▶ 0:51:11The task force on monetary policy, Treasury market resilience, and economic prosperity will come to order. Without objection, the chairman is authorized to declare a recess of the committee at any time. This hearing is entitled examining primary dealers and their balance sheet constraints. Without objection, all members will have five legislative days within which to submit extraneous material to the chair for inclusion in the record. I now recognize myself uh for four minutes for an opening statement.
▶ 0:51:42Welcome to today's hearing from the task force on monetary policy, Treasury Market Resilience, and Economic Prosperity. I want to start by thanking Chairman Varcus, ranking, sorry, Chairman Hill, and ranking member Vargas and our witnesses for their flexibility in rescheduling this hearing after the government shutdown delayed our October plans. The Treasury market is the deepest, most liquid, and most essential market to the global economy.
▶ 0:52:09Our focus today is on the primary dealers that intermediate in that market and the regulatory and administrative burdens that constrain their ability to do so. Primary dealers facilitate trades between the Treasury, foreign central banks, pension funds, and asset managers, among others. Our market structure relies on primary dealers to ensure steady demand for the nation's debt and the effective implementation of the monetary policy.
▶ 0:52:37Capital requirements such as Basel 3, the GIP subcharge, and the risk incentive leverage ratios have undermined primary dealers's intermediation capacity. Robust participation from intermediaries in the Treasury market is essential to the market's ability to function well among stress and volatility.
▶ 0:52:59Congress must continue to evaluate the health of the markets, particularly as the capacity to intermediate does not grow commensurate to the government's ever growing issuance of debt. Market disruptions in 2014, 2019, and 2020 demonstrate the need to examine and re-evaluate the limitations and constraints regulations may inadvertently put on the Treasury market.
▶ 0:53:24This morning, Vice Chair Bowman testified before the full committee and we agreed that our capital framework should not unnecessarily constrain the intermediates our market relies on. That's why I was pleased to see the Fed finally adjust the enhanced supplemental leverage ratio to remove the disincentive for banks to engage in low-risk activities such as holding treasuries. But more is yet to be done.
▶ 0:53:50Capital regulations may need adjustment to properly recognize treasuries as a nearly risk-free assets, particularly as liquidity regulations require an increase in the volume of these liquid asset banks are holding. Other leverage ratios such as a supplementary leverage ratio and tier one leverage ratio may also need to be adjusted to increase balance sheet capacity and ensure that they function as intended.
▶ 0:54:15a backs stop to risk wade capital requirements not a binding constraint on the I also continue to agree with chair chair myron excluding treasuries and reserves from the SLR and the ESLR would help insulate the treasury market from potential disruption during periods of market stress.
▶ 0:54:38Finally, I intend to ask GAO to re-examine the operation of the treasuries market, including its operations, risk, and regulatory structure. The last time this report was conducted was in 1986. The landscape has changed since then, and we should get an updated report, and I look forward to the discussion today, and I yield back. I now recognize the ranking member of the task force, Mr. Vargas, for four minutes for an opening
▶ 0:55:06Thank you very much, Mr. Chairman, I want to thank you for convening this hearing. And I too would like to thank the witnesses and especially for your flexibility. Thank you for coming today. We appreciate it very much. With a market value of nearly $30 trillion, the US Treasury market plays a critical role in the global financial system. Our Treasury market has long been considered the most stable and liquid market in the world. And that stability has been immensely beneficial for Americans.
▶ 0:55:32The Treasury market serves as a tool for setting the monetary policy and a benchmark for interest rates. It serves as a dependable asset for investors and offers the broader market a safe haven in times of stress. And it allows us to finance our government at low cost to taxpayers. That's why it's critical that we continue looking at ways to maintain and even improve our Treasury markets resilience and efficiency.
▶ 0:55:56That means continuing to explore options to address concerns of increased volatility, strained market liquidity, and the long-term quantitative growth of treasuries. Continuing to effectively manage these challenges will keep borrowing costs low, increase investor confidence, and strengthen financial stability. One way we can do this is by reviewing [clears throat] the function of primary dealers.
▶ 0:56:19As the largest intermediaries, primary dealers play an important role as a connective tissue within the treasury market. They ensure ensure smooth functioning of the market between market participants including the US Treasury investors and the Federal Reserve because of the important function primary dealers have. It is essential we make sure they have enough balance sheet capacity to effectively serve their role as market makers.
▶ 0:56:45This flexibility is a vital part of making sure they can absorb any shock and shifts in the Treasury supply and investor demand. We saw episodes of these shocks in October of 2014, September of of 2019, and March of 2020. That's why it's worth looking at the reforms aimed at making our sure primary dealers can continue in intermediating without disrupting and disruption.
▶ 0:57:09The central clearing rule finalized by the SEC in December of 23 is an important step in that direction. This rule reduces risk, improves efficiency, and enhances the financial stability of the market. Targeted reform of the supplementary supplementary leverage ratio is also worth examining further. As the chairman noted, SLR reform has the potential to assist primary dealers in holding an increasing number of treasuries.
▶ 0:57:37At the same time, we should recognize one of the central sources of expanding Treasury issuance is rising deficits. Over the years, Treasury debt held by the public has increased significantly. In 2007, it made up 30% of our GDP. Today, it makes up 97%. And this expansion is showing no signs of slowing down.
▶ 0:57:59Following the passage of what we call on our side the president's Trump's big ugly bill, the CBO is projecting this number to elevate to 134% by the end of third of 2034. Primary dealer capacity keeping up with the growth of treasuries is of paramount importance in improving market resilience. I look forward to the hearing to hearing from the witnesses about these issues and the potential solutions impacting the treasury market. And with that, Mr. Chair, I yield back.
▶ 0:58:28Thank you, Mr. Mr. Ranking member, I am now pleased to recognize the chairman of the full committee, Mr. Hill, for one minute for an opening statement.
▶ 0:58:35Thank you, Chairman Lucas. It's been nearly one year since this task force was formed, and what a year it has been for both the Federal Reserve and the Treasury markets. No one anticipated the events that would occur in the bond market back in April. And as a few days ago, the move index, a measure of bond market volatility, is at its lowest level in four years. But this does not mean that we can kick our feet up and sit back.
▶ 0:59:02The Congressional Budget Office projects annual deficits growing from 1.8 trillion this year to 2.5 trillion by 2035. Congress must stop force-feeding our current primary dealers more and more debt, especially as the post DoddFrank regulations constrain their ability to absorb growing Treasury issuance. Thankfully, Central clearing helps free up balance sheets for dealers to take up and serve more of our debt.
▶ 0:59:27But should our primary dealers fail to live up to their obligation to purchase treasuries, yield spike, shooting up borrowing costs for the government to finance its priorities and consumers to acquire homes, cars, and college education. Therefore, the work of this committee is essential, and I thank the chairman and I yield back the balance of my time.
▶ 0:59:44Gentleman yields back. Today we welcome the testimony of Miss Susan Mccclaclin, executive fellow of the Yale School of Management. Dr. James Tbachi, chairman of the Independent Dealers and Traders Association, Laura Climpool, managing director and head of DTCC's Fixed Income and Financing Solutions, and Dr. Haong Zoo, uh, Gordon Y.
▶ 1:00:10Billard, associate professor of management and finance at the MIT Sloan School of Management. And we thank each of you for taking the time to be here. And each of you will be recognized for five minutes to give an oral presentation of your testimony. And without objection, any written statements you would uh like to be made a part of the record. And with that, uh, Miss McLolin, you're now recognized for five minutes for your oral remarks.
