Hearing of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the House Financial Services Committee - The Present Condition and Future Status of Fannie Mae and Freddie Mac
Chaired By: Rep. Paul E. Kanjorski
Witnesses Panel I: James B. Lockhart Iii, Director, Federal Housing Finance Agency; Edward J. Demarco, Chief Operating Officer And Senior Deputy Director For Housing Mission And Goals, Federal Housing Finance Agency; Christopher Dickerson, Deputy Director For Enterprise Regulation, Federal Housing Finance Agency; Panel Ii: Bruce A. Morrison, Chairman, Morrison Public Affairs Group; Susan M. Wachter, Richard B. Worley Professor Of Financial Management, The Wharton School, University Of Pennsylvania; Frances Martinez Myers, Senior Vice President, Fox & Roach/Trident, Lp On Behalf Of The National Association Of Realtors; Lawrence J. White, Arthur E. Imperatore Professor Of Economics, Leonard N. Stern School Of Business, New York University; Michael D. Berman, Cmb, Vice Chairman, Mortgage Bankers Association; Joe Robson, Robson Companies And Chairman Of The Board, National Association Of Homebuilders.
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REP. KANJORSKI: (Sounds gavel.) Committee will come to order. This hearing of the subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises will be in order. I ask unanimous consent that Ms. Kaptur have permission to participate in today's hearing.
Pursuant to a prior agreement with the ranking member, each side will have 15 minutes for opening statements today. Without objection, all members' opening statements will be made a part of the record. I yield myself such time as I may consume.
We meet today to examine the present condition and future status of Fannie Mae and Freddie Mac, which together have lost more than $150 billion since the third quarter of 2007. This hearing is not only the first hearing in the 111th Congress on the two government-sponsored enterprises, but is also the first in a series that the Capital Markets Subcommittee will convene to review these matters.
Last summer, Congress completed work on an eight-year project by enacting the Federal Housing Finance Reform Act. Shortly thereafter, the new Federal Housing Finance Agency placed Fannie Mae and Freddie Mac in conservatorship. Since then, the Treasury Department has purchased $85.9 billion in senior preferred stock at the two enterprises. This investment could ultimately grow to as much as $200 billion per institution under current agreements.
In recent months, the Treasury Department has supported Fannie Mae and Freddie Mac in other ways, as well, by purchasing $5 billion of their mortgage-backed securities in 2008 and requesting $249 billion more in 2009. In addition, the Federal Reserve now has a sizable interest in the success of the two companies, holding more than $71 billion of their bonds and $365 billion of their mortgage- backed securities.
In total, these growing taxpayer commitments are quite sizeable, if not staggering. They have also led many to conclude that the implicit government guarantee toward the enterprises has now become an explicit one. Our hearing today will therefore examine the government's financial support for Fannie Mae and Freddie Mac and explore the options for the future of their relationship with the government.
From my perspective, the emergency actions taken to date by the Federal Housing Finance Agency, the Treasury Department, and the Federal Reserve were needed to ensure the continued functioning of our nation's housing finance system during this period of considerable economic turmoil. With all of these problems and imperfections, Fannie Mae and Freddie Mac have ensured that millions of Americans can continue to purchase and own their homes.
While the existence at this time of Fannie Mae and Freddie Mac is essential for our nation's economic recovery, this is also an appropriate moment to begin to consider how we might modify their mission, operations, and ventures going forward.
As former Treasury Secretary Henry Paulson has observed, and we need to use this period while Fannie Mae and Freddie Mac to stabilize and -- to decide what role they should play in the markets. I must, however, caution everyone that this debate will be a long-distance relay between Congresses, not a 100-meter sprint within the 111th Congress.
This debate over what roles and functions Fannie Mae and Freddie Mac should perform has, of course, raged for many years. Many good reform ideas have started to come to light in recent months, and we should study them closely. Some of our choices include reconstituting the enterprise as they were before the conservatorship decision; splitting them into smaller operating companies like we did with AT&T; regulating the prices they charge like a utility; creating cooperative, non-profit ventures or resolving them back into the government.
Many have also called for privatizing Fannie Mae and Freddie Mac, and there is some precedent for such actions. In the 1990s, for example, we enacted a law that allowed Sallie Mae to graduate from the school of government-sponsored enterprises. While we could do the same here, we ought to move cautiously.
We created Fannie Mae and Freddie Mac because of a market failure. And we ought to ensure that any new system of housing finance continue to provide a stable source of funding and long-term credit to help people to purchase homes.
In short, we must keep our minds open to all reform proposals and refrain from drawing lines in the sand about what each of us will or will not support until we have had the chance to consider the pros and cons of the many different options. That said, I will use one key factor in my examination of these choices, namely, I want to ensure that community banks and retail credit unions continue to have access to a neutral source of affordable funding to help them compete against large institutions. These mortgage providers are important participants in our markets, and we must ensure that they continue to have an opportunity to help hard-working families to achieve the American dream of homeownership.
In sum, this hearing is timely.
Congress has a constitutional responsibility to conduct effective oversight of the work of the Federal Housing Finance Agency to make sure that it is operating as we intended. We also have an obligation to ensure that the executive branch is effectively allocating federal tax dollars and helping as many people as possible to remain in their homes.
Finally, Congress needs to begin to think about how it will structure the government's relationship with Fannie Mae and Freddie Mac once we emerge from this financial crisis. I look forward to a vibrant debate on these important issues.
I recognize the gentleman from New Jersey, Mr. Garrett for five minutes.
REP. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman. I also want to thank the Chairman for your comments, in saying you are open to different ideas with regard to restructuring our mortgage finance system. I think the one agreement is that doing nothing, and keeping the status quo is unacceptable.
You know, Fannie and Freddie played a leading role in adding fuel to the mortgage finance fire that burned down a good portion of our financial system and the economy as a whole. By financing roughly 36 percent of the subprime housing market and increasing their leverage to 100-to-1, they really abused the governmental granted advantages in the marketplace and they have run up a bill to the taxpayers of $85 billion and counting.
Now, the total bailout costs of Fannie and Freddie are expected to climb much higher. When the Housing and Economic Recovery Act was passed, an arm-twisted CBO scored the GSE titles of the bill as $25 billion and said there was less than a 50 percent chance that a bailout authority would ever be used, and less than a 5 percent chance that the costs would ever run over $100 billion.
And the chairman of this committee, Chairman Frank, chastised Republicans on the floor who said that the costs would likely go well over the CBO estimates. He said, "It is the most inflammatory arithmetic I ever heard." Well, the higher cost estimates being used by Republicans he stated, "these numbers that are being thrown out are simply inaccurate and misleading," he said.
Well, speaking of inaccurate and misleading, the CBO recently updated their scores and the cost estimates have increased by over 1,500 percent. And so we begin this month with a more formal debate over regulatory restructuring and providing the government with an explicit bailout authority, I think it is essential that any conversation begins and ends with the GSEs. And any regulatory reform that does not include GSEs is not true reform. Fannie and Freddie were a large part of the problem, and reforming them should be a large part of the solution.
Also, I am very worried that proposals being discussed by the administration and some others to create a so-called Systemic Risk Regulator will actually create what amounts to another new set of government sponsored entities. By creating a new Systemic Risk Regulator we could essentially establish a dozen new Fannie and Freddies that will be "too big to fail" and have the inherent market advantage that will come with that distinction.
As our distinguished ranking member from Alabama points out, private -- this will be privatizing profits and socializing risk is a bad business model and we should learn from our past mistakes, not repeat them. As we are going forward, I do believe it is very important that we have a viable and liquid secondary mortgage market to provide additional funding so that people can experience the American dream of owning their own homes. And one tool that I believe that we can do that with is -- I may have talked about here before, and that is, covered bonds.
You know covered bonds are debt instruments offered by financial institutions, they are backed by collateralized pool of mortgages. Investors purchase these bonds and the pool of mortgages are treated as secure collateral. Investors also continue to have a full recourse on the institution in case of a failure. This type of securitization is widely used in Europe to provide liquidity over there, and I believe we can do it here in the U.S. as well.
I also want to thank Chairman Frank for his comments some time ago when he said he would hold a hearing on this important topic and I do look forward to working with him and all my colleagues as we continue to move forward on this.
So I want to again thank the Chairman, and thank you for the other witnesses who are coming forward. Thank you.
REP. KANJORSKI: Thank you very much, Mr. Garrett. We will now hear from Mr. Scott for three minutes.
REP. DAVID SCOTT (D-GA): Thank you, Mr. Chairman. I want to thank the chair and ranking member for holding this important hearing concerning the state of Fannie Mae and Freddie Mac as it continues to be of utmost concern to our economy. The collapse of these two mortgage giants has had a profound impact on our markets and total economy. And I am interested to hear more details and opinions about the risk of a prolonged economic slump and how long the GSEs plan to proceed in the future, as well as access their current conservatorship situation.
I am further interested to hear what the Federal Housing Financing Agency has to say about the future of SEs and what this agency believes they should or will look like down the line, especially if mortgage markets continue to face turmoil.
There are many ideas and proposals regarding the direction in which GSEs should take, from making them a government entity or absorbing them into an another government entity, such as the FHA, to splitting them up into multiple GSEs, to privatization and simply eliminating all implicit and explicit government backing for mortgage related instruments.
The Fannie-Freddie fallout not only affected the economy overall, but it affected Main Street as well. Many of our nation's community banks have been hard hit because they have held some 85 percent of lenders that held Fannie and Freddie stock. Our community banks are the backbone of communities across this country.
And this is especially true in my state of Georgia, as we are currently experiencing a very large number of bank closures. This whole situation is helping to reduce bank capital and impede upon the ability of banks to make new loans and renew existing ones.
And I just want to make one mention of one particular situation that has resulted -- that's raised big questions. When Freddie Mac ignored the two leading rating agencies Moody's and Standard & Poor's on rating the markets, the securitization in nine months, relying instead on the market to smaller agencies, Fitch and Canadian agency, Dominion Bond Rating Services.
That $1 million deal has led to AAA ratings. Some close to the deal claim that Moody's and S&P lost the Freddie mandate as their rating method used was considered too rigorous.
So the question has to be answered and dealt with today is this. Is it not the role of these agencies to be more vigilant in their rating process after getting chastised by Congress and the media over handling of AAA rating on complex securities that began to falter when home buyers could no longer pay their mortgages? And of course the flip side of that of course are the big credit rating agencies may be making some of these institutions jump through hoops that aren't necessary.
Serious questions and a very timely hearing, I look forward to hearing from our witnesses. Thank you, Mr. Chairman.
REP. KANJORSKI: Thank you very much, Mr. Scott.
We will now hear from Mr. Bachus for three minutes.
REP. SPENCER BACHUS (R-AL): Thank you, Mr. Chairman. I appreciate you convening this hearing.
Congress established Fannie Mae during the New Deal to make homeownership more affordable and they created Freddie Mac with a similar purpose in 1970. Neither provides home loans. Instead their purpose is to increase the funding available for home mortgage financing either by providing credit guarantees on mortgage backed securities or by directly investing in mortgages and mortgage related securities through their retained mortgage portfolios.
To further their missions, the GSEs' congressional charters granted them unique privileges shielding them from many of the financial standards and tax burdens imposed upon their competitors. These benefits created a perception that Fannie and Freddie were backed by the U.S. government and this implicit guarantee also provided them a funding advantage over private sector participants.
Not surprisingly, over time, the GSEs' advantages enabled them to dominate the secondary mortgage market. Today, they have more than $5.0 trillion in obligations outstanding, an amount that is nearly 40 percent of the size of the entire U.S. economy. The systemic risk posed by the size of these entities was only magnified by investor perception that GSE securities were backed by the full faith and credit of the U.S. government.
In September those perceptions became reality. On September the 7th, 2008, shortly after Congress passed the GSE regulatory reform legislation, the federal government placed Fannie and Freddie into conservatorship. The rescue was one of the most extraordinary federal interventions into the private sector and is on track to become one of the most expensive if not the most expensive.
As part of the GSEs' conservatorship agreement, Treasury committed up to $200 billion to purchase preferred stock from each company through December 31, 2009. In exchange, Freddie and -- Fannie and Freddie provided the Treasury with $1 billion in senior preferred stock and warrants to acquire 80 percent of each GSE. In addition to Treasury purchases of preferred stock both the Treasury and Fed also scheduled -- are also scheduled to purchase trillions of dollars worth of GSE debt mortgage backed securities.
As of May the 29th, Treasury has purchased $167 billion of GSE MBSs using authority granted under the HERA Act of 2008. The CBO estimates in March that the GSEs titled HERC (ph) will cost $384 billion.
The Fed currently holds $81 billion of GSE debt and $507 billion of agency MBS. On March 18th, the Fed announced it will -- its purchases of agency MBSs will total $1.25 trillion by the end of the year. Finally, the Treasury has also initiated a credit facility for both GSEs to provide liquidity.
Mr. Chairman, in conclusion, the magnitude of the $1 trillion GSE bailout demands our full engagement about the future of the GSEs. Congress must work to develop a new model for housing finance. Some like Treasury Secretary Hank Paulson -- or former Secretary Paulson have endorsed a public utility model. Others, myself included, have proposed shrinking and privatizing the GSEs.
Whatever the GSE's ultimate fate, we can all agree that the GSEs cannot continue as before. Socializing risk and privatizing profit, as Mr. Garrett said, must end. The American people demand an end to the bailout. Any discussion of the long-term future of the GSEs must include a bailout exit strategy.
I would like to thank our witnesses for appearing today and look forward to the hearing and their ideas for a transition period for the GSEs. I yield back the balance of my time.
REP. KANJORSKI: Thank you very much. We will recognize the gentleman from Illinois, Mr. Foster for two minutes.
REP. BILL FOSTER (D-IL): I'd like to follow up on Ranking Member Garrett's expression of interest in covered bonds. I think we should all show some humility in our current situation and look laterally at countries that didn't have systems that did not get into this mess.
And in particular, the American Enterprise Institute has recently had some public presentations and meetings on converting the present GSE based system and mortgage backed security based system to a variant of covered bonds that is known as the Danish system for mortgage origination, which I personally think has tremendous potential.
This provided an efficient and liquid model for housing finance ever since the Great Fire of 1795 in Copenhagen, survived numerous booms and busts. And as I said, I can't see what's wrong with it. And there is a fairly worked out scenario in these presentations for actually transitioning Fannie and Freddie into the system. And I would be very interested in pursuing this, if not in this hearing, in subsequent hearings and conversations.
Thanks much. I yield back.
REP. KANJORSKI: Thank you very much, Mr. Foster. And now we will hear from the gentleman from Delaware, Mr. Castle, for one and a half minutes.
REP. MICHAEL N. CASTLE (R-DE): Thank you, Mr. Chairman and thank Mr. Garrett for holding today's hearing. I believe debating the future of Fannie Mae and Freddie Mac is of importance, as these entities have tremendous impact on our housing and finance markets. I also believe that we cannot neglect talking about the future of other elements of the housing market. While the GSEs are important, we also need to consider other aspects of housing finance and their role in the market, moving forward.
The events that began unfolding last summer have led many to believe the public-private business model of government sponsored enterprises is inherently flawed. Does this model invoke moral hazard for entities backed by the government to take unnecessary risks all because they know they will be provided a life line if things go really bad?
On the other hand, does this argument apply to all public-private partnerships even those -- even though some of these partnerships have worked well? Perhaps, it is not necessarily the model at fault, but perhaps some of the practices adopted by the GSEs themselves that are in need of reform.
So the question is raised -- what do we do with Fannie and Freddie in the future? Should they return to GSE status? After we have exhausted the conservatorship role, should they become an official government entity? Or do we privatize them and eliminate the government backing role all together?
I'm looking forward to the testimony of the panel before us to try and hash out this issue. I also hope that the experts before us today will be able to address the future of the housing and mortgage market in general, as Fannie and Freddie are simply parts of the greater debate this committee needs to address.
Thank you. I yield back the balance of my time.
REP. KANJORSKI: Thank you very much, Mr. Castle. And now, we will hear from the gentleman from California, Mr. Royce for one and a half minutes.
REP. EDWARD R. ROYCE (R-CA): Thank you, Mr. Chairman. I think I've warned 16 times in this committee about the danger of government involvement in the market with respect to GSEs. The goal of the government should be to be a regulator. What we did was we replaced political pull with market forces.
And in 2003, I introduced the first legislation to bring Fannie and Freddie under one regulator. In 2005, I got the amendment on to the House floor, frankly, that would allow the GSE's regulator to control for systemic risk, to actually step in, which is exactly what the regulators wanted to do. But political pull and the lobby by Fannie and Freddie prevented this from happening.
Now, we've got $6 trillions worth of a mortgage market out there, and basically what we did was we allowed a quasi political government sponsored enterprise here to borrow at a much lower rate than their competitors could in the market. We allowed them to form a system in which they could arbitrage. And in which they could build up a portfolio of $1.5 trillion. And then forces in Congress, forced the majority of that loan portfolio to be in subprime and Alt-A loans.
And when we called attention to this repeatedly, we were told, there is no risk, or we are going to roll the dice on this risk. Well, the consequences have been not only to drive up a balloon in the housing market, but with the collapse, to lose billions of dollars for stock holders.
But more importantly, to lose that money for those who are involved in the housing market and the side effect that this has had on housing prices in the U.S.
So the observation I would make first is -- I get to hold any member that is interested in this debate. I get to hold Thomas Sowell, the economist's new book, "The Housing Boom and Bust," and see the role that Congress played in terms of helping create this crisis.
And second, I think long and hard in the future about creating political manipulation into the market. We should be the regulator, we shouldn't be tying the hands of the regulator.
In '89, we had from Freddie Mac -- the chairman of that organization come up here and say it would risk safety and soundness to allow these kinds of portfolios to develop. And instead we allowed 101 to 1 -- 100 to 1 leverage out of these institutions and the resulting collapse and the systemic risk. And we ignored the very institutions and regulators that tried to warn us and we tied the hands of those regulators.
That's the debate we should be having today and we should learn a lesson from it.
I thank you, Mr. Chairman.
REP. KANJORSKI: Thank you, Mr. Royce.
We will now hear from the gentle lady from West Virginia, Ms. Capito.
REP. SHELLEY MOORE CAPITO (R-WV): Thank you, Mr. Chairman. I would like to thank you for holding this hearing today, and it is my hope, as others have shared that this will be the first in a series of discussions on the future of the GSEs, Fannie and Freddie.
As we are all too well aware, the long debate over whether or not the GSE's federal guarantee was explicit or implicit, was resolved last fall due to an overabundance of risk on their portfolios. Fannie and Freddie were placed to conservatorship by the Treasury and the Federal Housing Finance Agency.
Since then the government has set up new management teams within the two GSEs to control day-to-day operations but it remains in tight control over all -- other overall operations. I look forward to hearing the director of FHFA -- did I get that right? -- (laughs) -- on the current status of the GSEs, the role they continue to play in the mortgage markets and the future of the two entities.
The current situation is not ideal, and it is my hope that we can return the GSEs to the private markets as quickly as possible. What shape or form this will take is unknown at this time, but it is clear that the previous business model was not sustainable as it allowed the GSEs to take on too much risk and leaving the taxpayers to step in when the losses became too great.
There are many proposals out there for the future and our witnesses will be elaborating upon them. One issue that does concern me -- and I've heard from numerous constituents throughout the last several months -- is the affect that adverse market fees from the GSEs are having on my constituents' abilities to purchase a home. In some cases, these additional fees are actually pricing home buyers out of the market.
I look forward to hearing the director speak on the genesis of these fees and their effect on liquidity in the mortgage market. I look forward to hearing from all of our witness today and I want to thank the chairman for holding the hearing. I yield back.
REP. KANJORSKI: Thank you very much, Ms. Capito. And now, we will hear from the gentleman from Florida, Mr. Klein for three minutes.
REP. RON KLEIN (D-FL): Thank you, Mr. Chairman, and thank you for holding this hearing and the ranking member as well.
The current downturn has certainly showed weaknesses at Freddie and Fannie and it is important to determine the proper structure and goals of these programs going forward. However, it is equally important to ensure that FHFA is currently doing everything possible to stabilize the mortgage market and prevent foreclosures.
I'm particularly concerned about the current condition of housing markets, where I come from in South Florida, particularly because of the lack of the quantity of staff at Freddie Mac and Fannie Mae serving Florida.
I've heard from plenty of loan modification specialists, law firms, and other distressed asset managers in my district and throughout Florida, that are ready to assist Fannie with a vastly increased caseload of foreclosures, modifications, and refinancing. Yet, they are having trouble being approved by Freddie and Fannie because of red tape.
My concern is that foreclosures are occurring because there isn't enough staff to do proper loan modifications. And we also understand its unacceptable -- and we all know it is unacceptable for families to lose their homes to foreclosure because there isn't enough staff to do proper loan modifications.
I would just like to point out as I said that we had some conversations and we'd certainly recommend and ask that as we work through this difficult time period, that we have the staff and support to get these modifications working through the process. And look forward to hearing the comments and looking forward to working with all of our members and the representatives to accomplish this.
Thank you, Mr. Chairman.
REP. KANJORSKI: Thank you very much, Mr. Klein. And now we will hear from the gentleman from Texas, Mr. Hensarling
REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman. From my perspective, as a member of this committee and as a member of the congressional oversight panel for the TARP program, I believe there are a number of "but for" causes of our economic recession. None loom larger than the monopoly powers that were granted to Fannie and Freddie, coupled with the so-called affordable housing mission. That essentially mandated they loan money to people to buy homes that ultimately they could not afford to stay in.
Many of you have said though that, under H.R. 1427 passed in May of '07, that somehow the situation has been rectified. Since that legislation has passed, the conforming loan limits have increased to $729,000, increasing taxpayer liability.
The portfolio limits of the GSEs have been increased to $900 billion more tax payer exposure. Their share of new mortgages have gone from 50 percent to 90 percent more taxpayer exposure.
Taxpayers have now been forced to invest almost $87 billion through the preferred stock agreements. They are exposed to up to $400 billion under those particular agreements. The Congressional Research Service has estimated the cost of the conservatorship to be $384 billion at a time when Americans are struggling to pay their taxes and keep their jobs.
I'm glad, Mr. Chairman that you're holding this hearing. Since certainly, H.R. 1427 hasn't taken care of the worst of Fannie and Freddie, ultimately we need to see this conservatorship have a time certain to end and transition these enterprises back to the private market and get the hand of government out of this enterprise that has caused this taxpayer debacle for generations to come.
Thank you, and I yield back the balance of my time.
REP. KANJORSKI: Thank you very much, Mr. Hensarling. And now, we will hear from the second gentleman from Texas Mr. Neugebauer for a minute and half.
