Time	Speaker	Text
00:00:28	REP. WAXMAN	(Strikes gavel.) The committee will please come back to order. Our second panel consists of five of the most successful hedge fund managers of 2007. George Soros is the chairman of Soros Fund Management. James Simons is the president of Renaissance Technologies. John Paulson is the president of Paulson & Company. Philip Falcone is the senior managing partner of Harbinger Capital Partners. And Kenneth Griffin is the president and chief executive officer of Citadel Investment Group. And we're pleased to welcome all of you to our hearing today. I appreciate your being here and cooperating with our committee. I understand Mr. Falcone had to reschedule an overseas business trip to join us today, and I particularly appreciate the fact that he's here. It's the practice of this committee that all witnesses that testify before us do so under oath. So I would like to ask each of you, before you even begin giving your testimony, to please stand and raise your right hand. (The chairman administers the oath to the witnesses.) Thank you. The record will indicate that each of the witnesses answered in the affirmative. Your prepared statements will be in the record in full. What we'd like to ask each of you to do is to make a presentation to us, mindful of the fact that we'll have a clock that will be green for four minutes, orange for one minute and then red at the end of five minutes. And at point, if you see that it's red, we'd like to ask you to conclude your oral presentation to you -- to us. We're going to want to leave enough time for questions by the members of the panel (sic). Mr. Soros, we'd like to start with you. There's a button on the base of the mike. Be sure it's pressed in, and please proceed how you see fit.
00:02:31	MR. SOROS	Thank you, Mr. Chairman.
00:02:31	REP. WAXMAN	There's a button, yup.
00:02:31	MR. SOROS	Thank you. We are in the midst of the worst financial crisis since the 1930s. The salient feature of the crisis is that it was not caused by some external shock, like OPEC raising the price of oil. It was generated by the financial system itself. This fact -- that the defect was inherent in the system -- contradicts the generally accepted theory about financial markets. The prevailing paradigm is that markets tend towards equilibrium. Deviations the equilibrium either occur in a random fashion or are caused by some sudden external event to which markets have difficulty in adjusting. The current approach to market regulation has been based on this theory, but the severity and amplitude of the crisis proves convincingly that there is something fundamentally wrong with it. I have developed an alternative paradigm that differs from the current one in two important respects. First, financial markets don't reflect the underlying conditions accurately. They provide a picture that is always biased or distorted in some way or another. Second, the distorted views held by market participants and expressed in market prices can under certain circumstances affect the so-called fundamentals that market prices are supposed to reflect. I call this two-way circle of connection between market prices and the underlying reality reflexivity. I contend that financial markets are always reflexive and on occasion they can veer quite far away from the so-called equilibrium. In other words, it is an inherent characteristic of financial markets that they are prone to produce bubbles. I originally proposed this theory in 1987, and I brought it up to date in my latest book, "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means." I have summarized my argument in the written testimony I have submitted. Let me recall briefly the main implications of the new paradigm for the regulation of financial markets. The first and foremost point is that the regulators must accept responsibility for controlling asset bubbles. Until now, they have explicitly rejected that responsibility. Second, to control asset bubbles, it's not enough to control the money supply; it's also necessary to control credit, because the two don't go in lockstep. Third, controlling credit requires reactivating policy instruments which have fallen into disuse -- notably, margin requirements and minimum capital requirements for banks. When I say reactivate them, I mean that the ratios need to be changed from time to time to counteract the prevailing mood of the markets because markets do have moods. Fourth, new regulations are needed to ensure that margin requirements and the capital ratios of banks can be accurately measured. The alphabet soup of synthetic financial instruments -- CDOs, CDSs, (EDSs ?) and the like -- have made risk less apparent and hardest to measure. These new products will have to be registered and approved before they can be used, and their clearing mechanism has to be regulated in order to minimize counterparty risk. Fifth, since financial markets are global, regulations must also be international in scope. Sixth, since the quantitative risk management models currently in use ignore the uncertainties inherent in reflexivity, limits on credit and leverage will have to be set substantially lower than those that have been incorporated in the Basel Accords on bank regulation. Basel II, which delegated authority for calculating risk to the financial institutions themselves, was an aberration and has to be abandoned. It needs to be replaced by a Basel III, which will be based on the new paradigm. How do these principles apply to hedge funds? Clearly, hedge funds use leverage and they contribute to market instability in times like the present, when we are experiencing wholesale and disorderly deleveraging. Therefore, the systemic risks need to be recognized and more closely monitored than they have been until now. The entire regulatory framework needs to be reconsidered, and hedge funds must -- need to be regulated within that framework. But we must beware of going overboard with regulation. Excessive deregulation is at the root of the current crisis, and there is a real danger that the pendulum will swing too far the other way. That would be unfortunate, because regulations are liable to be even more deficient than the market mechanism itself. That's because regulators are not only human, but also bureaucratic and susceptible to political influence -- influences. It has to be recognized that hedge funds were an integral part of the bubble which has now burst, but the bubble has now burst and hedge funds will be decimated. I would guess that the amount of money they manage will shrink between 50 and 75 percent. It would be a grave mistake to add to the forced liquidation currently depressing markets by ill-considered or punitive regulations. I'll be happy to expand on these points in greater detail in answering your questions.
00:09:33	REP. WAXMAN	Thank you very much, Mr. Soros. Mr. Simons?
00:09:33	MR. SIMONS	Oh. Okay. Well, good morning, Chairman --
00:09:33	REP. WAXMAN	There's a button on the base of the mike. Be sure to press it in and pull the mike closer.
00:09:45	MR. SIMONS	No, I think it's on.
00:09:45	REP. WAXMAN	Okay, good.
00:09:45	MR. SIMONS	Is it on? Yeah.
00:09:45	REP. WAXMAN	Good. Thanks.
00:09:47	MR. SIMONS	Good morning, again, Chairman Waxman and Ranking Member Davis, members of the committee. I'm Jim Simons. I'm chairman of Renaissance Technologies. And in my opinion, this series of hearings is quite important. And I appreciate your interest in trying to understand what this is all about. Now, in my view, this crisis has a number of causes: the regulators who took a hands-off position on investment bank leverage and credit default swaps, everybody along the mortgage-backed securities chain, who should have blown a whistle rather than passing the problem on, and, in my opinion, the most culpable, the rating agencies which, in effect, allowed sows' ears to be sold as silk purses. Before addressing the committee's questions, I'm going to say a little bit about myself and my company, because Renaissance is a somewhat atypical investment management firm. Our approach is driven by my background as a mathematician. We manage funds whose trading is determined by mathematical formulas. We operate only in highly liquid, publicly traded securities, meaning we don't trade in credit default swaps or collateralized debt obligations or some of those alphabet soup things that George was just referring to. Our trading models actually tend to be contrarian, often buying stocks recently out of favor and selling those recently in favor. We manage three funds. Our flagship fund, Medallion, accounts for nearly all of our income and is almost entirely owned by Renaissance employees. We charge ourselves fees, which has the effect of shifting income away from the largest owners of the firm, like me, to the rest of the employees. Our two new funds, designed for institutional investors, are both widely leveraged and charge fees roughly half of those charged by most hedge funds. So I'll now turn to the -- briefly to the questions that the committee asked. Do hedge funds cause systemic risk? Well, in my view, hedge funds were not a major contributor to the recent crisis and generally hedge funds have increased liquidity and reduced volatility in the markets. Moreover, because of their remarkably diverse strategies, hedge funds as a class are unlikely to create systemic risk, although it's not out of the question that they could. Hedge funds do use leverage, but here's an important point: Each hedge fund's leverage is controlled by its lenders, which is far more than one could say for investment banks. Will the hedge funds require further regulation? I do think additional regulation focused on market integrity and stability will be useful. And I'll get back to that. Should hedge funds be registered with the SEC? Well, we've -- we've always been registered, at least for 10 years, and we're certainly not opposed to an appropriate registration requirement. Should hedge funds be more transparent? Well, transparency to appropriate regulators can be helpful. And as Professor Ruder said very well -- described a procedure which was also in my written testimony -- you may wish to consider requiring all market participants to report their positions to an appropriate regulator and then allowing the New York Fed to have access to aggregate position information and to recommend action, if necessary. This is pretty much what Ruder said. I'll say it again. I stress, however, that the funds' specific information should not be released publicly, which could do more harm than good. Does the compensation structure of hedge funds lead to excessive risk taking? Well, this question doesn't really apply to us, as almost all of our income is based on profits on our own capital, but generally speaking, I think not. The statistics bear this out to some extent. Compare the 7 percent annual volatility of the hedge fund index to the 15 percent annual volatility of the S&P over the last 10 years. Thus, hedge funds appear to be at least on the cautious side. Moreover -- obviously there are exceptions. Moreover, typically a manager's largest investment in his own fund. Is special tax treatment for hedge fund managers warranted? Well, I would only say that if Congress decides it's good policy to alter the tax treatment of carried interest, that change should apply to all partnerships -- private equity, oil and gas, real estate, et cetera, all of which are based on that same principle -- not just hedge funds. And I personally would have no objection whatever to such a change. Before concluding, I'd like to reflect on how we could help get out of this hole and make a proposal to prevent us getting back in. So I think that in the near term the most important thing we can do is keep people in their homes, even if their mortgages are in default. This would help millions of families already coping with a tough economy and would maintain higher home values than would foreclosure. This would also mitigate losses on the securities collateralized by these mortgages. Now, there have been a number of proposals on how to do this, and I won't opine on which is best. Now, Mr. Chairman, you mentioned you had a hearing on the failure of the credit rating agencies. And I particularly appreciate your attention to that issue. See, I propose a new rating agency. Now historically the bond rating agencies were paid by the bond buyers, which was natural, because it was them -- it was they whom they were supposed to be serving. But in the '70s, when the agencies began to be paid by the bonds' issuers -- now despite the obvious conflict of interest, the new model worked okay with conventional-type bonds. But until the advent of financially engineered products -- now I -- even though I don't trade these products, I believe in their value. I think they're good. But the organizations rating them must owe their allegiance to buyers, not to issuers. I therefore encourage the major holders of these bonds, such as CALPERS, TIAA, PIMCO, et cetera, to sponsor a -- new, nonprofit rating agencies, focused on derivative securities. Congress might considering chartering such an organization, having board representation from appropriate regulators. Revenues could come from buyer-paid fees on each transaction, which I think would be minuscule. These complex instruments would then be subject to proper analysis and rating, the interests of buyers and raters would be aligned, and the likelihood of again seeing a problem like this one would be dramatically reduced. Thank you, and I look forward to your questions.
00:16:52	REP. WAXMAN	Thank you very much, Mr. Simons. Mr. Paulson.
00:16:57	MR. PAULSON	Chairman Waxman, Ranking Member Davis and members of the committee, thank you for inviting me to appear today. Paulson & Co. is an investment advisory firm that was founded in 1994. We currently manage assets of approximately 36 billion (dollars) using event-driven strategies. We are based in New York and also have offices in London and Hong Kong. We have approximately 70 employees.
00:17:26	REP. WAXMAN	Is your -- there's a question whether your mike is on. There's a button on the base of the mike. Is it pressed or is it -- yes.