▶ 1:00:35Thank you, Mr. Chairman, Ranking Member Vargas, and distinguished members of the task force. It's truly my honor to be here with you today. Prior to my appointment at Yale, I worked at the New York Fed for 30 years in a series of operational, policy, and management roles in which the primary dealers were my key counterparts. My views reflect this experience, though my testimony today is based on information entirely in the public domain. The size and continued growth of the debt is the first order risk to the Treasury market's resilience.
▶ 1:01:05As has been well documented, the growth of the national debt has outpaced dealers capacity to intermediate it. In addition to financing the US government's operations, the Treasury market serves an anchor for global financial markets. It's where the Fed implements monetary policy and where global investors have historically sought safety in periods of market stress. and the Treasury curve is the basis for the pricing of credit instruments worldwide.
▶ 1:01:29So the ongoing stability of this market is a serious concern both for US economic security and global financial stability. I would like to highlight two main points. First steps are already being taken as as has been mentioned to augment dealer balance sheet capacity to interate intermediate treasury securities.
▶ 1:01:49The Treasury's buyback program, recent changes to the enhanced supplementary leverage ratio, and the SEC's Treasury clearing rules are collectively likely to add at least several trillion dollars in balance sheet capacity to the market over the next few years. But when you consider that the quantity of marketable Treasury securities outstanding grew by 1 trillion just between July and October of this year, it is not clear that these measures alone can address the potential for future capacity needs.
▶ 1:02:16Second, while it is worth exploring whether scope remains to designate additional primary dealers, my view is that this will not go very far to address the problem of the broader market's balance sheet capacity to intermediate treasuries. Rather, I think the great potential lies in changes to the structure of the treasury market itself. We've already mentioned central clearing. Another option to explore is all toall trading in which buyers and sellers trade directly with each other rather than going through an intermediary.
▶ 1:02:45All to all protocols are not yet present in the Treasury market, but do exist alongside marketmaking in some other markets such as the corporate bond market. To be sure, primary dealers play a special role in the Treasury market. Their original purpose was to serve as counterparties in the Fed's monetary policy operations. But over time, their responsibilities have evolved to include uh sub being subject to a pro rata bear share bidding requirement for treasury auctions that does not apply to any other market participants.
▶ 1:03:13Through this pro rata share mechanism, the primary dealers provide a backs stop to mitigate the risk of an undersubscribed or failed treasury auction, which could have dire consequences for our sovereign credit rating, the dollar, and the US economy. If we are concerned about adding net new capacity to intermediate treasury debt to the market, increasing the number of primary dealers is unlikely to move the needle very much.
▶ 1:03:38Moreover, given the dual responsibilities that primary dealers have for Treasury auction support and monetary policy implementation, the firms best suited for designation are those who can buy, hold, and sell Treasury securities on a continuous basis across the yield curve in all market environments and in sufficient size to to support the Fed's operational needs. Firms that are not two-way market makers and treasuries would not be fit for purpose as primary dealers. Thank you for the opportunity to share my views with you today. I look forward to your questions.
▶ 1:04:08Thank you, Mr. Kbaki. You are now recognized for five minutes for your oral remarks.
▶ 1:04:14Thank you, Mr. Chairman, Mr. Vargas, members of the committee. It's my pleasure to appear here today. I am am currently uh representing the Independent Dealers and Traders Association. It's um a a group of independent dealers. They're not part of any bank holding company. uh they are typically have between 200 and 500 million in capital.
▶ 1:04:38Um and uh they are probably responsible for about 15 to 20% of the capacity of the repo market on any given day probably a little bit higher uh on typical quarter ends when balance sheet gets uh extremely tight. In addition, I'm the CEO of South Street Securities, which is a firm I I
▶ 1:05:01uh co-founded and started 25 years ago, and it's a middle market broker dealer and part of and a member of the independent dealer and trader association. I'm also a sitting board member of DTC.
▶ 1:05:15I'm also uh uh on the um advisory council of Bank of New York's uh uh government securities uh division [clears throat] and um I I think I'm fairly unique in the marketplace in that I have managed the balance sheet at a large global bank, City Bank, City Corp for 20 years and then started my own firm with significantly less capacity and significant significantly
▶ 1:05:45less But I understand the pressures that executives and managers of both the largest banks and the mid-market firms go through and I I understand them very well from both sides and they both have critical jobs but their jobs are also very difficult.
▶ 1:06:07The theme that I'm trying to uh bring to this committee is um I'm more concerned with the US Treasury market than maybe some of my esteemed colleagues because if you look back 10 years ago, we had about 8 n trillion in outstandings. Uh we're currently I think it's a little more than 30 trillion. We're passing through like 34 35 trillion right now.
▶ 1:06:33And by the Fed's own reckoning and forecasting, we're headed toward 50 trillion in six to eight years. I will tell you that unless we use every solution in the drawing board right now, we do not have capacity for 50 trillion in the US Treasury market. So, [clears throat] and look, there's central clearing was designed to reduce counterparty risk. It did that, but it also increased concentration risk.
▶ 1:07:03So, that's a little bit of moving spaghetti around on the plate because concentration risk has gone through the roof. Uh, it was [clears throat] also designed to make the market more efficient from a balance sheet standpoint. It did that. But I have to give some kudos and again full disclosure I'm on the board of DTC.
▶ 1:07:27who Miss Climpmple uh represents and runs had done a had gone a long way through the sponsorship program to making the market more efficient. Now what I think some significant steps that we have to take almost right away are two right away and one is a longer term project I will admit.
▶ 1:07:49One of all the major participants in the US Treasury market including regional dealers some regional banks need to have access to the standing repo facility. The standing repo facility, just so that you know, it [clears throat] was designed so that when markets were constrained for liquidity in the repo market, you could go to the Fed and they would give you liquidity against So the reason why that has not worked is when I was running
▶ 1:08:20the desk at City Bank and the treasur of the bank come and tapped me on the shoulder and says, "Jim, balance sheet's closed. No more." And that was it. the balance sheet was full. So, how can I borrow from the the standing repo facility and lend to the marketplace? So, once those balance sheets of the the participants that are eligible to for that resource are full, you're done. So, it'll never work unless more balance sheet capacity is brought to bear.
▶ 1:08:50The other thing I think is really important is, and I'll get into it a little bit more because I'm running out of time, is hedge funds are not a bad thing. American pools of capital, buying US treasuries, America's paper, is that a bad thing? I don't think so. Who would you rather have buying them? The Chinese. However, hedge funds need financing and uh they also cannot be unlimited.
▶ 1:09:19So standardized minimum haircuts needs to be implemented right away. And lastly, and I'll I'll just jump quickly through this. I do believe we need more participants in the US Treasury market, more intermediaries in the US Treasury markets, more primary dealers, more regional dealers, more regional banks. And with that, I'll pass along the
▶ 1:09:42Thank you, Miss Clenpool. You are now recognized for five minutes for your oral remarks.
▶ 1:09:50Chairman Lucas, Ranking Member Vargas, and members of the task force, thank you for the opportunity to testify today. My name is Laura Climpmple, and I serve as the managing director and head of the Fixed Income Clearing Corporation or FIC at DTCC. I appreciate the chance to speak with you about DTCC and FICC's role in central clearing and the work we've undertaken to prepare the industry for the SEC's expansion of US Treasury clearing.
▶ 1:10:20For more than 50 years, DTCC has served as the premier post-trade market infrastructure for the global financial industry. Every day we help automate, standardize, and process financial transactions for thousands of broker dealers, custodian banks, and asset managers. Our core mission is to reduce risk, enhance transparency, and ensure that our markets remain resilient and efficient. DTCC is industry-owned and industry governed.