REP. RANDY NEUGEBAUER (R-TX): Thank you, Mr. Chairman.
I look forward to the testimony of our witnesses today and I believe the task ahead for this committee and for Administrator Lockhart and his team is, number one, stop the bleeding, as obviously you're going to testify, the American taxpayers have had to put on the extremely large amount of money into this entity, and it looks like we are going to have to put more.
The second is, in this committee, as we go down the road, is how do we keep this from happening again, because certainly we want to take steps in the future that do not put us back in the position that we are in now. And also making sure that we develop an exit strategy that protects the money that the taxpayers have already invested in these entities.
And fourthly, while we are doing all of this now we have to ensure that there is a substitute, another entity, another way to ensure that there is not a major disruption in housing finance in this country. If we do not have a way to transition to a housing financing source that will take up the slack because what we are going to see is testimony that basically the only game in town now is Freddie and Fannie and FHA.
If we do not have entities in place to take up that slack, we will cause another major disruption in the housing market at a time where American families have already lost a substantial part of their equity. We do not need to be in a situation where we're creating that.
So it is easy to identify the problems where we -- that need to be addressed. Obviously, many people have reasons how we got here, but more importantly, I think the important questions are, where we go from here. And I look forward to hearing from the witnesses today as where do we go from here.
Thank you, and I yield back.
REP. KANJORSKI: Thank you very much, Mr. Neugebauer.
And now we will introduce the panel, if I may. I want to thank you for appearing before the committee today and your written statement will be made part of the record.
Today, the Honorable James B. Lockhart, director of the Federal Housing Finance Agency will present a single statement on behalf of the agency. Also joining him at the table are two of his deputies, Mr. Edward DeMarco, chief operating officer and senior deputy director for Housing Mission and Goals and Mr. Christopher Dickerson, deputy director for enterprise regulation. These two individuals have the responsibility for regulating Fannie Mae and Freddie Mac.
Mr. Lockhart, you're recognized for such time as you may consume to make your remarks.
MR. LOCKHART: Thank you, Mr. Chairman. Chairman Kanjorski, Ranking Member Garrett, and committee members thank you for inviting me to speak today about Fannie Mae and Freddie Mac, their future and federal involvement in the housing finance system.
With almost $12 trillion in outstanding mortgage debt, housing finance is critical to the U.S. economy. As a conservator, FHFA's most important goal is to preserve the assets of Fannie Mae and Freddie Mac, that is our statutory responsibility. As a regulator, FHFA's mission is to ensure the enterprise and to provide liquidity, stability, and affordability to the mortgage market in a safe and sound manner.
That is also our statutory responsibility, and it is the public purpose the Congress gave the enterprises. The enterprises own or guarantee 56 percent of the single family mortgages in this country for a total of $5.4 trillion. Given that massive exposure, the best way to preserve their assets and fulfill their mission is to stabilize the mortgage market and strengthen their safety and soundness.
Working with the Federal Reserve, the Bush and Obama administrations and other regulators that has been our top priority since the conservatorship began and we will continue to be so. Supporting mortgage modifications and refinancing for homeowners into safer mortgages are an important element of stabilizing the housing market and thereby the U.S. economy.
The form in which Fannie Mae and Freddie Mac exit from conservatorship, once the housing market is stabilized, should be addressed by Congress and the administration and I think this is a great first step to have this hearing.
FHFA continues to classify Fannie Mae and Freddie Mac as critical supervisory concern. As there was -- were significant risk that they would be unable to fulfill their missions, we placed them into conservatorship last September. Since then, the Treasury Department has purchased $86 billion in their senior preferred stock. The enterprises' short-term financial outlook remains poor, which will result in additional request for preferred stock investment from the Treasury Department.
However, both enterprises have stress tested their capital shortfalls and expect the Treasury's commitment to fund up to $200 billion in each -- in capital for each of them to be sufficient. The senior preferred stock purchase agreements have given investors confidence that there is an effective guarantee of GSE's obligations.
In addition, the combined financial support of the Treasury Department and the Federal Reserve of over three quarters of $1 trillion to date for housing GSE debt in MBS have ensured they remain liquid.
Because of this support, both enterprises have been able to maintain a critically important presence in the secondary mortgage market. Their combined share of mortgage originations in the first quarter of 2009, and also in 2008 was 73 percent that was double the 37 percent in 2006.
While the enterprises have continued to support the secondary mortgage market, the new senior management teams have worked with FHFA to establish and implement comprehensive remediation programs.
The enterprises have made progress, but they face numerous significant challenges to their operations. The staffs of the enterprises and FHFA have been working hard to help to strengthen their safety and soundness.
In the current mortgage crisis, the enterprises are focused on mortgage availability, mortgage affordability, and foreclosure preventions. Loan modifications undertaken for their own broker business are critical for limiting their own credit losses and even more importantly stabilizing the mortgage market.
The enterprises and the FHFA worked closely with the administration to develop the Making Home Affordable program. Both enterprises have undertaken home affordable refinancing initiative to enable homeowners who are current on their enterprise owned or guaranteed mortgages to refinance at lower rates.
FHFA expects both the modification and the refinance program, which is just starting to really ramp up rapidly by late summer. In my written testimony, I summarize what went wrong in housing and mortgage markets. I identified some lessons learned and raised basic questions that policymakers face at this juncture.
I will now focus on my thoughts on the potential roles for the federal government and the housing finance market and some principles that I think should guide policy choices going forward.
The starting point has to be the future role of the secondary mortgage market, which connects global investors to local lenders and borrowers. Doing so helps to lower borrowing costs for home buyers and -- part because large institutional investors may be better able to fund mortgages and manage the risk in those mortgage portfolios.
Whatever options are chosen, the country's financial system will continue to require a vibrant secondary mortgage market including the function performed by the enterprises.
There are three specific roles in the secondary mortgage market. The first role is that of a liquidity provider to the secondary mortgage market for mortgage-backed securities.
The second role is that of a structure and/or insurer of the credit risk of conventional mortgage-backed securities. Private firms are limited in their ability to insure against catastrophic events, but government insurance comes with significant risks and moral hazards.
A third role is to alter the allocation of resources by providing subsidies to attempt to increase the supply or reduce the cost of mortgage credit to targeted borrowers. Such a role has really been house -- central to all the housing GSEs not just Fannie and Freddie, but the federal home loan banks which we now regulate.
But unfortunately, as the present crisis shows, it's had some mixed results. With these roles in mind, I would like to turn to what I consider some of the basic principles you have to consider as you're looking at the future of the mortgage market and Fannie and Freddie.
The first principle is that these institutions should have well defined and internally consistent missions -- missions that do not encourage excessive risk taking. The second principle is that there must be a much clearer demarcation of the respective roles of the federal government and the private sector in the secondary mortgage market.
Any federal risk bearing should be provided explicitly and at an actuarial cost. The old hybrid model, as many of you said, of private for-profit ownership underwritten by an implicit federal guarantee poses a large systemic risk to the U.S. economy as we found out.
The third principle is to base any organization that provides mortgage guarantees on insurance -- on sound insurance principles. That may require strong underwriting, strong capital positions, risk based pricing, and flexibility to react to changes in the marketplace.
The fourth principle is to create a regulatory and governance structure that ensures risk taking is prudent. From nearly the first day on my job three years ago, I pointed out the folly of allowing the enterprises to have such large portfolios, which we did cap, and also the folly of allowing the legally leveraged on mortgage credit by over 100 to 1. And of course, many others including many in this room did as well.
Congress did provide a stronger regulatory structure of the housing GSEs as part of HERA last July, but unfortunately, it was much too late. The fifth and final principle is that the housing finance should be subject to supervision that seeks to contain both the riskiness of individual institutions and the systemic risks associated with housing finance.
The latter type of supervision would include counter cyclical capital and policies that counter the private sector's tendency to generate lending booms and busts. With those principles in mind, there is really three basic structures for the future of Fannie Mae and Freddie Mac.
One is a government agency, another is a hopefully much improved GSE, and the third is a fully privatized firm. The first option would be the equivalent of nationalizing the enterprises, which I'm opposed to because I believe government insurance programs are particularly high risk and rise with moral hazards.
The second alternative would be to keep the enterprises as GSEs building upon HERA. They could be a public utility or a cooperative structure. They could continue with Treasury net worth protection or government reinsurance for catastrophic risk.
But extreme care would have to be taken to prevent the inherent conflict always present in the GSE model. A third option is to establish purely private sector firms to supply liquidity to mortgage markets with or without some form of government catastrophic reinsurance.
Private firms could offer greater competition and improved operational efficiency. However, to maintain the liquidity -- the level of liquidity, the MBS market has enjoyed under Fannie Mae and Freddie Mac, a high degree of standardization and quality control across firms would be necessary.
I would like to close with a few personal thoughts. Having worked at several private-sector insurance companies and advised many others, and actually run several government insurance programs, I can tell you government insurance programs are high risk.
They invite the private sector to shift risk to the government. Among other issues, it is often difficult in a political environment to calculate or charge an actuarially fair price. It's difficult to resist pressure to broaden the mission, and prevent inadequately compensated increases in risk taking.
Nevertheless, government has an important role to play in providing certain types of insurance, especially reinsurance against catastrophic risk. But again that insurance has to be pre-funded and actuarially sound and that is difficult in the government.
The enterprises and the federal home loan banks are playing a vital role in helping to stabilize housing in the economy today. Fannie Mae's and Freddie Mac's participation and leading role in the Making Home Affordable Program is extremely important in helping to stabilize their mortgage market and their own books, as Congressman Neugebauer said they will help stop the bleeding if we can make this program work.
As markets and the enterprises stabilize, there will be need to address the complex issues I have outlined in this testimony. It is important to get the mortgage market model right and the restructuring and the GSEs right, not for the U.S. economy, but also for all present and future American homeowners and renters.
I will be happy to answer any questions as will my colleagues. Thank you.
REP. KANJORSKI: Thank you very much, Mr. Lockhart. Mr. Lockhart, you know, part of a problem that we have and I probably would like to clear it up pretty early, is we've never had a definitive set of hearings or a commission appointed to designate what the cause of the disaster -- the economic crisis over the last year, a year-and-a-half has been.
And I hear many of my colleagues as I hear other commentators throughout our economy, asserting that it was caused for several reasons and quite extremely to say I never knew that CRA were so extensive within our system that they brought down the whole system but I've heard some people make that charge.
I've also heard people make the charge that Fannie Mae and Freddie Mac brought down the system, and I guess, I want to ask you the questions. Is that your opinion -- I can express mine -- and that Fannie and Freddie fell after the credit crisis occurred.
And the credit crisis basically occurred more in the securitization in the private markets, particularly the subprime loans than of Fannie and Freddie. They followed in the destruction of credit in the country. Is that relatively true?
MR. LOCKHART: There is many, many factors and lots of people guilty over this bubble we had in the economy and in particular the housing market. There was excess liquidity. There -- as former Secretary Paulson used to say, risk was mis-priced not only in the housing market but across financial markets and across financial institutions.
Certainly, in the housing market, underwriting standards fell dramatically and in particular the subprime and Alt-A market and most of that did go into the private-label securities.
I have to admit that Fannie and Freddie were big buyers of those securities. They -- only the AAA ones, but they and everybody else and including the rating agencies did not do enough analysis on those securities.
Certainly, to keep some market share and their market share actually dropped over -- about a three-year period from over 50 percent to about 33 percent. They did lower their standards in '06 and '07.
They didn't lower as far as the rest of the market, but they did lower their standards. As I said there were a lot of reasons for what happened. Fannie and Freddie, I do not think were the cause, but they like many other institutions and including the poor regulatory structure that OFHEO had.
We didn't really have the power to stop them from being 100 to 1 in leverage. We actually had an extra capital charge on them, we froze their portfolios, and still there were problems. So there were a lot of different reasons, the regulations, we were too slow to get the new legislation. The housing market bubble was caused by you know world-wide financial issues and not just you know, Fannie and Freddie.
REP. KANJORSKI: And as you know the reform legislation, to correct your present agency and give you the powers of world class independent regulator. That started considerably before it actually became law.
If I remember in 2005, we put that legislation before us and it failed to get Senate confirmation and therefore did not proceed to the president for his signature, but after that it wasn't enacted either.
And not to place blame, because I think it's the worse mistake we can make in placing blame. It was a Republic administration, a Democratic administration, a Republican Congress, a Democratic Congress.
But so we do entertain the facts that at all times during this immediate run up to this crisis that is the four or five years of the real estate bubble, the Senate and the House were in the control of the other party than they are now. That is the Republican Party, is that correct?
MR. LOCKHART: I guess so, yes, sir.
REP. KANJORSKI: And the presidency of the United States was in the control of a Republican, is that correct?
MR. LOCKHART: That's correct. And that Republican was asking for reform from almost the day one he took the job. Yes, sir.
REP. KANJORSKI: And his party's Congress did not respond, is that correct?
MR. LOCKHART: As I understand the history, and I wasn't here in '05, so you just have to bear with me, but --
REP. KANJORSKI: But I --
MR. LOCKHART: -- they wanted stronger legislation -- (cross talk.)
REP. KANJORSKI: No question about it, he wanted a stronger legislation, but the people that controlled the House and the Senate at that time were his own party, is that correct?
MR. LOCKHART: That's correct.
REP. KANJORSKI: Now, I don't want to place blame. I think if --
I think if we could waive today's hearing, I join my colleagues on the other side that they appreciate my attempts here. I think we have to finally draw the line on quite -- on finding fault. It is not going to get us anywhere.
The one thing that does disturb me though as we talk through that, there is a tendency to think that maybe if this had been done in the -- totally in the private market and government had not been involved, do you see that as a viable alternative that we can just let Fannie Mae and Freddie Mac dry on the vine and become prunes and forget about them and let the private market go on.
Or will there be a negative impact in the United States in terms of real estate, ownership of real estate. And so the history is correct, Fannie and Freddie weren't instrumentalities forced upon the American people even though one of them was done in the Depressionary time, it was to fill a void that the private market wasn't filling. We didn't have a secondary market in real estate until government took the responsibility of establishing Fannie Mae, is that correct?
MR. LOCKHART: That's correct. In the -- you know, in the recent decade the private market through these private label securities did increase their market share pretty dramatically from Fannie and Freddie and from the FHA for that matter.
REP. KANJORSKI: And they did --
MR. LOCKHART: And unfortunately they did it in an unregulated and in an unsafe and sound fashion.
REP. KANJORSKI: I just want to say they didn't do it in a very superior way, did they?
MR. LOCKHART: That's correct.
REP. KANJORSKI: If we had to say anything in making the comparison between the government agency of grading the secondary market and Wall Street left to its own designs, Wall Street those last two or three years became an absolute disaster.
MR. LOCKHART: Right. And I think, going forward, we need a private sector in the market though and there is a lot of activity going on --
REP. KANJORSKI: Okay, we're going to try Wall Street again?
MR. LOCKHART: A much reformed version with much more transparency, much stronger underwriting. One of the things we did in '07 is we told and Fannie and Freddie that it couldn't buy any more private-label securities unless they conform to the nontraditional mortgage guidance, the subprime guidance. And those kinds of rules have to come forward that we do have much better transparency.
REP. KANJORSKI: Last night I had an interesting dinner by an -- with an interesting gentleman and members of the committee were there. Mr. Simon, who is a financier and quite renowned in the United States. He made a proposal to us.
And I think it merits consideration, I would like your opinion of what it roughly is. He feels that one of the major blows to the securitization market was the failure of the rating systems. The institutions that were there to rate and did in fact create all these AAA ratings that we found out much later on were nonsense.
And his suggestion and opinion was that we should take upon forming a non profit governmentally sponsored and supervised super rating agency that does not make money from the issuer but gets paid independently and separately either through an assessment or a fee and that it has to rate all of these bundled securities to securitize operations. Have you given any consideration to that type of thought?
MR. LOCKHART: Well, there is no doubt that the rating agencies failed. If you look at the AAAs that Fannie and Freddie bought, about 60 percent of them now are junk and only 5 percent are still AAA, not on down grade.
So there is no doubt that they failed. That there is no doubt that they should be reformed. I had not really thought about that, but there is in somewhat of an analogy in the insurance world where the NAIC does rate for insurance companies.
Whether that works or not I'm not sure but it's something that can be considered. I think more importantly, we need to reform the rating agencies and we need to get them back to rating and not consulting and getting fees for structuring bonds.
REP. KANJORSKI: Thank you, Mr. Lockhart. I've already run over my time and now I would like to recognize Mr. Garrett of New Jersey to proceed with his time.
REP. GARRETT: Thank you, and I too will not try to, you know, lay blame or be partisan on any of these things.
I appreciate the fact that you're just laying out the history of things that it was -- the reforms did get through the House. They were requested by -- you were here sometimes, other people during the Bush administrations were here. I remember Secretary Snow was here, a number of people pushing for limitations on portfolio and other limitations as well.
We were able to get it through the House.
It did go to the Senate, and then senator, not President Obama, I guess, was in the Senate at that time and not being partisan at all one way or the other, just saying that we just couldn't get cloture, as I recall, to be able to get the piece of legislation to the president's desk.
Had we done at that time, perhaps we wouldn't be sitting here today looking back to say, why didn't the world class regulator do the job, because the world class regulator potentially could have, I mean, done the job.
I also find this in your comment with regard to whether the GSEs or other federal regulations were part and parcel of the cause of it. Just very quickly, you ran down, you said it was excess liquidity, I guess, that's been part and parcel of a number of economists due to the excesses by the Fed on monetary policy.
You talked about lowering of underwriting standards, and I guess, that's part and parcel again of the Fed and the Boston Fed and others which instructed Wall Street to lower their underwriting standards and also with regard to the GSEs. I appreciate your candor of saying that those standards themselves were actually lowered at a period of time.
And so, we can't say that this one factor was the cause of it, but certainly we can say that certain -- this one factor was -- helped to exacerbate a problem when they bought up some of these bad -- bad securities that had bad underwriting standards.
With that all said, you know, one of my objectives has been to try to lower the risk that the GSEs have -- pose to the taxpayer. Both enterprises have a significant amount of interest rate risk due to the hedging practices with a limited number of counterparties.
We have discussed this before. It just was only a handful that you're able to deal with. And that these interest rates -- really are -- swaps are basically standardized bilateral transactions to help you manage your portfolio and hedge the risk.
Now, there are new clearing houses that have been popping up, if you will, being established. And they have the potential to significantly reduce the counterparty risk posed to the enterprises through these transactions if you were to just funnel them through and of course you know how that works. So could you elaborate how you are working to try to reduce the risk to the taxpayer with their counterparty risk through clearing houses like this for these swaps?
MR. LOCKHART: Counterparty risk is a big issue in the financial markets today. There is -- actually over the last year have been concentration of counterparties as there's been mergers and acquisitions whether it's in the mortgage market and the positive market and other areas.
But certainly as the quality of some financial institutions that suffered that it's meant that Fannie and Freddie and many others who have had to concentrate their derivative activity in Fannie and Freddie, both have well over $1 trillion of derivatives as do the federal home loan banks.
And so one of the concerns we have is that counterparty risk, what can be done about it, and we have certainly talked to them and they are looking very seriously about starting to move in some of their businesses into clearing houses and exchanges to diversify the risk and lower the risk.
REP. GARRETT: The product here is basically a standard product that we're dealing with, right?
MR. LOCKHART: Right. Well a lot of the Fannie and Freddie hedge the interest rate risks and pre-payment risks basically and they use swaps to a large extent. Sometimes they use more exotic instruments, but they do a lot of interest rate swaps and certainly that --
REP. GARRETT: (Cross talk) -- holding you back then or is there a timeline that --
MR. LOCKHART: As you said these are relatively new vehicles.
REP. GARRETT: Right.
MR. LOCKHART: They are looking at them. We want to make sure that, you know, it's done in a safe and sound manner.
REP. GARRETT: Okay. On another note, you -- with regard to the portfolio which is one of the areas that there was request four years ago to try to rein them in. What's the purpose of keeping the portfolio where it is now?
Actually, it has gone up since this whole problem began. I know it's supposed to begin to run down starting in 2010 next year. But why don't we just begin running that down right now and then just say we're going to eliminate that?
MR. LOCKHART: Well, the key thing that the portfolios have been used for since the conservatorship is to support the mortgage backed securities market. Now, obviously the Treasury has been buying a lot, the Fed has been buying a lot, but that's extremely important to get those mortgage rates down.
Since the conservatorship, we're seen mortgage rates drop about 150 basis points, 1.5 percent to about 5 percent from 6.5 percent. And part of that has been the Treasury, the Fed, and also Fannie and Freddie buying those mortgage backed securities.
But obviously, the Fed and Treasury have much more firepower and at this point their portfolios are relatively stagnant.
REP. GARRETT: They are stagnant, but are you -- actually well they went up over --
MR. LOCKHART: They went up and now they are coming down.
REP. GARRETT: And so can you give us a timeline projection and on when they will be running up?
MR. LOCKHART: Well, a lot of -- you know, will depend what happens in the mortgage market, I mean to be perfectly honest what we need to do is to stabilize this mortgage market and then we need to figure out, you know, what to do with the portfolios.
The key job, the number one job is to stabilize the mortgage markets and that's by bringing mortgage rates down. It's by modifications. It's by re-financing.
REP. GARRETT: And I guess that's my last question if you will is, is that your overall job and this is -- on your opening comments is what's the job of the conservator? And you said it was to preserve the assets of the GSEs. What you didn't say in any sentence or paragraph after that, "and balance it against the interest or the -- to the taxpayer." Do you see that? Actually, are you charged with that? Or you see that as part of your role?
MR. LOCKHART: Very much so. The -- you know, if the assets of Fannie and Freddie go down, that means more money from the taxpayer.
Well, that's part of the -- very much the job is to try to over time, limit the draws from the Treasury Department. And my view is the best way to do that again is to stabilize the mortgage market through modifications and re-financings.
REP. GARRETT: Yeah. And we've had correspondence in the past on -- with regard to the last point and that is as far as the statutory authority to the GSEs, to enter into these modifications.
Some outside experts have said that there is not that statutory authority to enter those modifications and that -- the fact that that doesn't actually -- (inaudible) -- to the benefit to the taxpayer as well, as a side issue as well. Just want to comment on your statutory authority to --
MR. LOCKHART: Right. You're asking about the modifications that are about -- higher than 80 percent loan to value.
REP. GARRETT: Right. Right.
MR. LOCKHART: Our view is that these are the risks that they are already holding. They already hold these mortgages and by lowering the payments or refinancing they are lowering their risk and therefore helping the taxpayer potentially going forward.
And by the way the guarantee fees on these new mortgages tend to be higher than the ones they are replacing. So it's really a benefit to the taxpayer.