00:17:33	MR. PAULSON	All of the investment funds we manage are open only to "qualified purchasers," those with the minimum 5 million (dollars) in investable assets, if they are individuals, and 25 million (dollars) in investable assets if they are institutions. Our investors include pension funds, endowments and foundations. These investors look to us to protect their capital and to show positive returns in both good and bad markets. We do this by going long securities that we think will rise in value and by going short securities that we think will decline in value. We have been able to operate profitably in 14 out of the last 15 years, including this year, when the S&P is down over 40 percent. We believe that our ability to protect our investors' capital and generate positive returns over the long term is the reason we've grown to be one of the largest hedge funds in the world. Regarding compensation, we share profits with our investors on an 80-20 basis, where 80 percent of the profits go to the investors and 20 percent remains with us. We only earn performance allocations if our investors are profitable. All of our funds have a "high water mark," which means that if we lose money for our investors, we have to earn it back before we share in future profits. Some of our funds also have a "claw back" provision, which requires us to return profits earned in prior periods if we lose money in subsequent periods. In addition, we invest our own money alongside that of our clients, so we share investment losses along with gains. We are a private company and have no public shareholders. We receive no taxpayer subsidies. All of our investors invest with us on a voluntary basis. We also use very little leverage. Over the past five years, for over half the time, our base portfolios were not funded with any borrowed money. And our maximum borrowing over the last five years, as a percentage of equity capital, was only 33 percent. In February 2004, we voluntarily registered with the SEC as an investment adviser. As a registered investment adviser, we are subject to periodic inspections, focused reviews and ad hoc requests for information. We are also subject to stringent recordkeeping requirements and have to file information regularly with the SEC. We comply with all rules and regulations, not only in the U.S. but in each of the over 15 countries where we invest. As Americans, we are proud of the leadership position the United States occupies, in this industry, the jobs our industry has created, the export earnings we have produced, for our country, and the taxes we generate for the Treasury. For example over the last five years, our firm has increased our employee count by 10 times, creating numerous high-paying jobs for Americans. In addition, 80 percent of our assets, under management, come from foreign investors. The revenues we receive, from foreign investors, allows us to contribute to the U.S. economy like an exporter of goods, bringing in money from abroad. In 2005, our firm became very concerned about weak credit underwriting standards, excessive leverage amongst financial institutions and a fundamental mispricing of credit risk. To protect our investors against the risk in the financial markets, we purchased protection through credit default swaps, on debt securities we thought would decline in value. As credit spread widened and the value of these securities fell, we realized substantial gains for our investors. We have offered suggestions on the causes of the credit crisis and what the U.S. government can do to help the situation. I also have some recommendations on how future purchases of preferred stock, under the TARP, can be structured both to protect taxpayers better and to provide greater stability to financial institutions. And I would be pleased to share those thoughts with you. Again thank you for the opportunity to address this committee.
00:22:24	REP. WAXMAN	Thank you very much, Mr. Paulson. Mr. Falcone.
00:22:24	MR. FALCONE	Thank you, Chairman Waxman, Ranking Member Davis and other members of the committee. My name is Philip Falcone. I am the senior managing director and co-founder of the Harbinger Capital Partners Funds. I am extremely proud of the work that we have done at Harbinger. Year-in, year-out, we have generated substantial returns for our investors, which include pension funds, endowments and charitable foundations. We have achieved our success for our investors by doing things the right way. Through our investments, we have also provided much- needed capital to American companies, supporting them as they pursue their business plans and giving them a second chance to reach their potential. I appreciate the committee holding today's hearing in order to learn more about hedge funds and their positive role in the financial markets. I am hopeful that this committee can take four points away from the testimony. Number one, compensation in the hedge fund industry is performance-based. I think that is the right way to do business, because it creates incentive for hard work and innovation. Number two, hedge funds use a variety of investment strategies, including traditional approaches. Investors, especially large institutions, want a broad array of strategies and disciplines so they can diversify their portfolios. Number three, short selling is a valuable, long-standing feature of our markets. It isn't short selling that puts companies out of business, but rather over-leveraged balance sheets, poor management decisions and flawed business plans. Number four, I support greater transparency and better reporting in the hedge fund sector. I would like to take a moment to tell you a little bit about myself. I currently reside in New York City with my wife of 11 years and two children. By way of background, I was born in Chisholm, Minnesota, population 5,000, on the Iron Range in Northern Minnesota. I was the youngest of nine kids who grew up in a three-bedroom home in a working class neighborhood. My father was a utility superintendent and never made more than $15,000 per year, while my mother worked in the local shirt factory. The point of all this is I take great pride in my upbringing, and it is important for the committee and the public to know that not everyone who runs a hedge fund was born on 5th Avenue. That is the beauty of America and the beauty of the potential in our industry. Through hard work and perhaps a little bit of luck, Harbinger Capital Partners has been able to generate substantial returns for our investors since 2001. Our investment philosophy is very simple; we study, often for months, the fundamentals of companies to identify those that are undervalued or overvalued, and we act decisively when opportunities present themselves. We are not momentum traders, nor are we day traders; we are investors. It is not magic. My analysts perform thorough due diligence rather than relying on ratings agencies or other research reports -- like many of the reports that improperly valued securitized mortgage products over the past few years. My compensation is based upon the returns that we generate for our investors, which have far exceeded the performance -- (word inaudible) -- the overall market. There is no doubt that as a result of the success of Harbinger Funds, I have done extremely well financially. But this is not the case where management takes huge bonuses or stock options while the company is failing. My success is tied to that of my investors, and I have reinvested a substantial portion of my compensation over the years back into the Funds, alongside my investors, who are fully aware of the compensation formula when deciding whether to place their money with us. Because of the events of the past few months, the American public, including my investors, have justifiable concerns about our financial markets and the economy. The important thing to remember, however, is that we must keep things in perspective and not overreact, misperceive or misrepresent what has happened. We are a resilient society. We must focus on the positives and continue taking steps forward rather than backward. Hedge funds play an important role in the economy by providing needed capital and encouraging creativity and "outside the box" thinking. Many viable companies struggling under a huge debt load or poor cash flow have not only survived, but flourished, through an infusion of hedge fund capital, saving thousands of jobs. I am proud of Harbinger's track record of helping these types of companies emerge from bankruptcy and helping others avoid filing in the first place. Finally, I would like to offer a thought or two on how Congress and the hedge fund industry can work together to increase public confidence not only in our industry, but in the financial markets as a whole: I support some additional government regulation requiring more public disclosure and transparency for hedge funds, as well as for public companies. All investors, whether individuals or sophisticated institutions, have a right to know what assets companies have an interest in -- whether on or off their balance sheets -- and what those assets are really worth. I also support the creation of a public exchange or clearinghouse for derivatives trading, especially credit default swaps. An open and transparent market for these transactions would reduce confusion and improve understanding, as well as help with valuation issues. In summary, while I was growing up, my family may have lacked money, but one thing we didn't lack was integrity and pride in what we did and how we did it. It was the cornerstone then, and it remains the cornerstone of my family and my business today. In 1990 one of my investors once told me something that continues to resonate with me today. He said, "I can't guarantee that if you work hard you will be successful, but I can guarantee that if you don't work hard, you won't be successful." We should never lose sight of that. Needless to say, I love this country and am grateful for the opportunity that I have been provided. That being said, we are living in difficult times now. Consequently, I hope that this committee and indeed the entire nation will look at the hedge fund industry as part of the solution to our economic turmoil. Given the tightening of credit markets, access to capital is more important than ever, and I believe that hedge funds can and should be a source for this capital. Thank you for permitting me the opportunity to make this statement, and I would be happy to answer questions that you may have.
00:29:16	REP. WAXMAN	Thank you very much, Mr. Falcone. Mr. Griffin.
00:29:16	MR. GRIFFIN	Mr. Chairman, Congressman Davis and distinguished members of the committee, my name is Kenneth Griffin, and I am the founder and CEO of Citadel Investment Group. Thank you for the opportunity to address this committee. Today our nation is working through the worst financial crisis since the 1930s. It is imperative that we as a nation continue to take actions to mitigate the impact of the credit crisis on our broader economy, in the hopes of keeping Americans employed and productive. I appreciate your leadership on this important undertaking. I am proud that in the 18 years since I founded Citadel, it has grown into a financial institution of great strength and capability. With a team of over 1,400 talented individuals, Citadel manages approximately $15 billion of investment capital for a broad array of institutional investors, high-net-worth individuals and Citadel's employees. Citadel's Capital Market division plays an important role in our nation's financial markets. Our broker-dealer is the largest market maker in options in the United States, executing approximately 30 percent of all equity option trades daily. In addition, Citadel accounts for nearly 10 percent of the daily trading volume of U.S. equities. All businesses take risk. In some industries, we refer to risk taking as "research and development." At financial institutions, we often take risk by investing in securities. Failure to understand and manage risk can be severe, as we have seen far too often in recent weeks. Although the financial crisis has affected virtually every participant in the financial markets, including Citadel, I believe that Citadel's constant and consistent focus on risk management has been a key asset in successfully navigating this financial crisis and will continue to serve us well in the years to come. In this crisis, the concept of "too interconnected to fail" has replaced the concept of "too big to fail." The rapid growth in the use of derivatives has created an opaque market whose outstanding notional value is measured in the hundreds of trillions of dollars. As a result, there is great concern about the systemic effects of the failure of any one financial institution. In the area of credit default swaps, for example, there is an estimated $55 trillion of outstanding notional contracts between market participants. This number is almost four times the GDP of our nation, The creation of central clearing houses, to act as intermediaries and guarantors of financial derivatives, such as credit default swaps, represents a straightforward solution to the issues inherent in today's opaque over-the-counter market. Of greatest importance, such a clearing house will dramatically reduce systematic risk, allowing us to step away from the Too Interconnected to Fail paradigm. Numerous other benefits will accrue to our economy. Regulators for example will have far greater transparency into this vast and important market. In recent months, Citadel and the CME Group have partnered in building such a clearing house for credit default swaps. Our solution is an example of how industry, in cooperation with regulators, can solve complex market problems. I believe and have said before that our financial markets work best when they are competitive, fair and transparent. Proper regulation is critical. But the best regulation is created with an eye toward unleashing opportunities, not limiting possibilities. To achieve this, Congress, regulators and industry must all work together. Our markets are complex and they must be well understood if they are to be well regulated. We must solve the serious issues we face, but not in a way that stifles the best innovative qualities of our great capital markets. I thank the committee for holding this hearing today and I look forward to answering your questions. Thank you.
00:34:15	REP. WAXMAN	Thank you very much, Mr. Griffin. We're now going to -- (audio break) -- members of the panel, who will each have five minutes each. I want to remind the members that the hearing today is about hedge funds and the financial markets. And questions about other topics are not relevant to the hearing. The chair won't bar any member from asking any particular question or a witness from answering a particular question. But witnesses will not be required to answer questions unrelated to the topic of today's hearing. So I urge members and witnesses to keep their questions and answers focused on the topic of today's hearing. I'm going to start with myself. (Audio break) -- asking about systemic risk. In 1998, there was Long-Term Capital Management. It was one of the nation's largest hedge funds. It had about $5 billion in capital and was leveraged at a ration of 30 to 1. It has made investments worth about $150 billion. And when those investments went bad, its capital was quickly wiped out. The Federal Reserve became so concerned, about the broader -- (audio break) -- collapse, that it organized a multi-billion dollar bailout. That was in 1998, when only about 3,000 hedge funds managed approximately $200 billion in assets. Current estimates suggest that there may now be more than 9,000 hedge funds managing assets worth more than $2 trillion. Some say hedge funds have become a shadow banking system. So I'd like to ask each of you two questions. Do you believe that the collapse of large hedge funds could pose systemic risks to the economy. And if so, do you believe this justifies greater federal regulation? Mr. Soros, why don't we start with you? And we'll go straight down the line.
