 
The way these structures work is they are floating rate, they 
are owned by funds and they are counted as a short-term 
financial instrument. Therefore, the difference between a 
variable rate demand bond, which has liquidity, and an auction 
rate bond that does not, those were counted as short term 
products. But the reason why that interest rate spiked up for 
all the auction rate products, regardless of whether it is the 
Port Authority, a student loan transaction or the State of 
California, was because investors, the liquidity market started 
to dry up and investors were nervous and not comfortable that 
they would own this bond and not be able to get out of it. They 
owned the bond thinking it was variable rate and therefore a 
short term security, which they had to qualify for. And they 
thought it is like musical chairs that say, ``Holy cow, if I 
don't put this back to the re-marketing agent right now, I am 
going to own this as a long-term bond, and that is not what I 
intended.'' So all of those bonds came back.
    Now, at FSA, we are spending--kudos to our municipal 
finance analytical team, they are spending 23 hours a day 
underwriting transactions to try to convert municipalities from 
auction rate, regardless of who did them, to either floating 
rate or fixed rate to solve this particular problem. And it has 
nothing to do with the quality, which in most cases for option 
rates is very good, it has nothing to do with the credit 
worthiness of the municipality.
    Mr. Perlmutter. Thank you.
    Mr. Cleaver. A follow-up, please.
    Mr. Perlmutter. I would yield to Mr. Cleaver.
    Mr. Cleaver. Thank you. One final question, what do you 
call the professionals who are paid a fee to unwind the option 
rate securities into other instruments?
    Mr. McCarthy. Well, investment bankers.
    Mr. Cleaver. I'm sorry?
    Mr. McCarthy. Investment bankers and then financial 
advisers are the two counter-parties. You can speak to that 
    Mr. Vogtsberger. That is right, yes. Investment bankers who 
underwrite bond issues are, as Sean mentioned, working to 
restructure option rate bonds into either variable rate bonds 
or fixed rate bonds, and they are paid a fee to do that.
    Mr. Cleaver. By whom?
    Mr. Vogtsberger. By the issuer.
    Mr. Cleaver. That is all. Thank you, Mr. Chairman.
    Mr. Capuano. [presiding] I want to thank you for putting up 
with this abuse today, and I hope you did not take too much of 
it personally, but at the same time, honestly, it is the first 
time I have had in 18 years to tell you what I think, and I was 
not going to pass up the opportunity. I also hope that you get 
some of the frustration and some of the disappointment that has 
happened over the years, and my hope, my preference is that the 
industry takes action without government interference, if you 
want the truth. However, I will tell you that if something does 
not happen, the likelihood of government involvement increases 
dramatically, and I think you have heard some of the 
frustrations. Some of the things that have been mentioned here 
today, I think many of us agree with relative to some of the 
SEC rules and some of the other things. But like many times, I 
for one would prefer that the market does its own work but 
government regulation to me is not a swear word, it is a 
bastion of last resort.
    Before we dismiss, before we end this panel, the Chair 
notes that some members may have additional questions for the 
panel, which they may wish to submit in writing. Without 
objection, the hearing record will remain open for 30 days for 
members to submit written questions to these witnesses and to 
place their responses in the record.
    With that, I declare that this hearing is adjourned.
    [Whereupon, at 4:15 p.m, the hearing was adjourned.]

                            A P P E N D I X

                             March 12, 2008