REP. GARRETT: My understanding is that Fannie Mae's financial statement indicated that that would actually increase risk for the GSE.
MR. LOCKHART: Not for re-financings. I think what they may have said is that modifications could potentially have the impact of increasing short-term loses. But my view is over the long term, there will be a benefit and to the GSEs and to the taxpayers.
REP. GARRETT: What's your foreclosure rate now?
MR. LOCKHART: The foreclosure rate is relatively low at Fannie and Freddie at the moment we're talking in, you know, they have 100,000 properties in --
REP. GARRETT: Well, that steps on everything. I'm just talking about what we're talking about here on the re-finance side.
MR. LOCKHART: On the re-finance side, it's too early for these new re-financings to miss the payment, let alone --
REP. GARRETT: Really?
MR. LOCKHART: -- to redefault, yes.
REP. GARRETT: So the figure that I was, I guess, thinking about, the 75 percent figure that's --
MR. LOCKHART: Well, if you're talking about the historical redefault rate at Fannie and Freddie --
REP. GARRETT: Yeah.
MR. LOCKHART: Okay. It has actually been relatively low around 30 percent. But in the last year that's, you know, risen quite rapidly with the downturn in the economy.
REP. GARRETT: Right. And but that's what we're talking about with this --
MR. LOCKHART: And --
REP. GARRETT: -- with this provision as far as the modifications --
MR. LOCKHART: Well, and again, these new modifications are significantly deeper and -- than the ones even a year ago. I just saw a chart that a year ago in the first quarter only 2 percent of the modifications had payments reductions of 20 percent. This quarter -- the first quarter this year, it is 52 percent.
So the modifications have changed so dramatically over the last year that it's really hard to use those historical numbers to say that, you know, we're going to have those higher redefaults.
Now, the economy, you know, still has trouble and that and certainly the reason for the default tend to be lost jobs, lower income, and the things that are affected by the economy.
REP. GARRETT: All right. Okay. I appreciate it.
MR. LOCKHART: Thank you.
REP. KANJORSKI: We're in the midst of four votes right now. They should take probably 30 minutes and we'll recess until that time.
REP. KANJORSKI: (Sounds gavel.) The committee will reconvene and we probably will get interrupted very shortly for another vote, but we're going to take question while we can.
Mr. Campbell, you're recognized for five minutes.
REP. JOHN CAMPBELL (R-CA): Thank you, Mr. Chairman, and thank you, Director Lockhart.
There is a Bloomberg report out today about a letter from then SEC Chairman Christopher Cox written to you, I guess, in January of this year with a number of subjects, I guess, including suggestions that that perhaps Fannie and Freddie are being encouraged to make loans that might not be in the best interests of the profitability -- (inaudible.) Are you familiar with this letter?
MR. LOCKHART: We don't really comment on correspondence from board members. But I can tell you that -- and Chairman Cox was the member of the new board that was created out of HERA.
I can tell you that we worked closely with Chairman Cox over the three years that I was at OFHEO, and now FHFA, where he is very involved actually in the Fannie fines that we did right about three years ago.
The issue that as reported -- and I will comment on the issue as reported in the Bloomberg article, and the issue I think is if you want to sum it up, is does modifying mortgages and re-financing them cause damage to Fannie and Freddie?
And my view is -- I think I said earlier, they sit on $5.4 trillion in mortgages. That mortgage book is so large and so important and that that -- what if they have -- what they can do to stabilize the market will be good.
Now, one of the problems is from an accounting standpoint, when you modify a loan they have to take it out of their mortgage-backed securities and they have to write it down as if it wasn't modified. And so there is a large deduction.
So there is a short-term cost, but my view is that there is a -- if it goes into foreclosure the cost will be worse on that mortgage, but more importantly they'll be worse in the neighborhood and it will be worse for the $5.4 trillion book.
So the view that I have had and I share with the management of Fannie and Freddie is that their number one job at the moment is to help try to stabilize the mortgage market.
REP. CAMPBELL: Even if that -- maybe in the short-term or whatever is not the best thing for the financial result of Fannie and Freddie.
MR. LOCKHART: It's a really a very short-tern negative on the financial result because they get to take this back in, and in fact that accounting is going to change January 1st of next year with the consolidation of all their mortgage-backed securities, so it's an extremely short-term effect. And then some of that actually may be written back.
REP. CAMPBELL: Let me ask you, Director Lockhart, if I can, could we, members of this committee see this letter?
MR. LOCKHART: I don't think that's appropriate, but I will check with my lawyers.
REP. CAMPBELL: Okay. Because I don't -- Mr. Chairman --
MR. LOCKHART: I think it was an SEC letter, so it may be better to ask the SEC in fact.
REP. CAMPBELL: Okay. Mr. Chairman, there was a letter written from then SEC Chairman Christopher Cox to Director Lockhart in January.
And so that's something I think the committee members should be able to see and I'll just say I would have a hard understanding why. And members of committee given that the Fannie and Freddie are under receivership --
MR. LOCKHART: Conservatorship.
REP. CAMPBELL: Conservatorship -- sorry. You're correct, my bet -- would not be allowed to see this letter, but I would hope that the chairman and the committee would support that position.
MR. LOCKHART: I can tell you this letter has been discussed with the new board, at the first meeting of the new board when -- as the new secretaries came in and we've gone through the contents and we're continuing to look at those issues and we'll continue to work through those issues.
Again, as we work with the board members it is an advisory board and they have been very helpful. And I think it's very useful to have that kind of dialog but I think to the extent that dialog gets out into the public it's not as helpful, and we may not have as much dialog in the future.
REP. KANJORSKI: A very confidential letter. The only people that I know that have it are the press.
REP. CAMPBELL: And I guess that probably makes my point for me. Thank you, Mr. Chairman. I think that since we have an oversight responsibility we should be seeing that letter.
But another question is that I believe the SEC -- I think your belief, sir, is that we have about ($)150 billion in risky -- that Fannie and Freddie have about ($)150 billion in risky outstanding mortgages that the SEC believes that it's closer to ($)1.7 trillion.
How do you reconcile that difference or what -- why do they feel it's so dramatically higher than I believe -- if I have the numbers right that you believe?
MR. LOCKHART: I don't know where the ($)150 (billion) came from. It might be that they have about ($)170 billion in private-label securities which are risky. There is no doubt about it. But they also have the rest of their book which is well over ($)5 trillion. And there is obviously, higher risk mortgages in that book. There is some subprime, not a lot, but Alt-A mortgages, interest-only mortgages, option ARMs, there is a series of things.
REP. CAMPBELL: That add up -- (cross talk.)
MR. LOCKHART: They don't add up to ($)1.7 trillion. The SEC, sort of double counted some of the mortgages. The numbers I would say is about ($)1.4 (trillion) out of the ($)5.4 (trillion).
REP. CAMPBELL: Okay. I believe, I'd love to ask more questions, but I believe my -- no? Then I'll a question we discussed earlier, it's my understanding that some of the early default rates, first payment default, that sort of thing, on loans made since the first of the year, in other words, long after we knew about this crisis, at Fannie and Freddie are equivalent to some default rates that were done before all of the subprime stuff kind of became out there.
Is that true? And if so, is that part of the strategy of helping the housing market by continuing to make loans to subprime and other lower qualified buyers and lower underwriting standards?
MR. LOCKHART: It does no one any good. And I think it's one of the lessons we really learned in the last two years to make a loan that we think they are going to default on, or Freddie and Freddie think they are going to default on. It hurts the individual, it hurts the neighborhood, it's just terrible. So it's certainly not part of the strategy to make loans that we think that Fannie and Freddie think there is going to be defaults on.
Fannie and Freddie have tightened their credit standards over the last year and since the conservatorship and they, you know, and frankly they have gotten grief from many groups for doing that. But I think it is appropriate you have to take a balanced look at the credit but it certainly does no one any good to make a loan if someone is going to default.
REP. CAMPBELL: Do you know what the first payment default rate is?
MR. LOCKHART: I don't have the number in front of me. I can provide it to you. It's -- it's not only a function of, you know, the loan, but it's the function of the economy and it also can, you know, as I've told you earlier it can be a function that the underwriting was poorly done. And in that case, Fannie and Freddie have the right to return it to the financial institutions that sold it to them.
REP. CAMPBELL: Thank you for your forbearance there, Mr. Chairman.
REP. KANJORSKI: Will the gentleman yield on that --
REP. CAMPBELL: I'm happy to yield whatever time the chairman will allow me to have.
REP. KANJORSKI: Maybe actually, it would be along the analogy that there may be some costs involved, short term on some of the aspects of things, but as a long-term the overall goal -- overarching goal is to just to stabilize the marketplace, maybe it's not a bad -- from that analysis this may not be a bad thing to say, we're going to underwrite loans on rates -- at terms that aren't necessarily, likely to get paid back because it will prop up the economy over the long- term.
MR. LOCKHART: Again Congressman, you know, a default doesn't help anybody and it certainly doesn't help individuals, neighborhoods and --
REP. CAMPBELL: Particularly a first payment default if --
MR. LOCKHART: Right.
REP. CAMPBELL: -- if that information that I have is correct.
REP. KANJORSKI: Well, we have two votes on here. We'll take a recess that would probably consume at least 15 minutes and then we'll reconvene.
Committee stands at recess. (Sounds gavel.)
REP. KANJORSKI: (Sounds gavel.) The subcommittee will reconvene. We'll recognize Mr. Hensarling of Texas for five minutes.
REP. HENSARLING: Thank you, Mr. Chairman.
Mr. Lockhart, in your testimony you stated that, quote, "As conservator FHFA's most important goal is to preserve the assets of Fannie and Freddie, but as regulator FHFA's mission is to ensure liquidity, stability, affordability in the mortgage market," seems to me that kind of gets to the crux of the matter. How do you reconcile these two missions? How are you serving two masters?
MR. LOCKHART: Well, we actually reconcile it pretty easily because the safety and soundness that you left out of that statement is also important in the mission side. And certainly conserving assets is a safety and soundness principle. The -- what my view is, and it's critical that the best way to conserve assets for Fannie and Freddie is to be able to be aggressively modifying loans, refinancing loans and ensuring the liquidity in the mortgage market.
They sit on $5.4 trillion in mortgages, and if the market continues to fall, those losses will continue to mount, so the best way to conserve assets is for them to continue to fulfill their mission of providing liquidity, stability, and affordability to the housing market.
REP. HENSARLING: Under what scenario would you recommend a alteration of the status from conservatorship to receivership? Already we're at about $85 billion of taxpayer exposure; ($)400 has been authorized but yet Uncle Sam is 80 percent owner of the GSEs, ostensibly, really on the hook for ($)5.3 trillion, I believe.
Is there a scenario under which you say conservatorship simply is not working?
MR. LOCKHART: We looked at the receivership versus conservatorship last August and September as we considered the, what to do with Fannie and Freddie. And we weighed the plusses and minuses and it was our view that conservatorship was the better alternative for the mortgage markets and for the U.S. economy.
And that's still my view that if we're going to stabilize the mortgage market, receivership might have the wrong impact and might unstabilize the market. So at this point we are not contemplating receivership and I really don't -- I really don't see the advantage of receivership versus conservatorship.
REP. HENSARLING: Is the taxpayer on the hook for the ($)5.3 trillion or not?
MR. LOCKHART: The taxpayer's on the hook for the senior preferred facility that the Treasury Department negotiated and that's ($)200 billion to Fannie and Freddie and ($)200 billion to each of them.
REP. HENSARLING: But the ($)5.3 (trillion), the federal government is an 80 percent owner, correct?
MR. LOCKHART: The federal government has a 80 percent warrant and it has never exercised that warrant so -- but it has the right to exercise that warrant. But that's a common warrant, and as you know, if you are a shareholder you are not responsible for the debts of a company.
REP. HENSARLING: Well, it's a very unique shareholder at the moment. It seems to me that part of the problem that was created was the whole implicit versus explicit guarantee. And we know that one of the reasons that Fannie and Freddie, assumingly are the only game in town and their market share in mortgages has roughly doubled, is because of that guarantee.
Is there any scenario, where you would recommend that the full faith and credit of the U.S. be behind all $5.3 trillion of MBS?
MR. LOCKHART: The implicit guarantee was a problem and, you know, we've talked about it in this room many times and other places that there was no market discipline for these two companies because of that. And we didn't have the power as a regulator to, you know, control their growth and the market wasn't doing it either.
My view is that there is no reason at this point to make that explicit. I think the $200 billion senior preferred, given effective guarantee and I think that is all that is necessary at the moment. And certainly, you know, there are buyers in their debt and mortgage- backed securities at this point.
REP. HENSARLING: Don't you think the buyers of this paper think that once again Congress would come to the rescue and bail them out?
MR. LOCKHART: The buyers of this paper think that there is strong support from the U.S. Treasury through the senior preferred, yes.
REP. HENSARLING: So what's your exit strategy?
MR. LOCKHART: The exit strategy is partially the new structure we've been talking about here today. And you can't do that, in my mind, you can't bring them out in conservatorship until the market is stabilized and still you can see a profitable future. There maybe a portion, as in receivership, that gets left behind in what you might call a bad bank, if you will, that is protected by the senior preferred and then there is a bridge to a new organization.
REP. HENSARLING: Thank you, I see I am out of time.
REP. KANJORSKI: The gentle lady from Illinois, Ms. Biggert.
REP. JUDY BIGGERT (R-IL): I thank you, Mr. Chairman.
I have several questions, Director Lockhart, so if you could run through them rather quickly --
MR. LOCKHART: Okay.
REP. BIGGERT: -- in the time allotted. Number one is, many consumers in my district are thinking long and hard about purchasing a condo based on all of the new GSE requirements which are causing strain for -- also causing strain for homebuilders and community bankers. You know, so many people start and they say, "Well, I just not going to through the process," when they get into that. Could you comment on that?
MR. LOCKHART: Well, the GSEs have -- historically had standards that for a new condo that 70 percent has to be pre-sold. During the period when they lowered the credit standards in many areas they lowered the credit standard there as well. And now they have restored that old standard.
You know, in some markets there is a big issue of very empty condos. And again it doesn't make sense to make a loan that might go into default. And so work -- they continue to work with condo developers and to the extent that they see that if it is a good project they can bend those -- and change those rules but it's something that they think from a safety and soundness standpoint make sense.
REP. BIGGERT: Yeah, so if they -- it's a waiver or just bending the rules?
MR. LOCKHART: Well, it would be a waiver. I mean they would look at -- bending the rules -- probably not the right word. But basically, they'd look at projects and to the extent that they see that they had a good, sound project they will make the loans.
REP. BIGGERT: Thank you. And why is it that nonprofit social services groups in -- this is in Illinois -- who provide housing to very low income people and families with disabilities can't qualify for a lower refinancing rates, these are -- you know these are multifamily houses or homes that are now considered commercial versus home occupied properties. And why is that designation for them?
MR. LOCKHART: I'm not sure about that. I'm going to have to look into that --
REP. BIGGERT: Okay, if you can --
MR. LOCKHART: -- I really had not heard about that issue before.
REP. BIGGERT: Okay, thank you. Then another Illinois issue is, why is it that Fannie and Freddie still have a policy, for example, in the state of Illinois they only permit a handful of law firms, and I think in Illinois its two to handle foreclosures. And this continues to bottleneck the system as anticompetitive and I think a dis-service to lenders and sellers and borrowers.
MR. LOCKHART: I'm not sure about the situation in Illinois, but I know in some other states they are trying to expand their legal representation. You know historically, they weren't a lot of foreclosures and now that we're seeing, you know, unfortunately, a pretty rapid growth in them. They too will be looking at how to more expeditiously work through the issue.
REP. BIGGERT: Is that something -- is there anything regulation on this or is it just --
MR. LOCKHART: Nothing I'm aware of, but we'll certainly go back to ask Fannie and Freddie of that issue.
REP. BIGGERT: Okay. Then, why is it that the Home Valuation Code of Conduct is been implemented without the traditional public scrutiny and review. And it seems like this new policy wasn't vetted through Congress but only on a side deal made with the officials from the state of New York. It's -- you know it, I think it really is a dramatic policy that could severely impact many small businesses in my district and elsewhere.
MR. LOCKHART: The new appraisal code actually is by Fannie and Freddie. And they have, historically, had appraisal codes and this is strengthening of that code and it was done after a lot of comment, they received many comments from a whole series of different groups.
And they made significant changes in the appraisal code from what they had originally agreed to.
And it's really designed not to hurt small businesses what it's designed to do is in many ways the opposite of take pressure of appraisals -- appraisers to do bad appraisals, to do too high an appraisal. You know, there was a lot of problems that went on in the last three or four years in the housing market. And one of them was appraisal fraud. And this code was designed to help reduce that. And you know, Chairman Kanjorski is obviously been working on --
REP. BIGGERT: Right --
MR. LOCKHART: -- a companion -- a piece of legislation as well, and we applaud that effort. And certainly, Fannie and Freddie will comply with it.
REP. BIGGERT: Okay, then just quickly, what's the compelling reason to increase consumer fees?
MR. LOCKHART: The -- if you are talking about the fees related to guarantee fees that Fannie and Freddie have in place, they have a 25 percent -- excuse me -- 25 basis point adverse market fee that they've had for a while. They were going to raise that another 25 basis points after the conservatorship, they decided not to. But they've also done some risk based pricing.
So where they have raised these it's because the risks are higher. And you know, this is the balance of trying to conserve assets versus helping the mortgage market. And there are things that have to be done there. We have watched what they've done and certainly we've talked to them about what they've done. And we're trying -- and they are very much working to try to achieve a balance between safety and soundness and mission.
REP. BIGGERT: Okay. Well, thank you it's -- there is no question that we need a GSE reform package. I don't know that it's -- we want to have the taxpayers internally bailing out all of these various companies including the mortgage giants, so thank you very much.
MR. LOCKHART: I agree with the you, Congresswoman.
REP. KANJORSKI: Thank you very much, Ms. Biggert.
And now we'll hear from Mr. Adler from New Jersey for five minutes.
REP. JOHN ADLER (D-NJ): Thank you, Mr. Chairman.
Mr. Lockhart, I want to follow up on some questions on some of the dialog I heard earlier. My sense is that mortgage insurers lack the capital to underwrite new mortgages. I am wondering what you suggest the FHFA could do to solve that problem for America?
MR. LOCKHART: That's a good question. As you know, Fannie and Freddie cannot write mortgages above 80 percent loan-to-value. So that they have relied historically on mortgage insurers, and in the more recent past there was something called piggyback mortgages but those have totally disappeared.
So they have relied on mortgage insurers to make greater than 80 percent loan-to-value mortgages. The mortgage insurers like many other players in the mortgage market took some very significant losses and their capital has been depleted and that has meant that they can make -- do less mortgage insurance than they have in the past, and rightfully so, they have tightened their standards as a result.
And that has meant that Fannie and Freddie can make less loans in that space, which historically, has been an affordable space. And we have been working with the mortgages insurers. We being FHFA, but also Fannie and Freddie have also worked with the mortgage insurers. But FHA, in particular, has been working with the Treasury Department and we're looking if there is some mechanism under the TARP funding to help them get back into the marketplace and help bring some more liquidity to the mortgage market.
REP. ADLER: And do you think the TARP is a proper vehicle to achieve more -- (cross talk.)
MR. LOCKHART: It is certainly well within the philosophy of the TARP, it was related to mortgages and housing as one of the key target markets for the TARP funds. We've been talking to Treasury to see how it's structured because it's different. The TARP banks all have federal regulators. The insurance companies, as you know, do not have federal regulators and that -- and it was the federal regulators that made the recommendations to the Treasury team. And so we're working our way through the various issues there.
REP. ADLER: Leaving aside TARP for a second, are there other governmental solutions, Congressional solutions, you would seek for us to consider that would try to right this situation?
MR. LOCKHART: My view is that the better mechanism would be TARP. The -- it's difficult to see what, you know, these are state regulated entities. It's difficult to see what Congress could do to help.
REP. ADLER: Okay. I think there is enormous concern that Fannie and Freddie are big, and maybe too big. There is some discussion that maybe we need to have a few smaller entities to provide the GSE service that Fannie and Freddie have traditionally provided, do you have any view of that?
MR. LOCKHART: Well, certainly, I have always said that their portfolios are too big. And one way to shrink them would be to shrink their portfolios over time and that is part of the senior preferred agreement. I don't think it should be done right away. I think we need to get through this crisis first.
There are proposals on the table that say that, maybe there should be more GSEs or more players in this -- the secondary mortgage market space. And I think that's something that has to be looked at. You know, and I really have not formed an opinion one way or the other but I -- definitely should be worth looked at.
REP. ADLER: I'm sure we're going to look at it.
Thank you very much. I yield back the balance of my time.
REP. KANJORSKI: Thank you very much, Mr. Adler.
And now, we'll hear from the gentleman from California Mr. Royce.
REP. ROYCE: Thank you very much, Mr. Chairman.
I think when we look at the factors that created this economic catastrophe here, I don't think anybody says there was a sole cause. I think most economists believe that one of the major causes, besides Fannie Mae and Freddie Mac, one of the major causes was the fed funds rate in Europe and here in the United States.
The central banks setting a negative interest rate when adjusted for inflation for four years running there is no way that that wouldn't cause a housing bubble. But the question about the involvement in Fannie and Freddie purchasing subprime, purchasing Alt- A loans, purchasing instruments that otherwise would not, maybe find ready buyers out there.
That is unique, and that is a part of their role as government sponsored enterprises really that they evolved into. And as I said, originally, in '89 they wouldn't go -- they wouldn't go near a lot of these practices and especially wouldn't go near the idea of buying these things for their own portfolio. But then that process changed and politics took over.
What I wanted to ask about -- and I'll mention a couple of other factors as well. I don't think anybody says it was solely Fannie and Freddie. But a number of economists worry about the amount of bullying of the market that went with CRA in terms of the direction of loans to be made.
Now, there is a lot of worrying about what we placed in statute in terms of the NRSROs in terms of the credit rating agencies and the way in which we replaced by statute what otherwise would have been done by market discipline.
And the implication there, where that because these where government sponsored -- or because the government was engaged in setting up these standards, that it removed market discipline from the equation. And that helped compound the problem and this is the root of my question and I wanted to ask this of Mr. Lockhart and Mr. Dickerson.
I think one of the most telling statements of the GSE's impact on the entire mortgage market came, for me, from a former Freddie Mac employee who mentioned that the executives of the company understood that when they began purchasing junk mortgage-backed securities, as he called them, based on subprime and Alt-A mortgages they were sending a clear message to the market that these were, in fact, safe investments.