00:36:16	MR. SOROS	Yes, I think that some hedge funds do pose a systemic risk. And I think particularly leveraged capital was built on a false conception. I talked about the false paradigm that -- on which our financial system has been built, and that was actually embodied in leveraged capital, which was very -- which basically assumed that deviations from -- are random. And that is not the case.
00:37:01	REP. WAXMAN	Do you believe this justifies greater federal regulation?
00:37:05	MR. SOROS	Pardon?
00:37:05	REP. WAXMAN	Do you believe this justifies greater federal regulation?
00:37:09	MR. SOROS	Yes, it does.
00:37:09	REP. WAXMAN	Thank you. Mr. Simons?
00:37:15	MR. SIMONS	Yeah, well, certainly the --
00:37:15	REP. WAXMAN	Is your mike on?
00:37:15	MR. SIMONS	Yeah, it is. Certainly the possibility exists that an individual hedge fund or hedge funds in aggregate could cause -- be a cause of systemic risk. And I think that regulation in the form of reporting up to the SEC, for example, in a more detailed manner than is presently done, with those things aggregated, that information aggregated and passed on to the Federal Reserve or some such, would be a good approach. So, yes.
00:37:55	REP. WAXMAN	Thank you. Mr. Paulson?
00:37:55	MR. PAULSON	I think the risk --
00:37:55	REP. WAXMAN	Is your button pressed on the mike?
00:37:55	MR. PAULSON	Yes.
00:37:55	REP. WAXMAN	Okay.
00:38:03	MR. PAULSON	I think the systemic risk in the financial system -- and that includes hedge funds as well as banks and other financial institutions -- is due to too much leverage. And when banks or hedge funds use too much leverage, you only need a small decline in the value of the assets before the equity's wide out -- wiped out and the debt is impaired. I do think there's a need for more stringent leverage requirements on banks, financial institutions and, where necessary, on hedge funds. The amount of common equity that institutions are operating with is simply too thin to support their balance sheets. The primary reasons why financial firms have run into trouble, whether it's Lehman Brothers, Bear Stearns or AIG, is they have way too much leverage. Lehman Brothers, as an example, had over 40 times the assets compared to their tangible common equity. They just didn't have enough equity. If hedge funds used -- every hedge fund that's had a problem, whether it was the Carlyle funds, the Bear Stearns funds or even Long-Term Capital before, was because of the use of too much leverage.
00:39:23	REP. WAXMAN	Do you think, therefore, that there ought to be more government regulation on the --
00:39:28	MR. PAULSON	I think that --
00:39:28	REP. WAXMAN	-- of the hedge funds and particularly on leverage?
00:39:28	MR. PAULSON	Yes, yes. I think that the equity requirements of financial institutions need to be raised, and the margin requirements, the amount of capital institutions or investors have to hold to support individual securities, should also be raised. And by doing that, that would reduce the risk in the system.
00:39:47	REP. WAXMAN	Thank you very much. Mr. --
00:39:47	MR. PAULSON	I may add just one point, is that in all the trillions of government support globally to try and stem this financial disaster, not one dollar yet has been used to support a hedge fund. So the problems have been -- with our Wall -- with our investment banks, with other (financial ?) institutions. And although Long-Term Capital was large, as a $4 billion hedge fund, that problem was also solved privately, without any government intervention. And the problems in Long-Term Capital, which today was the largest hedge fund to experience a problem, are minuscule compared to the 150 billion (dollars) that was required to bail out AIG, the 700 billion (dollars) in the TARP program or even the 139 billion (dollars) that was just advanced to GE in the form of guarantees.
00:40:44	REP. WAXMAN	Good point. Thank you. Mr. Falcone?
00:40:44	MR. FALCONE	Yes. I think that any institution that has a pool of capital at its availability and uses reckless leverages indeed poses a systemic -- potential systemic risk to the marketplace. I think that when you look at the hedge fund industry, with the trillion or trillion-and-a-half dollars outstanding, that the -- (inaudible) -- aspect of it is a bit isolated. And there are certain institutions that may pose risks, but I would suspect that for the most part the industry in general is not nearly as levered as some of the banking institutions that we were dealing with over the past four or five months. And I do support additional regulation as it relates to that, because I don't think it's in anybody's best interest to see these institutions unravel and create a domino effect.
00:41:47	REP. WAXMAN	Thank you. Mr. Griffin?
00:41:47	MR. GRIFFIN	Mr. Chairman, as you referred to Long-Term Capital's consortium bailout in 1998, it is important to remember it was a private-market solution to a very challenging problem. Just a few years ago, Citadel and JPMorgan created a private-market solution to the challenges faced by Amaranth and its shareholders when they incurred even greater losses in the natural gas market. Private- market solutions can address crisises (sic), and we should keep in the center of our minds that we want to foster private-market solutions as the way that we handle crisises (sic) first and foremost. Of second point, hedge funds are already regulated indirectly by the fact that the banking system is regulated and the banking system is the primary extender of credit to hedge funds. And last but not least, I think it's important that we keep in mind, it's very convenient to say we should simply have more equity in the system, but equity is very expensive. And if we wish to reduce the cost of loans to consumers and loans to homeowners, we need to think of capital structures that have the right mix of equity to debt. Thank you.
00:43:02	REP. WAXMAN	Thank you. Well, the private-market solution was organized by the Fed, so it wasn't without some public intervention. But is it your conclusion that we do need some greater federal regulation of hedge funds --
00:43:16	MR. GRIFFIN	I do not --
00:43:16	REP. WAXMAN	-- because of the systemic risks?
00:43:16	MR. GRIFFIN	No.
00:43:16	REP. WAXMAN	Okay.
00:43:20	MR. GRIFFIN	It is not my belief that we need greater government regulation of hedge funds with respect to the systemic risk they create.
00:43:27	REP. WAXMAN	Okay.
00:43:27	MR. GRIFFIN	And to be very direct, we've gone through a financial tsunami in the last few weeks. And if we look at where the failure stress points have been in the system, they have been in the regulated institutions, whether it's AIG, an insurance company, Fannie or Freddie, the banking system. We have not seen hedge funds as a focal point of carnage in this recent financial tsunami.
00:43:49	REP. WAXMAN	Well, our expert witness in the first panel testified they believe hedge funds do pose systemic risk -- former FCC Chairman David Ruder said this. "Highly leveraged hedge funds that borrow large sums and engage in complex transaction using exotic derivative instruments may severely disrupt the financial markets if they are unable to meet counterparty obligations or must sell assets in order to repay investors." And Professor Andrew Lo gave a similar testimony. My concern is that our regulatory system has not recognized these potential risks. The hedge fund industry is getting bigger. The systemic risks are growing larger. And yet federal regulators have virtually no oversight of your industry, and that's a potentially dangerous situation. So I appreciated hearing each of your views on that subject. Mr. Davis.
00:44:40	REP. TOM DAVIS (R-VA)	Thank you, Mr. Chairman. I would ask -- and let me just amplify your question and they can answer a question you just posed, because our first panel -- (inaudible) -- they proposed requiring hedge funds to divulge comprehensive risk information to regulators. But I've heard some concern here and elsewhere that we need to keep such data in an aggregated and confidential format. And so I'd ask, along with Mr. Waxman's question, is there a danger of too much transparency in the hedge fund industry, and what is that? So, Mr. Griffin, I'll start with you. I think you've -- have some limits on regulation and ask you to address that. And then I'll move right on that --
00:45:20	MR. GRIFFIN	So on the issue of disclosure of positions or aggregate risk factors, we would, at Citadel, not be adverse to that so long as the information was maintained confidential and in the hands of the regulators. To ask us to disclose our positions to the open market would parallel asking Coca-Cola to disclose their secret formula to the world.
00:45:25	REP. T. DAVIS	Mr. Falcone?
00:45:25	MR. FALCONE	I agree. I think that it's important to disclose the information to the -- to the appropriate regulatory agencies. We work long and hard in developing our ideas and to make them public I don't think is the right thing to do. And the public would not necessarily use them in the same way, shape or form that we would use our ideas.
00:46:15	REP. T. DAVIS	Mr. Paulson?
00:46:15	MR. PAULSON	Yes. As you know, we voluntarily registered with the SEC in 19 -- 2004 --
00:46:24	REP. T. DAVIS	Is your mike on?
00:46:24	MR. PAULSON	As you know, we voluntarily registered with the SEC in 2004. We believe, to the extent -- having a regulatory oversight over the policies of hedge funds, to the extent it provides greater comfort to the public sector and to private investors, is a beneficial thing.
00:46:50	MR. SIMONS	Yeah, I don't have much to add. I've already said, I think, my -- reporting up to the regulators is a good idea, more so than is now reported. I agree with the others it should stay with the regulators or with the Federal Reserve. It shouldn't be --
00:47:04	REP. T. DAVIS	Would you agree that --
00:47:04	MR. SIMONS	-- reported to The New York Times.
00:47:04	MR. SOROS	As I have said, I think regulators need to monitor positions more closely than they have done until now, but disclosing it to the public can be very harmful in many ways. And I think that the publication of short positions, for instance, practically endangered the business model of long-short equity investors. It's not our business. It's the other hedge funds that do that, because of the action of the companies whose shares they were selling short.
00:47:45	REP. T. DAVIS	Okay. Let me ask this -- a little off -- I asked Mr. Waxman. He's comfortable with me asking this. Do you have any opinions on what the Treasury Department's doing now with the Troubled Asset Recovery Plan, how they could deploy that maybe better than they're doing, it's -- in light of the fact that the 700 billion (dollars) is not actually being used to buy up troubled assets, but rather to purchase equity stakes in financial firms? Secretary Paulson has indicated the Treasury may even start purchasing stakes in non-bank financial firms. And do you think any hedge funds might take advantage of such an offer? Anyone want to opine an opinion on that? I'll start, Mr. Griffin, with you and --
00:48:27	MR. GRIFFIN	Congressman Davis, I believe that the decision to focus on injecting equities -- or equity or preferred equity into the banking system versus buying assets will create a larger effect for all of us and is a good decision on a relative basis. So in other words, I applaud the secretary of Treasury for making the decision to increase the equity capital base, the banking system at this moment in time. Of course, we have a difficult decision to make ahead of us. Do we expand TARP to include the non-banking sector? And if we do so, where do we draw the line? I think that is a very difficult decision that we have to make in the weeks and months ahead. Obviously the economy as a whole is slowing down. And we need to keep Americans employed. And I believe that we are going to need more stimulus packages to keep our economy as close to full potential as possible.
00:49:25	MR. FALCONE	I've been in favor of TARP, to a certain extent, considering that it could be a safety net for isolated incidents. I don't believe however that the money should be used for random purchasing of assets, because of the lack of clarity as it relates to what the institutions will do with that capital and what benefits it will do for the individual consumer. And I furthermore do not think that it should go above and beyond the financial institutions.
