听证会记录——对冲基金与金融市场（众议院监督委员会，GPO完整记录）

[Extract from the official GPO hearing volume "Hedge Funds and the Financial Market" (Serial No. 110-210, 203 pp.). Only George Soros's oral statement and the questions put to him with his answers are retained; testimony by the other witnesses is omitted and marked. The scanned pages of his written prepared statement carry no text layer in this volume and are supplied separately as soros-prepared-statement-house-oversight-2008-11-13.txt.]

STATEMENT OF GEORGE SOROS

Mr. SOROS. Thank you, Mr. Chairman. We are in the midst of the worst financial crisis since the 1930’s. 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 toward equilibrium. Deviations from 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 be 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 is not enough to control the money supply. It is also necessary to control credit because the two don’t go in lock step. 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 harder 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 counterpart risk. Fifth, since financial marketings 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 2, 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 3 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’re experiencing wholesale and disorderly de-leveraging. 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 need to be regulated within that framework. But we must be aware 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 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 will guess that the amount of money that 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’d be happy to expand on these points in greater detail in answering your questions. [The prepared statement of Mr. Soros follows:]

[... exchanges with other witnesses omitted ...]

Chairman WAXMAN. Thank you very much, Mr. Griffin. We are now going to proceed to questions by Members of the panel, who will each have 5 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. Let me start off by asking about systemic risk. In 1998, Long Term Capital Management was one of the Nation’s largest hedge funds. It had about $5 billion in capital and was leveraged at a ratio of 30 to 1. It had 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 impacts of this collapse that it organized a multibillion dollar bailout. That was in 1998 when only about 3,000 hedge funds managed approximately $2 billion in assets. Current estimates suggest that there may be 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 go straight down the line?

Mr. SOROS. Yes, I think that some hedge funds do pose systemic risk. And I think particularly leveraged capital was built on a false conception—I talked about the false paradigm 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.

Chairman WAXMAN. Do you believe this justifies greater Federal regulation?

Mr. SOROS. Pardon?

Chairman WAXMAN. Do you believe this justifies greater Federal regulation?

Mr. SOROS. Yes, it does.

[... exchanges with other witnesses omitted ...]

Mr. SIMONS. I don’t have much to add. I have already said that reporting up to the regulators is a good idea, more so than is now reported. I agree with the others that it should stay with the regulators or with the Federal Reserve. It should not be reported in the New York Times.

Mr. SOROS. As I have said, I think the 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 endangers the business model of long-short equity investors—it is not our business, it is the other hedge funds that do that—because of the reaction of the companies whose shares they were selling short.

[... exchanges with other witnesses omitted ...]

Mr. DAVIS OF VIRGINIA. Mr. Soros.

Mr. SOROS. I am on record being very critical of the original TARP proposal. And I would like to go on record saying that while it is a great improvement that it is 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 to TARP and get an offer. 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. And only if the shareholders don’t take it 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 you remove the pressure of foreclosures, which are liable to push down the value of mortgage securities way below that. That is an undone business that has to be urgently attended to.

[... exchanges with other witnesses omitted ...]

Mr. TOWNS. Mr. Soros.

Mr. SOROS. What was your question? I didn’t fully understand your question. Was it how it affected our——

Mr. TOWNS. Yes. How you seemed to have been able to anticipate when others were not able to anticipate, especially Wall Street and Washington.

Mr. SOROS. I fully anticipated the worst financial crisis since the 1930’s. But frankly, what has happened in the last 8 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, 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 felt. Now, as far as my own fund is concerned, I came out of retirement to preserve my capital, and I have 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.

[... exchanges with other witnesses omitted ...]

Mr. SOUDER. Thank you, Mr. Chairman. And I understand this is a financial hearing, and I am not going to get into other questions, but I just want to say, Mr. Soros, we have had deep disagreements over the years on the heroin needles promotions and your promotion of different what I believe are back-door legalization of marijuana. And I believe while you have 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 has damaged many Americans. And I hope you will 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?

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. In other words, the 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 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 is 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 is nothing specific to hedge funds, it relates to everyone who uses credit.

[... exchanges with other witnesses omitted ...]

Mrs. MALONEY. 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, ‘‘an obvious and indisputable need to require financial institutions to provide additional data to regulators.’’ Chairman Ruder made the same point when he said, ‘‘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, ‘‘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 industries, must provide that information even if it is costly and cumbersome. The costs pale into insignificance when compared to the costs 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?

Mr. SOROS. Yes.

[... exchanges with other witnesses omitted ...]

Mr. SHAYS. Thank you, Mr. Chairman. I only have 5 minutes, so I would love some short answers, and then I am going to just focus on one individual, just so I can pursue a little more in detail. I would like to ask each of you, and I will just preface it when I meet with hedge fund partners and they are in a room and I ask them about treating capital gains—income as capital gains or as regular income, when they are 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 would like each of you to tell me capital gains or regular income? Mr. Soros.

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 take capital gains and you want to change that, I think that would be appropriate. It would be inappropriate to——

Mr. SHAYS. Let me just cut you off, Mr. Soros, because you have all answered the question. Do you all agree with or disagree with——

Mr. SOROS. 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.

[... exchanges with other witnesses omitted ...]

Mr. SHAYS. OK. 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 be 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.

Mr. SOROS. Exactly in order to avoid this kind of conflict of interest, I only have one fund and all my assets are in that fund.

