Restoring American Financial Stability Act of 2010--Continued

Floor Speech

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Mr. SHELBY. Madam President, as part of the debate on the McCain-Shelby-Gregg amendment, I wish to take this opportunity this afternoon to discuss the history of Fannie Mae and Freddie Mac from my perspective. By doing this, I want to emphasize past Republican attempts at regulating and reforming these institutions, while also discussing their role in the financial crisis.

The government-sponsored enterprises that we call Fannie Mae and Freddie Mac were key players in the collapse of the U.S. housing market. Their multitrillion dollar portfolios gave them the purchasing power to drive markets. In addition, false presumptions about their housing finance expertise and their connections to the government gave them further power to influence the housing market. And let us not forget the GSEs' nationwide lobbying and public affairs apparatus that was designed to keep reformers at bay and their supporters flush with cash.

When the GSEs began to buy subprime securities, other firms, including most of the Wall Street banks, took this as a signal that subprime mortgage securities were safe and worthwhile investments. In effect, Fannie Mae and Freddie Mac placed the Good Housekeeping ``Seal of Approval'' on these risky instruments. As a result, the rest of the market engaged in this practice, and the race to the bottom began. Ultimately, the GSEs' collapse lit a wildfire that burned throughout the financial markets.

Due to their miscalculations, Fannie Mae and Freddie Mac have been placed in conservatorship and have already cost the taxpayers well over $100 billion. Just last week, we learned that the GSEs will need another $20 billion in taxpayer assistance for their losses during the previous quarter.

This did not have to happen. For years, the warning signs were flashing, and Republicans made multiple attempts to adopt the necessary reforms. Unfortunately, those efforts were opposed by Democrats in the Senate Banking Committee and ultimately caused the many efforts put forth by Republicans to stall in the Senate.

In 2003, as chairman of the Banking Committee at that time, I held multiple hearings on proposals for improving the regulation of the GSEs. I wish to read a portion of my opening statement from one of those hearings. I quote from that time:

The enterprises are large institutions. Collectively, Fannie Mae and Freddie Mac carry $1.6 trillion in assets on their balance sheets and have outstanding debt of almost $1.5 trillion. The Federal Home Loan Bank System is not far behind, with combined assets of over $780 billion and outstanding advances to member institutions of $495 billion. Due to the importance of the housing GSEs' mission, and the size of their assets, I believe that the enterprises require a strong, credible regulator.

I further read from the statement then:

I remain concerned that the current regulatory structure for housing the GSEs is neither strong nor credible.

At this same hearing, it became apparent that the two parties had very different perspectives regarding the need for reform. One of my Democratic colleagues noted--and it is in the record:

There is an old expression, if it ain't broke, don't fix it. I think some of us here in the Senate believe that when we try to fix things that aren't really broken, we can end up doing more harm than good.

Notwithstanding the mindset on the other side of the aisle, my Republican colleagues and I persevered, and we remained engaged in the effort to reform the GSEs by holding numerous hearings and closely tracking the GSEs' activities at that time.

We decided those who believed ``things aren't really broken'' were wrong. In the face of strong Democratic opposition and a relentless lobbying campaign by the GSEs and their supporters, we proceeded with a markup of the Federal Housing Enterprise Regulatory Reform Act of 2004.

I wish to again read portions of my brief opening statement from that markup which lays out the issues and the responses we crafted to address the problems of the GSEs then:

This afternoon the committee will consider S. 1508, a bill to address regulation of the housing GSEs.

Today, we are faced with the most important decisions considered by this committee in years--determining the strength, independence and credibility of regulation of our nation's Government Sponsored Housing Enterprises. The strength, independence and credibility of this regulatory system have tremendous implications for the future health and vitality of our housing markets, our capital markets, and the economy as a whole.

I continue to quote the statement:

Freddie Mac and Fannie Mae currently have $1.7 billion debt outstanding. To provide some perspective, our nation's Treasury debt in the hands of the public stands at just over $4 trillion. The Federal Home Loan Bank System has also grown significantly since the 1990s and has a vastly expanded membership base.

Its current regulator is not up to the task of providing adequate oversight of its significant role.