In other words, if the duopoly that controls most of the market is now going out and buying this from Countrywide. It's a message to the market that these have been analyzed as safe. As you know, prior to that time, Fannie Mae and Freddie were exclusively known for buying more conservative, conforming loans, so when they began purchasing junk mortgage-backed securities it was a clear deviation from their prior endeavors.
Do you believe the executives at Fannie and Freddie understood the message they were sending when they began to invest in junk mortgages, and especially at such a large scale?
MR. LOCKHART: Well, they were investing in these private-label securities that had subprime, Alt-A, option ARMs and other higher risk mortgages that were nontraditional mortgages, there is no doubt about it. They stayed in the AAA space as it turned out they and the rating agencies model failed dramatically.
Yes, they probably had some endorsement factor by buying them, there is no doubt about that, whether the management realized it or not, I cannot speak for them. I can tell you, to pick up your other point that they did get affordable housing goal credit from HUD for buying these securities. And they thought they were profitable and they were buying them because they thought they were profitable but it also did help them to get those credits.
REP. ROYCE: And I wanted to go to something now, the Treasury secretary mentioned, former Secretary Paulson actually said this. And this has to do with the three objectives that he thought we should have in terms of a reformed GSE structure. And I'll ask Mr. Dickerson about this too.
No ambiguity as to government backing. A clear means of managing the conflict between public support and private profit and a strong regulatory oversight of the resulting institution, taking politics out of the regulatory oversight function and allowing the regulators to actually do their job. Now, going forward, do you agree that these three objectives should be achieved, and what do we risk if we failed to meet that task in the future?
MR. LOCKHART: Well, I definitely agree with the three objectives. And I think I incorporated them in my five principles as well. It is extremely important to get it right. The ambiguity between public and private, the ambiguity between mission and safety and soundness help caused some of the problems we have today.
So as we go forward, we're going to have to really concentrate on what I said were five principles, what you said were three, to make sure that we can recreate the secondary mortgage market in this country in a safe and sound fashion.
REP. ROYCE: Okay, if you want to --
MR. DICKERSON: Right, I would agree with that. Certainly, the need for strong regulatory oversight is going to be a need that we will need to continue for sure --
REP. KANJORSKI: Manzullo, five minutes, please.
REP. DONALD A. MANZULLO(R-IL): Thank you, Mr. Chairman.
Mr. Lockhart, I personally want to thank you for the phone conversation that we had several weeks ago concerning the Home Valuation Code of Conduct. But I'm very disappointed in the answer that I got to our letter dated April 30th under your pen on May 8th of 2009.
The ostensible purpose of the Home Valuation Code of Conduct as set forth in your news release of December 23rd of '08 is to improve the reliability of a home appraisal. My question to you is, if a homeowner gets an appraisal that he doesn't like, what is his remedy?
MR. LOCKHART: If a homeowner gets an appraisal he doesn't like --
REP. MANZULLO: That's correct. What is his remedy?
MR. LOCKHART: His remedy is to try to get another appraisal.
REP. MANZULLO: That's not correct. If you take a look at page --
MR. LOCKHART: From a different lender.
REP. MANZULLO: Well, he would be forced to go to a different lender.
MR. LOCKHART: Yeah -- (cross talk) -- the lender has the right to make the decision whether they want to make the -- (cross talk.)
REP. MANZULLO: No, I understand that. But what if the lender is open to another appraisal?
MR. LOCKHART: What if the lender is open to another appraisal?
REP. MANZULLO: That's correct.
MR. LOCKHART: The lender -- I -- my view is that the lender cannot shop around for appraisals.
REP. MANZULLO: That's not --
MR. LOCKHART: That's one of the big problems we had in the last two or three years.
REP. MANZULLO: Right, I understand. The other problem is this. I would refer you to page three, number nine. We discussed this at length on the telephone and you gave me no answers in the written enquiry. If an appraisal comes back, that's an error.
The only way they could get another appraisal, a second or subsequent appraisal is, if there is a reasonable basis to believe that the initial appraisal was flawed or tainted and such basis is clearly and appropriately noted in the loan file, or unless such appraisal or automated evaluation model is done pursuant to written, pre-established, bonafide pre-approved funding appraisal review, work quality, et cetera, et cetera.
Your inability to understand my question and the inability to answer is based upon the fact that I don't think that your organization knows anything about real estate closing. You know the people that came up with this rule that would have --
MR. LOCKHART: The people that came up with this rule are the biggest mortgage lenders in this country.
REP. MANZULLO: Now that is interesting.
MR. LOCKHART: I mean, it's Fannie and Freddie that came up with the rule.
REP. MANZULLO: I understand. I understand that but my question --
MR. LOCKHART: And that the point is that, if there is a mistake this mistake can be --
REP. MANZULLO: No, not under your rules. If you read --
MR. LOCKHART: And if there is a problem they can go to the -- every state has appraiser regulatory board -- (cross talk.)
REP. MANZULLO: So here we are, we are trying to close a real estate sale. And there is a big problem with an appraisal. Let me give an example.
In a town house area that I know, end units are selling for ($)500,000, an inside unit for ($)470,000 and an end unit just sold for $350,000 because the party had died and it was out of state heirs and they were in a hurry in order to get that sale done.
So the appraisal comes in at ($)350,000. And the guy who wants to sell his townhouse, that's a end unit that should be sold for around $500,000 under these rules -- I mean, these are your own rules here, he has to either go to another lender which is absurd under the circumstances, or he has to show a reasonable basis to believe that the initial appraisal was flawed or tainted. I mean your rules can purposely devalue a home that somebody is trying to sell because you got so much bureaucracy tied up in it.
MR. LOCKHART: Well, if the appraiser is a professional he will have looked at the circumstances of that $300,000 --
REP. MANZULLO: Ah, that's not correct. That's not correct because you many have somebody that may not know that the original owner decided -- died and that it was a -- it was a fire sale. My whole point here is, if your job is to come up with a fair appraisal which you say to improve the reliability of home appraisals there is no recourse in here for the homeowner and the homeowner doesn't choose who the mortgage company will be to say, let's get another appraisal. Somehow you think that's collusion. And I think that's just a lack of foresight on the part of the people that came up with the regulations.
MR. LOCKHART: Well, a lot of this regulation is based on the USPAP as you know.
REP. MANZULLO: Based on the what?
MR. LOCKHART: What?
REP. MANZULLO: Based on the what?
MR. LOCKHART: The U.S. appraisal practices that have been -- (cross talk.)
REP. MANZULLO: Well, I understand that. But that's methodology of doing this in fairness. But I'm just talking about -- and it is a very simple situation that I brought out.
MR. LOCKHART: I mean -- I would be happy to see your proposal and we'll certainly forward it to Fannie --
REP. MANZULLO: Well, I'd like you to answer my letter, number one. And number two, we asked to -- the number of banks that actually own these -- these appraisal --
MR. LOCKHART: We tried to answer your questions in the letter and if there is some areas that you feel that we didn't --
REP. MANZULLO: I would like -- I would like to submit this under the authority of the chair, if it's okay with -- Mr. Kanjorski and force you to answer my questions. I mean, one of the basic questions in this --
MR. LOCKHART: Well, I think that we tried to answer your questions, but if there is some that you feel we haven't answered as well -- (cross talk.)
REP. MANZULLO: Well, you haven't answered. I mean, just take a look at the -- just a take a look at the -- at the -- at my questions and your answers to them. One of my questions was very simple. How many banks actually own AMCs? And you answered, "Well, we don't know."
MR. LOCKHART: We don't know but we'll try to find out for --
REP. MANZULLO: Yeah, but that's not what you told us in the letter.
MR. LOCKHART: Well, that's what I'm telling you now.
REP. MANZULLO: Well, then I would like to -- you know, would you consider regulation forcing any bank owns and AMC to disclose that. So that you can avoid any collusion, which is the purpose of this document, would you consider regulation to that effect.
MR. LOCKHART: We don't have powers over banks. We only have powers over Fannie and Freddie, so I mean that would certainly --
REP. MANZULLO: No I -- and you could make -- you could make a suggestion or you could even put into an amended rule if your whole purpose is to stop collusion. Wouldn't you agree with that?
MR. LOCKHART: Excuse me?
REP. MANZULLO: I mean, you could amend your rule here, couldn't you?
MR. LOCKHART: It's Fannie and Freddie's code and it's not --
REP. MANZULLO: No, I understand that. But you are the regulator for them.
MR. LOCKHART: Right, well I mean, as I said earlier, Congressman Kanjorski is working on legislation in this area and if there is something that you feel that Fannie and Freddie did not do properly, or what Fannie and Freddie were trying to do, and I think it's an extremely important role that, frankly, they didn't do as well, in the last two or three years, is set better standards in the market place.
REP. MANZULLO: No, I understand that -- (cross talk.)
MR. LOCKHART: And that's what we're really trying to do here.
REP. MANZULLO: But what you gave here was banks -- (cross talk) -- you gave banks the sole authority to pick the appraisal -- appraisers.
MR. LOCKHART: No, I don't think that's what we did at all.
REP. MANZULLO: But this is what you did, because it's the bank that chooses the appraiser either through an in-house appraisal company that the bank owned --
MR. LOCKHART: Well, we tried to --
REP. MANZULLO: -- or through somebody else.
MR. LOCKHART: -- definitely separate the lending officer from the lender that was choosing the appraiser.
REP. MANZULLO: Well, you -- that's like asking people to go to separate restrooms. I mean, that doesn't work. You know that doesn't work. There's -- I mean, if the -- if you have the opportunity to stop collusion, you would say, look, the banks cannot own these AMCs. Wouldn't you agree that'd be the better way to do that?
MR. LOCKHART: The -- again, it's to the bank regulators as to the ownership of AMCs.
REP. MANZULLO: Well, I know, but you could have made that suggestion, could you not have?
MR. LOCKHART: We can make suggestions, but it wouldn't have the power of --
REP. MANZULLO: No, I understand that. But I mean, do you understand what I'm trying to get around here?
MR. LOCKHART: Well, I certainly understand that you're concerned in this area, and certainly will try to respond, and will be happy to have another meeting with you to go through these issues to figure out, you know, what you think should be changed in the codes that would make it more responsive to your needs.
REP. MANZULLO: Sure enough.
MR. LOCKHART: Okay.
REP. MANZULLO: Thank you.
REP. KANJORSKI: Thank you very much, Mr. Manzullo. And if I may recognize for a motion, Mr. Royce.
REP. ROYCE: Just for a second, Mr. Chairman, I'd like to introduce to the record a -- for the record, a highly confidential restricted report from 2005 that Fannie Mae staff presented to management at that time which showed the tradeoffs between staying the course, and maintaining strong credit discipline in the company, versus accepting higher risk, higher volatility, and higher credit losses in order to drive up profits for their shareholders.
REP. KANJORSKI: Without objection, so ordered. (Sounds gavel.) And now we'll recognize the gentleman from California, Mr. Miller.
REP. GARY G. MILLER (R-CA): Thank you, Mr. Kanjorski. And I have great respect for the chairman, we just happen to disagree on this one issue, which is very unusual.
And I -- I did write you a letter, and I appreciate your response, but I read the letter several times and it basically boils down to one sentence.
Your response -- business practices have been adjusted and each market participant can adapt to a more responsible system that avoids coercion of appraisers and reduces the opportunity for fraud.
And I guess the problem I have with this is I know that a lot of realtors and mortgage brokers and appraisers have been in the real estate business since I was in my early 20s that are really good people.
And it seems like we have struck a deal here between the attorney general of New York and perhaps throughout -- prevalent New York, I don't know. And your office that impacts 80 percent of all the loans made in this country, period.
It didn't go through the Administrative Procedure Act or the Regulatory Flexibility Act, which I think normally it should have. And I'm really bothered that we're in a very difficult real estate market. I mean, I -- most of the people I know are somewhat involved in development or real state.
I was a realty broker and a developer since I was in my early 20s, and everybody I know is doing pretty bad out there. I mean, I know banks are suffering out there because they're having to foreclose homes, and they have dishevelment in the marketplace, which is further declining the value of homes out there that are for sale.
And I think it's problematic and ever reaching a real bottom in the market, so the markets could somewhat recover. And if we're going to look and say what can we do that really helps consumers, what can we do that is really fair to business people and everybody in the broad base, it seems like we're going in the wrong direction. This is just my opinion.
You could have a mortgage broker who has a client, they're really trying to shop for the best loan that they possibly can, but they can't even shop for the best loan and provide an appraisal associate with it that lenders can look at, and where they can determine where they can really get the best deal for their client, because now we solely have to rely on the bank to do the appraisal.
Now, when I was a developer and building subdivisions that was very common. You would go to a bank, and the bank would do their appraisal on your subdivision.
But a subdivision is altogether different and much more complicated than making a loan on just a single family home, or a new home that's just been completed and you can establish some reasonable fair market value.
One has much broader pitfalls in more areas that can go wrong and complicate the appraisal for a lender when you're dealing with a subdivision than when you're dealing with an individual home.
And I just -- I'm really concerned that we're dealing with a very difficult marketplace. We're dealing with consumers that are having very difficult times even getting loans today, as you know.
They have to have stellar credit to get a good loan, and if GSEs weren't in the market today, they'd be making no loans in California to be quite honest with you, because they're the only ones really willing to lend in -- (inaudible) -- jumbo marketplace.
Most lenders can't make a fixed 30-year loan and sit on that loan for that period of time, because they don't have the liquidity to do it.
So when they've got consumers out there that go to the realtor or they go to their local mortgage broker who's trying to package a loan for them, and go out and shop for that loan in the marketplace, it seems like we're making it much more difficult and hamstringing them in more ways by saying that an agreement that perhaps works in New York, and may be it's the best thing for the state of New York, I don't know, but I can say it doesn't seem to be the best thing for the state of California and to many other parts of this nation to make it much more difficult and place much more control in the hands of one bank rather than having an individual being able to shop a loan with numerous banks.
Because the problem is if you go approach a bank for the loan, they're going to be the appraiser, you can't take that to another bank, because the appraisal is proprietary property of the lender.
And I don't know why we're going in this direction, so may be you can tell me. I mean, I understand fraud, but we can deal with fraud. If you have appraisers writing improper or fraudulent appraisals, you can hold that appraiser accountable.
MR. LOCKHART: Right.
REP. MILLER: And it's very easy. That's why we have laws in this country, and there are laws against doing that. It seems like we have all these laws in the books that prohibit coercion and prohibit fraud, and yet we're saying, yeah, that we might have laws, but that's not good enough. We're just going to make it illegal altogether. Could you -- I mean --
MR. LOCKHART: Well --
REP. MILLER: I'd like to understand the benefit of why we're doing this.
MR. LOCKHART: I certainly agree to you that we don't need to make like more difficult for the housing market at this point. I think you're right on there.
On the other hand, we also want to make sure things are going on a safe and sound basis. There is not -- a mortgage broker can take a appraisal ordered by one bank and use it for the other banks. That's certainly --
REP. MILLER: But there are proprietary appraisers in many cases where they prohibit that package from being shopped.
MR. LOCKHART: As I understand it, the bank regulators do permit the transfer of that --
REP. MILLER: Well, they permit them, but the banks don't necessarily is the problem. They pay for the appraisal the bank did. That's like -- I'm not allowed to go use -- I'm not trying to interrupt you. I'm in the middle --
MR. LOCKHART: Yeah, then the banks will have to get another appraisal from other banks.
REP. MILLER: -- with authorization, they're not allowed to use somebody else's appraisal because they paid for the work product.
MR. LOCKHART: And there may be some occasions where more than one -- another bank will order its own appraiser. I mean, that unfortunately is a little extra friction in the system that could happen.
But the idea was that in too many cases brokers were, you know, getting inflated appraisals during that period that so many things went wrong in the mortgage market.
And I think it is --
REP. MILLER: Well, let me back up. What went wrong in the mortgage market was GSEs did a great job of bundling mortgage-backed securities for years. They really did.
MR. LOCKHART: Yeah.
REP. MILLER: And if a loan that they bundled went bad, they would replace that loan. And then a lot of these other private sector lenders said that's a really good idea, because look at all the money coming from Wall Street.
And they started making loans just forgoing normal underwriting standards and appraisals and to see if a person had a job. I mean, we can go back to predatory versus subprime, and we can really define what went wrong in this marketplace.
And I can blame the lenders who made that -- in many amount of business today who've made a fortune bundling mortgage-backed securities, making loans that were not even junk bond quality because they didn't even confirm the person had a job.
But I don't want to go back and blame my local mortgage broker and realtor who didn't participate in that fraudulent act, and say perhaps there's a few bad apples out there, so let's overturn the entire bucket.
And I'm not trying to argue with, and I just -- I don't think we thought that particular process through. I think we're ramping -- and I agree there was a lot of fraud.
But I can point to a few people out there who made it, that caused a lot of problem that I don't need to publicly point out, because a lot of them are gone today, been bought by other groups.
But we know who bundled these, and we know who made a fortune bundling them, who left the investors holding the bag who bought the junk. But we seem to be going after a sector of the marketplace that was not responsible for that and drawing -- and I would just -- I would ask you -- I'm not -- I'm trying to be polite in this.
I'm not trying to argue with you. And I'm not trying to be rude and cut you off. And I have the greatest respect for Mr. Kanjorski, I really do. We just don't agree on this one issue.
I would really hope that you would just take a moment and have somebody go back and review the process that normally took place, how we would deal with this; look at the existing laws that are on the books, if not occasions need to be made as far as corrupt brokers, and corrupt mortgage brokers, and corrupt appraisers or whatever.
That we deal with that effect without taking and turning the entire cart over, because an agreement that -- between one state and your office that perhaps may be -- may be there's a real problem in the state of New York.
I don't know, I'm not trying to accuse them of it, but may be there is. May be there is a real reason why the attorney general would come to you saying this -- there is such rampant fraud within our housing market here that we need to turn the laws over.
Perhaps they need to look -- shed light on their problem, but I think we've done it nationally, and impacting 80 percent of the marketplace in a very, I think negative way at the worst time.
And sir, I would just ask that you please take a moment and revisit this and say, did we really do the right thing?
I understand what you were trying to get at, and I applaud you for that, for getting the bad applies out of the marketplace. But what caused us to get in the problem we're in today are not the people I believe that are being impacted by them.
I'm just asking you if you would take time -- and Mr. Kanjorski, you've been very generous with your time on something you'd hate for me to talk about.
Well, I want to thank you for being generous and granting me more time, but we are good friends, and I have great respect for the individual.
And Mr. Lockhart, I have great respect for you and I'm asking that -- and you did mention something earlier that for years, I think we sent five bills through the Senate that were really good, finding a strong regulator over GSEs, and changing their -- the way they could do business.
We never accomplished that, but we tried hard. And I would just ask you to please revisit with earnestness what we've done here, because I think we're -- I think we're going at the wrong people trying to resolve a legitimate problem.
MR. LOCKHART: Yes, there is a legitimate problem there, and it's not just in New York State. Why the attorney general of New York got involved with all of these securities, the ones you don't like --
REP. MILLER: Yes, I --
MR. LOCKHART: -- were sold in New York. Fannie and Freddie have put out the rule, and they are continuing to look at the impact. And as they get impact back, and they understand better what's happening out there, they certainly have the ability, and we'll continue to --
REP. MILLER: And you will look at this?
MR. LOCKHART: We will look at the --
REP. MILLER: Thank you.
MR. LOCKHART: I mean, we don't see it directly. We see it --
REP. MILLER: That's what I'm asking.
MR. LOCKHART: We --
REP. MILLER: But you weren't responding to my letter, so I'm going to yield. You weren't -- I signed it, and I want to thank you for taking the time to respond.
MR. LOCKHART: We continue to dialogue. I have meetings now with both CEOs once a week. Certainly this issue has come up in the last month with both CEOs.
And so we're continuing to dialogue as to what is happening out there in the marketplace, and we will continue to do that.
REP. MILLER: And I was looking to dialogue and have my picture taken, so let's continue the dialogue.
MR. LOCKHART: Okay, but the other point you have to realize too is that the bank regulators are also looking at the --
REP. MILLER: Yeah.
MR. LOCKHART: -- issue at this point, and are looking at potentially making changes with them.
REP. MILLER: Yeah, but see I have a problem with -- when you say bank regulators are looking into it, we're focusing on one sector, and I think I'd like to look at all the people that are being impacted --
MR. LOCKHART: Right.
REP. MILLER: -- by this. And I agree the need -- bank regulators need to look at it, but if you would just revisit it, and I thank you, sir, and I thank you, Mr. Chairman.
MR. LOCKHART: Thank you.
REP. KANJORSKI: Thank you very much, Mr. Miller.
Mr. Lockhart, I'm sure we would have more questions, more members. We still have one last gentleman from Florida, Mr. Grayson, five minutes.
REP. ALAN GRAYSON (D-FL): Thank you, Mr. Chairman. I have here the Form 10-Q filed by Fannie Mae the month before it went broke. I actually went through it and read it myself personally.
And I had some questions I want to ask you about that to try to get a sense of how this happened and what we can learn from it. Specifically on page 112, it says risk management derivatives.
And in the table there it indicates that between December 31st of 2007 and June 30th of 2008, Fannie Mae increased its notional balances for derivatives by $255 billion.
Can you give me some idea of the justification for a company like Fannie Mae increasing its exposure to derivatives at seemingly the worst possible time by a quarter of a trillion dollars?
MR. LOCKHART: The Fannie and Freddie had many problems that surfaced over the last year, and certainly in their June 10-K of last year, they mentioned many issues.
The derivatives have not been an issue that actually caused any of the problems, any significant problems at the two firms. The derivatives were used to hedge their mortgage portfolios, and what they do oftentimes as the markets change is they add a derivative, but then rather than closing it out, they just buy one to counter the one that they had before.
And so you get this piling up of derivatives. It's an issue that we've talked to them over the years about, could they close these derivatives out rather than just buying a counter one?
Oftentimes, they'd buy it with the same counterparty, and so the actual exposure is not that large. But it's an issue that we've been talking to them about before that and before the conservatorship and after the conservatorship.
And as I think Mister -- Congressman Garrett asked earlier, there are ways to lessen the exposure of derivative exchanges and clearing houses. And it's something we're looking at, at the moment.
REP. GRAYSON: I wonder if it's really true that this had no effect on them. I mean, logically having a exposure that as of June 30, 2008 totaled $1,141 billion is something that could conceivably have some effect on your operations, particularly since we're talking about the time just two months before it went broke.
MR. LOCKHART: Right.
REP. GRAYSON: Why would they have such an exposure like that unless it were for a purpose, and for that purpose, couldn't it easily have been something that went wrong?