▶ 1:10:49We process securities activity across US equities, treasuries, mortgage back securities, mutual funds, and ETFs, and other asset classes. We are also a highly regulated organization overseen by more than 20 regulatory bodies worldwide, including the Federal Reserve and the SEC. Let me turn now specifically to FIC.
▶ 1:11:14As an SEC registered central counterparty, FIC provides critical netting, clearing, and settlement services across the US Treasury and mortgage back securities markets. The SEC's expansion of central clearing for US Treasury activity is one of the most significant market structure developments in decades.
▶ 1:11:34Policymakers, academics, and market participants broadly agree that expanding central clearing will improve the safety, soundness, and efficiency of the Treasury market while also enhancing transparency, supporting all-to-all trading, and reducing credit and liquidity risks. The SEC finalized its rule in December 2023 and later extended the industry-wide implementation timeline by one year.
▶ 1:12:00As a result, mandatory clearing for cash transactions will now begin on December 31st, 2026 and for repo transactions on June 30th, 2027. Although the SEC postponed the industry's compliance deadlines, FIC maintained its commitment to implementing required access model and riskmanagement enhancements, successfully launching all necessary changes as planned.
▶ 1:12:26Those enhancements include expanded access models, the separation of house and customer activity, and the creation of segregated customer margin accounts. FIC is well positioned to handle the increased volume that expanding clearing will continue to bring. Prior to the SEC rule proposal, FIC cleared roughly 4.5 trillion a day. By the end of 2023, that number rose to about 7.2 trillion.
▶ 1:12:55And today we routinely clear more than 11 trillion per day. We have also demonstrated resilience during periods of market volatility, including new record volumes, most recently yesterday when our volumes hit 13.2 trillion. As we prepare for the clearing requirement, FIC has focused on enhanced access, promoting capital efficiency, and improving risk management tools.
▶ 1:13:21We continue to expand our sponsored service and agent clearing service to allow both buyside and sellside firms to participate in the manner that best meets their needs. We also have two proposed rule changes currently under SEC review, both designed to address double margining concerns and make it easier and more cost-effective for firms to bring repo activity into central clearing.
▶ 1:13:45In addition, FIC is working with CME Group to extend cross margining to enduser clients subject to regulatory approval. The expansion should reduce capital requirements and further encourage the use of central clearing. In closing, DTCC's work often takes place behind the scenes, but it plays a critical role in maintaining the liquidity, efficiency, and competitiveness of US financial markets.
▶ 1:14:12The SEC's expansion of Treasury clearing is a major industry effort that will strengthen the market for years to come. FIC remains committed to working with our clients, regulators, and industry partners to ensure a safe and successful implementation in 2026 and 2027. Thank you for the opportunity to testify today. I look forward to your questions.
▶ 1:14:34Thank you. And Dr. Zoo, you are now recognized for five minutes for your oral remarks. Dear Chairman Lucas, ranking member Vagus and members of the task force, thank you for the opportunity to testify before you today on the critical topic of primary dealers under the balance sheet constraints in the US treasuries market. My name is Hashanzu. I'm associate professor of finance and MIT loan school management. From 2021 to 2024, I had the honor of serving as a director of the division of trading markets at the US Securities and Exchange Commission.
▶ 1:15:05I believe the most powerful policy initiative now for expanding the mediation capacity in the US treasuries market is the full and timely implementation of treasury clearing. Additional measures that could also strengthen the US treasury market include increasing postry transparency of treasury securities, enhance the oversight of trading platforms for treasury securities and repo and making more active use of floating rate debt for government financing. First, treasury clearing. The central clearing of treasury cash and repo transactions delivers three principal benefits.
▶ 1:15:36First, it substantially reduces risk through multilateral nighting. Central clearing transforms large gross exposures into small night exposures. Moreover, the clearing house guarantees the performance of the participants which further mitigates default risk, limits contagion and reduces systemic risk. Second, central clearing provides standardized and transparent risk management.
▶ 1:15:58And third and perhaps most relevant for today's hearing central clearing of treasury repo transactions frees up significant amount of balance sheet capacity for primary dealers and other intermediaries. Joining on my on the methodology developing my work with an ali we estimated that sponsored clearing of treasury repo and reverse repo at the fixed income clearing corporation uh has already freed up approximated $1.2 trillion in balance sheet capacity as of October 2025.
▶ 1:16:26Furthermore, if all uncleared primary dealer repo and reverse repo were to transition into central clearing as of October 2025, up to $1.3 trillion of additional balance sheet capacity could be created. Second, increasing transparency. The evidence regarding postal transparency has been overwhelmingly positive in the US income market.
▶ 1:16:48Study after study has documented improved price discovery and the lower transaction cost for investors following the implementation of postra transparency including in corporate bonds, agency debt, mortgage bank securities, municipal securities among others. The US Treasury market has been one of the last major markets to implement and benefit from post trade transparency. In March 2024, FINRA began dissemination on the daily frequency of transactions for underrun treasury coupon securities.
▶ 1:17:16I believe the department of the treasury, the SEC and fenra can further enhance the liquidity of US treasuries market by continuing to strengthen post trade transparency. Third, enhancing oversight of trading platforms. Currently, trading platforms that meet the definition of exchange and the exchange act but exclusively trade government securities are exempt from regulation ATS.
▶ 1:17:38As such, these platforms are not required to register with the SEC or be subject to regulatory The policy objective of removing such exemption has received a broad bipartisan support over the last six years spanning three different administrations. I believe completing this initiative would represent a significant positive step forward in supporting the growth and integrity of US treasuries market. Fourth and finally more active issuance of floating rate debt.
▶ 1:18:06The outstanding amount of treasury securities held by the public reach approximately 30 trillion in October 2025. That's roughly six and a half times the level in 20 2005. This stark comparison actually underestimate the growth in the treasury market in another critical metric interest rate risk. The average maturity of treasury securities today is about 70 months compared to 54 months in 2005.
▶ 1:18:32Therefore, investors and intermediaries in treasury securities today bear interest rate risk that is approximately eight times as large as it was 20 years ago. investors and intermediaries demand risk premium for bearing such risk which in turn translate into a higher borrowing cost for taxpayers. I believe the time is now right for the Treasury to consider reducing interest risk of newly issued debt.
▶ 1:18:56Specifically, the Treasury can more actively issue floating rate debts in index to short-term interest rate such as the Treasury bill rate or the secured overnight financial rate so these floating rate instruments carry significantly less interest rate risk. For example, the interest rate risk of a 10-year floating rate note is comparable to that of a three months or six months Treasury bill. Floating rate securities should also be attractive to investors whose objective is to protect the market value of their US dollar denominated asset and reserves.
▶ 1:19:26In addition, floating rate debt can be structured to spend a wide range of maturity dates. For these reasons, I believe floating rate debt deserves a more prominent role in treasury issuance decisions both for reducing interest rate risk borne by investors and for maintaining flexible management of the design and maturity structure of the treasury debt. Thank you very much again and I welcome any question you may have.
▶ 1:19:47Thank you. We'll now turn to member questions and I recognize myself for five minutes for questions. Uh, Miss Kimell, can you provide an update on market participants readiness to comply with the SEC's clearing role? Should the SEC provide more clarity for firms before the deadlines go into effect, such as the scope of requirements for interaff affiliate
▶ 1:20:12Thank you for the question, Mr. Chairman. At FIC, we have seen over the past several years a steady trend of Treasury market participants adopting central clearing on a voluntary basis due to the economic, operational, and risk mitigation benefits that it [clears throat] provides.
▶ 1:20:31To give context, before the SEC introduced its proposed rule to expan expand central clearing of US Treasury activity in 2022, fixed daily volumes averaged around 4.5 trillion as it and as I noted um we hit an all-time peak yesterday of 13.2 trillion of activity in a single day.