My statement continued:

Fannie Mae is the second largest financial institution in the United States. Freddie Mac is fourth. Their debt is held by foreign central banks, insurance companies, money center banks and community banks. Because of the interest rate risk these GSEs must manage, they have an extensive network of derivative contracts. Should one of these institutions encounter significant financial difficulty it could make the S&L crisis pale by comparison.

I was here speaking as an early member of the Banking Committee, as was Senator Dodd, during the bailout of the S&Ls. And it was no pretty matter. It ended up costing the taxpayers at least $130 billion.

I continue:

This experience has only reaffirmed my resolve to ensure such a debacle never revisits the taxpayer. And, quite simply, the real truth is we cannot afford a crisis of the magnitude a failing GSE would pose.

I approach this markup today with a firm appreciation of the gravity and relevance of what we do here today. I state again, as I have before--I support the housing missions of the GSEs. Home ownership is the primary source of wealth for many Americans. It fosters strong communities and promotes stability for children and families.

But, and I believe there is consensus in this Committee on this one point at least, they are not well-regulated and, therefore, pose significant risk to the taxpayer and the markets they serve.

To be clear: they are not well-regulated because the regulatory structures and authorities that Congress created are insufficient and weak by design.

And that is what the draft before us is all about. Reaffirming the important mission of GSEs, creating a regulator that has all the tools and independence that other first class financial regulators require, and protecting the taxpayer. These are the guiding principles that animate the draft that I have put forth before the Banking Committee today.

Unfortunately for the taxpayers of this country, politics got in the way of advancing credible public policy then. Apparently, the Democrats felt it was better to block necessary change, adhere to the status quo, and ignore the risk to the financial system, all while leaving the taxpayers fully exposed.

We, the same Republicans who have been characterized by Democrats as being pro-Wall Street and antiregulation throughout this process, were trying to create a stronger regulator, raise capital standards, reduce risk taking, and put in place a resolution regime that would limit taxpayer exposure in the event of a firm failure.

That was a number of years back. I wish to revisit the words of one of my then-Democratic colleagues who made the following statement--and it is in the record--as we debated the merits of the Republican GSE reform bill at that time:

Lord only knows where the economy would be today if it were not for the stability of the housing market in the midst of so much turbulence and the ability of Americans to draw down some of their home equity to engage in consumer purchases.

Then, as we stood on the precipice of a housing and financial meltdown, my Democratic colleagues were opposing more regulation and promoting more consumer spending. As if that were not bad enough, we were encouraging homeowners to raid the home's equity to finance their purchases. And look where it brought us.

Another Democrat took issue with the fact that we attempted to give the regulator the power to place a GSE into receivership:

Receivership, first, it does not have to be in the bill, but, second, to allow a regulator who may not like this institution to then sort of dole out little pieces of it one way or another and weaken the fundamental structure of Fannie and Freddie easily leads to its demise.

I am not sure whether my colleagues then understood the basic concept behind establishing an orderly resolution process, but I hope the lesson has now been learned. Ironically, Democratic opposition to strong reform actually produced the exact outcome my colleague feared. When reform stalled in the face of Democratic objections, investors once again viewed Fannie Mae and Freddie Mac as ``too big to fail.'' They were confident that Congress and the U.S. Government would never allow them to go under. This, of course, gave the GSEs a significant financing cost advantage which led to their explosive growth and excessive risk taking.

Finally, and most telling, one of my Democratic colleagues was concerned about how Wall Street might interpret the regulatory changes that Republicans were advocating, stating:

It is a fact that just mere speculation about the prospects of some provisions in the bill is sending shock waves through Wall Street.

Really?

When Wall Street became concerned that our legislation at that time would provide a stronger regulator, require higher capital standards, mandate less risk taking, and establish a well-designed resolution regime, the Democrats came to Wall Street's rescue, not the Republicans.

When the choice was between Main Street and Wall Street, the Democrats made it absolutely clear whose side they were on. They chose Wall Street, and Wall Street ultimately paved the road that led to this collapse.

I ask unanimous consent to have printed in the Record a copy of the recorded vote of the proceedings of that day in the Senate Banking Committee. That result was a party-line vote with all 12 Republicans voting for GSE reform and all Democrats opposing it.