00:50:03	MR. PAULSON	Congressman Davis, I do think it was a tremendous improvement, shifting the focus of TARP from buying assets, which has very little impact on recapitalizing banks, to directly buying equity. I think the problem in the financial sector is one of solvency. Financial firms don't have enough -- (audio break). Injecting equity is the solution to the problem. I also think the list of recipients needs to be expanded, to include other types of financial firms whose failure could pose systemic risk. That may include auto finance companies, other finance companies and insurance companies. However I do think the structure of TARP investments can be improved. I think the current terms are overly generous to the recipients. I'll give you some examples. When -- (audio break) -- bought preferred stock in one of the investment banks, they received a 10 percent dividend and warrants equal to 100 percent of the value of the investment. Under the TARP program, the yield was only 5 percent and warrants equal to only 15 percent. In the U.K. and Switzerland, when they invested preferred stock in their financial companies, they got a 12 percent yield, also substantial equity stakes. By investing proceeds at less than market rates and less than other governments are doing -- (audio break) -- indirect transfer of wealth from the taxpayers to these financial institutions. In addition, in the U.K., Switzerland and all other governments, when government money was required to help out financial institutions, there were restrictions on common dividends and on executive compensation. In the U.K. and Switzerland, as long as government money is inside these companies, there are prohibitions on the payment of common dividends and caps on executive -- (audio break). And this is essential in order to increase the retained earnings and common equities of the banks. It doesn't seem to make sense to me that the bank is short of capital, the government puts in capital, and then that capital comes out the other door in the forms of dividends and compensation. I would make two suggestions that, I think, should be required of any financial firms that receive preferred stock investments or any form of guarantee, from the federal government, on their debt or other securities. One would be, while that guarantee is outstanding, or while the preferred investment is made, that cash common dividends be eliminated, and any dividends be restricted to dividends in additional shares of common stock. Secondly, as other governments have required, there should be restrictions on cash compensation and any bonuses or payments above that amount should be paid in common stock. By making those three adjustments -- first, increasing the terms of the -- of preferred, in terms of yield and equity, to benefit the taxpayer; second, eliminating cash dividends; and third, capping executive compensation -- that will both protect taxpayers and restore the badly needed equity capital to these institutions.
00:53:53	MR. SIMONS	Okay. Well, it was generally agreed that the original goal of TARP to buy some of this paper was perhaps not the best idea and more leverage would be created by capitalizing the banks and so on. So on the other hand -- and I more or less agree with that. But nonetheless, something has to be done about this paper. No one knows what much of it is worth, and it's in weak hands. People don't know how to -- you know, to appraise the balance sheets that the company's -- (off mike) -- and so on. So it is a problem, and it's a big problem. I had suggested to Bob Steel, when he was undersecretary of the Treasury, that the -- that rather than buy this stuff, they organize an auction, a two-sided auction, dividing the paper up into various categories and so on, and conducting auctions that people could buy and sell, and hopefully buyers would come in and sellers would put up, and the market would kind of get cleared. It's a pretty good idea, but it's a dangerous one, because the prices might not be -- make some folks very happy -- people who maybe aren't selling, but all of a sudden their balance sheets get whacked way down. So -- but sooner or later we have to face the question, what is this stuff worth, and how do we get it out of weak hands, which much of it is -- (off mike) -- strong hands? And -- because only with the paper being in strong hands can the issues -- some of these issues be dealt with. If a mortgage is chopped up into a million pieces and owned fractions of its cash flow is owned by all kinds of people, there's not -- it's very hard to deal with that homeowner and renegotiate the terms. But if you've bought this mortgage at, okay, a discount, then you can go -- (off mike) -- and I'm of course projecting this on a much wider scale -- and say okay, you know, you can't make your monthly payments, but could you make it half, and can we make a deal here? And because he or she bought this paper at a substantial discount, everyone can make out okay, in a reduced way. Somehow or other that paper has to be dealt with, and that's all I have to say.
00:56:10	REP. T. DAVIS	Yes. (Mr. ?) Soros --
00:56:10	MR. SOROS	I'm on record in -- of being very critical of the original TARP proposal. And I'd like to go on record saying that while it is a great improvement that it's not used for removing toxic securities but for equity injection, the way it is done is not an adequate or acceptable way; that if it were properly done, then $700 billion would be more than (sufficient ?) to replenish the gaping hole in the banking system and to encourage the banks to start lending again. And the way that this should be done would be to ask the examiners to determine how much capital each bank needs to bring it up to the required 8 percent. Then the banks would be free to raise that capital or go through TARP and get an offer. And, but TARP should only underwrite the issue and not actually take it on, but underwrite it on terms that the shareholders would be likely to take it on. (Audio break) -- would TARP take it on? Then you would have replenished the banking system. You would then reduce the minimum lending requirements from 8 percent, let's say, to 6 percent, the minimum capital requirements. And the banks would be very anxious to put that very expensive capital, because equity capital is expensive, to good use, to get a good return on it by actually lending. So that would solve that problem. And as far as the toxic securities are concerned, I think, the first thing is to renegotiate the mortgages, so that people would actually stay in their houses, and remove the pressure of foreclosures, which are liable to push down the value of mortgage securities way below. That is an undone business that has to be urgently attended to.
00:58:44	REP. T. DAVIS	Thank you all.
00:58:44	REP. EDOLPHUS TOWNS (D-NY)	Let me tell my colleague, he has no time to yield back. (Laughter, cross talk.) Let me just ask a question and just go right down the line and get an answer from each of you. All of you have successfully navigated the recent problems in the economy, which appears to have blindsided the people on Wall Street and, of course, the people here in Washington. I don't think we can pass up this opportunity to explore what it is that you knew that allowed you to get so far ahead of everyone else, when it came to predicting what would happen in the markets? I would like to go right down the line, right down the line. Let me just start with you, Mr. Griffin, and go right down the line.
00:59:35	MR. GRIFFIN	Sir, the last eight weeks have been a challenging eight weeks for Citadel. We've had a very successful 18 years holistically but we've had a tough time the last eight weeks, as the banking system around the world came close to the verge of collapsing. I think what's very important to note is, what has happened in the last eight weeks looks like nothing that any of the traditional risk management metrics would have shown as a realistic possibility. I think that's very important for everyone to keep in mind, in terms of -- (audio break) -- on a going-forward basis. We had a panic in the money-market system. We had a panic in the banking system. And we've had very negative consequences, as a result of that, in the entire Western world financial system. I think if we look at the firms that have done well, over the last eight weeks, they came into this position with portfolios of both credit risk and equity market risk that could tolerate extreme moves which we have witnessed. And they've come into this crisis with very solid financing lines, which have been important in terms of weathering the storm that we've just gone through.
01:00:44	REP. TOWNS	Mr. Falcone.
01:00:44	MR. FALCONE	I think in looking at what's happened over the past eight weeks versus what's happened over previous history, in the financial markets, is a very unique point in time. The markets are very irrational right now. And I've always said, you could be right fundamentally and wrong technically. And the technical situation in the marketplace is putting a lot of pressure on a lot of institutions. (Audio break) -- weathered the storm and how we've done, over the past, has really been a function of our diligence. And I think in looking at where we've been successful, we've taken our time and been methodical and really thought things through. And we were very involved in the mortgage market over the past couple years. And it's been to a point -- it was to a point where it took me about eight to 12 months of some pretty substantial analysis before we put that trade on or trades like that on. So I would say that over the past couple of months, it again has been very irrational and very -- been very difficult to avoid, no matter what type of institution you are, to avoid the pitfalls of what's been taking place. And I think in order to succeed going forward, the proper liquidity and the proper lines with the right institutions are a very critical and very important thing.
01:02:15	REP. TOWNS	Okay. Mr. Paulson.
01:02:15	MR. PAULSON	Mr. Chairman, we conduct a lot of detailed analysis independent of the rating agencies. And -- REP./MR. : (Off mike.) Yes. Our firm conducts a lot of detailed, independent research that's independent of what the rating agencies do. And we determined late in 2005 and early 2006 that there was a complete mispricing of risk of mortgage securities. We found Moody's and S&P rating various securities investment grade, including as high as triple-A, that we thought would become worthless. The reason we had this opinion was we looked at the underlying collateral of these securities. The subprime securities were comprised of mortgages that were made with a hundred percent financing and no down payment. They were made to borrowers that had a history of poor credit. There was no income verification. And the mortgage -- (audio break) -- based on an appraisal that was typically inflated. We felt this was very poor underwriting quality, that the default rates in these mortgages would be very high and that securities backed by these mortgages would also like very high -- likely also have very high defaults. And it was that analysis that allowed us to buy protection on these securities which resulted in large gains for our funds.
01:03:54	REP. TOWNS	Thank you. Mr. Simon?
01:03:54	MR. SIMONS	Okay. Well, I didn't have that kind of wisdom. Happily, the funds that we operate didn't require that kind of wisdom. So our principal fund -- it's called Medallion -- is long and short, equal amounts of equity and is not necessarily effected by the rises and falls of the stock market and, in fact, has done -- has done fine through this period. A second fund, which is designed to be a dollar long -- that's for outsiders, not employees -- obviously, has -- it's long more than it's short, so it's net long a dollar if you invest a dollar. That has obviously had some declines -- the stock market down 40 percent -- but considerably less than the declines of the market. And our investors in that fund are quite happy, because that's what they -- that's what we advertised would happen. And that's -- so that's fine. An outside futures fund we have was hurt by the explosion of volatility in October. I couldn't have predicted that. Maybe I should have. I didn't. It was on the wrong side of a few things and suffered some losses in October. But by and large, our business is not highly correlated with the -- with the stock market. And so that's how we've skated along here.
01:05:22	MR. SOROS	What's your question? I didn't fully understand your question. Was it how it affected our --
01:05:28	REP. TOWNS	Yes, how you seem to have been able to anticipate when others were not able to anticipate -- (inaudible) -- of the market.
01:05:37	MR. SOROS	I fully anticipated the worst financial crisis since the 1930s. But frankly, what has happened in the last eight weeks exceeded my expectations. The fact that Lehman Brothers was allowed to go -- declare bankruptcy in a disorderly way really caused a meltdown, a genuine meltdown of the financial system, with a cardiac arrest. And the authorities have been involved since then in resuscitating the system, but it has been a tremendous shock, the impact of which has not yet been fully -- fully felt. Now, as far as my own fund is concerned, I came out of retirement to preserve my capital, and I've succeeded in doing that. So we are flat for the year because by taking the necessary steps, I was able to counterbalance the losses that we would be suffering otherwise, which would be quite substantial.
01:07:09	MR. TOWNS	Thank you very much. Thank all of you for your answers. The gentleman from Indiana.
01:07:16	REP. MARK SOUDER (R-IN)	Thank you, Mr. chairman. And I understand this is a financial hearing and I'm not going to get into other questions, but I just want to say, Mr. Soros, we've had deep disagreements over the years on the heroin needles promotions and your promotion of different -- what I believe are backdoor legalization of marijuana. And I believe while you've done humanitarian efforts around the world, your intervention in the drug area has been appalling. And I haven't had the chance to talk to you directly, and I wanted to say that, because I believe it's damaged many Americans and I hope you'll reevaluate where you put your money. But I do have a question directly to you on your question on equilibrium; that don't hedge funds (provide ?) some of that equilibrium by buying long and selling short and going after companies that haven't been responsible? And why do you think there wasn't more of that in this case?
01:08:17	MR. SOROS	Well, to some extent, hedge funds do. And of course, we shouldn't put all the hedge funds in one category. There are different strategies and they have different effects. And definitely, selling short is a stabilizing factor, generally speaking, in the market; you know, as markets that allow and facilitate short selling tend to be more stable than those that prohibit them. At the same time, hedge funds do use leverage, and leverage by its very nature has the potential of being destabilizing, because as the (price ?) -- market goes up, the value of the collateral increases, you can borrow more; and also, maybe since you are making profits, your appetite for borrowing more is increasing, so there's greater willingness to lend by the banks. So this is the -- generally speaking, bubbles always involve credit. And since hedge funds use credit, they are contributors to the bubbles. It's nothing specific to hedge funds; it's -- it relates to everyone who uses credit.
