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Testimony of Steven R. Meier
Chief Investment Officer, Global Cash Management
State Street Global Advisors
Financial Crisis Inquiry Commission
May 6, 2010
Chairman Angeli des, Vice-Chairman Thomas, and Members of the Commission:
Thank you for the opportunity to appear before you today. My name is Steven Meier,
and I am the Chief Investment Officer, Global Cash Management, for State Street Global
Advisors ("SSGA"), the investment management operation of State Street Corporation
("State Street"). I hope my testimony will assist the Commission with its important
work.
The Commission has asked me to address a number of issues, including (1) my
responsibilities at SSGA; (2) the primary instruments available in the short-tenn funding
markets that are used by SSGA in its cash mandates; (3) how SSGA as investment
adviser to these funds evaluates the risk of those instruments; (4) the extent ofSSGA's
funds' exposure, if any, to failed institutions; (5) any changes in the short-term funding
markets during, and as a result of, the financial crisis; and (6) the causes of, and lessons
learned from, the crisis.
Before turning to these topics, please allow me one personal indulgence. The
events of 2007 and 2008 were unprecedented, and their consequences were devastating:
millions of people saw the values of their homes and savings decline, businesses failed,
and our economy entered into a recession. State Street is deeply grateful to the American
people and our leaders for their resolve and determination throughout the course of this
incredibly difficult period in our nation's history. And although many are still suffering,
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the commitment of America's people and institutions has put us back on the path to
recovery.
BACKGROUND AND EXPERIENCE
As requested, let me begin with a brief description of my background and
experience, as well as a general overview of SSGA 's investment management business in
the cash asset class. I have more than twenty-six years' experience in financial services,
with a focus on traditional money markets, fixed income, global cash, and financing.
Prior to joining State Street, I was a senior repurchase agreement, matchbook and
financing trading manager at Merrill Lynch Capital Markets from 1987 to 1992.
Following that, I spent seven years at Credit Suisse First Boston in a similar capacity with
responsibility for equity and whole loan funding businesses, and financing various forms
of alternate assets through repurchase agreements. I have been at State Street for eleven
years, including seven years with SSGA. I am currently an Executive Vice President,
and my primary responsibility as Chief Investment Officer of the cash asset class is to
manage global cash activities, including money market funds, and other cash
management products. I am a member ofSSGA's Executive Management Group, as
well as its Senior Management Group and Investment Committee. I am also a participant
on the tri-party repurchase agreement refonn task force sponsored by the Federal Reserve
Bank ofNew York.
State Street is one ofthe world's leading providers of financial services to
institutional investors, with nearly $19 trillion in assets under custody and administration
and almost $2 trillion under management. SSGA is the investment management division
of State Street. SSGA manages traditional cash, money market funds, and other
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investment programs, as well as all of the other cash products for State Street's securities
lending program. In October 2009, SSGA was named the "World's Best Bank" in the
Asset Management category by Global Finance Magazine.
As you know, State Street was among the initial group ofbanks asked to
participate in the Federal Govemment's Capital Purchase Program, at a relatively modest
$2 billion level. State Street is pleased to have participated in the Capital Purchase
Program, which helped stabilize markets. We were also pleased to be one of the first
banks to retum the investment to the Treasury Department in June oflast year at a profit
to U.S. taxpayers. State Street was also selected to serve during the financial crisis as the
custodian and administrator for the Federal Reserve's Commercial Paper Funding
Facility. On behalf of State Street, I would like to express my appreciation for the
prompt and decisive actions taken by the federal govenunent to promote stability and
liquidity in the midst of a difficult and uncertain market.
SHORT-TERM FUNDING INSTRUMENTS
With this as background, let me describe three short-term lending instruments and
activities that I understand the Commission is interested in: repurchase agreements,
commercial paper, and securities lending.
Repurchase Agreement Market
First, let me talk about the repurchase agreement market, which has been in
existence since the 1920s as a means of collateralized financing. It is difficult to measure
the overall size ofthe U.S. repurchase agreement market, but estimates of$8 to $10
trillion at its peak seem reasonable. It is helpful to divide the repurchase agreement
market into two categories based on the type of collateral used in the transaction. The
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first category is the traditional repurchase agreement market, which is typically
collateralized with U.S. Treasury bills, notes and bonds, agency debentures, or agency
mortgage-backed securities ("MBS"). The other category, which is often referred to as
"non-traditional" or "alternative," encompasses repurchase agreements involving any
other fonn of collateral, such as money market instruments, investment-grade and highyield bonds, asset-backed securities ("ABS"), equities, or unsecuritized whole loans.
Repurchase transactions provide our clients with a fonn of secured investment that offers
a yield advantage compared to other short-term investments of equivalent credit quality,
and alternative collateral normally will provide a yield advantage over traditional
collateral.
There are also two principal types of repurchase agreement transactions defined
by settlement mechanics: bilateral and tri-party. In a bilateral repurchase agreement, one
party obtains short-term funding by selling securities to a second party, with an
agreement to repurchase them at a future date. Settlement of this initial purchase occurs
in the buyer's individual clearing account. In a tri-party repurchase agreement
transaction, a third-party custodian intennediates between the two counterparties to the
transaction. More than 98% of State Street's U.S. repurchase agreements settle via a triparty arrangement, and we deal with the Bank ofNew York and JP Morgan Chase as the
tri-party custodian.