The reason I'm asking you these questions because if you look at page 78 of this same 10-Q, what you see is that for non-performing single family and multi-family loans together in their portfolio, which was almost $1 trillion by itself, the amount of interest income they lost because of non-performing loans was only $192 million and going down; $192 million versus $255 billion.
Isn't it more likely they got into trouble over the $255 billion than they did over the $192 million?
MR. LOCKHART: Well, I can tell you in retrospect the -- they haven't lost significant money in the derivatives area. They are using derivatives to hedge their mortgage-backed exposure.
Where they lost money, where they -- the vast majority of those losses, the over ($)100 billion combined losses in the two companies has been not on their interest rate risk and their interest rate risk management, although there has been some there. Most of it has been credit losses.
And it's credit losses related to the private-label securities, and credit losses related to their books. When we did look at the two companies in a very extensive look at the two companies in August, we worked with the OCC and the Fed.
We also -- Treasury had hired an investment bank as an adviser. And as we looked through all the issues in these two companies, the derivatives was an issue, but nowhere near the top. The key issues really were, they had a deferred tax asset, they had credit exposures in their private-label securities.
And in, you know, the three quarterly reports since then have shown that's where the big losses were.
REP. GRAYSON: Well, again, let's look at the information I just provided to you. If in fact the interest income that was lost -- and interest income is defined in the 10-Q as the amount of interest income that would have been recorded during the period for on balance sheet non-performing loans, had the loans performed according to their contractual terms -- if those losses are only $192 million, how could a $192 million loss result in a $100 billion plus loss to the taxpayers?
How is that possible?
MR. LOCKHART: What has happened since then is they've had to put up reserves for all the loans that are -- not all the loans, but they put up reserves for loans that are in default, and they've also had to take others in temporary impairments on their private-label securities.
And they've booked a lot of losses related to the credit. The interest give-up is a very small issue. Under proper GAAP accounting, if you think you cannot recover, you have to take another temporary impairment, or with a loan, you have to write it down to the value they expect to recover. And that's what's happened.
REP. GRAYSON: Well, I see my time is up, but let me just ask you this last follow-up question.
And thank you, Chairman, for your indulgence.
I still don't have a clear understanding from you about how a relatively tiny amount like a $192 million in unpaid mortgage interest on what is a $1 trillion portfolio, how that could possibly lead to taxpayers having to shell out a $100 billion plus?
MR. LOCKHART: Well, they have had a lot more missing payment since then, and it's spread throughout not only their lower quality book, but even into some of their prime loans.
And they've had to put up reserves, and they've built their reserves very dramatically since June, because of the deterioration in the mortgage market, and the deterioration in the economy.
We'd be happy to go through those numbers with you and meet with you and show you, you know, what really happened here, and go through not only the June numbers, but the September, December, and March numbers, and how these losses have marched through their -- unfortunately have marched through their financial statements.
REP. GRAYSON: Well, that would be great. Thank you very much for doing that, because as we know those who don't understand history are doomed to repeat it.
MR. LOCKHART: Yes.
REP. GRAYSON: Thank you, Mr. Chairman.
REP. KANJORSKI: Thank you very much, Mr. Grayson.
Mr. Lockhart, I want to thank you very much for appearing. And gentlemen, sorry that we had two interruptions and taken such a long time, but I'm actually sorrier to the next panel because you're going to --
But thank you very much and we may ask your indulgence again to appear again, because I think this is an important area where we want to spend a little more time on. Thank you.
MR. LOCKHART: Well, thank you for having the hearing and we'd be happy to come back.
REP. KANJORSKI: Thank you.
I'm pleased to welcome our second panel. Each of you will have five minutes to verbally summarize your written statement.
And first we have the Honorable Bruce Morrison, Chairman of the Morrison Public Affairs Group, a former member of our committee, and the former head of the Federal Housing Finance Board.
Mr. Morrison, welcome.
MR. MORRISON: Thank you, Mr. Chairman, and members of the committee. I appreciate the opportunity to be here, and I commend you on starting this process; as you have correctly said that it's not something can be done in a sprint.
These institutions were built over a long period of time. Our mortgage industry and our secondary market have been built over a substantial period of time. Repairing what's gone wrong needs to be done carefully.
When you're talking about an industry of ($)11 (trillion) to $12 trillion of assets, you're talking about real money. And it's important that the future of housing opportunity in the country not suffer as it has suffered in the last several years because of mistakes and misjudgments that have been made historically.
I think it's important to acknowledge that the federal role is not going away, and cannot go away. We can pretend that this entire industry can be operated without federal risk, without government risk, and then wait until the calamity comes.
But you can ask if -- you know, where was the federal role in AIG. And yet -- they -- all those credit default swaps which related to the housing market among others resulted in huge federal intervention, nothing that anybody really anticipated before it happens.
With respect to the mortgage industry, we have used the federal government to facilitate liquidity on a broad international basis for a very long time and on an increasing basis.
I think our challenge is not to try to privatize our way away from that, but to narrow and focus what the federal role is and to make sure that the insurance that is coming, the guarantees that are being given are paid for, and are priced upfront, so that the system really ensures itself rather than wait for the calamity, and then go out looking for the taxpayer money for the bailout.
We have gained a lot in this country by broad liquidity function that the secondary market provides. We need to preserve that. We don't have to preserve the precise institutional structures that have provided it in the past, but we have to protect the function.
It's important when we talk about this subject to separate who bears the credit risk and other risks involved in the mortgage industry, and who owns which entities that participate.
A lot of the discussion that goes on in this subject tends to fuzz them up as to which is it that the federal government is going to do and the private sector is going to do, who is going to own the GSEs.
The most important question is who is going to take which risk. And I think that the federal government should take a very narrow and catastrophic risk, that is risk of catastrophic failures, and that the private sector should take as broad and extensive risk position as possible, as we are able to define.
And I think in the past that the GSEs have taken more risk than they needed to take, that their role in the market was a part of a source, their limitations, and their size both of which led to the growth of the private-label securities market in a way that undermined the entire structure.
And it wasn't Fannie and Freddie who led the way, but it is Fannie and Freddie who followed along and became part of the problem. I don't think we should be drawing those lines.
I think we need a broader structure that brings the entire mortgage industry under one structural scheme, and we can do that without implicating the federal government more.
We can actually implicate the federal government less, but we're going to have the federal government as the ultimate guarantor, not as the guarantor of all risks, but of the catastrophic risks.
So that goes into credit to the scope of the guarantee, and I think the -- if you think about all of the credit risk that can be and will be covered by a securitization model, a first-loss protection that mortgage insurers and others carry a general expected loss coverage, the kind of structured debt that parcels out different levels of credit, but which requires a rating agency system that is not corrupted in the way that the system we currently have was during the crisis.
You can design a model that is a narrow federal guarantee that will give the kinds of liquidity the international access to funding that we've had, but have the federal government very rarely, if ever, have to step up to the plate.
And you can pay for it through guarantee fees from the beginning, if you design it that way, and I think that's what we ought to do.
I think other attempts to carve up the market that leaves the federal government's role not that broad will lead to regulatory arbitrage as we've already had, will lead to the situation in which the private market brings down the whole system because it's not part of the scheme.
With respect to ownership of the entities, as I say in my testimony, I really think that serious look ought to be given to cooperative ownership of Fannie and Freddie or whatever comes after Fannie and Freddie.
I think that the Federal Home Loan Bank system is a success in terms of its ownership structure, that it is better than the GSEs have been at aligning the interests of the public sector and the interests of the capital providers, that it doesn't require government capital, that it's able to scale its capital to the needs of the people who are the customers of the entity.
And that you don't hear people saying the Federal Home Loan Banks are displacing us out of the marketplace as you always heard about Fannie and Freddie from other players in the mortgage business, because the people in the mortgage business own the Federal Home Loan Banks.
And in the same way the people in the mortgage business can own the secondary market outlet, and get an advantage in terms of an overall federal catastrophic guarantee, but can provide both the capital and the risk-taking to make the system run. And in routine times there'll be no calling forth of any federal participation beyond that.
Finally, I'd say that in thinking about your regulatory restructuring that you're going to be thinking about -- across a broad range of financial institutions, think about the mortgage industry as a subject for functional regulation.
Right now you've just heard from FHFA, and you've heard when certain issues are being raised about appraisals, about how they don't regulate this or that, they'd have to go the bank regulators.
The mortgage industry should not have its regulatory structure divided into so many pieces, because looking just at the GSEs as a regulator doesn't give you the authority nor the perspective to see that the mortgage industry is properly regulated.
So think of mortgage industry regulation as a functional regulation subject, and may be when you overall change the financial institution regulatory structure, that will mean a specialization within one agency, a coordination among several agencies, but there ought to be a mortgage regulator, there ought not to be just a GSE regulator. Thank you very much.
REP. KANJORSKI: Thanks very much, Mr. Morrison.
And now we'll hear from the Honorable Susan Wachter, the Richard B. Worley Professor of Financial Management of The Wharton School of the University of Pennsylvania. Professor Wachter.
MS. WACHTER: Chairman Kanjorski, members of the committee -- Chairman Kanjorski, members of the committee, thank you for the invitation to testify in today's hearing on "The present condition and future status of Fannie Mae and Freddie Mac."
It is my honor to be here today to discuss the role of secondary mortgage market institutions in contributing to the crisis and what form these institutions should take going forward.
The government sponsored enterprises Fannie Mae and Freddie Mac have historically provided a secondary market for mortgages, but in considering their future role, today it is most important to consider how we may develop and maintain a housing finance framework that supports homeownership that is sustainable, and contributes to overall financial stability.
Broadly speaking, there are three options to the future of GSEs; first, privatization; second, nationalization, and third, a return to their original federal charter as hybrid public-private entities.
I will outline here the pros and cons of these three approaches and the factors that can be and should be considered as the subcommittee, and indeed the nation weigh the options.
Privatization of the GSEs in theory could have the benefit of desocializing the risk involved with secondary market housing finance. Critics argue that the GSE's special access to cheap credit and high leverage exposed the taxpayer to large liabilities.
However, as we have seen with the socialization of private entities' losses, privatization does not exempt the taxpayer from such liabilities.
A second option is to nationalize the GSEs and have a solely public secondary market, essentially FHA/Ginnie Mae for everyone. Taxpayer exposure to large liabilities is still a risk in a solely public sector approach.
There is automatic socialization risk, and no market check on underwriting, because of the US government guarantee.
The third possibility is a hybrid public-private secondary market. Hybrid public-private GSE financing worked fairly well until private-label securitization arose.
The GSEs found themselves losing market share, and shareholders pressured the GSEs to lower underwriting standards to compete, while federal regulators did not stop it.
In fact, it is useful to think of privatization and nationalization as one choice, and not two choices, because nationalization effectively means that the existing FHA function is augmented with a larger sphere for lending.
And the private sector of course would continue to originate and securitize mortgages much as it did in the run-up to the crisis. Thus the private-label mortgage securitization would take off again.
Within the hybrid public-private approach, there are various options, such as cooperative versus shareholder ownership, and choices on regulation such as a public utility approach versus a larger role for the federal government in governance.
These choices are not inconsequential in system design, but today I will focus on the larger pros and cons of this middle ground versus the alternative of a federal government entity and GSE privatization, that is a private-label mortgage-backed securities market which it would lead to.
While this issue is complex and multifaceted, the overriding question is which of these two alternatives best serves the interests of the public? The public has an interest in systemic stability in the financial system.
Individual households are the least well-equipped to weather instability in the financial system. In addition to financial stability, a key public interest in mortgage finance is consumer protection.
Moreover, from a household portfolio perspective, the long-term fixed-rate mortgage supports the goal of most families to at least have the option of continuing to live in their homes and neighborhoods, and the availability of this mortgage and this option depends on securitization.
To understand why, and to understand the importance of the secondary mortgage market, it is only necessary to note that historically in the US, housing finance was provided through banking systems funded by demand deposits.
In most countries today, deposit-funded banks remain the predominant, if not the sole source of funding for mortgage borrowing. In countries with bank-provided mortgages, adjustable-rate mortgages predominate, and the long-term fixed-rate mortgage is largely absent.
As colleagues and I have shown, real estate, including residential real estate, has been linked to banking and financial crises, not just once, but many times. Real estate crashes and banking crises tend to occur together.
In our own recent history, the savings and loan crisis of the 1980s both contributed to the recession of 1990-1991, and destabilized the financial system requiring a federal bailout.
Securitization was the answer to this crisis, with the recognition that the stability of the banking system depended upon ending banks lending long, financed by short-term demand deposit liabilities.
And securitization enabled the housing finance system to continue to offer the long-term fixed-rate mortgage to America's homeowners without endangering the banks' stability. Elsewhere, in the absence of a secondary -- secondary market institutions, banks provide borrowers with adjustable-rate mortgages.
As I noted, the long-term fixed-rate mortgage is essentially absent. The exceptions to this, besides the United States, is Denmark and to a lesser extent, Germany. Both of these countries also historically had in place extensive secondary market institutions, which while may differ from those of the US, do in fact link long-term funders to long-term borrowers.
Fannie Mae and Freddie Mac grew with banks' continued securitization of long-term mortgages originating and securitizing. The growth occurred both in the GSEs' guarantee business, in which they guaranteed mortgages bundled into pass-through securities and sold to investors, and in their portfolio purchases.
The growth of the secondary market coincided with a period of financial and economic calm in the United States known as the "Great Moderation." The controversy over the GSEs continued growth was to a great extent focused on the growth of their portfolios.
Ultimately, it was viewed that these institutions were implicitly guaranteed by the federal government. Thus, with the growth of the portfolio, taxpayers were liable for interest rate risk taken on by these institutions.
Interest rate risk was and is an unnecessary risk for the GSEs to take on. Importantly however, the GSE's federal charter did and does require them to set standards for default risk, to minimize default risk, and to monitor and standardize contracts to do so.
The current crisis originated not with the growth of the GSEs, but rather with the growth of private-label mortgage securitization. In an era of deregulation, private-label securitization drove the demand for new types of risky mortgages.
The demand for securitized mortgages fed the demand for recklessly underwritten loans. As private-label MBS grew in market share, so did non-standard mortgages from only 15 percent of market origination in 2002 to almost half of market origination in 2006.
Lending standards were not monitored for private-label securitization and declined over time. Surprisingly, so did risk premiums as Wall Street encouraged such lending despite growing risk.
Home prices were artificially inflated, and the willingness of institutional investors across the world to buy these subprime mortgages in the form of complex securities created by investment banks.
As lending standards deteriorated, the demand for homes and the price buyers were willing and could pay was artificially driven up. There was no and is no regulation in place to stop the deterioration of lending standards over time driven by the competition for market share for private-label securitized loans.
The lending was -- this lending was not sustainable and resulted in a credit bubble that burst, bringing down not only poorly underwritten nontraditional loans, but carefully underwritten traditional loans as well.
The private-label securities backing these loans were not liquid, nor did they bear risk premium based on their issuers and the underlying loans' originators' balance sheets.
Because these securities were not backed by standardized assets, they did generally not trade. Even if short-sellers knew of the heightened risk and mispricing of securities, they could not easily trade on this knowledge.
Private-label securities were marked to model, with the imprimatur of rating agencies and not to market. Thus market discipline was absent, could not work -- and could not work.
While it's clear that systemic risk derives from the pro-cyclical erosion of lending standards, there is not yet a consensus on how to avoid this going forward.
While no system is perfect, securitized fixed-rate long-term mortgages are critical for a stable mortgage system, and that robust, standardized securitization is unlikely to be accomplished by an FHA- like entity alone.
REP. KANJORSKI: Professor, could we wrap it up?
MS. WACHTER: I will finish up now. To be -- in any event, standardization need not only apply to securitized mortgages. Financial institutions could still originate non-standard mortgage products and hold on to them on their books or resell them to each other.
This means that financial institutions could continue to serve as a laboratory for product innovation. But they would be required to retain the risk on those products. This is the proper niche for niche products.
And in closing, the GSEs should not be removed from conservatorship until the economy is on a stable recovery path. They are currently helping to stabilize economy through their support of the housing market. This effort is especially critical in light of recent discussion over government purchase of toxic assets that may be difficult to price and liquidate.
In the future, the benefits for long-run stability and consumer protection point to the need for strongly regulated and private- market-disciplined entities to support the U.S. housing finance system. Thank you.
REP. KANJORSKI: Thank you very much, Professor.
And next, we'll hear from Ms. Frances Martinez Myers, senior vice president, Fox & Roach/Trident, LP on behalf of the National Association of Realtors.
MS. MYERS: Chairman Kanjorski -- I'm sorry. Chairman Kanjorski, Ranking Member Garrett, and members of the committee, thank you for inviting me to testify today on the current condition and future status of Fannie Mae and Freddie Mac. I am a senior vice president for Fox & Roach/Trident, LP, the holding company of six home services, financial and relocation related companies, located in southeastern Pennsylvania.
I am here to testify on behalf of more than 1.1 million realtors who are involved in all aspects of the real estate industry. Realtors believe that the GSEs' housing mission and the benefits that are derived from it continue to play a vital role in our nation's real estate market. Had no government entity existed when private mortgage capital dried up in 2008, America's housing market would have come to a complete halt throwing our nation into a deeper recession.
We need only look at the current status of the affairs in the commercial and jumbo residential mortgage market to see how different things might be today in the tradition -- if the traditional -- in the traditional residential mortgage market without Fannie Mae and Freddie Mac. For those reasons realtors believe that pure privatization of the GSEs is unacceptable. Rather, now support a secondary mortgage market model that includes some level of government participation, protects the taxpayers, and ensures that all creditworthy consumers have reasonable access to affordable mortgage capital.
NAR is currently conducting research to determine what model for the secondary mortgage market would best achieve these goals. We will share that information with you as soon as it is completed. For now, I would like to briefly outline a set of nine principles that NAR's board of directors has adopted and that we are using to guide in our research.
One, capital must flow into the mortgage market in all market conditions. Two, qualified borrowers should have access to affordable mortgage rates. Three, affordable housing goals should ensure that all qualified borrowers, including low and moderate-income households, have an opportunity to realize the dream of home ownership. However, such goals must also promote sustainable home ownership.
Four, financial institutions should be required to pass on the advantage of lower borrowing costs and other costs of raising capital by making mortgages with lower rates and fees available to qualified borrowers. Five, conforming loan limits should be based on increases in medium sale prices including higher index limits for areas with high housing costs.
Six, sound underwriting standards must be implemented and adhered to; seven, institutions must uphold the highest standards of transparency and soundness with respect to the -- to disclosure and structuring of mortgage related securities. Eight, there must be sufficient capital to support mortgage lending in all types of markets. Nine, the government must provide rigorous oversight.
Simply stated, the housing market must work in all economic conditions at all times and mortgage capital needs to be available to all potential qualified housing consumers. In conclusion, now I respectfully ask that Congress and all partners in the industry carefully consider these nine principles when discussing a new secondary mortgage model.
Working together, I believe we can create a solution that will serve our best interest now and become a model for the global real estate and financial markets well into the future. I thank you for this opportunity to present our thoughts on the current and future status of Fannie Mae and Freddie Mac, and as always the National Association of Realtors is at the call of Congress and our industry partners to help facilitate a housing and national economic recovery. Thank you.
REP. KANJORSKI: Thank you very much, Ms. Frances Myers.
Next, we have Dr. Lawrence J. White, the Arthur Imperatore professor of economics of the Leonard Stern School of Business in New York University.
MR. WHITE: Thank you, Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee. My name is Lawrence J. White.
I am a professor of economics at the NYU Stern School of Business. During 1986 to 1989, I served as a board member on the Federal Home Loan Bank Board. And in that capacity I also served as a board member of Freddie Mac. Thank you for the opportunity to present my views on the present condition and future status of Fannie Mae and Freddie Mac.
The hybrid private-public model that is and was and continues to be at the heart of the operation of the two companies is broken and should not be reconstructed. Before addressing what should be done, however, it's important to step back and remember that Fannie and Freddie have been just one part of a much larger mosaic of government policies at all levels to encourage the construction and consumption of housing.
Much of this encouragement is broad-brush, unfocussed that it mostly just encourages people who would otherwise buy a home anyway. So it's really not encouraging homeownership but just encouraging them to buy a bigger, better appointed house on a larger lot. I don't see a big social purpose in that kind of encouragement, instead of doing what social policy should be doing which is focusing on encouraging homeownership itself.
Now, Fannie and Freddie structure was just part of and still is just part of this broad-brush approach through the implicit and now somewhat more explicit support for their debt by the United States government. It looked like a free lunch, something for nothing, but we've now found out just how costly this meal has been.
So what is to be done? For the short-term, it's clear. Fannie Mae and Freddie Mac need to continue to be wards of the United States government, wards of the FHFA. The financial markets are simply too fragile to support anything else. However, for the longer term, because the model is broken, Fannie and Freddie should be really, truly privatized.
To replace their implicit broad-brush, off-budget effects in housing finance, there should instead, be an explicit, on budget, adequately funded, targeted program to encourage and of course, including appropriate counseling low and moderate-income households who might not otherwise be homeowners to become homeowners, focusing on the first-time homebuyer in the low and moderate-income household category through targeted help on downpayments, targeted help on monthly payments.
This is an appropriate function for government to really deal with that important spillover effect that everybody benefits when a neighborhood is more stable with more homeowners. Finally, and I think there are some other things that the Congress could do that could lower the real cost of housing, make housing more affordable, that would improve the efficiency of markets, benefit consumers and I would hope all the people at this table, as well as the people on your side of the table could support.
This would include making sure that there aren't impediments to shipments of timber from Canada so that we can keep the costs of construction of housing lower; making sure that there aren't impediments to shipments of cement from Mexico so that we can keep the cost of constructing housing lower; leaning on the states and localities to undo restrictive zoning that would otherwise keep the costs of property higher and make it harder to build lower cost housing; leaning on the states and localities to undo restrictive building codes that inefficiently causes the costs of constructing housing to be higher.
These are all things that could really benefit housing, make housing more affordable. Thank you again for the opportunity to appear here before the subcommittee. I'll be happy, of course, to answer questions.
REP. KANJORSKI: Thank you, Dr. White.
And next we have Mr. Michael Berman, vice chairman of the Mortgage Bankers Association.
MR. BERMAN: Thank you, Mr. Chairman. Every part of the real estate finance industry was deeply impacted by the financial crisis which led to the conservatorship of Fannie Mae and Freddie Mac, large and small lenders, servicers, investors, multifamily lenders, and most importantly consumers.
A smoothly functioning secondary mortgage is not only important for our industry, but for the entire economy. Despite their financial situation, the GSEs currently participated in over two-thirds of single-family mortgage transactions and about 75 percent of all multifamily mortgage transactions.