There being no objection, the material was ordered to be printed in the Record,

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Mr. SHELBY. Madam President, that was not the end of the story, though. More than 1 year later, we tried again to pass these important reforms. The Banking Committee held more hearings leading to the markup of S. 190, the Federal Housing Enterprise Regulatory Reform Act of 2005. I will not read my entire statement from this markup, but I will read a part of it that describes the commonsense steps that we were attempting to take with our newest effort to pass then GSE reform.

I quote from that markup:

My legislation creates a new regulator with combined oversight for both the safety and soundness and the housing mission of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System.

The new regulator will have general regulatory authority over all housing GSEs, including enhanced authority over capital requirements, and enforcement and prompt corrective action authorities that are comparable to those of the bank regulatory agencies.

Among other enhanced regulatory authorities, the bill we will consider today includes clear direction on portfolio review for compliance with safety and soundness, mission and systemic risk.

Under this proposal, the enterprises are permitted to hold those assets which promote the enterprises' mission in the housing market.

The bill also transfers the product review function from HUD to the new regulator and creates a two-tier approval process through which the enterprises must receive approval prior to offering any new product.

The bill also establishes new criteria for approval of a product that will ensure the enterprises remain focused on their statutory mission of facilitating a secondary mortgage market.

The new regulator will also have the power to conduct an orderly resolution of a failing or insolvent GSE through a receivership process. This clear and definitive process for dealing with a troubled enterprise is a critical tool for the credibility and strength of a new regulator.

Madam President, unfortunately, the Democrats did not share my view of increasing regulations on the GSEs, and their comments during the second attempt to pass meaningful reforms are telling. One of my Democratic colleagues stated then, ``When the sink is leaking, you do not tear down the house, especially if the house has served you well.'' Another recalled a critique he read of the bill before the markup, which claimed, ``It is like trying to cure the common cold with chemotherapy.''

In fact, at one hearing, one of my Democratic colleagues expressed an interest in hearing how the roles of the GSEs might be increased, when he explained:

I am not only interested in hearing about the role GSEs currently play in the mortgage market, I am also interested in how their commitment to home ownership and affordable housing can be expanded.

In the end, the result of our 2005 markup was the same as our 2004 markup--a strict party-line vote with all 11 Republicans supporting the reforms and all 9 Democrats opposing them. Unfortunately, the Democrats once again sided with Wall Street and the special interests by rejecting GSE reform and any attempt to move the legislation beyond the Banking Committee.

Madam President, I ask unanimous consent to have printed in the Record a copy of that recorded vote in the Banking Committee.

There being no objection, the material was ordered to be printed in the Record,

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Mr. SHELBY. I would like to point out another bit of irony right now. Many of my colleagues who recently complained about the process regarding consideration of this bill were some of the same people who took every measure to block all consideration of GSE reform. Actions have consequences, and in this particular instance, they were almost immediate. As soon as it was apparent that GSE reform was dead, Fannie Mae and Freddie Mac took steps to dramatically increase their risk.

The Government Accountability Office, GAO, detailed this in a September 2009 report. The GAO discovered that in 2004 and 2005, the enterprises:

..... embarked on aggressive strategies to purchase mortgages and mortgage assets with questionable underwriting standards. For example, they purchased a large volume of what are known as Alt-A mortgages, which typically did not have documentation of borrowers' incomes and had higher loan-to-value ratios or debt-to-income ratios.

Furthermore, purchases of private-label MBS increased rapidly as a percentage of retained mortgage portfolios from 2003 to 2006. By the end of 2007, the enterprises collectively held more than $313 billion in private-label mortgage-backed securities, of which $94 billion was held by Fannie Mae and $218.9 billion held by Freddie Mac.

Recently, Daniel Mudd, Fannie Mae's former chief operating officer and chief executive officer, testified:

While the market was changing, Fannie Mae struggled to meet aggressively increasing HUD goals. The goals were extremely challenging, increased significantly every year, and permitted no leeway to account for the challenging lending environment. Certain mortgages that may not have met our traditional standards could not be ignored.