01:10:01	REP. SOUDER	Mr. Paulson, you said a little bit ago that you felt that the government need to get -- needed to get more involved in the fact that some use too much leverage, and that it's kind of a slippery slope because, as Mr. Soros just suggested, that, in fact, hedge funds use some leverage as well, and, in fact, while you serve a function for equilibrium, you often exaggerate the extremes of that through selling short or buying long. How -- could you respond some to what Mr. Soros said? How do you feel -- do you still feel you shouldn't have additional regulation with that? And if -- and how do you respond to the fact that you do, in fact, exaggerate some of these trends?
01:10:55	MR. PAULSON	Well, I think what leverage does it is exacerbates any move --
01:10:55	REP. WAXMAN	Is your mike on, sir? Because --
01:11:03	MR. PAULSON	Yeah. The danger of leverage is that it exacerbates any type of market move, so almost every financial firm that has run into problems -- not only hedge funds like Long-Term Capital, but Lehman Brothers, AIG -- has because they used too much leverage, and a small decline in the value of their assets wiped out their equity. So I think that the -- there is a need to raise the margin requirements on particular asset classes and to require stronger equity positions in banks so that -- and that would reduce the risk of failure.
01:11:44	REP. SOUDER	Mr. Griffin, you've been the most aggressive in saying that there shouldn't be regulation. How would you respond to the other comments there?
01:11:53	MR. GRIFFIN	Well, let me -- let me be very direct on the point to regulation. Good regulation is good for every market participant. I mean, for (example ?), in the middle of the financial crisis, we worked hand-in-hand with the SEC to create the necessary exemptions to allow Citadel to continue to make markets every day in options to millions of retail investors. And every day during this crisis, we have provided liquidity -- in the equities markets -- to millions of retail investors, whether they're at Schwab or Fidelity or Ameritrade or E-Trade. I'm very proud of my firm's commitment to providing liquidity to retail investors in America. We've also worked hand-in-hand with the Federal Reserve Bank of New York on creating a clearinghouse for central -- for credit default swaps. I think that as a nation we need an intelligent dialogue about the right regulatory frameworks to encourage markets that are transparent, that have the appropriate amount of leverage in the system and that create value for society. The point of our capital markets is to allocate capital efficiently, to allow corporate America to raise equity to grow, and to allow America to be more competitive in the world markets. And any regulation that furthers those key goals of our capital markets is regulation I would support.
01:13:28	REP. SOUDER	Would -- if regulation goes too far, would your funds -- because I assume you all have foreign investment -- would we see this move offshore, either to Europe or Asia or other places?
01:13:40	MR. GRIFFIN	It breaks my heart, when I go to Canary Wharf and I look at the thousands and thousands of highly paid jobs, in London in the derivatives markets, that belong in America. We went through a period of regulatory uncertainty, with respect to derivatives, that pushed thousands of high-paying jobs abroad, jobs that belong in our country.
01:14:06	REP. SOUDER	Thank you.
01:14:06	REP. TOWNS	Thank you very much. The gentlewoman from New York.
01:14:06	REP. CAROLYN MALONEY (D-NY)	Thank you. Thank you very much. And I would like to ask a question about a specific regulatory proposal, which is to require hedge funds to disclose information to regulators. This is an idea that was proposed, in the prior panel, by both Mr. Ruder and Professor Lo. Right now the SEC, the Fed and other entities have virtually no information about hedge funds. As a result, they have very limited ability to assess systemic risk. As Professor Lo testified, one cannot manage what one cannot measure. He said that it is, and I quote, "obvious and indisputable need to require financial institutions to provide additional data to regulators." Chairman Ruder made the same point when he said, and I quote, "I continue to believe that a system should be created, requiring hedge funds to divulge, to regulators, information regarding the size, nature of their risk positions and the identities of their counterparties." And I see you have your book with you, Mr. Soros. And in your book, you said, and I quote from you, "There are systemic risks that need to be managed by the regulatory authorities. To be able to do so, they must have adequate information. The participants, including hedge funds and sovereign wealth funds and other unregulated entities, must provide that information even if it is costly and cumbersome. The costs pale into insignificance when compared to the cost of a breakdown." And we are now experiencing a major breakdown. And so Mr. Soros, would you support a requirement for hedge funds to report financial information to regulators?
01:15:58	MR. SOROS	Yes.
01:15:58	REP. MALONEY	And Mr. Simons, you also in your testimony made a similar statement about transparency and appropriate regulation. So would you agree also that it's correct to have more?
01:16:12	MR. SIMONS	Yeah.
01:16:12	REP. MALONEY	And I -- also Mr. Paulson, Mr. Falcone and Mr. Griffin, would you support additional information and transparency to regulators?
01:16:22	MR. PAULSON	Congresswoman Maloney, you make a very good argument. I think given the size of the industry and the potential for systematic risk, such -- (Cross talk.) Congressoman Maloney, I think you make a very good argument. Given the size of the industry and the potential for systemic risk, greater disclosure and transparency would be warranted.
01:16:45	REP. MALONEY	Mr. Falcone.
01:16:45	MR. FALCONE	I agree. I think providing information to the regulatory agencies is very important. I think however it's very critical what they do, with that information, and that we have to make sure that it's properly analyzed. And I think that can go a long way, as opposed to providing the information and just seeing it filed away.
01:17:08	REP. MALONEY	Mr. Griffin.
01:17:08	MR. GRIFFIN	I think one of the challenges that we need to address, before we can get to the goals that you want to get to, is to have a common language to describe derivatives.
01:17:16	REP. MALONEY	That's important.
01:17:16	MR. GRIFFIN	Every firm uses a different set of terminologies, a different set of representations to describe their portfolios. Until we create central clearing houses for over-the-counter derivatives, any reporting that we're likely to create will be inscrutable to regulators. And we need to fix that.
01:17:33	REP. MALONEY	Well, we are moving towards that direction, as you have read and know the Fed is moving in that direction. Mr. Paulson, I would like to ask you to comment on an article that you wrote, for The Wall Street Journal, on the TARP when it first came out. Along with many of us in Congress, you argued that we should not be investing in these, in a toxic asset purchase, but to move into an equity injection. And some -- (audio break) -- including yourself and others, have argued that -- why are we being treated differently as taxpayers in America as opposed to Great Britain? We have a 5 percent return. They have a 12 percent; Switzerland, a 12 1/2 percent. Mr. Buffett got a 10 percent. Would you comment further on this and how the TARP possibly could -- should be structured in a way that's more beneficial to the economy and to the American taxpayer.
01:18:31	MR. PAULSON	Certainly. In terms of --
01:18:31	REP. MALONEY	And you could speak up into your mike?
01:18:31	MR. PAULSON	Yes, certainly. In terms of using the TARP money for equity instead of buying assets is much more beneficial. And the benefit can be -- can be described very simply. If you put a dollar of equity in a bank, and a bank uses 15-to-one leverage, then that dollar would support 15 dollars of new lending. If you merely use that dollar to buy a toxic asset from a bank for a dollar, it doesn't increase the equity and doesn't provide for any new lending besides the dollar of equity provided. So the leverage to support the system and provide for liquidity, new lending, is far more efficient by putting in equity rather than buying assets. So I think the --
01:19:22	REP. MALONEY	And could you comment on the difference between the equity returned to the tax payer, 5 percent versus Great Britain, Switzerland and even Mr. Buffett.
01:19:33	MR. PAULSON	Yes. Yes. So the -- so the change in TARP to buy equity instead of assets is very beneficial. But secondly, the terms that the Treasury's been providing equity, it seems to be very generous to the recipients; that it's way below what market terms are, what the firms would have to pay if they raised this money privately, and is also considerably below the returns that other governments get when they're forced, involuntarily, to support the financial institutions with equity.
01:20:03	REP. MALONEY	Thank you.
01:20:07	MR. PAULSON	So I think the three -- the three changes I would recommend is that for future equity injections, the government should get a higher dividend, perhaps around 10 percent, and warrants that equal or greater percentage of the investment than they're currently getting. Secondly, in order to restore the equity in the financial firms, I think it's imperative that while that preferred stock is outstanding, that common -- cash dividends on common be prohibited. And as an additional -- (audio break) -- creating more equity that ultimately will allow the company to pay back the preferred, that cash compensation be capped and bonuses above that amount be paid in additional shares of common stock. That will go a long way to restoring the equity in these financial firms.
01:20:56	REP. MALONEY	My time is expired. I wish I could ask many more questions. Thank all of you for your very insightful, important testimony. I yield back.
01:21:04	REP. TOWNS	Thank you very much. And the gentleman from Connecticut.
01:21:04	REP. CHRIS SHAYS (R-CT)	Thank you, Mr. Chairman. (Audio break) -- five minutes, so I'd love some short answers. And I'm going to just focus on one individual, just so I can pursue a little more in detail. I'd like to ask each of you -- and I'll just preface it, when I meet with hedge fund partners and they're in a room and I ask them about treating capital gains income as capital gains or as regular income, when they're with their colleagues they say we should have capital gains treated the way it is. And when they meet with me privately, they put their arm around me and say, "Chris, this is crazy. They should be treated as ordinary income." So you know, the people that I respect look me in the eye and say it should be treated as regular income. I'd like each of you to tell me quickly, capital gains or regular income. Mr. Soros.
01:21:56	MR. SOROS	I think earned income should be taxed as earned income. If you have a partnership arrangement and you -- and that allows you to pay capital gains and you want -- you want to change that, I think that that would be appropriate. It would be inappropriate to --
01:22:11	REP. SHAYS	Okay, let me just cut you off.
01:22:11	MR. SOROS	-- to --
01:22:11	REP. SHAYS	Let me just cut you off, Mr. Soros, because you've answered the question. Do you all agree with it, or do you disagree? Do you all --
01:22:18	MR. SOROS	No, I am in agreement with it being taxed as earned income, but I would take exception if this was only applied to hedge funds and not other forms of partnership.
01:22:30	REP. SHAYS	I'm sorry. I thank you for answering -- finish the answer. Do you any of you disagree with that answer?
01:22:36	MR. FALCONE	I disagree, to a certain extent. I think that hedge funds shouldn't be looked at differently, and it's really a function of the underlying asset. If you have an asset, and you hold it for longer than 12 months, then you should be subject to capital gains tax like any other individual or real estate partnership or any investor --
01:22:55	REP. SHAYS	Okay. You've answered the question. I just have so little time. I don't mean any disrespect.
01:22:55	MR. FALCONE	Okay.
01:22:55	REP. SHAYS	Mr. Griffin, I'm just going to focus in on you, because I just have to isolate one, and you're the furthest away from my district. So if I offend you, I won't -- (laughter) -- you won't bother me. I'm told you can only have 99 members as part of a particular hedge fund. It's 99 or less. Is that correct?
01:23:18	MR. GRIFFIN	The rules have changed over the years. That's not necessarily applicable anymore.
01:23:18	REP. SHAYS	But it's limited.
01:23:18	MR. GRIFFIN	Yes.
01:23:24	REP. SHAYS	What concerns me is that some funds say 20 percent profit, 1 percent management fee. I'm told that you don't do 1 percent management fee, you do cost, and that could be closer to 8 percent. Is that accurate or not?
01:23:39	MR. GRIFFIN	We do pass through cost. Cost, as we define, will include, for example, commissions paid to other firms --
01:23:45	REP. SHAYS	So does it amount to more than 1 percent?
01:23:45	MR. GRIFFIN	Yes, it does.
01:23:45	REP. SHAYS	Okay. I'm also told that some of your funds have done well and some haven't. And the accusation was that the funds that have done better are the ones you have your own money in, your own personal money, and the funds that haven't have not. And I want to know if that's accurate.
01:24:05	MR. GRIFFIN	That is completely inaccurate. I am the single largest investor in our largest funds, by a significant margin. I'm also the largest investor, and some of our funds have been very profitable this year.