While the FHA also facilitates a significant share of residential mortgages, the GSEs currently are the prevailing force in the mortgage market. In addition to failing home -- housing prices and unprecedented foreclosure crisis the GSEs face severe management challenges. At the same time they are being used as instruments of public policy.
While MBA supports the temporary use of the GSEs in this manner, this is an unsustainable and artificial business model. We are committed to working with you to create a new structure for the future. Before we discuss the future, we must ensure that the current market works as efficiently as possible. For example, the credit facilities established by Treasury through the GSEs expire at the end of this year as does Treasury's authority to purchase GSE mortgage- backed securities in the open market.
We must ensure that these important programs are extended at least until the economy recovers. Congress should also help make mortgage credit more available and affordable by permanently raising the GSE loan limits. The higher loan limits have benefited consumers, but because they are temporary investors have been hesitant to purchase high balance loans. This dilutes the full benefit of a high loan -- higher loan limits because liquidity has artificially restricted them. Ultimately, consumers are forced to pay higher interest rates on their loans.
After the conservatorship was announced, MBA convinced -- convened a council of mortgage finance experts from every part of the real estate finance industry to examine these issues. The Council on Ensuring Mortgage Liquidity, which I'm privileged to chair, has identified the key ingredients of a functioning secondary market and established a set of principles for you and the policy community to consider when debating how to rebuild the secondary mortgage market in the future.
Our approach has been to examine the issues so that stakeholders could assess options in a measured and thoughtful way. We agreed early to avoid an overly prescriptive approach and instead to assess the market and present alternatives, which we plan to refine in the coming weeks and months.
I've attached to my testimony a white paper on this issue that has been cited as one of the more helpful compilations of options available today. This paper presents a set of building blocks to aid in understanding and discussing the merits of various market structures. It also lists and begins to describe nine alternative models for channeling government support to the housing finance system.
I've also attached to my testimony a set of guiding principles based on the key considerations mentioned in the white paper. The scope of these principles is the entire secondary market including responsibilities of the private market participants as well as the role of the federal government. I hope to address our principles in greater length during question and answer period, but let me close with a few thoughts to help guide the policy discussion moving forward.
First, secondary market transactions should be funded by private investors seeking market returns who understand, accept, and are held accountable for the risks that they take. Next, in order to attract consistent levels of private capital from a wide range of investors, the MBA believes that there is a role for an explicit federal government credit guarantee on mortgage-related investments in the core single-family and multifamily products. There is also a clear government role as a liquidity backstop in times of market distress.
Finally, a careful measured approach should be adopted so that current markets are not further destabilized. Safeguards should be established to ensure smooth transition from the present to whatever future model is developed. Thank you for the opportunity to appear before you today and I'm happy to answer questions that any of you may have.
REP. KANJORSKI: Thank you very much, Mr. Berman.
And next and last we'll hear from Mr. Robson of the Robson Companies and Chairman of the Board of the National Association of Homebuilders.
MR. ROBSON: Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee, I too am thankful for the opportunity to be here and testify today. The housing GSEs, Fannie Mae and Freddie Mac, and the Federal Home Loan Banks are vital components of the housing finance system providing liquidity to the mortgage markets and supporting the flow of credit to meet affordable housing needs.
Fannie Mae and Freddie Mac recently have encountered severe problems and are currently operating under conservatorship under their new regulator, the Federal Housing Finance Agency. The Federal Home Loan Bank system has also experienced stresses which, while considerably less intense, have affected its capacity for mission pursuit.
NAHB believes that the housing benefits that the GSEs have provided in the past and their significant roles in dealing with the current financial system's problem clearly demonstrate the need for federal government support for the secondary mortgage markets. There is broad agreement, however, that Fannie Mae and Freddie Mac will not be able to emerge from conservatorship without alteration in their current structure.
While NAHB believes the liquidity and affordable housing mission must continue with federal government backing, the primary objective is a system that assures that the continued availability of affordable housing credit that facilitates healthy housing markets and consistency in satisfying community housing needs. Therefore, NAHB looks forward to discussing different models for achieving that objective.
As the credit crisis has worsened, Fannie Mae and Freddie Mac have tightened underwriting standards and increased loan delivery fee. At the same time, their combined market share has an increase and now represents nearly 75 percent of the single-family market. The continual ratcheting up of delivery fees and tightening of underwriting standards has flung the pendulum too far denying credit to viable buyers.
NAHB urges to repeal these obstacles to help to increase mortgage affordability, enhance policy makers' attempts to reduce foreclosures, and help the country get back on the road to economic recovery. Last year, NAHB Housing Finance Force recommended a permanent federal backstop to the housing finance system in order to ensure a consistent supply of mortgage liquidity as well as to allow rapid and effective responses to market dislocations and crises.
The current crisis has clearly demonstrated that the private sector unaided is not capable of consistently fulfilling this role. The task force concluded that the enterprises should not be transformed into fully private companies because such companies could not be counted on to provide liquidity in times of crisis or to consistently address affordable housing needs. And they should not be converted to federal government agencies because such entities would be burdened by government red tape and would lack the resources and agility to respond effectively to market developments and housing finance needs.
NAHB's taskforce recommended that Fannie Mae and Freddie Mac be recast retaining federal backing, but limited primarily to providing credit enhancements of mortgage-backed securities. Some portfolio capacities should be permitted to accommodate mortgages and housing related investments that do not have a secondary market outlet, although Fannie Mae and Freddie Mac should have the flexibility to support the mortgage market under the types of conditions we are currently experiencing.
Specific principles for restructuring the housing finance system are outlined in my written testimony. In closing, NAHB urges that any changes to the role and structure of the GSEs not proceed until the current financial turmoil passes and that the markets return to more normal condition.
It would be extremely difficult, if not impossible, to restructure Fannie Mae and Freddie Mac when they are so intertwined in the ongoing efforts to address the deepening financial morass. NAHB looks forward to working with you to develop an effective, safe and sound, and reliable flow of housing credit under all economic and financial market conditions. Again, I thank you for the opportunity to testify today and I'd be happy to answer any questions.
REP. KANJORSKI: Thank you very much, Mr. Robson.
Listening to all this testimony here today I, sort of, come to conclusion that, maybe, we should go back to basics. And I want to pose just some basic questions, if I may. Who says that the government should have a role in ownership of real estate? I mean, should we -- I mean, I hear some arguments posed. It forms sometimes questions or opinions that the private sector and the private marketplace can take care of it. Is there anybody on this panel that agrees that we don't need a government involvement in real estate?
Unanimous consent. I don't know if I'm going to ask for party registrations -- (laughs.) Why -- you know, it seems to me that there is a little bit of an analogy not clear but a little bit of what happened in the late '20s and what happened in -- most recently in the real estate bubble burst. And that is that greed, to an extent, caused people to over inflate and create a false value that kept on feeding on itself to the extent that just as the boiler shops did in the '20s with the securities that didn't have the financial worth behind them in ultimate end the real estate didn't have the ultimate end -- the end and the --
I, you know, fortunately or unfortunately I sat here and watched this fever. And I remember quite well having Alan Greenspan before, it's not too many years ago, about five years ago, and I posed a direct question to him. I think we have a tape of that. I think I'll play that at my retirement party.
And I asked him whether or not he had any fear whatsoever of the real estate bubble and he said, absolutely not, 2005, and it could not cause a problem. They had it all handled, and managed, and analyzed. Now I have a lot of respect for Mr. Greenspan's economic capacity and ability to calculate economics. But he certainly missed that one.
And it seems to be the story today that we always miss the one at hand and then somebody in their testimony used those horrible words, "So this will never happen again." Good God, do we knock that out of our vocabulary? It's going to happen again regardless of what we do. It's just in another form or another method. Now the question is do we owe some loyalty to the private market that government should stand behind these things and in fact it's necessary?
You know, one of the methods I was thinking about here, if we pay the average people just a few percentage, maybe 10 (percent) or 20 percent more, in wages and income in this country we wouldn't have a problem. You would think that way because it's the difficulty in some of these people in honoring their commitments.
Now on the other hand, we do know that some people regardless of the amount of money they have they always over buy or over shop. But how -- what's the role of government? Are we to put a label teaching responsibility through government action?
Yes, Dr. White.
MR. WHITE: Yes, Mr. Chairman. I've been thinking about your earlier question as well as this one. And I didn't raise my hand before because there is a role for government in housing. But I think it's a much more limited role that, in fact, we see government playing. It ought to be dealing with the true social spillover effects the "positive externalities," to use an economist's term that comes with home ownership.
There's a role for encouraging innovation. After all it was Ginnie Mae, an arm of the Department of Housing and Urban Development that was the first securitizer of home mortgages. Freddie Mac was a fast second, a year later, but it was Ginnie Mae. So there is a role for government to play. But markets can be terrifically efficient in allocating resources; I think we're all appreciative of that. And I believe that a -- yes, there's room for government, but it's a much more limited role we ought to be seeing.
REP. KANJORSKI: I didn't ask whether there's room for that. That seems to say that we want to compete. Bailout is a is a member of the government. I don't want to compete.
And the reason I vote for housing is I want people to have good housing to live in and if they can otherwise do it, I wouldn't give them a penny. I mean, I wouldn't support any organization.
MR. WHITE: There are better ways by finding direct transfers. Rather than trying to lean on housing markets, all we do is encourage inefficiency in housing markets. We end up investing too much of our income, too much of our total capital stock in housing, not enough in productive physical capital, not enough in social capital, not enough in human capital, but to help people earn higher and higher income.
REP. KANJORSKI: We've got two more activists here. So we want to get to them. Let's --
MR. MORRISON: Mr. Chairman, I -- you'll always get the answer from the economists that, you know, if you appropriate the money directly and you target it most narrowly that that will be the best outcome and yet our political system doesn't really work that way. And we have been much more successful in providing fundamental benefits that work for the society as a whole when they work for the whole society.
And it's really the -- you could just compare how successful our social security program is compared to targeted income support that only goes to the worthy or those things that are most needy. And the fact is that we gain public support for a broadly successful intervention in a necessity like housing when it's broadly shared. And that doesn't mean that the targeted interventions that Dr. White is suggesting aren't good ideas.
But our basic access to housing for individuals, both multifamily and single-family, need an ultimate liquidity backstop to make it most affordable and most broadly available. And that can be done with a minimal government risk and a maximum private sector operation and risk-taking. It's not the system we have because certainly Fannie and Freddie took on much more risk and much more power than they needed to take on. But it can be redesigned so that you get minimal government, but something that is broadly available and has broad political support as the system has had.
So I think we should be careful of not facing up to the political realities of how we get the best overall result. You and I both have worked for years on what goes on in the committee on specific targeted matters. We had limited success. The broadly available benefits have broad political support.
REP. KANJORSKI: Thank you, Mr. Morrison. Doctor and then I -- we've got to get to my friend. But we're going to get a lot of time because I don't see a heavy population here.
MS. WACHTER: We need mortgages for home ownership. I think that's obvious. People can't put down ($)200, 000, $300,000. We need mortgages. We need government to set the rules for a mortgage market.
If we don't have a secondary market, we will have short-term variable rate mortgages. Many crises in other countries have come from that system, and of course, our savings and loan crisis came from that system. Thus we need a secondary market.
If we have a secondary market without standards we have a private-label securitized system. I'm not calling it a market, because it's not a market. We actually had market failure in the sense that we actually did not have a mortgage market. In order to have a mortgage market that works you need to have a structure, the rules of the game set out with the market players.
In the private-label securitized market, there was heterogeneous mortgages that were not traded, did not have market discipline, that -- the heterogeneity itself was a way of hiding the true cost and prices both to investors and to borrowers.
REP. KANJORSKI: Thank you, doctor. I've another couple of questions myself, but I'm going to allow my friends here on the other side --
REP. GARRETT: Mr. Chairman, thank you. Thank you to the panel. And I appreciate your opening comments as far as some basic questions. I -- when you said there's a role for the government here, I thought your next question would go -- and at least everybody concur, is there a constitutional basis for the federal government.
Yeah, I know we have a professor, anybody want to cite the constitutional basis for the federal government intervening directly or indirectly in assisting someone to buy a house.
MR. : I'm not a lawyer and I never try to practice law without a license.
MR. MORRISON: Commerce Clause -- it's a Commerce Clause.
MR. WHITE: That's right.
REP. GARRETT: At Commerce Clause, we can do just about everything. I'm not exactly sure why we have 50 states anymore actually since we had it.
But also on a broader note, is there -- we sort of had this discussion back when things were going well in the housing market. And the past administration would also often time be championing the fact that things are going well in the housing market and then the percentage of homeownership was always going up.
And similar to we'd hear from those in the rental community, in the -- in construction phase and what have you with say, you know, there's another trade out there as well, and how about us. And so their question would be, is there a target number that we should be looking at and saying this is what we're trying to get to in homeownership that when we reach 65, or 68, or 69, or 70 percent, we're never going to get a 100 percent homeownership degree.
That we've reached the approximate number that we should be striving for in homeownership realizing that there would always be some people who have to rent, and there will always be some construction guys out there and investors who say we should be building multi-family housing.
MS. MYERS: Our view on that, I think, would be that if you limit -- if you decide that well, once we get to 75 percent homeownership rate we should stop pushing that button.
REP. GARRETT: Yeah.
MS. MYERS: -- it also says that you would stop pushing the button that allows people to create wealth through homeownership. And homeownership creates so many other opportunities for people, and families, and the government, because there's a higher paying of taxes, there's greater investment in the community, and all those things that you would sort of limit its capability.
So to -- in my view, if you're going to limit the homeownership rate by saying oh, once we get there that's good enough. You're also saying you would limit the possibilities of what it could mean to the community.
REP. GARRETT: Now, I'm not going to put words in his mouth, Dr. White, might say to that, that there are other ways to create wealth in this country other than homeownership, and that if we're picking and choosing on that, am I -- is that something where you might go down that road?
MR. WHITE: I was going to say, gee, the last three years it hasn't been a creator of wealth and other things --
REP. GARRETT: Yeah, now, there you go.
MR. WHITE: -- I guess, it was for previous decades. Look, I don't know what that number is, it can't be a 100 percent, because it's clear homeownership is not for everyone.
It requires a relatively steady income, it requires budgetary discipline, it requires understanding of the obligations you're taking on.
There are, as Ms. Martinez Myers just indicated, positive consequences for communities; that's why we want to be encouraging it. But we -- you know, within limitations. And for sure, the very broad brush approach mostly doesn't encourage homeownership, it mostly just encourages people, who would otherwise buy anyway, to just buy a bigger house with five bedrooms rather than four, four bathrooms rather than three on a bigger lot --
REP. GARRETT: Right.
MR. WHITE: -- where's the social value in that. I don't know --
MS. WACHTER: This deregulated environment did not encourage homeownership. Contrary to what Dr. White said, homeownership rates have declined in the last few years. Homeownership rates were at the maximum in 2004.
And since 2004, homeownership rates have declined in this country. What's important is a mortgage market that works not only for homeownership, but also for multi-family housing. Mortgage market that works supports multi-family options as well.
REP. GARRETT: And did you comment on recourse loans in the -- in your testimony, or -- with regard to -- I guess you talked about the Danish system.
MS. WACHTER: I would be pleased to talk about that.
REP. GARRETT: But just a sentence, I don't have much time. Their system has recourse loans, right?
MS. WACHTER: That is correct.
REP. GARRETT: We generally don't.
MS. WACHTER: That is correct.
REP. GARRETT: Which is better, which works better?
MS. WACHTER: Well, certainly recourse is decided by the states --
REP. GARRETT: Yeah.
MS. WACHTER: -- and I do think we could have a viable system that is consistent with financial stability without -- with a non-recourse. We have had it for decades. It is only with the growth of the private-label mortgage-backed securities that we've had the financial instability that we've seen --
REP. GARRETT: Okay, I got you Mr. Morrison. Real quick though, with regard to the private-label it seems what I hear is it didn't work, because in part we didn't have all the rules and regulations in place so you'd have all those problems.
But if we come up here with all the right rules and regulations in place for the private-label marketplace, could we see that with one of my pet projects, which you heard before, the covered bond situation -- could we see those combined to basically expand the level that we need for a secondary market, and the --
MS. WACHTER: I'm sorry Congressman, I may not be understanding your question completely, but my understanding of the Danish mortgage system is actually it's not that different than our GSEs.
REP. GARRETT: All right.
And Mr. Morrison.
MR. MORRISON: Yeah. Mr. Garrett, the -- I'm a proponent of recourse. I think recourse is an important part of a good system, and there's no reason you can't have recourse of various structures.
Recourse is actually wrung out of our system by BASEL I capital rules, which made a transferred asset with recourse look exactly the same as a retained asset in terms of capitalization.
REP. GARRETT: Okay.
MR. MORRISON: And that's really why we have a non-recourse market. And we could have a recourse market if we design the capital rules sensibly to measure the risk. So you can have a recourse market, and it is one option for ways for the private sector to bear the risk.
And it's not the only model. It can be a part of the model, it can be a mixed model. So I would support your notion, covered bonds are no magic --
REP. GARRETT: Right.
MR. MORRISON: -- vehicle, it's another way of putting certain amounts of collateral behind your credit guarantee. And so it's a way for the originating institution to stand behind it. The question at the end of the day still is where does the liquidity come from in the system as a whole, and what kind of liquidity you get for those bonds versus bonds which have some kind of guarantee on them.
REP. GARRETT: Right.
MR. MORRISON: And you can do both, I don't think we're at -- really at war with each other on the options. I think it's a question of maximizing the benefit in the end.
REP. GARRETT: Right. And I'll close on this then is that and we're hopefully coming up with a solution in light of your comments on the political realities. Some great sage once said, don't let any great crisis go to -- do make good use.
Now, we're going to try to use this crisis to come up with something that actually works. And one last comment is, is that I know you've made a comment to Mr. White's comment as far as -- I appreciate your thought as far as targeting the money.
And you're suggesting that you don't -- you can't always target and you gave the example of social security being the broader system that really works, as an example of course. But we know that within a decade or so, social security is broke. And so that may not be the best example of saying -- giving us a system that's really working well across the board in targeting health care systems, and targeting things -- might actually be --
MR. MORRISON: Whatever system you have, you got to pay for it.
REP. GARRETT: Yeah. Sure.
MR. BERMAN: If I may respond to an earlier part of your question, with respect to multi-family --
REP. GARRETT: Yeah.
MR. BERMAN: -- in that instance -- and I happen to be a multi- family lender; Fannie, Freddie, FHA. That system today as well has become totally reliant on the GSEs -- over 75 percent of lending today in the multi-family sector is through the GSEs.
And so it in part points to another role of the government, which is to smooth out times -- certainly times like this when we're in crisis, but also its not just when there's a 100-year flood, but between those times to create a stable system where there's always liquidity in those markets for both multi-family and for single family.
REP. KANJORSKI: Mr. Manzullo -- sure.
MS. MYERS: I just want to -- I wanted to add to that as well. And I guess, to go back to some of the original questions around the role, and why the government should continue to play a role.
And I guess when you look at real estate in general, the industry, and if we looked at it honestly and said all the various sectors of the industry combined represent what would you say 20 to 25 percent of our GDP, I would think the government would have an interest in preserving and keeping a healthy industry, because it's so much of our GDP.
REP. KANJORSKI: Mr. Manzullo, and after you get your reservations, if you guys don't mind we'll open it up to the three of us to throw questions back and forth and sort of make a roundtable panel, because I think we could get some interesting responses that way.
REP. MANZULLO: I want to thank you guys for sticking around. I had some other things to do, but I called my wife and I said these people have been here all day and it's a very interesting and tremendously important topic. I've been listening to the testimony going on here and this is -- it's very interesting.
Ms. Martinez Myers, on behalf of the National Association of Realtors, you want to have this hybrid, and Dr. White, you say no hybrid let's let the market forces determine everything. But our -- you know, the real mess has to do with the fact that people bought homes that couldn't afford them in the first place. Isn't that correct?
MR. WHITE: Certainly, in many instances that has to have been true.
REP. MANZULLO: I mean, that's what made the loans go bad, as they closed down these loans, and they -- the so-called cheater loans and the --
MR. WHITE: But it's because everybody was drinking the Kool-Aid that housing prices can only go up and if housing prices can only go up --
REP. MANZULLO: Well, you had --
MR. WHITE: -- they're never going to be a problem.
REP. MANZULLO: Right.
MR. WHITE: There's never going to be a problem.
REP. MANZULLO: But even under the Fed -- the Fed had the authority -- it has the authority to do among other things, two things. Number one, the Fed can govern the instruments, and number two, it can set forth underwriting requirements. Okay.
So the regulator that could've stopped all of this was already in place. And it wasn't until December of 2007 that the Fed did this top to bottom review, and came to the incredible decision that you can't buy a house unless you can afford to buy it.
And I was stunned when the testimony came forth. And then again, that testimony came forth in October of last year, but the requirement is not effective until October of this year.
And I'm listening to your testimony and see the tremendous angst that goes on from the builders with Mr. Robson to the Realtors and the mortgage folks in between and -- but I mean, if somebody just -- if the Fed had said look at -- you can't sell a house to somebody who can't afford it. I mean, the regulatory agency was in place. Don't you think that they would've stopped this? Yes.
MS. MYERS: If I may comment, because your comment, it says that all of this is only because people bought -- got loans, because they -- loans they couldn't afford to pay.
And I know that in the light of our conversation around the GSEs, I think, that we need to kind of step back a moment and say, okay, for many, many years, decades the GSEs did a really great job of providing affordable products that was sustainable, and in fact their foreclosure rate was something less than 1 percent.
So for years, they did a very good job at helping to grow homeownership particularly among low-to-moderate income folks. Now, their biggest crime is probably diverting from that and buying those bulk loans with some assets that were -- and loans that were not the kind of loans --
REP. MANZULLO: Under pressure from both parties and presidents of both --
MS. MYERS: That's right. That they -- so they diverted from what they normally would do. So I think when we -- when we're sort of -- you know, using the hammer to sort of hit them over the head for that action, I think, everybody has to take a little responsibility for that.
And I think the industry has to take some responsibility, because there's no doubt -- and I think Chairman Kanjorski said there was a lot of greed out there. The field got hotter.
People kept selling. People kept pushing. People thought it will continue. People took loans thinking that they could flip the house or sell it and make a profit, and when it stopped it was not a good story.
So I think there's lots of different factors that contributed to that, some people themselves. I mean, a lot of people who have been homeowners for years refinanced their house, took out that equity, used it for things unrelated to their home, and the market changed, and guess what, now their house is worth less.
REP. MANZULLO: But you know, there are -- there have been, in the past 20 years, periods of time when people have paid x amount for their house, and then the houses have fallen in value. You've seen it happen here in Northern Virginia, but they just hang on and then five, six, seven years later they recover.
