Panel II of a Hearing of the House Agriculture Committee - The Role of Credit Derivatives in the U.S. Economy

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REP. JIM COSTA (D-CA): Thank you, Mr. Chairman.

Starting with Mr. Damgard, I'd like to ask and have all those in the line up there whether or not you believe that there is a conflict of interest in a clearinghouse run by the same dealer banks that have the largest position in a current credit default swap market.

MR. DAMGARD: Well, most clearinghouses actually are connected in a vertical silo to an exchange. So, for instance, the governance of the Chicago Mercantile Exchange decides what's going to happen at the clearinghouse at the Merc, even though there is a risk committee made up of member firms that can make recommendations, which can either be followed or not followed.

x x x followed. So --

REP. COSTA: But do you think there's a conflict of interest?

MR. DAMGARD: I don't think the conflict of interest exists at the -- at the firm level. I think from time to time there may be a conflict of interest at the exchange level. And we've encouraged exchanges to put as many public members as possible on their boards in order to avoid that risk -- in order to --

REP. COSTA: Mr. Pickel?

MR. PICKEL: As far as ISDA, we don't have a particular position on that issue. I think that the questions of governors --

REP. COSTA: Well, you don't have to have a position. Do you believe there's a conflict of interest?

MR. PICKEL: I think that you need to have robust governance in place, which I think Mr. Short and others on the first panel referred to. And I think that, you know -- Mr. Corrigan referred to earlier about the tension among the -- among the firms who are competitors; I think you see that play out in the development of the clearing platform.

REP. COSTA: I want to get that competition issue. Mr. Thompson, how do you think -- see that?

MR. THOMPSON: I don't believe there is a conflict of interest. As we have gone through the process with ICE on ICE Trust U.S., it has become abundantly clear to me that they are making all of the important fundamental decisions. They will seek dealer input on particular risk management issues.

REP. COSTA: Mr. Corrigan?

MR. THOMPSON: But I don't view ourselves as having any conflict.

REP. COSTA: Mr. Corrigan?

MR. CORRIGAN: I think it's inevitable that there is at least the potential for conflict in some of these relationships. But having said that, I would quickly hasten to add that that potential for conflict, I think, is clearly manageable.

MR. MURTAGH: I would agree with that and just say that these companies are typically providing services to financial institutions who are very much interested in making sure that those services perform -- are performed properly.

REP. COSTA: Well, then, for the three representatives representing JPMorgan and UBS and Goldman, how much ownership interest would you have in an ICE Trust that's being proposed?

MR. THOMPSON: I don't believe we have any current ownership interest in them.

MR. CORRIGAN: Again, I do not know of the answer to that question, whether --

REP. COSTA: Mr. Thompson?

MR. THOMPSON: I'm just informed we have some preferred shares but do not have a seat on the board and do not own any of the equity.

MR. MURTAGH: I'm not aware of what our ownership interest is, but we can find out for you and get back to you.

REP. COSTA: Please.

MR. : Mr. Costa, each clearing member is required to own a substantial amount of shares in the Chicago Mercantile Exchange in order to become a clearing member. And naturally, for competitive reasons, they belong to every clearinghouse. They don't want one of their competitors to be able to bring customers to a clearinghouse other than their own. So it's a two-edged sword. There's some capital inefficiencies in belonging to a lot of different clearinghouses, but there's also the advantages of competition keeping prices in reasonable shape.

REP. COSTA: Well, I want to get back up to about 50,000 feet here, because we talk a lot about risk and risk management and how we assess risk. And clearly, as my colleagues have stated earlier, I think our constituents are very frustrated and want to know why there weren't any, you know, canaries in the coal mines, so to speak, in indicating that risk wasn't being properly managed.

Mr. Corrigan, in your experience, what's the hallmarks of prudent risk, since we haven't done it so well here lately?

MR. CORRIGAN: Well, the way I think about it, Mr. Congressman, is that you go back and you look at financial train wrecks over a fairly long period of time.

REP. COSTA: We have a history of them.

MR. CORRIGAN: Pardon me?

REP. COSTA: We have a history of them.

MR. CORRIGAN: Yes, we have. And so do others, by the way.

You know, I do think there's something to the proposition that there are three or four common denominators that tend to be associated with most of them. The first is a phenomenon that Mr. Thompson mentioned earlier, and that is broad-based, widespread maturity mismatches in the credit space. That's been there almost every time.

The second is a systematic tendency for a period of time to underprice credit risk. And that's been there almost every time. In this case, it's really the dimensions of that problem are astonishing.

The third --

REP. COSTA: But as a -- but as a manager, you have risk assessment --

MR. CORRIGAN: Right.

REP. COSTA: -- wearing one hat, and as a risk manager, you're wearing another hat. I mean, you're trying to assess the risk as you manage the risk.

MR. CORRIGAN: Right. Right.

REP. COSTA: And it seems to me that folks in the last 18 months, based upon the meltdown that we have, have not done a very good job in coordinating managing the risk versus assessing the risk. I mean, how else did we get into this mess in the first place?

MR. CORRIGAN: Well, as I said, you know, if you go back, you can pretty well come up with clear diagnostics of how we got into this mess, but there's no single point.

It's a collection of things that built up over a period of time. Now, when you look at the crisis itself, I would suggest -- and I suspect others would agree with this -- that some of the worst failures were not so much the complexities of risk management, but it was basic risk monitoring; that there were failures on the part of institutions and markets to simply be able to monitor the extent to which they were at risk.

REP. COSTA: Maybe that's why we're having the hearing.

MR. CORRIGAN: I think it is, in a very real way. I think it is. And one of the things --

REP. COSTA: I mean, through transparency and through a regulatory scheme, we hope to, in effect --

MR. CORRIGAN: One of the things --

REP. COSTA: -- do a better job of monitoring that risk.

MR. CORRIGAN: One of the things that these gentlemen have heard me stress is that, you know, going forward, major financial institutions should have the capacity in a matter of hours to be able to monitor their counterparty exposures to any organization any place in the world, across all products, across all services. And they should be in a position where they can share that information with their primary supervisor.

And that is representative of the scale of some of the changes that I think we have to make. And I don't mean to monopolize this conversation, but I assume the others would probably agree with what I just said.

REP. COSTA: Since you're considered the sage, and I've gone way beyond my time, just one quick question, because it ripples through all of our constituencies. What fears (sic) you the most at this point in time?

MR. CORRIGAN: I'm sorry?

REP. COSTA: What fears you the most at this point in time?

MR. CORRIGAN: What I don't know.

REP. COSTA: Well, that's what fears (sic) all of us. But I'm talking about as it relates to the potential down sides of -- I mean, I don't think we've hit bottom yet.

MR. CORRIGAN: Well, let me try to do the best I can. What concerns me most of all right now is the pressure on the macro- economic situation; because as all of you know, for a variety of reasons, many of which are tied up with the financial crisis, our economy and the economies throughout much of the world are taking quite a beating. And that is why I think that one of the things that the Congress and the new president when he takes office have got to put right on the top of the list is a fresh stimulus package. So that's probably the thing that worries me most right now.

I am mindful of the fact that there are still pressures on the financial side, but the number one issue for me is the economy.

REP. COSTA: Thank you.

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