01:24:16	REP. SHAYS	So would your statement for the record be -- and under oath -- that you have investment in every fund that you have, or just some of the funds?
01:24:25	MR. GRIFFIN	I have a material -- several billion-dollar investment in Wellington and Kensington.
01:24:31	REP. SHAYS	Right.
01:24:31	MR. GRIFFIN	And I have an investment in the several hundred millions of dollars in our other funds.
01:24:37	REP. SHAYS	Okay. And in the one that you have the most investment in -- has that done the best or the worst or somewhere in between?
01:24:44	MR. GRIFFIN	Regretfully, it has done the worst.
01:24:44	REP. SHAYS	Okay. Let me ask all of you, then, do you think that you should be required to have your funds -- your own personal funds in every fund that you have? The implication is that since you make 20 percent of the profit, that you might tend to more risky with the funds you may not have your own money in, because you still make 20 percent, and if you lose, if the funds lose, you don't lose anything. So let me ask you about that. Mr. Soros.
01:25:16	MR. SOROS	Well, I -- exactly in order to avoid this kind of conflict of interest, I only have one fund, and all my assets are in that fund.
01:25:28	REP. SHAYS	Okay. Has that fund done better or worse than your other funds?
01:25:30	MR. SOROS	There's no comparison. It's the only one.
01:25:30	REP. SHAYS	Okay. I'm sorry. You just have one fund. Yeah, I'm sorry. Thank you.
01:25:38	MR. SIMONS	Oh, okay. Well, no, we -- I have --
01:25:38	REP. SHAYS	I can't hear you. You're mumbling.
01:25:38	MR. SIMONS	Well, all right. Is that better?
01:25:38	REP. SHAYS	Yup.
01:25:45	MR. SIMONS	All right. I have substantial amounts of money in the three different funds that we manage. I think that that question is generally asked in due diligence by people considering investing in hedge funds. We always do. We invest in a -- the family invests in many, many hedge funds. And that's the first due diligence question: Does the fellow have skin in the game or whatever?
01:26:02	REP. SHAYS	Yeah.
01:26:02	MR. SIMONS	Does he have a match? So to a large extent, I think that issue is taken care of by the market --
01:26:06	REP. SHAYS	So you've answered the question. Thank you. Paulson?
01:26:14	MR. PAULSON	Yes. All my assets are invested in the funds that we manage. I don't have any outside investments.
01:26:20	MR. FALCONE	I think it's very important that the manager aligns themselves with the investors. And in my situation, I'm the largest investor of both of -- in both of my funds.
01:26:28	REP. SHAYS	Thank you all. Thank you.
01:26:28	REP. TOWNS	Thank you very much. The gentleman from Maryland.
01:26:35	REP. ELIJAH CUMMINGS (D-MD)	Thank you very much, Mr. Chairman. Mr. Soros, Mr. Souder had some comments about you a little bit earlier. And I just want to let you know that I thank you for what you all have done for the citizens of Baltimore and my district. It has been simply phenomenal, and I thank you and the Open Society Institute. Let me go to all of you. And just to kind of piggyback on some of the things that Mr. Shays was just talking about -- each of you appearing here -- my neighbor, when I -- on his way to work this morning said to me, he said, "How does it feel to be going before five folks who have got more money than God?" And I'm sure you will disagree with him. But you are private citizens and your income is not required to be publicly disclosed so I'm going to respect your privacy and not disclose your specific compensation. But you have provided information about your income to the committee and it shows that although there are individual variations, on the average, each of you made more than $1 billion in 2007. I've got to tell you, that is a staggering amount of money. And I'm not knocking you for it. But even though you made enormous sums, you are not taxed like ordinary citizens, like the guy that said what I told you. Your earnings are not taxed as ordinary income. Instead, the fees you receive are called carried interest, which means that they are taxed at capital gains rates. There are two capital gains rates, a low 15 percent rate for long-term gains and higher rate for short-term gains. What this means is that to the extent your earnings are based on long-term gains, the tax rate is just 15 percent. My question for you is whether this is fair. A schoolteacher or a plumber or policeman makes on the average of $40,000 to $50,000 a year, yet they have to pay 25 percent tax. You make a billion dollars, that -- yet your rate can be -- can be as low as 15 percent. Is that fair, Mr. Paulson? I want to start with you, because I understand that a significant part of your earnings can be short-term gain, but not all of it is. And Mr. Paulson, press accounts say that you earned over $3 billion in 2007. If just 20 percent of your income is long-term gain, that's over $600 million in income that is being taxed at a low rate. And so we'll -- I'll start with you, and we'll just --
01:29:08	MR. PAULSON	Well, we certainly appreciate your --
01:29:08	REP. CUMMINGS	I want you to keep your voice up for my questions.
01:29:12	MR. PAULSON	Yeah. We certainly appreciate your concern for fairness in the tax code. But I will -- (audio break) -- our tax -- our tax situation is fair. If your constituents, whether they're a plumber or a teacher, bought a stock and they owned that stock for more than a year, they would pay a long-term capital gains rate. So for our investments, to the extent I own investments for more than a year, I also pay a long-term capital gains tax. If we own an investment for less than a year, we pay short-term capital gains, which is taxed as ordinary income. And any fee income we receive, such as management fees, for that, it's strictly ordinary income. So --
01:29:56	REP. CUMMINGS	But this is -- this is about money that you are managing for other people, not -- it's not your money, right? In other words, you said if I hold certain things for someone -- but you're actually getting paid for what you do, which is -- the work that you perform, is that right?
01:30:10	MR. PAULSON	The way -- the way partnership accounting works, if you -- if the partnership owns an asset for more than a year, that asset is taxed at long-term capital gains. And that tax is passed along to all the partners in the same way. If the -- if the asset in the fund, in the partnership is a short-term capital gain, then all the partners, including the general partner, pay short-term capital gain. So the --
01:30:39	REP. CUMMINGS	Do you have an opinion, Mr. Falcone?
01:30:39	MR. FALCONE	Yes, I do. I think that the important thing to realize that hedge funds, quite frankly, are not and probably should not be treated any differently than any other investor. And as the case may be with my particular situation, last year, approximately 98 percent of my taxable income was taxed under ordinary income. But I think it is important not to differentiate between hedge funds and the rest of the investment community, whether they're private equity or real estate or even individuals or the doctor that may own his hospital and decide to sell it.
01:31:23	REP. CUMMINGS	So would any of you support repealing this tax loophole -- (audio break) -- regular income rate? Mr. Soros, I can't hear you.
01:31:33	MR. SOROS	I agree to it. I have no problem with it.
01:31:33	REP. CUMMINGS	Mr. Simons, a little louder.
01:31:38	MR. SIMONS	Yeah, I said, the carried interest portion represented by other people's money, if that were raised to higher levels, that would be okay with me.
01:31:49	REP. CUMMINGS	Mr. Falcone, you just stated your position, I think, right?
01:31:54	MR. FALCONE	Yes, I did.
01:31:54	REP. CUMMINGS	Mr. Paulson.
01:31:54	MR. PAULSON	Yeah, I would. I don't think it is a loophole. The carried interest merely passes through the nature of the income to the partners. If it's short-term capital gain, we're taxed short-term capital gain. If it's long-term capital gain, it's taxed long-term capital gain.
01:32:14	REP. CUMMINGS	Mr. Griffin.
01:32:14	MR. GRIFFIN	I think tax equity is incredibly important. And most of the income if not all of the income that I generate is subject to either ordinary or short-term tax rates, the highest marginal rate. But if you and I were to start a restaurant together, and I was to be the chef and operator, and you were to put up the capital, even though my labor goes into making that restaurant work, every day, if we sell that business two or three years down the road, I will get long-term capital gains. Our society preferences long-term capital gains from a tax perspective. And I think what we should seek to have is consistency, in how we treat long-term capital gains, whether it's the hedge fund manager, the private equity manager or the entrepreneur who starts a restaurant together.
01:33:04	REP. CUMMINGS	I assume my time is up. Thank you.
01:33:04	REP. TOWNS	Thank you very much. Mr. Tierney.
01:33:09	REP. JOHN TIERNEY (D-MA)	Just to follow up on that, Mr. Griffin, when you use your analogy about the restaurant when you're the chef, the money you earn for being the chef gets taxed at a regular income rate.
01:33:17	MR. GRIFFIN	That's correct, sir.
01:33:17	REP. TIERNEY	When you're managing other people's money, you're in effect the chef of that process. You should get taxed for those earnings at the regular income tax rate.
01:33:24	MR. GRIFFIN	And management fees are taxed as ordinary income, sir.
01:33:28	REP. TIERNEY	Well, which one are you talking about, the management fees, the 1 or 2 percent or the 20 percent?
01:33:33	MR. GRIFFIN	The management fees are generally taxed as ordinary income for most firms.
01:33:38	REP. TIERNEY	What are you referring to as the management fees?
01:33:40	MR. GRIFFIN	The 1 or 2 percent.
01:33:40	REP. TIERNEY	Set that aside. You get 20 percent, and the other partners get 80 percent of the earnings, correct?
01:33:47	MR. GRIFFIN	That is correct.
01:33:47	REP. TIERNEY	You get 20 percent for the money that -- for the effort you made in managing those funds and making those investments and doing that type of work. That's being the chef, not in terms of selling the product. I know what you want to do. You want to wash it all through and come out the other end. But the fact of the matter is, that's compensation for your day-to-day efforts of managing those funds. Is it not?
01:34:06	MR. GRIFFIN	Well, let's go back to the story of the chef. The chef in his salary, every year, is taxes as ordinary income. But if the restaurant has capitalized, we'll value it.
01:34:16	REP. TIERNEY	But you're not selling anything when you're getting compensated for the day-to-day management efforts that you make.
01:34:21	MR. GRIFFIN	If I make an investment, that creates long-term capital gains. So I invest in a biotechnology company. Would the stock appreciate?
01:34:26	REP. TIERNEY	A good portion of that money isn't yours, right?
01:34:30	MR. GRIFFIN	That's correct.
01:34:30	REP. TIERNEY	So when you get 20 percent, it's for investing other people's -- (audio break) -- as well as your own.
01:34:37	MR. GRIFFIN	That is correct.
01:34:37	REP. TIERNEY	And some of that compensation is for your efforts in managing and investing those other monies.
01:34:43	MR. GRIFFIN	That is correct.
01:34:43	REP. TIERNEY	Right. And that, my friend, I suggest to you, is what we're saying ought to be taxed as regular income. You can disagree, but I just don't want to take the chef analogy too far on that.
01:34:54	MR. GRIFFIN	Well, just to be very clear, all of my income, or virtually all, is taxed at the highest marginal rates.
01:34:59	REP. TIERNEY	As it should. (Fine ?).
01:34:59	MR. GRIFFIN	All right. So I speak to this from that conceptual
01:35:03	REP. TIERNEY	Then we don't disagree on that, but I'm talking -- I didn't want you to take your chef analogy and confuse people with that. Let me just -- Mr. Paulson, except for our disagreement on that particular issue, I was thinking that we probably had the wrong Paulson handing out the TARP monies here, because I agree with you, in essence, about us not getting the deal as taxpayers that we ought to be getting. And I'm fairly adamant, and I can dare say that you can't walk down the street at home in any of our districts that people don't make that point -- is what the heck are we doing giving money to these institutions, and they're out there giving bonuses, paying high salaries without being capped, and then waltz around giving dividends. So I think that's an important point. And I know you've already mentioned that twice now, but I think it probably can't be mentioned loudly enough and clearly enough while the other Mr. Paulson is busy determining what he's going to do. What I'd like to know is whether the other four panelists here agree with our Mr. Paulson here that if we're going to have taxpayer money go to any of these institutions, we ought to get a better deal of, you know, better security on that, make sure the compensation isn't excessive, and make sure in fact that dividends aren't given out in cash during that period of time when we've got the guarantee of the investment made. Mr. Soros.