MS. MYERS: Uh-huh.
REP. MANZULLO: And -- you know, that's a lot different than whether or not they could afford the house when they bought it in the first place. And -- but what I don't understand, and maybe somebody, somebody here can clue me in why did the Fed sit back and do nothing? Does anybody -- (laughs) -- want to take a stab at that?
MR. MORRISON: I think it's a very good question. I think the Fed fed this crisis in two ways. They fed this crisis by keeping interest rates low for an excessive period of time, and they didn't discharge their regulatory responsibility with respect to the subprime market.
Those things, I think you're absolutely right about. Although it doesn't do us much good to be right about that.
REP. KANJORSKI: Whoa, whoa, whoa, whoa --
MR. MORRISON: What?
REP. KANJORSKI: -- let me break in here a second.
REP. MANZULLO: Of course.
REP. KANJORSKI: What obligation does the federal government have to do anything? You're the guys on that side saying, you are not staying out of our bedroom. Now, why do you want us to get into all your business --
REP. MANZULLO: No, no, Chairman, what I'm saying is that, you know, we're looking for a new regulatory system that will stop --
REP. KANJORSKI: Not really. Not really. We're looking really for the answer of why do we get ourselves so involved, create systems that fail --
REP. MANZULLO: Right.
REP. KANJORSKI: -- and then we end up blaming the person that wasn't originally part of the transaction.
REP. MANZULLO: Well, no --
REP. KANJORSKI: Your indication here is the federal government had a responsibility to see that prices weren't too high or --
REP. MANZULLO: No, no, no. I --
REP. KANJORSKI: What was the Fed supposed to do?
REP. MANZULLO: No, no, the Federal Reserve has the authority to -- they could've stopped the 2/28 mortgages and the 3/27 mortgages, and the Federal Reserve could've said look at -- we have some very basic underwriting requirements that when you buy a house you have to have, you know, minimum 5 percent down, or some other type of mortgage insurance, et cetera.
I'm just saying that those -- that the means by which the subprime mortgages could've been stopped, because they were too easy -- the credit was too easy. That regulatory process was already there. It just wasn't used.
REP. KANJORSKI: I think --
REP. MANZULLO: That's what Mr. Morrison just said.
REP. KANJORSKI: -- you know, I think you all convinced me at this point we have to prevail upon the speaker and the leader of the Senate to convene a committee to determine what the hell caused this thing.
If we think 2/28 mortgages caused the thing, no wonder we can't solve this thing. It has nothing to do with it; it's miniscule, it's -- who testified earlier, Mr. Lockhart, about the $200,000 -- $200 million of loss interest on a $100 billion loss. It's miniscule.
Our problem is why are we accepting the presumptions that we have a role to play, a committed role I have to play and why are we blind to really what happened. And I'm going to suggest it, as I did to --
REP. MANZULLO: Right.
REP. KANJORSKI: -- Scott here a little earlier. You know, our severeness in the real estate breakup occurred in the last four years.
REP. MANZULLO: Right.
REP. KANJORSKI: And it's when securitized mortgaging left government regulated entities, went to Wall Street, and Wall Street decided -- discovered a way to sell crap or AAA rating and did. And they sold it all around the world.
REP. MANZULLO: Right.
REP. KANJORSKI: And the only reason we felt obliged to go in and buy that crap from around the world is -- it looked like it had a good housekeeping field of approval of the United States of America. And we were too damn embarrassed to recognize that we stole this money all around the world with crap.
REP. MANZULLO: You know, I agree. I mean crap is crap. But the --
REP. KANJORSKI: Well, then why don't we identify who put that crap together, if it's a private --
REP. MANZULLO: Mr. Robson wants to clear up this crap.
MR. ROBSON: Well, I wish I could, but --
REP. MANZULLO: Are we in the informal --
MR. : It helps things grow.
REP. MANZULLO: Chairman, are we in the informal portion of the hearing, now?
REP. MANZULLO: All right. It's okay.
MR. ROBSON: I -- there are a number of issues, and I -- I'm -- I don't want to claim that I'm the expert on how this whole crisis came. But I think it goes to the point of -- I think if you have too much government or too much private side there can be a problem.
There needs to be checks and balance. And I'm not going to get into whether the Fed could've stopped it, or whether they could or would have or anything else.
But there -- I think there's a number of issues. If you look back, or the -- the private sector private mortgage securities started it was really because there was a failure of FHA for -- to a certain extent that they had not monetized, they had not kept up with a number of really the -- kind of providing mortgages on the low end of the market. The private sector stepped in and started offering a lot of things that FHA was not able to do, because government red tape and a lot of bureaucracy that was there. That kind of started the whole ball rolling. Certainly --
REP. KANJORSKI: We could cut that red tape real fast by giving -- taking away any tax consequences and letting interest be deducted from income. Would you recommend we do that?
MR. ROBSON: No, I wouldn't.
REP. KANJORSKI: Why not?
MR. ROBSON: As far as what?
REP. KANJORSKI: I'll bet I can identify three people at that table who would disagree with doing that, because you get an advantage in your business with it. You've bought into an advantage. I'm not castigating. I vote for it.
I think it's a good principle to get private housing out there. But everybody sitting at that table, and everybody in this country is pushing their own self-interest and have extended it to the point it took the system down.
Now, the question is, how do we get out of it? I'm trying to suggest that maybe -- let's not get out of it by doing -- redoing what we did before.
MR. ROBSON: And that's to my point. I mean, the GSEs were -- their primary responsibility was liquidity. And it wasn't necessarily guaranteeing. It was providing liquidity, because those of us who remember the days when you had a savings loan, you couldn't get a new loan until they either sold them or you got new deposits in.
The whole liquidity question changed the finance -- mortgage finance system of this country. And the new system whatever way -- forget about how we're going forward -- a joint private government system. And I would say, start with the -- federal home loan bank system is a good place to start.
REP. MANZULLO: Well, that's because the banks are shareholders in it. They --
MR. ROBSON: And they --
REP. MANZULLO: -- eventually would be the losers if their loans went bad.
MR. ROBSON: And they have skin in the game as owners of that bank system.
REP. MANZULLO: Dr. White, you were on the board for that weren't you?
MR. WHITE: And it was a different time, but that's right.
Part of the responsibility of being a board member of the Federal Home Loan bank board was overseeing the federal home loan bank system as well as Freddie Mac as well as regulating the savings and loan industry.
REP. MANZULLO: But would that really give us the problem that you were talking about before of a subsidization that's just -- is even more obscure than what we're -- we have today?
MR. WHITE: Well, I mean it's the same implicit guarantee that supports --
REP. MANZULLO: Right.
MR. WHITE: -- the federal home loan bank debt as supporting the Fannie and Freddie debt. It's the same -- they -- the federal home loan bank system is a GSE as well.
The mutual ownership -- the co-op ownership hasn't prevented a number of the banks from having their financial difficulties. Not as serious as Fannie and Freddie, but still they are suffering. They have -- their difficulties as well.
REP. KANJORSKI: That gets you in trouble. Good regulation and open regulation will tend to subside excess, is that correct? We -- I mean, I'm a great supporter of the home loan bank system, (Ms. Martin ?) knows.
But we know a few federal home loan banks that started to really get into serious trouble. If they hadn't been reined in by the regulator at the time we would've been bailing them out if we aren't already. And we've seen that in all of our financial institutions, but the -- the problem really goes to excess is the argument I'm trying to make.
That -- you know, if you went back to the values then you're not trying to get a free lunch, not you, but we, the American people. If we're not trying to get a free lunch, if we're not trying to find pie in the sky or something that doesn't cost us anything, we'll start evaluating things at their real value and that's all we're going to pay.
And if you're going to be a cosigner or a supporter of that, that's all you're going to support or cosign for. But we're always pushing the case, the envelope.
There was a great story, gentlemen, this morning, on the secretary of Treasury. I went through his purchase of his home in Westchester County, New York, did anyone hear that by any chance?
You know, he bought a $1.7 million McMansion. In a very short period of time had to sell it. And it showed what the drop of value was and how it went underwater very quickly for him.
But try it out in Virginia and look at the McMansions that are out there. And I think you start asking the question, where the hell are these people making all this money to buy all these McMansions. And they're not. They're getting it from institutions that are governmentally supported or underwritten. Aren't they?
Unless there's a -- an incredible amount of millionaires, that I'm not aware of in this country, it seems to me they're expending a great deal more for a piece of real estate than they should in rational terms, do you find that the case, Mr. Homebuilder?
MR. ROBSON: Well, the large -- I mean, those sorts of homes, I mean, if they're -- the McMansions wouldn't be part of Fannie and Freddie anyway.
REP. KANJORSKI: I agree. I agree. I'm not --
MR. ROBSON: Those are going to be the private-label mortgages.
REP. KANJORSKI: That's right. And are some of those underwater or not?
MR. ROBSON: Sure.
REP. KANJORSKI: And why should they be -- well, you know, here's a question I really -- going to the private sector, I think. I'm very impressed with all of the homebuilders, the realtors, all of you in mortgage, but I have to ask a question.
Did you, any of you, see this happening three, four, five years ago as some of us did? And some of us -- (inaudible) -- the question that, you know, I remember with embarrassment this committee passing amendment to reduce the requirement.
I think it was the FHA requirement -- reducing it from 3 percent to 1 percent or zero on the down payment. Does anybody remember that just recently? Actually doing it at the time the market was starting to collapse, because of these quote "crap mortgages" that were out there.
Now, some saw it here, and some made a question, but did any of you in the industry see that, and didn't it bother you? Okay. What did you -- what did -- did it bother you?
MS. MYERS: Actually, the realtors testified before this committee about predatory lending in 2004.
REP. KANJORSKI: Yeah, but I'm not talking about predatory lending. That's not necessarily predatory lending. Predatory lending is a much higher price on a piece of real estate than it's worth according to legitimate appraisal, that's --
MS. MYERS: Well --
REP. KANJORSKI: And then a high price of interest to be paid that shouldn't finance a piece of property that expensive. And so I'm talking about just a simple question that didn't you see the real estate excesses that occurred in this country probably the last four or five years?
MS. MYERS: We put up brochures in 2005 and 2004 to help the industry and the consumers understand how to buy mortgages, and to prevent them from buying unsuitable loans. We talked about --
REP. KANJORSKI: So all those smart people didn't buy the loans and all the stupid ones did?
MS. MYERS: No, no, no, no, no, they're all -- we -- I mean, at the end of the day we have to face it where the people buy homes -- well, people only buy homes once every seven years on average, I think, in this country. And they never become experts in the process, and we know that as people in the industry.
And we constantly have to educate them about what's available, what they should be watching for, and to watch out for predators who're out there giving them more mortgage and more promises than they probably should've been involved in? We also try to push for FHA reform, as Mr. Robson said earlier, in 2004 --
REP. GARRETT: But you also pushed for higher conforming loan limits, and so -- for those people who are buying those McMansions --
REP. : Right.
MS. MYERS: Well --
REP. GARRETT: -- and even though a $700,000 house is still a McMansion on the --
MS. MYERS: Well, except only in high market areas, because affordability was outpacing the ability for a buyer to get into a starter home at that point. Incomes weren't increasing at the rate that housing was increasing.
REP. GARRETT: A $700,000 house even in New Jersey, I mean, it's still pretty darn nice house as it's a --
REP. : That's not a starter home.
REP. GARRETT: It's not a starter home.
MS. MYERS: Well -- but in the State of California, it would be a starter home, $500,000 people cannot get into the State of --
MS. MYERS: -- not today, but --
REP. : That's economic discrimination. Maybe they shouldn't be living in California, if they can't afford it.
MR. : All right.
MS. MYERS: But I think that the industry knew; the industry saw that. I can tell you, the National Association of Hispanic Real Estate Professionals, we started to talk to them about the changes that were coming on as well. So the realtors have been very involved in trying to alert the brokers to protect their customers and to push for reforms.
REP. KANJORSKI: Okay. So how about the homebuilders? What the hell are they doing? They stopped building.
MR. : I've got a question.
MR. ROBSON: You know, there -- the private -- it was really the private-label mortgages that funded the McMansions and a lot of this, and the exotic stuff. I mean, Fannie and Freddie didn't fund exotic mortgages.
REP. KANJORSKI: No, no doubt. Not -- quite frankly, they didn't. They ended up buying the private --
MR. ROBSON: Well --
REP. KANJORSKI: -- and they ended up, you know helping --
MR. ROBSON: Unfortunately, yes. I mean, they bought the stuff they wouldn't underwrite.
REP. GARRETT: And though -- that -- it's the same effect. Should the FHA be raising it's down payments then?
MR. ROBSON: Down payment from three-and-a-half?
REP. GARRETT: Yeah.
MR. ROBSON: I think, in order to promote people to get into a home, I think, they ought to pay you something.
REP. GARRETT: Should they be tying -- they should be -- oh, so it should go up, I'm sorry.
MR. ROBSON: No, I'm -- I would not -- I think three-and-a-half is --
REP. GARRETT: Should they be tightening up? You made the comment before that part of the reason why we're -- part of the reason people weren't going to FHA before was because of the darn red tape, which some people -- could construe that as being underwriting.
MR. ROBSON: Well, it was red tape and not keeping up with technology. I had a meeting with former commissioner Montgomery last year. They were still hiring people that knew FORTRAN. And this is last year.
REP. KANJORSKI: We're doing what?
MR. ROBSON: FORTRAN. This is computer -- 40-year-old computer programs. And as of last summer they were still using FORTRAN in computers.
REP. GARRETT: So just -- as to the underwriting, I mean, Lockhart was here before. And I think he mentioned yesterday that -- and I guess, you probably know the numbers is that the default rate in FHA loans is beginning to spike up as well.
So some might say, hey, that's not -- that's like our first warning sign that we might have some problems over there that we all should be looking at, and so -- call it red tape or -- no, I understand the computer stuff and what have you. But we should be tightening these things up over there before we create a whole new problem. Anybody --
REP. MANZULLO: I've got a legitimate question down here.
REP. GARRETT: I think that's a legitimate question. Should we be tightening things up at FHA despite the fact that it may have a dampening effect, right? I mean, if you tighten things up, it may have a dampening effect on what you guys do. But would that be a prudent thing to do?
MS. MYERS: Well, it's -- I'm not sure it would be a prudent thing to do at this time since we're trying to absorb as much of those foreclosed properties and the inventory that's in the market to get things going again. But I believe Secretary Donovan has just said that FHA is doing great, and that they expect to see a profit of ($)1.6 million this year. So --
REP. KANJORSKI: That's only because we made the mark-to-market rule.
MR. : Mr. Garrett, I think you're right to ask questions about where FHA is going, so you better look at FHA --
REP. KANJORSKI: Let me ask you this -- are we just going to be putting a patch on the tire as we come out of this. Are we going to get the opportunity to focus and really make fundamental corrections to the system and is that possible.
Now, Professor, you mentioned non-recourse loans -- I'm not quite up on my real estate law. Are you talking about the principle that you can't go back for excess assets against the owner, the Pennsylvania rule?
MS. WACHTER: Yes, that's what I was -- that's what I understand the congressman to be asking. I don't know if that's what he was asking, but that was what --
REP. KANJORSKI: Right. Well, let me ask you that principle. Where does that come from that you can throw the keys in and walk away? In my state you can't do that. You throw the keys in, and they say, okay, where is your car, your first born and everything else you own?
MS. WACHTER: It does vary by state.
REP. KANJORSKI: Yeah, it varies by state, and did anybody do a comparison as to the foreclosure rate in Pennsylvania relative to California or almost any other state? That it has a non-recourse rule. It's very low.
When I sat on a bank board, a foreclosure of 0.5 to 1 percent was huge, because people didn't want to give up their trucks or their guns. Okay, we -- they like guns in Pennsylvania.
REP. : But that's when you are patching tires too --
REP. MANZULLO: I've got a question that I would like to ask Ms. Martinez Myers. I'd looked at your testimony along with the testimony of everybody else including the libertarian to your left, and you talk about wanting this hybrid, okay.
Well, apparently in today's economy of the United States any business is subject to being taken over by the federal government.
We've had several hearings here on systemic risk. And when Mr. Geithner testified before this committee, I believe, it was in -- guys, I'm not sure when it was -- it was in January.
And he talked about this great super regulator that would be over all the companies that could pose a systemic risk, or perhaps a moral hazard -- and a moral hazard really is the teetotaler who drinks the beer, if you want to -- because nobody can define these terms. But I guess, what bothers me is, you know, in the old days you get a mortgage, you go to the bank, and the bank holds it.
And the mortgage is securitized by an appropriate ratio of demand deposits. And the money is simply set aside to cover the mortgage, in case there's a problem on it. And then we lost that great personal contact that went on.
But my question to Ms. Martinez Myers is, you talk about having a system that's fluid, and liquid, and yummy, and that works, but you also make the statement that you want to make sure that money is available during tough times. And only the government can make that possible as Dr. White gives us his big smile on. That -- would you explain that?
And Dr. White, could you respond to that?
MS. MYERS: Well, I guess, you're asking me to explain why we feel that way. Well, the government has proven, through the experience with the GSEs that through their existence we're able to have liquidity in the market in good times and bad times.
When things are tough in private situations, they pull their money back. They don't make it available, and the market gets unstable. We're looking to make sure that we can continue to help people sell their homes, help people buy homes in any kind of market with people who are going to have housing needs regardless of what the market is doing at any given time.
I mean, we have situations. If you look at the example in the commercial mortgage scenario, and the jumbo residential mortgage scenario, those are not guaranteed by the U.S. government.
REP. MANZULLO: That's true.
MS. MYERS: Those folks -- right now, there are people who are in trouble, say, in the jumbo market who are looking to refinance their house. So let me give you an example. You are somebody who's made a good living, you have a partner that loses the job, suddenly you can't make this big payment anymore.
You have one of those exotic loans. You want to go and try and refinance it. And now your house is worth less, and it's not guaranteed, and you can't -- and you don't fit into the program that the president has put out there.
And -- there's no guarantee and you can't refinance it, because there's no money available. So now you're going to be delinquent when you were trying to avoid that, and you're going to lose your house. And the likelihood is you're going to go into foreclosure, and there's lots and lots of stories like that.
Commercial folks who are looking to their debts coming due, they're trying to get them refinanced. They can't get any liquidity in the market. There's no funding for them, and they're in the same boat. We're seeing delinquencies rise, and we're seeing them going to foreclosure.
REP. MANZULLO: So that -- that --
MS. MYERS: That would happen to the whole market.
REP. MANZULLO: Okay, it's a good answer.
Dr. White, what's wrong with her answer?
MR. WHITE: We do have a Federal Reserve. They are a lender of last resort. They are a provider of liquidity. We've seen just how creative Mr. Bernanke has been able to be over these past few years, and I applaud his creativity. I really do. I think he's done a spectacular job.
At the same time, we saw that the GSEs weren't able to step up when hard times hit. And in fact, went into the ditch, and it's only because the FHFA now is steering them, and trying to get them out of the ditch, that now they are part of the solution. But they weren't part of the solution.
And were going into the ditch themselves. And so we do have a -- back to my point. We've got a Federal Reserve.
REP. MANZULLO: Yeah, but so the --
MR. WHITE: They're the lenders' --
REP. MANZULLO: So you're substituting the private-public partnership that is advocated by Ms. Martinez Myers by saying privatize the GSEs, but have Federal Reserve in the standby?
MR. WHITE: You know, I do believe in there being a lender of last resort in the financial system.
REP. MANZULLO: You do. You do --
MR. WHITE: I think that's terrifically important --
REP. MANZULLO: Then you believe the same way she does.
MR. WHITE: Well --
REP. MANZULLO: That's okay.
MR. WHITE: I think, by lending --
MS. MYERS: (Off mike.)
MR. WHITE: Well, thank you.
REP. MANZULLO: You're -- Dr. White, you're --
MR. WHITE: You focus it in a single entity. You don't spread it out --
REP. MANZULLO: I've always wanted to ask a professor questions like that, and thank you chairman for the opportunity.
REP. KANJORSKI: Doctor, you're just switching insurance companies, right? You -- changing -- making the Federal Reserve the insurance company of the system.
MR. WHITE: Well, I mean --
REP. KANJORSKI: To be sort of consistent with the free market system, you all should be pressing not to have the Federal Reserve as the lender of last resort.
MR. WHITE: Oh, no, I'm sorry. But you know, when we do have financial crises, that's exactly when we do need a lender of last resort.
REP. KANJORSKI: So you do need the government?
MR. WHITE: Oh, I'm -- if -- for sure. For sure, and I said that before. We need a federal deposit insurance --
REP. KANJORSKI: And why didn't you say that when some of our members --
MR. WHITE: Well, we -- and we need a federal --
REP. KANJORSKI: You guys are telling me every day they don't need the government.
MR. WHITE: All right.
REP. KANJORSKI: We're interfering with it.
MR. WHITE: All right. I'm with you on this. And let me say for the record, we need a Federal Deposit Insurance Corporation.
REP. KANJORSKI: Mr. Manzullo, do you hear that, that you guys are wrong on that side?
MR. : This is -- this hearing started off pretty boring, but it's really picked up the last hour or so --
MR. BERMAN: Mr. Chairman, if I may. You know, we have a situation today where we have a 100-year flood about every 10 years.
REP. KANJORSKI: Right.
MR. BERMAN: And --
MR. : (Off mike) -- on that.
REP. KANJORSKI: And the government causes it --
MR. BERMAN: Well -- no, what I would suggest is that the government can play a role in helping to smooth out those kinds of crises. And there's not only a role for the government as a lender of last resort, but there's also a role in providing ongoing liquidity for a core set of products for both single family and for multifamily that can really be the central nervous system, if you will, for the secondary mortgage market, and providing that liquidity stable pricing, which is also important for homeownership and a stable set of mortgage products that the economy can be built on.
REP. KANJORSKI: No. I agree with you and of course I sound terribly radical up here. I mean to, because I want to excite you people. But the reality is I am getting very tired of having witnesses come in and testify and some of my friends on both sides of the aisle say, we are going to pass this special law, so this will never happen again.
And now -- none of these people are that stupid, okay. So they know it's going to happen again. It has happened all the way through our history. The fact of the matter is if you really look at our present situation, we went 50 years minimally without having a financial crisis, first time in our history as a nation that we went that long, or we perhaps went 75 years.
And I think everybody would have to admit the reason was we had good regulation until it went aright. Now, our problem is we have to get back to quote "good regulation." Maybe we even have to go a little beyond that and say, we need to get back to good values.