▶ 1:20:52But that being said, as Commissioner Mark UEA noted in his recent remarks on the progress towards implementation of Treasury Clearing, there are certain issues that still need to be addressed such as the scope and contours of the inter affiliate exemption from the clearing requirement amongst others.
▶ 1:21:11We look forward to the resolution of those open issues as clarity on them will be key as market participants get down to the business of implementation and migrate the remaining Treasury balances covered by the mandate into central clearing over the course of
▶ 1:21:27Continuing with you, how does central clearing reduce systematic risk in the treasury market? And should our regulators recognize the risk reducing benefits of central clearing through the implementation of cross margining for end users and corresponding capital
▶ 1:21:42Central clearing through a CCP like FIC offers treasury market participants the opportunity to have their activity novated and net settled by a central counterparty which creates various operational balance sheet capital and risk reduction benefits for those firms and for the Treasury market. as a whole.
▶ 1:22:03Extending our existing cross margining arrangement with CME Group to enduser clients would help those enduser clients by having their offsetting futures cleared by CME and their cash and repo positions cleared at FIC recognized across the CCPs for margining purposes which would increase margin efficiency for those end user clients making it more cost-effective for them to transact and smoothing their ability to migrate.
▶ 1:22:32additional treasury activity into central clearing. Implementing enduser cross margining will also result in improved risk management through crosscp coordination in a default situation and also increased transparency including to the official sector.
▶ 1:22:51Making the corresponding capital reductions for those end-user clients intermediaries is also critical to be able to give those intermediaries the capacity that they need to facilitate their clients activity as part of the cross margining
▶ 1:23:06Miss Mclofflin, I've seen reporting about the firm's reluctance to use the Fed's standing repo facility that's intended to serve as an additional source of liquidity in the treasury market. What should the New York Fed be looking at to improve the effectiveness of the SRF?
▶ 1:23:23Thank you, Mr. Chairman. I think that the SRF is generally working as intended to provide a ceiling on the level of the Fed funds rate. However, since it wasn't really needed when reserves were abundant, there is probably a little hesitation, and I've heard this from some market participants on the part of some uh to be among the first to use it. I suspect the tool may be slightly stigmatized by the fact that it wasn't previously used regularly.
▶ 1:23:45So I think the most important thing that Fed policymakers can do is to communicate clearly and often that the SRF is intended to support rate control that it's open for business and that market participants should not hesitate to use it when it's economically advantageous to do so. Usage in that scenario supports interest rate control and therefore supports effective monetary policy implementation.
▶ 1:24:06Mr. Mr. Tbaki, demand for our debt from rate sensitive buyers has grown as a proportion of Treasury purchasers and we saw resulting market volatility in April of this year. How would you characterize the health and functioning of the Treasury market in light of these
▶ 1:24:22Again, uh if you look at the US Treasury market over the last 5 years, it's changed dramatically. Uh so wealth funds aren't buying our paper.
▶ 1:24:31Can you hear me?
▶ 1:24:32Is your microphone on?
▶ 1:24:34Thank you. As I said, the market is changing dramatically. Sovereign wealth funds are not buying our paper. Treasury uh hedge funds are buying our paper. Treasury hedge funds need financing. Financing is not an unlimited and it is the main uh constriction to our US Treasury market. And that's what's causing.
▶ 1:24:56Now, I have to uh disagree a little bit with my esteemed colleague that I don't think that the standing repo facility is getting to where it needs to go. Uh the Fed when they call around to the primary dealers, they're all saying, "Yeah, there there's no problem. Uh there's plenty of liquidity." It's the non-primary dealers, the treasury market that [clears throat] need to have access to that facility.
▶ 1:25:27Thank you. I now turn to the uh ranking member for his five minutes of
▶ 1:25:34Thank you very much, Mr. Chairman. I appreciate it. Uh Dr. Zoo, a question for you. In your research you published in July with Dr. Nelly Leang, you mentioned risk reduction and enhanced intermediation capacity as two of the primary benefits of central clearing. You also discussed how central clearing could help primary dealers free up hundreds of billions of dollars in additional balance sheet capacity. I think today you I think you testified maybe 1.2 trillion.
▶ 1:26:03Can you explain how this central clearing rule will provide that balance sheet capacity?
▶ 1:26:07Yeah, thank you for the question. Happy to to [clears throat] elaborate on that. Um according to the supplementary leverage ratio rule whenever a primary dealer borrows money from let's say market mutual funds and onward lend it to a hedge fund that money shows up on the balance sheet if the if the primary dealer is a counterparty to the transaction. However, if that transaction the two sides of the transaction both move to central clearing the dealer is no longer a counterparty to the transaction. Therefore that gross amount of $100 in that example would would not be on the balance sheet of the dealer.
▶ 1:26:38therefore not subject to um supplemental leverage ratio. So I think that's a very powerful tool. Senior clearance is a very powerful tool in removing that uh balance sheet constraint. Uh that's why we we come up with these estimates.
▶ 1:26:51Thank you. Thank you for clarification. Now I have a number of questions here but Mr. McL you caught something that really you said something originally really caught my attention and that is you said this and I don't want to put words in your mouth. So if I misquote you please let me know. We do not have the capacity for 50 trillion. We could do all the things on the board. We just can't get there. That's that's too much. Did Did you say that or Oh, you said
▶ 1:27:16Yes, sir. I'm afraid I did.
▶ 1:27:17Okay. So, you don't think that then there will be enough capacity?
▶ 1:27:24No. I I I think if the mandate is implemented properly uh with some considerable thought, I think it can be a fine tool toward getting us to where we need to go. The the thing is though that we always seem in the marketplace and look, I'm not an academic. I've just spent the last 35 years in and around training desks,
▶ 1:27:48So I watch the way the market moves and There's the US Treasury market. There's parts of it that are struggling to work. SLR, yes, that's a Peter's piece of the puzzle. We should work on changing that and increasing balance sheet capacity. Is that an elixir? Absolutely not.
▶ 1:28:11Let me do this because they give us limited time here. Um would anyone challenge that position to say that there is capacity for 50 trillion? Because the reason is very simple. I don't try to hide the ball. I do think that ultimately we're right, everyone's right that you can't go on like this. The deficits are too big, that we can't do this, it's not sustainable. I don't know what level that is. Um, but at the end of the day, it's math. Would anyone disagree with that? Can I give you an example why I think it won't work on certain days?
▶ 1:28:41So, in September of 2019, repo rates went to 10%. Now the reason why that happened is we had three it was like the the perfect storm. We had five uh US Treasury uh [clears throat] uh securities settling. We also had quarter end. So balance sheets were already being constrained by window dressing.
▶ 1:29:04Right. But I I think the problem is but no no hold on I because you're going to a very specific thing. I want to know about capacity in general. Not one day. Hold on. No. I'm gonna go to ML. I'd like to ask her mad. Go ahead.
▶ 1:29:19Um I don't know if 50 is the right number or some other number is the right number, but I do agree that at some point we will reach a number where it's going to be a real problem. Dr. Zoom.
▶ 1:29:31I think once we implement the treasury clearing uh fully and other initiatives such as transparency um and potentially having more platform oversight, I think the there will be a a wider variety of market participants come in such as smaller broker dealers, clearing house, trading platforms.
▶ 1:29:47But how but it sort of creates more capacity. But does it get up to the 50 60 trillion wherever we're heading? It
▶ 1:29:54it's hard to speculate on the exact number uh at this point. But I think all these initiative that's why these are so important at least you know given the current level um completing these reforms would make the treasury market much more resilient. But I tend to agree that in the long run sustainable debt level is the fundamental solution.