SSGA has a dedicated credit group that evaluates credit for counterparties and
issuers for our clients and produces an approved credit list for transactions, including
repurchase agreements. In addition, our clients are able to review and set distinct, more
restrictive counterparty criteria consistent with their risk tolerance. SSGA's credit group
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takes into consideration a broad range of factors in evaluating potential client
counterparties, including financial strength, and sources and uses of funding. We do not
rely upon ratings assigned by independent rating agencies. State Street requires that
repurchase agreements be properly documented; all transactions are executed under the
tenns and conditions of a Master Repurchase Agreement, which establishes collateral and
pricing requirements. For transactions settling on a tri-party basis, custodial undertakings
are executed with the respective custodian bank, counterparty, and SSGA as agent for
disclosed clients.
Commercial Paper Market
The commercial paper ("CP") market is also a type of short-tenn money market
instrument. Like the repurchase agreement market, the CP market can be divided into
two categories. Traditional CP is an unsecured obligation issued by bank holding
companies, corporations, and non-bank financial institutions. The asset-backed CP
("ABCP") market consists of conduits or special purpose vehicles that typically have
back-up liquidity support provided by a bank or financial institutions. Note that these
back-up liquidity lines may also apply to traditional unsecured CP. The conduits and
special purpose vehicles typically finance the purchase of a portfolio of intermediate and
longer-term assets through the issuance of short-tenn CP, which is rolled over when due;
the liquidity support is basically a source of contingent financing and is used if the CP
issuer is unable to finance itself through the CP market due to either market or issuer
specific events. At its peak, the ABCP market was around $1.2 trillion. It has since
declined to around $400 billion.
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State Street buys on behalf of our clients both traditional CP and ABCP. Just as
in the case with repurchase agreement counterparties, our credit group evaluates CP
issuers, establishes an approved list, and sets limits on the maximum tenure and amount
of client exposure to individual issuers on the approved list. Our review involves careful
vetting of conduits or special purpose vehicles, thorough investigation of the underlying
assets and sponsoring entities, and an examination of the institution providing the
liquidity support. We do not purchase ABCP on behalf of clients if we are not
comfortable with the liquidity provider's reputation and ability to meet its contingent
funding obligations.
Securities Lending
The third short-tenn funding activity I would like to talk about is securities
lending. Securities lending is a means by which institutional clients who hold and plan to
retain long securities positions can earn incremental income. The asset owner, generally
with the assistance of a securities lending agent, lends a security it holds as a long
position to a borrower who needs the security to support a short sale or otherwise in
connection with the settlement of a securities transaction. The borrower has an obligation
to return the borrowed security and provides collateral to secure that obligation, with the
market value of the collateral in excess of the market value of the borrowed securities,
with 102-105% generally being market convention. This collateral can be either cash,
which is most common, or traditional or alternative securities. If the lender receives cash
collateral, it reinvests the collateral, pays the broker-dealer a "rebate rate" on the cash
pledged to secure the loan, and shares the remaining income with the securities lending
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agent. State Street acts as securities lending agent for clients, and SSGA manages the
cash collateral on behalf of our clients through an asset-liability construct.
One difference between securities lending and the repurchase agreement market is
the ability to rehypothecate the securities on loan. Rehypothecation is implicit in
securities lending, where the whole idea is to use the loaned security to make another
trade. In the tri-party repurchase agreement context, by contrast, the custodian bank is
responsible for the collateral, so the counterparties do not have access to it absent default.
Note that bilateral repurchase agreements, with settlement at the borrower's clearing
account, can be executed to obtain access to securities for other settlement and trading
purposes.
FINANCIAL CRISIS OF 2007 AND 2008
With that overview, let me talk about the events of the past few years and their
impact on the short-term funding market in general, and State Street in particular. None
of the money market funds advised by SSGA risked breaking the buck, and the other cash
products underlying our securities lending program have not experienced material credit
losses. The fixed-income and asset-backed markets, however, have experienced extreme
illiquidity, and the market prices for those products have not always reflected the quality
of the underlying assets. Neither State Street nor our cash funds had material exposure to
either Bear Stems immediately prior to its sale or Washington Mutual immediately prior
to its liquidation. While we had expected a managed resolution of Lehman Brothers and
consequently our clients had securities lending and repurchase agreement exposure to
Lehman and its affiliates, our clients did not incur any losses as a result of such exposure.
State Street did incur a loss in conjunction with certain repurchase agreement transactions
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between SSGA's clients and Lehman affiliates, where State Street had agreed to
indemnify those clients against a borrower default. In that case, the value of the
collateral underlying such repurchase agreement transactions proved to have a realizable
value substantially less than the value assigned to it by Lehman or an independent pricing
service.
Like many others involved in the financial industry-from bankers to investors to
analysts to regulators-! have thought long and hard about the lessons to be gleaned from
the historic events of the past few years. Our rigorous credit analysis helped protect our
investors and allowed SSGA to focus on solid investments during difficult economic
conditions. As we have seen, however, credit quality alone may not be sufficient to
protect against price degradation when there is limited market liquidity. In addition, the
secondary market liquidity mechanism has proven less reliable in a severely distressed
market, which has implications for portfolio construction. Lastly, I believe the industry
has recognized the need for substantial committed resources and infrastructure to manage
money market assets.
I do not believe that blame for the crisis can be pinned on a single event, entity,
product, or decision. In my view, the financial crisis flowed from a confluence of factors,
many of which this Commission is by now well aware. In particular, I would highlight
excessive leverage and inadequate capital requirements, which ultimately contributed to a
lack of liquidity and frozen credit markets.
Thank you again for the opportunity to be here today. I would be pleased to
answer the Commission's questions.
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@FedFRASER