01:36:08	MR. SOROS	I'm sorry. I didn't follow the question properly. I'm sorry.
01:36:13	REP. TIERNEY	(Chuckles.) The -- in my old business, we used to be able to have it read back. But do you agree with Mr. Paulson that as long as taxpayers' money is being given to these institutions for the purposes of thawing out the so-called credit freeze, that we ought to be getting a better deal for the taxpayers, we ought to be getting better security for that investment, we ought to be making sure that the banks or the people that are -- the entities are not giving excessive compensation with it, bonuses and things of that nature, and are not giving cash dividends while the stockholders, the taxpayers' money is there?
01:36:49	MR. SOROS	I'm not sure that I would agree with Mr. Paulson on that.
01:36:56	REP. TIERNEY	Why not?
01:36:58	MR. SOROS	I think that if you have a capital increase in the banks, then I think that as long as the money is put up by the shareholders, there should be no change in the -- it's up to the shareholders how they compensate.
01:37:23	REP. TIERNEY	But this is taxpayer money, not shareholders' money that we're talking about.
01:37:26	MR. SOROS	No -- well, when it's taxpayers' money -- no, there I agree.
01:37:30	REP. TIERNEY	Thank you.
01:37:30	MR. SOROS	Yes.
01:37:30	REP. TIERNEY	Mr. Simons, do you also agree?
01:37:31	MR. SIMONS	Yeah, generally speaking, I do, although I will make the point that when this first round of money was put into these banks, some of them didn't want to take it. And the -- Paulson said everyone has to take it. And therefore, if you're going to -- because he didn't want to -- the public to distinguish which bank is stronger, which bank is weaker or so on, which maybe was a good idea or maybe wasn't. But the result is that everyone had to take it, and if you have to take it, well, then you can mitigate that a little bit, saying: Okay, I won't gouge you too much or whatever it would be. So I'm not saying that 10 percent is gouging, by the way. But some of this money was not requested by some of these banks. To the extent that it was, I think it was quite a sweet deal.
01:38:17	REP. TIERNEY	Yeah. Well, I'll go on -- and I think, whether you request it or not, you know, you ought to have a fair deal, not a lopsided deal on that. But we can discuss that later.
01:38:24	MR. SIMONS	Well --
01:38:24	REP. TIERNEY	Mr. Falcone?
01:38:26	MR. FALCONE	I agree. I think that to the extent that capital is infused into some of these companies, it should be more along the lines of market rates.
01:38:34	REP. TIERNEY	Mr. Griffin?
01:38:34	MR. GRIFFIN	I believe that market rates for many of these companies would be extremely high, and if one of our goals is to reduce the cost of consumer credit, this is, in essence, an indirect subsidy to the banking system that I hope they will pass in some form or another to the ultimate consumers to whom they lend to.
01:38:53	REP. TIERNEY	Thank you. Thank you all for your answers. Thank you, Mr. Chairman.
01:38:53	REP. TOWNS	Thank you very much. Mr. Yarmuth?
01:38:57	REP. JOHN YARMUTH (D-KY)	Thank you, Mr. Chairman. I want to thank the panel. The testimony's been, I think, unusually candid and thoughtful. I appreciate that very much. I'm going to probably cross the line a little bit that Chairman Waxman set down, but I'm going to try to draw the connection. We have had a number of hearings related to the immediate financial crisis. And even going back some months we had a hearing on corporate compensation and its connection to the housing crisis. And we had a panel back then that included former CEO of Time Warner, former CEO of Merrill Lynch, Citigroup and we had Mr. Mozilo from Countrywide. And one of the questions that I asked was when the -- all these corporate -- executive compensation committee meetings met, was there ever a discussion of things like employee welfare, the communities that the corporations served, so forth, general corporate policies, or was there -- the discussion always about stock price? And with unanimity, they said the conversations were always about stock price. And one of the things that's become a common theme in the hearings we've had is that when you tie everyone's compensation to stock performance and relatively short-term stock performance then you get -- you have an incentive or pressure for maybe risky behavior that might have contributed to a lot of the crisis that we have. So I ask you, as people who own significant positions in some of these companies, whether you have a concern about the corporate governance structure in this country and whether we should be doing things -- whether it's related to corporate compensation generally or general corporate governance laws -- that might ameliorate some of this issue if you think it's a problem? Mr. Soros, would you like to start?
01:41:05	MR. SOROS	Yeah. I'm a little bit at a loss, because it's not a subject that I have really given a lot of thought to.
01:41:11	REP. YARMUTH	Chairman Waxman excused you so -- on that. Mr. Simons?
01:41:17	MR. SIMONS	I haven't thought about it a great deal, but I've -- generally speaking, I'm more of a fan of profit-sharing for CEOs than I am of stock options. It's a -- the latter is very volatile and you never know quite what he's getting.
01:41:35	MR. PAULSON	In this case, I would -- (audio break) -- Mr. Simons' comments.
01:41:40	MR. FALCONE	I'm inclined to agree with Mr. Paulson and Mr. Simons, that it is important to participate from a compensation perspective as it relates to profit-sharing, along those lines.
01:42:03	REP. YARMUTH	Mr. Griffin, do you --
01:42:03	MR. GRIFFIN	I will concur with the other panelists.
01:42:06	REP. YARMUTH	In today's Financial Times, Professor Markiel from Princeton suggested that one of the things that might be considered is when you have compensation tied to stock options and so forth that it involve restricted stock that the CEO could not sell until some time after the -- he or she left the company and therefore the concern would be more in the long-term interests of the corporation, rather than more short-term stock performance. Is that something that resonates with any of you that you think might be a good idea? You can say you didn't think about it --
01:42:41	MR. GRIFFIN	I think that would be a terrible idea.
01:42:44	REP. YARMUTH	Terrible idea?
01:42:44	MR. GRIFFIN	And part of the reason is that we need executives in America to take risks. Whether it's to put the money down on the line for R&D in -- (audio break) -- or willing to try to create new ways to power America, we need executives to take risks. And what we find is that as executives become more successful, they actually become more risk-averse often. And so if you have their entire net work tied up in stock options, which are inherently risky, and then they cannot monetize -- (audio break) -- after they retire, I would be gravely concerned about the reduction in risk-taking by America's corporate leaders. It sounds good on paper. I don't think it will give us what we need as a country. We need innovation.
01:43:27	REP. YARMUTH	Does anybody else want to address that? I don't have any other questions. But if you don't, that's fine. Thank you, Mr. Chairman.
01:43:34	REP. TOWNS	Thank you very much. (Cross talk.) The gentleman from Tennessee, Mr Cooper.
01:43:37	MR. SIMONS	Mr. Chairman, I'd like to excuse myself for a moment. I'll be right back.
01:43:40	REP. TOWNS	Sure.
01:43:40	REP. JIM COOPER (D-TN)	Thank you, Mr. Chairman. The headline of this hearing, I think, is definitely Paulson v. Paulson. As has been enumerated, John Paulson accuses Henry Paulson of botching the bailout, because taxpayers do want to get return for their money. And they're very worried when we're only getting 5 percent interest on the preferred stock and not getting sufficient warrant positions. But I think the real purpose of this hearing is to understand better the role that hedge funds play. And I asked the previous panel of professors largely if it's possible to distinguish between hedge funds that hedge and funds that are more speculative. Mr. Paulson for example bet right on the down housing market. But that was not necessarily a position, you know -- for example if you had taken that position three or four years ago, you wouldn't be as wealthy as you are today. The only thing worse than being wrong about the market is being right too early. So is it possible to distinguish between hedge funds that hedge and those that are speculative?
01:44:44	MR. PAULSON	Well, let me first say, I hope this is not Paulson versus Paulson, or that I'm accusing Paulson of botching -- (Cross talk.)
01:44:54	REP. TOWNS	We're having great difficulty hearing you. So could you pull the mike closer to you or even talk a little louder?
01:45:00	MR. PAULSON	Absolutely I'd be glad to do that, Mr. Chairman.
01:45:00	REP. TOWNS	Thank you very much.
01:45:00	MR. PAULSON	I in no way want to be critical of Mr. Paulson. He's done a tremendous amount for our country. He's willing to change his position when the circumstances change. And I think he has reoriented the TARP program in the right direction. The second part of your question: Are there -- really wasn't sure what it was again.
01:45:26	REP. COOPER	For example, Mr. Simons doesn't purchase credit default swaps. He's not leveraged much. Other hedge funds have quite different strategies. We'll never know, because it's a black box trade secret. But is it possible for the pension fund and other investors to know, in advance, whether they're buying interest in a hedge fund or a speculative fund? (Cross talk.) I know in the private conversation, you revealed a little bit more of your operations. But most people have no idea whether it's a hedge fund that hedges or it's not. It's a question about truth in advertising.
01:45:57	MR. PAULSON	Congressman Cooper, that's a very good question. Investors never have to invest in a hedge fund. If they don't get --
01:46:04	REP. COOPER	I know.
01:46:04	MR. PAULSON	If they don't get the proper transparency --
01:46:07	REP. COOPER	They don't. But there's a Wisconsin school board that put money in SIVs that got traced all around the world. You know, a lot of investors don't necessarily know. So right now we have hedge funds as a category that's not defined, some of which hedge but many of which do not. And people have no advance notice. So there's not truth in advertising.
01:46:28	MR. PAULSON	Well, we for one give a lot of transparency to our investors. And while we don't disclose them publicly, we do disclose a great deal about what we are doing to our investors. So I would encourage investors such as pension funds that they invest with managers that give disclosure, so the pension funds know what they're investing in.
01:46:50	REP. COOPER	Do any other witnesses know? Mr. Soros.
01:46:53	MR. SOROS	Yeah. I think that hedge funds, several hedge funds have claimed to follow a market-neutral strategy, exactly because -- (audio break) -- institution investors want to see low volatility. And I think that was rather misleading. I don't think it was deliberate misleading, but actually, because there is this false paradigm that has prevailed, that has pervaded the thinking on this subject, people thought that they were market-neutral. And in actual fact, when the event occurred that was not a random fluctuation or deviation, then it turned out to be non-market-neutral.
01:47:55	REP. COOPER	Thank you. You mentioned that investors usually want low volatility. The markets have been unusually volatile recently. And some trading strategies depend on volatility. How much volatility is enough?
01:48:09	MR. SOROS	Well, you see --
01:48:09	REP. COOPER	Two hundred points a day, 500 points a day, a thousand -- is more better?
01:48:14	MR. SOROS	Basically, what the prevailing paradigm has neglected is the uncertainty that is connected with this reflexive connection. We have become very adept in calculating risk. And by focusing on risk, we have left out uncertainty. And that has been our undoing in this particular case.
01:48:45	REP. COOPER	How about the other panelists? Is volatility only strategy appropriate? And if so, is more volatility always better?
01:48:54	MR. SOROS	Well, you see, I think volatility is an indication of uncertainty. And the fact that you've -- normal volatility is 30, and it shot up to 50 and 70 and 80. It just shows the increased uncertainty that is currently prevailing the markets.
01:49:17	REP. COOPER	Does the government have a role in limiting excessive uncertainty?