▶ 1:30:11Okay. I I know they give us very limited time. I just have 20 seconds. So I just want to say this. I I do think that there's a problem here and ultimately it's this is math. It's math and as insurance as people think it's no ultimately it's math and there's a problem.
▶ 1:30:25The politics is what creates the problem for the math obviously both sides when we were able to balance the budget created a political problem for a lot of people and and I think at some point we're going to have to figure this out both sides but anyway thank you for your testimony here today I appreciate
▶ 1:30:43gentleman's time is expired the gentleman from Kentucky Mr. Bar who's chair of the financial services inst institution subs recognized for five
▶ 1:30:52thank you Mr. Chairman, very important hearing about the proper functioning of the Treasury market with the growing um debt load that we are foisting upon future generations of Americans. Uh national debt is now what 38 trillion and growing. Um I think uh Miss Mclofflin, you said it best in your testimony when you said the greatest risk to the resilience of the Treasury market is the level of the national debt itself.
▶ 1:31:19So job number one is Congress needs to get our fiscal house in order. But in the meantime, we should continue to explore all avenues to support the markets capacity to intermediate treasury debt. U Miss Mclofflin, without primary dealers that can absorb rising issuance of Treasury securities and without more primary dealers participation, what happens to treasury So, I would just note first that um
▶ 1:31:50primary dealers are important intermediaries, but they're not the only ones. Um there's a wide range. I think FIC alone has over 250 firms that um but are two-way intermediaries and benefit from netting and repo and andor cash transactions. So, primary dealers aren't the entire story, but they're they're an important part of it.
▶ 1:32:08Um I think if we had a a case where treasury dealers were really cons primary dealers were really unable or unwilling to you know take down further debt um that that would be a problem I would hope not to see. Um I just want to make sure I'm answering your question. Can you
▶ 1:32:28I think I think you are. Let me let me go to Mr. Tbachi because um I I am interested in you finishing uh the analysis of what happened in 20 September 2019. Um I know we have limited time but but but finish finish your thought there. Um what what happened there and why do you why do you come up with this $50 trillion dollar figure at the as as the breaking point? The reason why is because most of the regulations to date have been centered around the largest banking institutions the cifhies.
▶ 1:32:58Now the global cifhies for example on that date we had five treasury issues settling. It was quarter and they're doing window dressing and at the same time bombs were being dropped in the Middle East. So what did that do? That caused all of the oil companies to draw down their lines of credit thinking they'd have to be repairing their refineries. So billions of dollars of cash left the biggest banks.
▶ 1:33:22They're already constrained on their balance sheet and now there's not enough money in the repo market. Those are the type of things that we are most susceptible to if we rely only and the regulatory environment relies only on the biggest
▶ 1:33:37Well, what happens um to same question to you. What would happen to the Treasury market um if the if you've reached the the the limit of capacity? What happens?
▶ 1:33:48Well, I I personally think that we're pushing that envelope today because again, the capacity issue is not on the buying and selling of treasuries. The capacity issue is on the financing of treasury because that's what takes up balance sheet. Most of the big uh hedge funds and asset managers come into the treasury direct. No long the primary dealer desk I ran at city bank you would never need the amount of inventory that we had today then today.
▶ 1:34:17But you do need financing capacity. That's the constraint and that's where we don't have enough participants in the marketplace and those that are in the marketplace don't have access to facilities like the standing repo
▶ 1:34:30So more regional banks that's one
▶ 1:34:32More regional banks, more regional
▶ 1:34:34more hedge funds.
▶ 1:34:36Well, hedge funds that comes with a little bit of a grain of salt. Hedge funds, the largest banks now give out repo at zero haircut. Now I I'm a proponent of hedge funds. I just said it. I'd rather have Americans buying American capital, American pools of capital buying American treasuries. However, nothing is unlimited without any haircut. And just so that I know, a haircut is like the down payment you do on your mortgage.
▶ 1:35:03It's an It is a first loss protection. So without haircut, you [snorts] allow hedge funds to be basically unlimited in terms of how much uh leverage they can
▶ 1:35:17Okay, I'm running out of time. the SLR fix is a no-brainer in my opinion, but but let me go to to Dr. Shu. Um very interested in in your more active issuance of floating rate debt idea. Can you uh elaborate?
▶ 1:35:31Yeah, of course. Um the currently the the Treasury Department mostly issue coupon securities with a fixed coupon payment and when interest rate start to rise these instrument will lose value very quickly. We saw that in Silicon Valley Bank and many other situations. So if the floating rate in floating rate debt the interest payment goes up as market level interest rate goes up. Therefore these instrumentments tends to be very insensitive to the level of interest rate. So people who want to invest their dollar asset for preserving the value would find this instrument to be very uh valuable.
▶ 1:36:02So lower interest rate risk means more
▶ 1:36:05lower risk premium
▶ 1:36:06more capacity.
▶ 1:36:07Correct. Yeah. Correct. Exactly.
▶ 1:36:09More purchases of of treasury debt.
▶ 1:36:11Exactly. There will be less penalized on the bar for example valid race models. There will be less penalized by the capital rules and and so on. Yes.
▶ 1:36:19Gentleman's time is expired. Chair now recognizes the gentle from California, Mr. Sherman, ranking member of the capital markets subcommittee for five
▶ 1:36:26The fundamental problem we're not going to solve in this room and it is that we have too much national debt. The debt has tripled since the 2008 uh global fiscal crisis. A big chunk of that is the 2017 tax cuts for the wealthy followed by the $5 trillion big beautiful bill that was I think we all agree big.
▶ 1:36:50Um during COVID both sides uh voted in a bipartisan way for some enormous expenditures. Uh obviously if we knew then what we know now we would have handled CO differently. So we have too much debt. We have a couple of things that are helping. One of those is the independence of the Fed and we've got to fight that to protect that. The other is that uh we are the world's reserve currency. Um the euro would like to play that role.
▶ 1:37:20Ian would bite perhaps like to play that role. Crypto would like to play that role. And I've had a lot to say about crypto over the years. And what I said, God, almost 10 years ago was that the undoing of crypto would be other crypto.
▶ 1:37:36What I didn't realize then was it stablecoin would undermine the rest of the other coins because stablecoin allows drug dealers, tax evaders, sanctions evaders, bankruptcy law evaders to have total confidentiality and secrecy without having to risk putting their money into some other u somewhat imaginary currency.
▶ 1:38:00So, uh, what we may see is that the dollar retains its role as the world's reserve currency and that all we lose from crypto is the ability to enforce all of our fiscal laws. Um, so we are where we are.
▶ 1:38:16In June, u uh partly in response to a letter uh number of us sent including representatives Wagner, Foster, myself and Bar, the Federal Reserve announced that it would change the calculation of the uh global systemically important banks. That's GI's leverage requirement effectively decreasing the leverage u capital that these banks are required to hold. Um obviously as we issue more debt, we need to have uh banks participate.
▶ 1:38:46Mr. Tbachi, uh should the Fed consider making similar changes to smaller banks on their leverage requirements so that they're not disadvantaged when uh compared to the GI GIS and to uh bring them uh as full players in dealing with uh uh this float of debt we have. I think that's an option that should be explored.
▶ 1:39:10Uh, Congressman, I I I um I also think that uh some of the other things that we've already talked about uh are frankly more important. If you look at central clearing,
▶ 1:39:22yeah, I'm I'm going to go on to my next question. I've got such limited time. Former Federal Reserve Board uh uh member Jeremy Stein has said that large banks are allocating less capital to low-risk assets like treasuries because they're dis incentivized to do so. Uh leverage capital requirements are insensitive to risk.