Mr. SHAYS. I see. Has that fund done better or worse than your other funds?

Mr. SOROS. There is no comparison. It is the only one.

[... exchanges with other witnesses omitted ...]

Mr. CUMMINGS. So would any of you support repealing this tax loophole and taxing your income at regular income rates? Mr. Soros.

Mr. SOROS. I do.

Mr. CUMMINGS. I can’t hear you.

Mr. SOROS. I agree to it. I have no problem with it.

[... exchanges with other witnesses omitted ...]

Mr. TIERNEY. We don’t disagree on that. I don’t want you to take your chef analogy and confuse people with that. Mr. Paulson, except for our disagreement on that particular issue, I was thinking that we probably had the wrong Paulson handing out the TARP moneys here, because I agree with you in essence about us not getting the deal as taxpayers that we ought to be getting. And fairly adamant. And I can daresay 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 are out there giving bonuses, paying high salaries without being capped, and then waltzing around giving dividends. I think that is an important point, and I know you have 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 is going to do. What I would like to know is whether the other four panelists here agree with our Mr. Paulson here that if we are going to have taxpayer money go to any of these institutions, we ought to get a better deal, 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 have the guarantee of the investment made. Mr. Soros.

Mr. SOROS. I am sorry, I didn’t follow the question properly. I am sorry.

Mr. TIERNEY. In my old business we used to be able to have it read back. 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 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?

Mr. SOROS. I am not sure that I would agree with Mr. Paulson on that.

Mr. TIERNEY. Why not?

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 is up to the shareholders how they compensate.

Mr. TIERNEY. But this is taxpayer money, not shareholders’ money we are talking about.

Mr. SOROS. When it is taxpayers’ money, no, that I agree. Yes. Yes.

[... exchanges with other witnesses omitted ...]

Mr. YARMUTH. Thank you, Mr. Chairman. I want to thank the panel. The testimony has been, I think, unusually candid and thoughtful, and I appreciate that very much. I am going to probably cross the line a little bit that Chairman Waxman set down, but I am 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 the former CEO of Time Warner, the former CEO of Merrill Lynch, Citigroup, and we had Mr. Mozilo from Countrywide. And one of the questions that I asked was when all these corporate executive compensation committee meetings met, was there ever a discussion of things like employee welfare, the communities that the corporation 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 has become a common theme in hearings we have had is that when you tie everyone’s compensation to stock performance, and relatively short-term stock performance, then you have an incentive or pressure for maybe riskier 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 is related to corporate compensation generally or general corporate governance laws that might ameliorate some of this issue if you think it is a problem? Mr. Soros, would you like to start?

Mr. SOROS. I am definitely at a loss because it is not a subject that I have really given a lot of thought to.

[... exchanges with other witnesses omitted ...]

Mr. COOPER. Do any of the witnesses know? Mr. Soros.

Mr. SOROS. I think that hedge funds, several hedge funds have claimed to follow a market neutral strategy exactly because institutional investors want to see low volatility, and I think that was rather misleading. I don’t think it was deliberately 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 an event occurred that was not a random fluctuation or deviation, then it turned out to be non-market neutral.

Mr. 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?

Mr. SOROS. Well, see——

Mr. COOPER. 200 points a day, 500 points a day, a thousand is more better?

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.

Mr. COOPER. How about the other panelists? Is a volatility only strategy appropriate? And if so, is more volatility always better?

Mr. SOROS. Well, you see, I think volatility is an indication of uncertainty. And the fact that normal volatility is 30, and it shot up to 50 and 70 and 80, it just shows the increased uncertainty that is currently pervading the markets.

Mr. COOPER. Does the government have a role in limiting excessive uncertainty?

Mr. SOROS. Well, I think that regulators have to understand that there is this uncertainty in markets. And that is 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 am putting forward.

[... exchanges with other witnesses omitted ...]

Chairman WAXMAN. Thank you, Mr. Cooper. Mr. Van Hollen. Mr. VAN HOLLEN. 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, 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?

Mr. SOROS. Yes.

[... exchanges with other witnesses omitted ...]

Mr. FALCONE. Yes. Mr. VAN HOLLEN. Now, we had just before you a panel of a number of professors, including Professor Lo and Professor Ruder. And the question I posed was OK, let’s say you are the SEC or the regulator and you are getting this information and data and you see your alarm bells go off. You say look, we really do think we have a problem here, whether it is 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 of you gentlemen is, is that something you think would be necessary? Because the obvious question that comes up once you say it is OK to collect the information is OK, you got it, now you make a determination that something is 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 have learned, at least with respect to the investment banks, is that the taxpayer is of course 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 pose that question to you, gentlemen, whether you think, whether it is the SEC or the Federal Reserve, they should also have additional authorities, whether it is leverage requirements or some other powers that they can intervene with respect to a particular hedge fund that they determine is causing systemic risk?

Mr. SOROS. Well, I would definitely argue that is exactly what you need. That is what 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 toward equilibrium, and it is the job of the regulators to prevent asset bubbles from developing.

[... exchanges with other witnesses omitted ...]

Mr. ISSA. 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 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, then 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 100 days, would it go at least a long way toward preventing the kind of over-leveraging that you’re speaking of, at least the lack of visibility on over-leveraging?

Mr. SOROS. Well, certainly the introduction of newfangled 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, then it becomes even more difficult. So I think that it may be necessary to actually—while it is 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.