And that's what I'm sort of digging you on. You and I have a responsibility, it seems to me, that when we see somebody that's hedging the system, defeating the system, hurting the whole system, we've got to realize that hurts us too, because as they destabilize this system, all of us are going to get hurt.
And the question is what are we doing about it? And I don't think the last five years we did a hell of a lot; certainly not enough. And if we go right back into repairing this, correcting some of our regulation, but we allow all these people to function out there in the system until they can find another way to escape responsible regulation in capitalism, and it goes critical as it has in the last five years, what do we gain?
We've gained very little. All we're doing is chasing our tail around the block. Maybe that's not wrong, maybe that's how the system is intended to be. But I would hope after -- it's a lot of pain, an awful lot of pain, and we don't see it down here.
You know, quite frankly, all of you are probably wearing suits that exceed the cost of most Americans, you're driving cars that exceeds the cost of most Americans, your kids are going to universities, and it's not -- no, seriously.
In Washington, you don't see the pain that you see when you go back to my district, or you go back to Mr. Manzullo's district. There are people living in this country that can't -- a sickness is a disaster, just meals, just food are disaster. It's a worrisome thing.
It's the -- not a question of educating your children. The need, actually, not to have them in school, because you can't even afford to have them in. Now, we're not making accommodation for that. Oh, we're passing goody acts and we're, you know, doing nice things that are blush -- covering it up with whitewash, if you will.
But this time my friend Ram (ph) is right. A disaster should not go unused. We can fundamentally change some of this system to make it fairer, better, and more equitable. And in some respects, all of us are going to have to give a little. I'm going to ask a question and we have to wrap this up. Don't worry though, we checked; the airplanes aren't flying because of the thunderstorm, so you're all safe.
But take a shot at us now, Republican and Democrat banking committee. Give me the worst criticism you can of our failures as government and its people. And don't pull any punches.
MS. MYERS: Can I?
REP. KANJORSKI: You start. You seem to like to do that, Ms. Myers, go ahead.
MS. MYERS: I'm going to give you two.
REP. KANJORSKI: Yes.
MS. MYERS: Okay. I think that -- and I'm -- and we're actually going to do one better. I'm going to say we're going to take some responsibility for this too, the FHAPs. And we've talked about this, and have alluded to this before.
Industry probably wasn't pushing the FHA reform soon enough. We should've been talking about this in 2001, maybe when we started to see changes and we didn't. We got around to it in 2003-2004.
We presented it to Congress, and it sat around, and sat around, and sat around. And we have to ask ourselves if we had a -- the FHA program that we have today that was relevant in the marketplace, would we ever have had the need for subprime mortgages and would we be here today.
I think we all have to take responsibility for that. The second area that I would point out to you is we've seen a lot of moratoriums on these foreclosed properties. We need to rip the band-aid off so we can start the healing, because right now as we keep those moratoriums, and now they're released, then we're going to see a big flood of real estate in the marketplace over the summer.
There's something like 800,000 foreclosed properties that are going to hit the street. That's going to have an impact on our market. We got to get those absorbed. If we're ever going to right this market, we got to get those absorbed.
And the only shining light on that foreclosed property, and it saddens me and breaks my heart, I -- you know, I'm involved in some of that business myself, that people are losing their homes, but the bright spot is there are a lot of first-time homebuyers buying those homes.
People that didn't jump into that subprime market, people that sat on the sides, because they couldn't afford it and they're in there. And maybe our homeownership rate will get back to normal in the process. But we got to get that -- blow that inventory through here and out of here for those that we cannot save, instead of -- dragging our feet is not -- no good is going to be come of that.
MR. : Mr. Chairman --
REP. KANJORSKI: Thank you. Could I just -- Mr. Robson, do you have something to add so we -- I just happen to know you have a pressing engagement.
MR. ROBSON: I appreciate that. Well, two things. I think I would just follow up to --
REP. KANJORSKI: This is hate mail now, you're supposed to give --
MR. ROBSON: One. I mean, the whole credit problem -- I mean, there is a whole credit problem in this country. It's not just mortgages. It's AD&C loans on the construction side, it's commercial, it's -- credit has completely frozen up. And what sprouts we're seeing in the economy, and especially in housing, and hopefully that we're -- looks like we're, maybe, reaching a bottom on -- at least as far as home sales are concerned, both new and existing.
But if we don't get credit flowing throughout this country, whether it's small business, whether it's construction, or development loans, or anything else, we will not have a recovery. And then I just echo, we -- and some of the other things that have been said today earlier that some of the questions with Doctor -- or with Mr. Lockhart, the appraisal problems are a very, very big issue.
If we don't correct some of the abuses on the appraisal problems, we'll never recover either. So --
REP. KANJORSKI: Very good.
MR. BERMAN: Mr. Chairman --
MR. ROBSON: If I could, Mr. Chairman?
REP. KANJORSKI: Yes.
MR. ROBSON: Thank you very much.
MR. BERMAN: Two issues that I put out there that I think maybe we could've done better on. One is taking a more holistic approach. And there've been a number of comments about not only the GSEs today, but FHA, the banks, the private labor market, and the rating agencies.
There, I think, if we are too focused on just one piece of the regulatory puzzle, it is unlikely that we'll be successful in solving and preventing this from happening again. Secondly, it has troubled me a little bit that some of the members are eager to latch on to a label of a solution.
I think that at this stage of the debate, it's absolutely critical that we focus on principles. And that we drill down on what kind of ownership do we want for the entity, what kind of regulation do we want, what kind of products do we want.
Where do we want the interest rate risk to be? Where do we want the credit risk to be? What do we need to do for liquidity? And jumping ahead and trying to put a label on that whether it's a public utility model, or a co-op model, or a bond model, I think, is a serious mistake.
And rather, I think, if we have a principled approach, and we start building up with building blocks from the ground up, we'll end up with a model that -- we'll figure out what the name of it is after we create it as opposed to trying to latch onto a model and say that's a good one or that's a bad one.
So I would encourage us to use that ground up principles approach.
REP. KANJORSKI: Very good. Should we save Mr. Morrison or the professor for last --
MS. WACHTER: Well -- the -- thank you. If I were to criticize going backwards, one, the consideration of lowering the FHA mortgage down payment to zero, at that moment, to me was just the thirteenth gong of the clock. And related to that, although I have no evidence, but -- this is hearsay. It is out there that the GSEs were being encouraged by Congress, as well, to move into all day into subprime to help support that market.
The regulator, in any case, was not -- this is hearsay as I'm saying, that Congress also had a role in not pushing that and it may be wrong. Going forward, I think that Congress has to be farsighted in understanding the problems with asset bubbles. Asset bubbles are just as lethal as inflation and recessions.
It brought -- Japan was brought to its knees for 10 years. The Asian financial crisis affected many of the tiger countries for more than 10 years. We've seen one, we can see more.
We have had a housing market for decades in the United States, more than that; hundreds of years even, in part because we have a very elastic supply of housing historically. We do not have an elastic supply of housing anymore.
And my dear friend and colleague, Dr. White, argues for reducing restrictions locally. So we'd have more of an elastic housing supply, but I just don't think that's in the cards for a variety of reasons including concerns of the environment, and local control is simply in our blood.
So I don't think it's going to happen. Therefore, like Europe, like Asia, we are in a different world now. We're in a world where housing supply is inelastic. That means we are in a bubble potential world. But I don't think we can do anything about that from the basic regulation side.
I think that means that we have to be attentive to when housing bubbles are being formed. There were those of us in academe -- I was one of them -- who said in the real estate academe that -- in the real estate department at the Wharton School, we were in a bubble 2006. And I wasn't alone.
And paying attention to this, and therefore, to the potential for a major crisis when even reasonable loans are being priced at a point where prices are going decline 20 percent a 20 percent down payment gives you no protection under those circumstances. We will need to pay attention.
REP. KANJORSKI: Well, let me stop you there for a moment, because I'm from Pennsylvania, and I have a great deal of respect for the Wharton School. My father, my brother, my nephew, they're all Wharton people.
You -- they do have telephones, isn't that right?
MS. WACHTER: Say that again.
REP. KANJORSKI: You do have telephones at the Wharton School?
MS. WACHTER: I spoke -- I was -- (inaudible) -- Wharton.
REP. KANJORSKI: But -- I mean --
MS. WACHTER: In fact put my papers out there.
REP. KANJORSKI: But why --
MS. WACHTER: Why wasn't it picked up?
REP. KANJORSKI: That's --
MS. WACHTER: My understanding -- and this is a question which I do not know the answer. This is a historian kind of a question. It's not an empirical, I can't do econometrics to answer your question.
But my understanding is that there were good models out there. There were people saying this. But the models were not being purchased, because there was no money in purchasing those models. Where the money was, was continuing to get the deals done.
REP. KANJORSKI: Did you have absolutely no faith in government, either the congressional side or --
MS. WACHTER: No, I absolutely have faith in government, I'm hoping --
REP. KANJORSKI: -- why didn't you take the time and the effort as an academic? You know, when a professor of your standing calls my office, you probably get a priority, because I assume that you wouldn't waste your time or my time by calling.
So I'm going to talk to you about it whatever the issue is. Why didn't you do that? We've got a lot of lonely people on the committee, they --
MS. WACHTER: Well, that's wonderful. I'm thrilled to hear that that's an option. I did do, I did -- we did publish our papers, we gave our papers at all of these meetings. We -- they were in newspapers.
There were models out there that were -- Case-Shiller had its models out there, you know, Case-Shiller is obviously out there and Mark Zandi was out there. Mark Zandi's company was purchased by Moody's, but prior to then -- that, Moody's did not use Mark Zandi's models, which were excellent models.
REP. KANJORSKI: Well, going forward, use the telephone.
MS. WACHTER: I will. And thank you very much for the offer.
REP. KANJORSKI: Thank you.
Mr. Morrison? Well -- you know, I just want to blame you. You were here. Why didn't you cure this problem?
MR. MORRISON: Well, I thought I fixed the savings and loan problems, so then I left. (Laughs.) Well, I think that -- just to go back to the GSE question, Fannie Mae and Freddie Mac were a wonderful, symbolic battleground in the Congress.
They either were the devil incarnate and needed to be dismantled and got rid of, so that the private market could function, or they were the best thing that was ever done for affordable housing. Without them, we would have no housing at all.
And they were allowed to run a model, which was totally unsustainable; a portfolio model of chasing growth stock status in the markets, and whatever they had to do to get there. And so nobody really wanted -- I mean, the years and years of the regulatory debate were most surprising to all the participants, that they were both wrong.
Those people who wanted to take Freddie and Fannie down apparently thought that Freddie and Fannie were so powerful that they would never be taken down. And on the other hand, there were those who thought they were so powerful that they would be the cash cow forever for affordable housing.
And what it really turned out is they were a house of cards that collapsed, from the very model that was defective, which was the -- you know, the growth stock model. We can get this capital from the marketplace, we can give them portfolios, whatever it takes.
I think everybody was blind to the reality behind that. It was warring parties over symbols. And I think by missing that -- yes, they were not the ones who created the private market securities. But they, in fact, created that marketplace, in many ways, by funding the AAA tranche of that early on and made that market go, and then everybody else followed on.
So I think that if the debate had been more honest -- in 1995, I had a conversation with Alan Greenspan about huge portfolios and the impact that they would have. And he was very concerned about the federal home loan banks, but not at all concerned about Fannie and Freddie, because he said Jim Johnson is the smartest man in town.
Well, he might've been, but his legacy we see. So we should be watching out for smart people and maybe do our own research.
MS. WACHTER: But Bruce if I may. It wasn't that they bought these early on.
MR. MORRISON: They did.
MS. WACHTER: They bought them -- what year did they start buying them?
MR. MORRISON: No they started buying them -- they funded Ameriquest, and others in the -- in 2002-2003 by buying their AAAs.
REP. KANJORSKI: Well now, Johnson was gone by that period.
MR. MORRISON: Oh, yeah -- no, I'm not blaming Mr. Johnson. I'm just saying that a lot of people were blind to a model that was not sustainable, including Mr. Greenspan in 1995.
REP. KANJORSKI: No question about it. Mr. Manzullo, you -- are you going to wise up? I think Dr. White should get a crack at us too, I --
REP. MANZULLO: No, I -- you know, the district I represent -- in 1980 to 1981, we had 25 percent unemployment. And there were more people unemployed in Rockford, Illinois during the early '80s than there were proportionally due to the so-called Great Depression.
And Americans worked their way through that. A lot of it had to do with the inversion of the dollar and the collapse of the ability to sell manufactured items overseas including machine tools et cetera, because your district is very much -- very much like mine.
But I -- you know, maybe I'm thinking too simplistically here, is that we would not be in this problem and this trouble had not people bought homes that they couldn't afford in the first place.
And Chairman, do you know who some of the people were that were waving a red flag five years ago? It was the National Association of Realtors. They would come into the office -- of course, they were thrilled to sell real estate and make everything.
But I was questioning all the easy money going on, and so -- and you know that. And so were a lot of your real estate colleagues saying, this is great, but you just can't keep on going on like this, because somewhere along the line, something is going to happen.
REP. KANJORSKI: I did hearings on it in --
REP. MANZULLO: Pardon?
REP. KANJORSKI: I did hearings in my district.
REP. MANZULLO: That's correct.
REP. KANJORSKI: In 2004.
REP. MANZULLO: That's correct. And this -- and these are the types of signals that were being sent out that people like myself and you were saying there's something wrong here. It started with that -- with the laundering of the books by Fannie Mae and -- in 1990 -- no, in 2003 and 2004 with Franklin Raines and those characters taking those incredible amounts of salaries.
And their bonuses were predicated upon the fact that they had to get to a certain point of profit and they got down to the mills. Remember that chairman? It was mills. Just so they could that extra amount of money squeezed out and we were screaming here.
In fact, Fannie Mae had hired 17 lobbyist firms that were out there getting bogus postcards from 2,500 of my constituents saying don't change anything at Fannie Mae, we don't want any reform. And that the reforms that we wanted really were to tighten up the lending standards. But I guess, we were just like John the Baptist, just crying out in the wilderness and no one was listening.
MR. WHITE: All right. Let me -- I'll try to be brief. It is getting late. If I were to offer the criticism that you invited, I'd say, you let us get way too deep into the whole housing issue. Again, there is a role for government, but -- Bruce, you and I differ on this, but I've got to speak truth to power.
It ought to be a focused targeted role; the broad brush role just gets us with a far too large stock of housing, a far too small stock of human capital, of physical capital as a consequence.
That is a big cost that we have paid. We're paying it now in the current crisis as well. Let's see. Some other things, some smaller things ---
REP. KANJORSKI: How could that have been --?
MR. WHITE: There is -- there's RESPA --
REP. KANJORSKI: Yeah, but how could that have been prevented?
MR. WHITE: Sorry?
REP. KANJORSKI: How could that have been prevented?
MR. WHITE: Well -- okay, you ask --
REP. KANJORSKI: Yeah.
MR. WHITE: -- the rating, the rating agencies.
REP. KANJORSKI: They're the buffer --
MR. WHITE: What they are -- you know, there's lots of blame to go around, but clearly they were one of the central parties here. And it was no accident that they became a central party.
They were a central party because of financial regulation. Had that whole structure -- and again, you could see each step made sense, but by the time they -- you went down the road, you had a handful -- literally, a handful of rating agencies --
REP. KANJORSKI: I've got -- should they have been federally regulated?
MR. WHITE: Say again.
REP. KANJORSKI: Should the rating agencies have been federally regulated?
MR. WHITE: I would argue no, but they also should not have been thrust into the center of the bond markets the way the bank regulators the insurance regulators, the pension fund regulators, the Securities and Exchange Commission, all forced them into the center of the bond markets, and when the securitization --
REP. KANJORSKI: I'm trying to figure out -- then you would have had us not have a rating agency in any way giving indications of --?
MR. WHITE: Oh, no. No, I would have the rating agency still there, but not as a mandated source of information. I want banks to have safe bonds, I want the regulator to work with the banks to have safe bonds, but it should be the responsibility of the bank to either demonstrate to the regulator, or have an advisor that it can demonstrate to the regulator.
REP. KANJORSKI: Something like AIG Financial Products in London, small operation of 400 people that have a bank and have a regulator come over for a couple of weeks every year to look them over, and they get involved in counterparty positions of $2.7 trillion. That's what you'd like to have --
MR. WHITE: Oh, no, heavens, no. They were --
REP. KANJORSKI: Well, that is not what a --
MR. WHITE: -- running a big insurance operation, and --
REP. KANJORSKI: Isn't that what an unregulated system brings us?
MR. WHITE: If we're going to let entities get so big with so many counterparties, then we got to have a regulator --
REP. KANJORSKI: So -- now, that's a good point. Then you would've liked us not to have repealed the Glass-Steagall?
MR. WHITE: Say again.
REP. KANJORSKI: Glass-Steagall shouldn't have been repealed.
MR. WHITE: No, no. The repeal of Glass-Steagall has absolutely nothing. Everything that has happened -- that happened
REP. KANJORSKI: Well, that's what allows entities to become huge.
MR. WHITE: Well, they could've -- they -- Merrill and Bear Stearns and Lehman and Morgan Stanley were all going to -- and Goldman were going to get huge regardless, and Citi. Citi got a little bit bigger, because of repeal of Glass-Steagall allowed it to buy an insurance operation --
REP. KANJORSKI: I'm not sure I catch your drift though. What -- did you -- you think the government should've had more or less regulation, you know --
MR. WHITE: It needed to be smarter regulation. In some places, it needed to be less, and in other places it needed to be more and --
REP. KANJORSKI: I sound --
MR. WHITE: For sure, it needed to be --
REP. KANJORSKI: It sounds like Monday morning quarterbacking, I'm on the field in Saturday. We're calling the plays on Saturday. We're not --
MR. WHITE: In the case of the credit rating agencies, I've been there for about eight years now. So I could've told you basically the story eight years ago, and did. And -- well, sorry, it was published.
REP. KANJORSKI: Well, should they be allowed to be paid by their users?
MR. WHITE: That's something that -- in -- the institutional bond market could really figure out on their own. I don't trust this guy, because I'm worried about his conflict of interest, I'm going to trust somebody else whose business model I think is a more solid model. That's something that an -- the bond market is, fundamentally, an institutional market, and those institutions can figure that out.
REP. KANJORSKI: For some reason, I think -- I'm sensing you're putting your foot on two icebergs here.
MR. WHITE: No.
REP. KANJORSKI: You're not coming straight with us. Give me a -- an image of what you want the government to do, what -- we're the big government that -- you have a right to hack at us.
MR. WHITE: Well, I --
REP. KANJORSKI: Tell us what the right direction is. In your opinion, and then you're going to be held responsible for it if --
MR. WHITE: Okay. All right. As I said, I would -- you know-- we cannot do anything radical at the moment, the financial markets are far too fragile.
REP. KANJORSKI: So you would clearly give advice to us to go easy, don't speed through this and have unintended consequences, let's get back on the recovery stage, and then be very serous about it reforming some of these institutions?
MR. WHITE: Fore sure, for sure. And then I would privatize Fannie and Freddie, I would have a targeted program to be encouraging first time homeownership --
REP. KANJORSKI: So if we private -- if we privatize Fannie and Freddie, they can do exactly what Wall Street did with their special securities that they privatized, is that right?
MR. WHITE: Well, they will -- you know, given the size in systemic risk, like it or not, we need a systemic regulator, we can --
REP. KANJORSKI: Well, then you don't -- you mean you want Fannie and Freddie privatized, but with a very stiff systemic risk regulator?
MR. WHITE: For sure, for sure, yes. Yes.
REP. KANJORSKI: Well, then what -- all you're doing is where the money flows?
MR. WHITE: Well --
REP. KANJORSKI: You want to --
MR. WHITE: -- I think it makes a difference.
REP. KANJORSKI: You want the wealthy institutions to be making more money off mortgage securitization than they are now. Isn't that the only difference?
MR. WHITE: I don't -- Congressman, I don't see it that way, but, you know, I think it makes a difference. Also I would not have the kind of implicit guarantees that -- where everybody knew that Fannie and Freddie were --
REP. KANJORSKI: You think if we have a private institution the size of $5.6 trillion, that there's not an implicit statement that the United States government has to come in and rescue it when it fails, or else it brings the entire system down?
MR. WHITE: Well,--
REP. KANJORSKI: You don't think we made that hard vote going back to September of last year, because we wanted to quote, "Bailout Wall Street?" You know the circumstances of that vote, don't you?
You remember what the -- you know what the Secretary of Treasury and Chairman Bernanke told us -- that famous meeting, or several meetings that we had? That we're 24 hours away from total meltdown of the American economy and 72 hours away from total meltdown of the world economy, that it would take us back several hundred years?
That we did not have even the security to feed America at the time if it happened. I could go on to other scary things, I'm not about to do it now. But you don't think we did that because we just didn't want some rich people on Wall Street --
MR. WHITE: For sure.
REP. KANJORSKI: -- to lose their banks.
MR. : I didn't do that.
REP. KANJORSKI: What?
MR. : I didn't believe it.
REP. KANJORSKI: You didn't believe him?
MR. : It was -- $700 billion was supposed to buy up the bad assets, they still haven't been bought up.
MR. WHITE: Right. Anyway, I'd be happy, you know, to expand on these. And I hope I can take up the invitation you offered to --
REP. KANJORSKI: Absolutely, absolutely, all of you. Even the other two who left already, and we'll send them a letter -- now, don't read -- (laughs.)
Really, if you have ideas on the subject regardless of how wacky they may sound, or out of the normal configuration of things, don't hesitate to tell us. We're going to try and do the best we can to do some management of what has been a relatively disturbing unstabilized system that we now have. And we're going to do our best, so -- and we're looking for the best thought process in the world, and that's why we asked you all to testify today, so that, one, we could harass, two, we could keep you here until 7:30 at night and get you a --
You know, I'm actually leading a seminar for divorce lawyers. Anybody has spouses, you're going to get, you know, potential catastrophes at home. No, I won't -- we're going to close up now.
I do want to thank you all very much. I hope you didn't mind going informal like this.
MR. WHITE: Thank you, Mr. Chairman.
REP. KANJORSKI: Thank you for appearing, and I'm supposed to read something into the record now.
The Chair notes that some members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record.
Before we adjourn, the following items, statements, will be made part of the record for this hearing. A statement from the Manufactured Housing Association for Regulatory Reform, a statement of the Independent Community Bankers of America, a letter from the National Association of Federal Credit Unions, and the letter requested by Congressman Campbell from Mr. Cox (ph) to Mr. Lockhart. An article by David Goldstein entitled "Private Sector Loans, not Fannie or Freddie" triggered crisis. Without objection, it is so ordered.
The panel is dismissed and the hearing is adjourned. (Sounds gavel.)