▶ 1:39:45Uh and so a regime for to uh uh a credential regulation designed to cause banks to have less risk actually incentivizes them to forego treasuries and do things that involve more risk. Um Mr.
▶ 1:40:00But uh could you walk us through what happens uh in the broader fed u financial markets if the US treasury becomes uh less liquid or more expensive and uh in particular um does that affect mortgages, car loans? Does it affect the average person trying to borrow some money?
▶ 1:40:22It does because rates would go up. We are we are playing with fire a little bit here sir because again if repo is the capacity constraint think of the funding level of treasuries has the capa has the issue when rates when the funding levels go up because there's not enough capacity and several market participants can't access the standing
▶ 1:40:52repo facility then what do what do the dealers do they increase the rate that we charge hedge funds, the variable buyer of uh treasuries. When they increase what we charge hedge funds, sooner or later, hedge funds are either going to increase risk, which they can do with the big banks with zero haircut, or they're going to stop buying
▶ 1:41:15I I understand. I'm going to try to squeeze in one comment and that is I think it's absurd to regulate banks in a way where at least for some purposes holding a corporate bond is treated as being as risky as holding a treasury. I yield back.
▶ 1:41:29Gentleman yields back. The gentleman from Wisconsin, Mr. Fitzgerald, is recognized for five minutes.
▶ 1:41:34Thank you, Chairman. Um rising government spending has uh made purchasing treasuries more ownorous for primary dealers. uh and as their balance sheets have not grown at the same pace.
▶ 1:41:48Miss Mclaclin, to be clear, is it fair to say that primary dealer balance capacity issues generally did not start to develop until after the financial So, what I can say is that um I was not really aware of that being a discussion point before the global financial crisis. So we heard a lot more about that from market participants almost immediately after the end of the crisis.
▶ 1:42:17Yeah. Because uh since ' 08 uh government debt held by the public has increased by nearly 27 trillion um wasn't all caused despite what you might hear from some members of Congress by the 2017 tax cut and the big beautiful bill. There were other things that happened in between there but apparently not everybody remembers that.
▶ 1:42:40Uh so as treasury issuance continues to grow and primary dealers uh shoulder an increasing share of that demand uh balance sheet capacity has become a real constraint. So Miss uh Clint how does expanding central clearing help primary dealers reduce balance sheet uh and uh more efficiently uh intermediate growing volumes of treasury securities?
▶ 1:43:10Thank you for the question, Congressman. Central clearing provides the opportunity for market participants to have their activity novated to a central counterparty uh such that when they're intermedi intermediating activity between two different dealers or between two different clients, they can postnovation face off against the same counterparty, which in in our case is FIC.
▶ 1:43:37That same counterparty creates a unique opportunity to take balance sheet netting on that activity which is much more difficult to do outside of central clearing. That balance sheet netting creates capacity both in terms of reduction of capital charges and otherwise to free up uh room and capacity on the balance sheet for uh market participants to continue to transact which increases liquidity in the system.
▶ 1:44:07So if I understand you then would central clearing enhance primary dealers capacity to perform kind of this role without compromising the market and its stability.
▶ 1:44:20Yes, that's correct.
▶ 1:44:22Very good. Uh Mr. Tbachi, improving balance sheet flexibility is essential for sustaining deep and resilient Treasury markets. Um can you explain what in your in your opinion what regulatory or legislative adjustments would best um maybe enhance dealers ability to support the treasury issuance? Any any comment there?
▶ 1:44:48Sure. The the the three [clears throat] the first of all we have to broaden the participants in the US Treasury market. Um [clears throat] the I always hear that uh you know all to all which is also got a place in the US Treasury market but nobody wants an intermediary until they need one in a crisis someone to take you out of your position. So we need more intermediaries of of whatever we need more dealers.
▶ 1:45:16We need more primary dealers and we need more regional dealers and we have to find ways to incent more intermediaries into this market and everybody has got to be lifting this burden of 50 trillion. It's doable but it can't be done with one elixir or one idea or or SLR or it's that's not going to get there. We need a lot of participation to make this work.
▶ 1:45:46And I'm not going to qualify at all the level of debt. That's not why we're here. As market participants and regulators, we're supposed to be prepared for what's coming. This is what's coming. This is what we need to do. We need to broaden the market.
▶ 1:46:01So would the burden of growing issuance um well, it's right now it's not concentrated solely on primary dealers, right? Would you say that's accurate or I would say it's very much concentrated on the largest cifi banks, their primary dealer subsidiaries. The concentration in in the the largest banks, we're not going to solve this by just making the biggest banks bigger. That's not going to work.
▶ 1:46:29that's one elixir. Give them a little bit of capital relief. That will help, but it's not it's not the whole deal.
▶ 1:46:38Thank you. I yield back.
▶ 1:46:39Gentleman yields back. The gentleman from Illinois, Mr. Casten is recognized for five minutes.
▶ 1:46:44Thank you, Mr. Chair. Um, I want to follow up with you, Dr. Zu, on your exchange with Mr. Vargas. And I'm I'm if I'm being way too simple or dumb, feel free to tell me. You wouldn't be the first person to tell me that. Um the idea that c that these these central clearing agencies free up um more money in the system, more liquidity in the I is that an accounting issue or just a riskshifting issue?
▶ 1:47:15So, you know, is is there something fundamental going on or or is this just that we're we're basically taking liabilities off the balance sheets of of entities that have obligations to maintain certain capital ratios and moving that risk to another spot in the system that doesn't have those obligations. Are we are we reducing total risk or just moving it around in ways that increases the capital in the system from those who are allowed to are constrained by capital
▶ 1:47:40Yeah, thank you for the question. The answer is that central clearing reduces risk. there is a risk um you know think about the broker dealer in the middle and they borrow money from one side of the market and lending money to other side of the market in two repo transactions. Now the risk is actually a perfect offset. However, because of accounting rules the gross amount must show up on the balance sheet that turns out to be constrained on the balance sheet capacity of dealers.
▶ 1:48:03central clearing collapses is to offsetting transactions into one and because there's a perfect offsetting there's a zero risk in that sense and of course the current house will still charge margin on the net position but that is way smaller compared to the gross
▶ 1:48:20I just want to clarify because you you said because of accounting rules if if I don't have a a central clearing agent in the middle am I holding more liability even if I'm on both sides of the trade because I've you know in some gap preponderance of risk question I bear more risk. So is that is that an accounting judgment primarily or is it is it that the end that all of a sudden I have an entity that has offsetting risks that I didn't have before
▶ 1:48:45in that example it is both an an accounting issue you know by accounting it shows on the balance sheet therefore it triggers all sorts of capital implications now of course the dealer in the middle has offsetting risk with two counter parties but because these are two counterparties the credit risk cannot offset without central clearing by moving these transactions into central clearing um the clearing house basically eliminates all the counterparty risk therefore reducing the overall uh risk in the system and free up balance sheet.
▶ 1:49:13Okay. So if I've if I think I understood that but I'll have to think about it. Um, if I've now reduced the risk on the primary dealers and we'll stipulate for this example that they're GIS, you know, someone who's who's got obligations, doesn't that immediate does that then by definition allow them to essentially have a stronger balance sheet and therefore less capital ratios before any change in SLRs?
▶ 1:49:40So, is is this redundant with a change in the SLRs or or how do you think about those two pieces together?