01:49:20	MR. SOROS	Well, I think that regulators have to understand that there is -- there is this uncertainty in markets. And that's why the risk-management methods used by individual participants who are only thinking of their own risk is not appropriate in calculating systemic risk. And to protect against systemic risk, you have to impose restrictions on the amount of credit or leverage market participants can use. That is actually the core of my argument that I'm putting forward.
01:50:02	MR. GRIFFIN	Congressman Cooper, if I may --
01:50:02	REP. COOPER	Yes.
01:50:07	MR. GRIFFIN	Good regulation, good policy reduce volatility in the market. And we are extremely invested in the safety and soundness of our financial system.
01:50:19	REP. COOPER	But doesn't your firm have a conflict of interest in grouping with CME to create clearinghouses and other means that might somehow prejudice the market?
01:50:28	MR. GRIFFIN	In the sense of --
01:50:28	REP. COOPER	Well, if you're partnering with the market maker or the clearinghouse, how do people know it's going to be a fair market?
01:50:37	MR. GRIFFIN	Well, we would clearly have a very sharp distinction between our role as a contributor of intellectual property and know-how to the CME to expedite the launch of this clearinghouse from the day-to-day management of the clearinghouse. We will have no involvement in the day-to-day management of the clearinghouse, because the positions of other market participants should not be made available to Citadel.
01:51:01	REP. COOPER	But that makes investors rely on a Chinese wall instead of a greater separation.
01:51:04	MR. GRIFFIN	Well, CME will be running the clearinghouse. So we're not running it, just to be very clear on the record.
01:51:12	REP. COOPER	Thank you, Mr. Chairman. I see my time has expired.
01:51:14	REP. WAXMAN	Thank you, Mr. Cooper. Mr. Van Hollen?
01:51:16	REP. CHRISTOPHER VAN HOLLEN (D-MD)	Thank you, Mr. Chairman, and thank all of you gentlemen for your testimony. We have had a lot of discussion about trying to create greater transparency over hedge funds. And as I understand all of your testimony, it is you agree with the idea that, at least on a confidential basis, it would be appropriate for some federal agency, the SEC or some other federal agency, to monitor and obtain that information for the purpose of making a determination whether there is systemic risk -- putting the taxpayer at risk. Am I right about that?
01:51:54	MR. SOROS	Yes. Yes.
01:51:56	REP. VAN HOLLEN	Okay. Now, the -- we had just before you a panel of a number of professors, including Professor Lo and Professor Ruder, and the question I posed was: Okay, let's say you're the SEC or the regulator and you're getting this information and data, and say your alarm bells go off. You say, look, we really do think we have a problem here, whether it's to the investors or systemic risk. What authorities should they have then with respect to the hedge fund? And the response we got was maybe the SEC shouldn't have that authority; but they would provide the Federal Reserve with that authority, which, according to their testimony, would require additional congressional action. So my question to all of you gentlemen is, is that something you think would be necessary? Because the obvious question that comes up once you say it's okay to collect the information is, okay, you got it; now you make a determination that something's going wrong. Shouldn't we also make sure they have the authority to deal with it, especially in light of the fact that what we've learned, at least with respect to the investment banks, is that the taxpayer is, of course, the -- sort of holding the risk as a last resort, and is going to be asked and has been asked, anyway, to go in. So I would -- I would pose that question to you gentlemen, whether you think, whether it's the SEC or the Federal Reserve, they should also have additional authorities, whether it's leverage requirements or some other powers that they can intervene with respect to a particular hedge fund that they determine is causing systemic risk.
01:53:23	MR. SOROS	Well, I would -- I would definitely argue that that's exactly what you need. That's what's currently -- is missing, and it needs to be introduced. We used to have that kind of authority in earlier years. In my youth I used to be aware of them. They have fallen into disuse, and I think they have to be brought back, because there is a distinction between money and credit, and markets don't tend towards equilibrium, and it's the -- it's the job of the regulators to prevent asset bubbles from developing.
01:54:06	MR. SIMONS	Yes.
01:54:06	MR. PAULSON	I would agree with that.
01:54:12	MR. FALCONE	I would agree as well. I'm not so sure if it should be the SEC or the Federal Reserve or a new regulatory agency, but I think it's a very good idea.
01:54:20	MR. GRIFFIN	I think what is important in the concept is for the hedge funds that are subject to this new paradigm to understand the rules of the road. Are we heading towards a Basel II requirement for hedge funds, for example? So long as I know what the rules of the road are, I can conduct my business in a way to be well within the lines.
01:54:40	REP. VAN HOLLEN	That's a very good point, I think.
01:54:40	MR. GRIFFIN	And then I'd just -- I'd like to clarify one previous statement. On the issue of clearinghouses for credit default swaps, there were two primary solutions proposed over the last couple weeks. One was the dealers in a consortium called TCC. The other is a solution by Citadel and the CME. A key distinction between these two solutions just a few weeks ago was that the CME solution is open to all, all financial market participants, both the buy side and the sell side, whereas the TCC solution, the dealer solution, was to be open only to the dealer community. And I believe that all of us on the buy side, whether we're PIMCO, BlackRock, Citadel -- Paulson would want a platform that is open to all. It goes back to transparent and fair markets. And we've seen the dealer community trying to create doubts as to why the CME's is the best one -- this issue of Chinese walls. Let me just make it clear, we need a solution to meet the needs of all market participants, and I believe that our work with the CME to do so is in the best interests of our nation and the entire world's financial system.
01:55:59	REP. VAN HOLLEN	Thank you. Thank you for that. Let me also just say, with respect to the -- your answers to the previous question, we appreciate it. We may need all of you gentlemen to continue to provide that input as we go forward, because, as you know, just the notion of providing greater transparency has been proposed in the past. It was proposed after the failure of Long-Term Capital Management. We took a case to the Supreme Court that you're all very familiar with. And the fact of the matter is, not you as individuals but certainly the industry fought efforts to provide greater transparency, to provide greater oversight and some of these things. So as we go through this effort to provide reasonable regulation of the financial markets, we appreciate your input going forward, as well as today. Thank you, Mr. Chairman.
01:56:47	REP. WAXMAN	Thank you, Mr. Van Hollen. Mr. Issa?
01:56:50	REP. DARRELL ISSA (R-CA)	ISSA (R-CA): Thank you, Mr. Chairman. Mr. Soros, it's good to meet you at last. I'm very intrigued at some of your comments, and one of them particularly has to do with leverage. Is it enough, or would it be at least a good, quick beginning, if the Congress, obviously with the president, were to create a Truth in, if you will, Transparency of Leverage; require standards and disclosure add -- as to leverage? And of course that means that, derivatively, if you leverage something and then you go to resell it, it would be standard, so that if you leverage a leverage a leverage, that that would have to be transparent and flow through. If that were one of the items on President Obama's short list of things to be done in that first hundred days, would it go at least a long way toward preventing the kind of overleveraging that you're speaking of -- at least the lack of visibility on overleveraging?
01:57:59	MR. SOROS	Well, certainly the introduction of new-fangled financial instruments has made it much harder to calculate leverage, because some of those instruments are leveraged instruments. So given all the derivatives that have been introduced, calculating the leverage becomes a very, very complicated problem. And especially if you have tailor-made instruments, this -- (off mike) -- even more difficult. So I think that it may be necessary to actually -- well, certainly necessary for the regulators to understand what they are regulating. And if they don't, they should perhaps not allow some of those instruments to be used. So I think that the instruments themselves would have to be authorized, approved by the SEC or whatever, before they could be used.
01:59:10	REP. ISSA	Good point. Mr. Paulson, first of all, congratulations. I'm not an investor with your fund, but I've noticed that you managed to be still up about 1 percent at a time in which the walls are falling all around most other people. In order to have the kind of stellar gains you've had, including, obviously, dealing with some of what we rename -- we call them, you know, caustic and corrosive and acidic products -- were you able to make sound decisions as to the real leverage that you were buying into in your investments?
01:59:50	MR. PAULSON	Absolutely. What we did was primarily buy protection on debt securities. And at the time we bought this protection -- it's like buying an insurance policy -- the premium was very, very low, on the order of 1 percent. So if the debt security never fell, we'd lose the value of that premium. But that premium, in our base funds, was only about 1 to 2 percent, and that was the extent of loss we would realize if our investments didn't pan out.
02:00:31	REP. ISSA	So, to characterize what you just said, you gambled less than those who went routinely long on any investment.
02:00:40	MR. PAULSON	I believe that's the case.
02:00:42	REP. ISSA	So the people who invested with you, including the pension funds and so on, were gambling less because of your technique -- which was available to them, and you have a track history since 1994 -- they were gambling less because you told them that in fact you hedged outcomes in order to protect their investment.
02:01:01	MR. PAULSON	I prefer not to use the word "gambling." What we did --
02:01:04	REP. ISSA	No, and I used -- I didn't use it for you, but I used the word "hedge" for obvious reasons. And the term "gambling," if -- and just correct me if I'm wrong. Most mutual funds, whether they're in small cap, midcap, large cap, foreign, they basically tell you they're going to be a hundred percent invested, or they're going to have a ratio. And no matter what happens in the market, they don't go to all cash, and they -- many of them refuse to go short the market as a matter of it's in the prospectus; isn't that right?
02:01:35	MR. PAULSON	That's correct.
02:01:35	REP. ISSA	So your technique and the technique of virtually all hedge funds is, in fact, to limit risk by stating how you will maneuver in a market as it becomes less than one-directional up. Isn't that true?
02:01:51	MR. PAULSON	That's true. An important goal of our funds is to limit risk and reduce volatility.
02:01:57	REP. ISSA	Okay. Last question, if I could, Mr. Chairman. There was some talk on the earlier panel about tax treatment. And I know this isn't the Ways and Means Committee, so I want to limit it. But do any of you see a way in which we could look at the long- term gains that you and your investors achieve when you're long for a period of more than a year, and differentiate between those and any other investor in stocks and other equity (products ?). Do any of you see -- or debt products -- any of you see a way in which you could effectively differentiate? Because we're often talking about hedge funds and saying, well, we've got to get rid of their capital gains treatment. Only reason I ask is, can any of you -- because you're very smart people -- think of a way that we would separate your category from every other mutual fund, if you will, and the capital gains treatment they get?
02:02:49	MR. FALCONE	If you -- if I may -- if you plan to go down that road, there might be one possibility where --
02:02:56	REP. ISSA	By the way, I don't plan to go down that road.
02:02:59	MR. FALCONE	-- instead of having the horizon be 12 months, maybe make it a little bit longer for hedge funds. I'd hate to see that eliminated in its entirety, because there are truly individuals in the hedge fund market that are investors. And if you extend that time frame, that could be one way of looking at it.
02:03:21	REP. ISSA	Thank you, Mr. Chairman.
02:03:24	REP. WAXMAN	Thank you, Mr. Issa. I want to thank the members of this panel. The members, I think, have asked very important questions and you gave very thoughtful answers, which is very helpful to us. Congress usually has trade associations at hearings, and they give the predictable responses, which are as in what they see their self-interest. And that's why we wanted to have you testify here today, to get an unfiltered response. And your comments and recommendations were very helpful. I believe there's been a consensus or near consensus that hedge funds can pose systemic risks, and there's been a similar consensus that there should be more disclosure about the activities of such hedge funds. Several of you have urged more oversight and reasonable restrictions on leverage and closing the tax loophole that benefits hedge fund managers. You're -- you have also provided insightful criticisms of the federal response to the financial crisis. We're facing a terrible economy and enormous disruption in our financial markets, and I think your testimony is very helpful to us in pointing out ways that Congress and federal regulators could help restore our markets. So I thank you very much for what you've done today. That concludes the business before the committee, and we stand adjourned. (Strikes gavel.)