▶ 1:49:46Thank you for the question. So if the dealer is able to move that amount off the balance sheet then that would um be really helpful in reducing the SLR requirement. It essentially take that number out of the total leverage exposure whereas what the Federal Reserve did last week is to change the ratio the capital ratio. These two sort of move in the same direction of relief balance sheet constraint. But I think the central clearing effect here is to remove that part of the balance sheet completed away from the calculation of leverage ratio.
▶ 1:50:17But if I'm but if I'm if I'm reducing my my declared liability, I've I've changed the my math wrong here. I've changed the denominator in a leverage ratio.
▶ 1:50:26Even before I've changed what the ratio is, right?
▶ 1:50:29Yeah, that that's right. So today the the primary dealer could immediately take that amount of money sort of away from the the total leverage exposure calculation by going to central clearing. In that sense it is a pretty um fundamental uh relief.
▶ 1:50:44And and it doesn't really matter what the ratio is because that part just disappears from the
▶ 1:50:49Okay. I'm getting closely on time but I I have a sort of a simple view that the Fed provides a discount window to the banks and then the banks provide a discount window to hedge funds through the repo market. And I I [clears throat] do want to make sure that we're not sort of financially engineering away a more fundamental problem. Um
▶ 1:51:11I the netting is an accounting and a transaction but the netting only reduces risk because there are two counterparties, one on each side. If one of them fails, there's still risk. that risk is either borne by the other counterparty or it's borne by the CCP.
▶ 1:51:29No, I understand. And I and I guess I know I'm out of time, but I'm I'm curious and if the chairman will indulge, if not, we'll take this in
▶ 1:51:38Do we all agree with Dr. Zu that the creation of more CCPs puts more transparency into the system? And if so, does that reduce some of the volatility risk in the system? And whether we're talking about the 2019 situation or the flash crash, do we reduce some of the inert innate volatility in a less transparent system by the creation of these CCPs?
▶ 1:52:01This may require response in writing, Dr. [laughter] Nature, for that question. And with that, I always indulge my friend from Illinois. Gentleman's time is expired. The chair now recognizes the gentle from Montana, Mr. Downing, for five minutes.
▶ 1:52:14Thank you, Mr. chairman for holding this hearing on the important role primary dealers play in facilitating facilitating liquidity in the treasuries market especially now with the uh national debt exceeding $ 38 trillion. Hard to even fathom that. Um with our national debt so high, it's prudent to ensure demand remains high for US treasuries so the federal government can continue to finance its operations.
▶ 1:52:40So on the first one um you know we've discuss discussed today how the increasing debt issuance has placed additional strain on the balance sheets of primary dealers. So I'm going to start with uh Miss Mclofflin. Uh over the long time do you consider Congress reigning in our outofc control spending the most critical aspect of reducing the strain on primary dealers?
▶ 1:53:01I do.
▶ 1:53:02Thank you. So continuing, if Congress continues to increase spending outside of investing into our economy and workers, what happens to interest rates should primary dealers simply no longer have the ability or willingness to purchase treasuries?
▶ 1:53:19That's for me.
▶ 1:53:21Um yes. So I think um as we've seen in other countries, a huge level of fiscal spending can be inflationary, which can push nominal interest rates higher over time. Additionally, as we've seen in other countries with this experience, high debt levels tend to face market scrutiny and eventually result in sovereign credit risk downgrades, which increases financing costs. So, yes, I think there would be up upward pressure on rates.
▶ 1:53:43Thank you. So, if the federal government cannot stop itself from spending and cannot help our banks to make it easier to buy our treasuries, the borrowing costs of my constituents and small business owners go up. So, not only does government spending tax our constituents through inflation, but it also taxes them through higher interest rates. Would you agree?
▶ 1:54:08I Yes, I would agree with that
▶ 1:54:11Thank you. Uh, moving on to M Mr. Tbaki. Um, despite the growth in our national debt, the number of primary dealers has not grown with it. All primary dealers are located in major American cities or Are there barriers that prevent financial institutions located in more rural areas from becoming primary dealers? Is in other words, is geography typically a constraint?
▶ 1:54:36I don't believe so. No. But also, I I I need to make a point in terms of primary dealers and large banks, they don't hold the treasuries. They buy them and sell
▶ 1:54:47The real constituents here that we're talking about are the ultimate holders of the treasuries. Those are the ones that we need to be worried about like treasury hedge funds which I keep saying and that is not without risk too because we cannot allow their leverage to go unabated completely. Right. Well, I I appreciate that. And going back to rural participation, do you suspect that there is any appetite from rural financial financial institutions to participate in any way?
▶ 1:55:18I think we're going to have to generate that appetite. And by that I mean we need to incent players to want to come into the US Treasury market. I'm not sure it's Look, I many of my members are in uh uh Midwestern cities, but um uh I don't know if in in real rural areas now with the electronification of today, they can certainly operate there.
▶ 1:55:43Thank you. Uh Miss Mclofflin, any comments on that?
▶ 1:55:46Yes, thank you, Congressman. Um I would note that in the 70s and 80s we had a lot of small independent broker dealers that were primary dealers um located all over the country. Uh we've subsequently seen massive consolidation in both the banking and the brokerage sectors between the 80s and the 2000s in particular. And a lot of those firms that were independent broker dealers located all over the country merged or were acquired by banking organizations. And that's why you see a lot of bank affiliated firms on the primary dealer list today.
▶ 1:56:16Right. Thank you. So the Federal Reserve recently conducted its second monetary policy framework review which provided an open forum and process to solicit feedback on how to improve their approach and conduct uh a monetary policy and in in this process they periodically hold conferences uh present academic papers and gather opinions from the public across the country.
▶ 1:56:38So uh again to Miss McGlaughlin uh given the importance primary dealers play in our financial system and monetary policy do you think it would be beneficial if the New York Federal Reserve conducted a similar style of review on how to improve the primary dealer system especially as primary dealers face an increasing Treasury security um
▶ 1:56:59Thank you for the question. I would say it depends on the problem that we're trying to solve. So if the problem we're trying to solve is increasing intermediation capacity for the market broadly, I don't personally think that increasing uh the number of primary dealers will move the needle very much because what it's really doing is just renaming existing intermediaries in the market as primary dealers. I see a lot more potential for added intermediation capacity from changes in market structure. I think that's going to be a lot more transformative.
▶ 1:57:28Central clearing is a great example of that. I've also advocated for further study of all to-all trading protocols which don't exist in the treasury market but do exist in some other markets such as corporate debt. I like Jim says there is no silver bullet. So I think it's going to be a a a range of solutions that we want to bring to bear but I think all avenues are worth exploring.
▶ 1:57:49Gentleman's time is expired.
▶ 1:57:50Time is expired. I yield.
▶ 1:57:51Chair now recognizes the gentleman from Nebraska, Mr. Flood, chair of the subcommittee on housing for five
▶ 1:57:58Thank you, Mr. Chairman. so fortuitous that we're having this conversation today because last night at 7:40 I got a email from one of my somebody I respect greatly in Lincoln, a longtime business person and he writes, "Mike, amongst our long list of issues facing our country, I think the biggest issue is our lack of willingness to deal with our growing massive debt. When do we wake up and deal with this issue?" The joke of shutting down the government is a minor issue compared to an economic meltdown.
▶ 1:58:28Now, I don't think that uh shutting down the government is a joke. That it's very serious stuff. But this is relevant and part of the subtext behind our conversation about primary dealers today is a cold hard reality that we've talked about. We have a budget problem in this country. Our debt is continuing to rise year-over-year. And any student of history will tell you that when debt and deficits increase fast enough, their effects start to become evident in other parts of the economy. Today's hearing covers one such example of this phenomena.
▶ 1:58:58Uh, Treasury market primary dealers are stretched thin when Treasury must issue more and more debt to finance the operations of our government. The more debt we issue, the more capacity required to release those notes and securities to the broader Treasury market. Let me be clear, the long-term solution here is to simply tackle the problem of overspending. We need to get our fiscal house in order. If we curb our deficit and issue less debt, less primary dealer uh capacity is required.
▶ 1:59:24Better yet, if we actually stop running a deficit and run a surplus to start paying down, uh that's outstanding. However, in this budget environment, a well functioning and liquid market for treasuries is absolutely essential and primary dealers are a very important piece of that puzzle. Mr. Mr. Tbaki, if Treasury keeps issuing more securities and financial regulation is holding dealers back from purchasing these securities, what happens to interest
▶ 1:59:51They're going to have to go up. I mean, you don't have to be a rocket scientist to know that one.
▶ 1:59:55So, Mr. Tbachi, the president and Secretary Basant shared a goal to lower 10-year Treasury yields to make the cost of borrowing more money affordable. They've begun addressing some of those regulations, thankfully. Would the next step in your opinion be to encourage the demand for Treasury securities? And if so, how could we effectively encourage that demand?
▶ 2:00:16Well, I think you have to make it a little bit both easier and harder in a way for the variable buyers of treasuries, which are treasury hedge funds. By easier, I think the the funding rate right now is squeezing their spread. Now, they're the variable rise buyer of treasuries and because funding rates are elevated, we're squeezing their spread. So, we're playing with fire that they're not going to get tired of the Treasury market and go on to do something else.
▶ 2:00:47Now, case in point, for the month of November, the average uh uh sofa rate, repo rate was 40 401 or so. It was basically over four for the entire month. Well, in that month, the Fed uh reduced interest rates by 25 basis points. There wasn't a real impact on the marketplace because funding rates are higher because of a lack of balance sheet.
▶ 2:01:15That's why I'm saying we're playing with fire here. Okay. Miss Climpmple, in your testimony, you highlight uh the enduser cross margining as a critical uh initiative for the market. Can you talk a little bit more about what the expansion of enduser cross margining will do for the market and what other areas you are focused on to improve margin efficiency?
▶ 2:01:38Thank you for the question congressman. So FIC and the CME group have had a cross margining arrangement in place since 2004 for our common members. The proposal that we have been working on together uh along with our respective supervisors is to bring that crossmargining arrangement down to what we call the enduser customer level so that enduser clients of our common members who have offsetting futures
▶ 2:02:08interest rate futures positions at cleared at CME Group and cash and repo positions cleared at FIC can to the extent that those positions are offsetting from a risk perspective gain margin efficiencies recognizing that risk offset that efficiency is going to improve the capacity of those enduser customers to be able to transact treasury activity and also smooth their implementation of bringing more activity
▶ 2:02:38into central clearing in connection with the treasury clearing requirement. Um, end-user cross margining is also going to improve risk management in the treasury market by allowing for closer crossCP coordination in a default situation and it's also going to help improve transparency across the asset classes by being able to see the client's activity across the CCPs.
▶ 2:03:05Um, we are also focusing in addition to the cross margining arrangement with
▶ 2:03:10you are fantastic by the way. Thank you. time. I yield before I get in trouble.
▶ 2:03:16Chair now recognizes gentleman from Indiana, Mr. Stzman, for 5 minutes.
▶ 2:03:20Thank you, Mr. Chairman, and thank you all for being here. Uh, Mr. Debbach, I'd like to to come to you. Um, our country has a serious spending problem. Um, the federal government, I should clarify, and primary dealers provide steady demand for our ever growing debt. Uh however the size of balance bank balance sheets has not kept pace with our outofc control spending which we saw explode under the bid administration. How has government spending affected balance sheet utilization for primary dealers in the last few years?
▶ 2:03:49again uh the the important constraint of the primary dealers of all the dealers that are um intermediaries in the US Treasury market is the financing markets financing the securities and again it's simple how many people buy a car that don't use financing just about every the variable buyer of treasuries today need financing and financing is constrained I'll give you another statistic year end looks like it's going to be difficult this year.
▶ 2:04:18It's currently trading at 4 and a half while 90% probability the market is pricing in another 25 basis point cut. How can that be? The funding markets where the constraint of financing hits the most are not functioning well. I and look, I'm not an academic. I just sit on a desk and I watch it all day. It's not working. Would you say primary dealers should dedicate more room on their books to our debt?
▶ 2:04:51it's more than just that. There once you get to balance sheet capacity, you have so much capacity based on your capital. Once you get to that capacity, as I told you, the treasurer taps you on the shoulder. That's it. You can't take anymore. So we need more balance sheets coming into the market.
▶ 2:05:11If you look at the CCPs as the hub of the or of the treasury market, the intermediaries, the broker dealers, the primary dealers, the regional banks, those are all the spokes coming in. We need more of them because they provide the balance sheet capacity to the end user.
▶ 2:05:32Ms. Mclofflin, I saw you shaking your head. Um I want to ask you so with the current barriers to entry um are we preventing institutions capable of becoming primary dealers from doing so? H uh how has that number of primary dealers fluctuated over time and what are the factors that have contributed to that number?
▶ 2:05:53Thank you Congressman. Yes, the number of primary dealers has fluctuated over time. um since the primary dealer system that we know today was formed in 1960 uh we've seen the number go up and down. The drivers of those changes um haven't actually been as much the eligibility criteria as just trends in the market structure. So for example, the number of primary dealers grew during the Japanese economic boom in the 1980s when Japanese firms were becoming global and stepping into the the treasury market to intermediate treasuries.
▶ 2:06:22We saw a fall in that number during the late 1990s and early 2000s as rapid consolidation resulted in the mergers, some failures, and some acquisitions of primary dealer firms. Um, and then we've seen uh the number creep up again since the global financial crisis from a low of 17, I think it was in 2008 to the current 25.
▶ 2:06:43Are are there incentives for banks to become dealers right now? And if there are, do you think those are sufficient or attractive as they should be? So surely there are incentives. I think the you know the answer to whether it's attractive might be different for different firms. Um primary dealers do enjoy some benefits. For example, there are uh a number of large investors and smaller investors that only transact with primary dealers. So access to customer base might be one.
▶ 2:07:09Um primary dealers also have access to uh the Fed's standing repo facility and the securities lending program which is only available to primary dealers. uh and primary dealers currently have access a loan to the Treasury's buyback program as well.
▶ 2:07:22So there there are clearly reasons why some firms might want to do that. But I would also note that there are firms that are intermediaries that have chosen not to apply for primary dealer status weighing the costs and benefits of of that status.
▶ 2:07:34So are there ways that those that aren't primary dealers, are there ways that we could encourage them to purchase more
▶ 2:07:41I mean I guess again it's what kind of what is the problem that we're trying to solve? So if we're trying to solve the problem of balance sheet capacity um I think things like uh ch central clearing you know other innovations in market structure that either add net intermediation capacity to the market or uh relieve demand for intermediation may be the most helpful.
▶ 2:08:04Can you be a small or midsize institution and participate? So if you meet the capital threshold which was reduced in 2016 um for broker dealers uh and you have the operational capacity you can certainly apply and you would be considered and if you can demonstrate that you can meet the requirements operationally and also that you have a sufficient presence in the market
▶ 2:08:24you you would generally be admitted as a primary dealer.
▶ 2:08:27Okay. Thank you Mr.
▶ 2:08:28Gentleman's time is expired. All time is expired. I would like to thank all of the witnesses for their testimony today and without objection all members will have five legislative days to submit additional written questions for the witnesses to the chair. Questions be for the witnesses for their response. Witnesses please respond no later than January 7, 2026. This hearing is