While Mr. Mudd may be correct that these mortgages aided their ability to meet their HUD goals, it also should be noted that the GAO in this same report did not see these purchases as a benefit to their mission, stating:

The rapid increase in the enterprises' mortgage portfolios and the associated interest-rate risk did not result in a corresponding benefit to the achievement of their housing mission.

Ultimately, this increased risk played a significant role in the demise of Fannie Mae and Freddie Mac.

I would like to read one final section of that 2009 GAO report here this afternoon.

According to the Federal Housing Finance Administration, while these questionable mortgage assets accounted for less than 20 percent of the enterprises' total assets, they represented a disproportionate share of credit-related losses in 2007 and 2008.

For example, by the end of 2008, Fannie Mae held approximately $295 billion in Alt-A loans, which accounted for about 10 percent of the total single-family mortgage book of business. Similarly, Alt-A mortgages accounted for nearly half of Fannie Mae's $27.1 billion in credit losses of its single-family guarantee book of business in 2008.

At a June 2009 congressional hearing, former OFHEO Director James Lockhart said that 60 percent of the triple-A rated private label MBS purchased by the enterprises had since been downgraded to below investment grade. He also stated that investor concerns about the extent of the enterprises' holdings of such assets and the potential associated losses compromised their capacity to raise needed capital and issue debt at acceptable rates.

Madam President, we all know what happened once they were unable to raise capital, but let's also remember the consequences that followed our failure to properly regulate Fannie Mae and Freddie Mac.

Charles Duhigg of the New York Times, part of a group of journalists who produced ``The Reckoning,'' a series that explored the roots of the financial crisis, wrote in 2008 that:

The ripple effect of Fannie's plunge into riskier lending was profound. Fannie's stamp of approval made shunned borrowers and complex loans more acceptable to other lenders, particularly small and less sophisticated banks.

James Lockhart supported this conclusion in his testimony before the Financial Crisis Inquiry Commission on April 9 of this year when he observed that the GSEs:

..... indirectly encouraged lower standards by purchasing private label securities. They also encouraged lower standards by not aggressively pursuing the obligations to repurchase mortgages if they did not comply with the enterprises' underwriting requirements.

Madam President, during the debate on this bill before us, we have heard numerous times that we need to have a tighter grip on Wall Street to prevent those large Wall Street firms from harming small businesses on Main Street.

If only my Democratic colleagues had been less concerned with Wall Street's reaction in 2004 and 2005, perhaps we could have protected not only those less sophisticated smaller banks on Main Street but also the millions of consumers caught up in the resulting inflated housing market and the millions of taxpayers who have had to foot the bill for the resulting debacle. Instead, the stalling of this legislation by Democrats at that time ended any attempts of meaningful GSE reform until mid-2008, when Fannie Mae and Freddie Mac were already in serious trouble.

The simple truth is that we didn't act when we could have effected real change. Republicans were ready to enact real reform and--unfortunately for the taxpayer--Democrats were not. Let's not make the same mistake again here today.

The McCain-Shelby-Gregg GSE amendment takes several important steps to reform the GSEs. It provides transparency to the conservatorships of the GSEs by establishing much needed investigative oversight. It also requires Fannie Mae and Freddie Mac to be included in the Federal budget as long as they are in conservatorship or receivership status. It reestablishes taxpayer protections that were abolished by the Obama administration last Christmas Eve, and it requires that Congress be involved in any decision to spend additional resources to stabilize the housing markets. Finally, it establishes a definite end to the ongoing conservatorships of Fannie Mae and Freddie Mac and paves a responsible path forward by refocusing their efforts, installing proper safeguards, and untangling the U.S. taxpayer from this mess.

I urge my Democratic colleagues to ignore Wall Street and the special interests lobbying against this amendment. Join the Republicans in doing something good for the American taxpayer--support the McCain-Shelby-Gregg amendment.

I yield the floor, and I suggest the absence of a quorum.

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Mr. SHELBY. Mr. President, earlier today in the Senate I spoke about the past actions or, rather, inactions of this body that led us to the current situation with Fannie Mae and Freddie Mac. I now will take just a few minutes to discuss the current status of these institutions as Senator McCain has mentioned. I will also explain the specifics of the McCain-Shelby-Gregg amendment and why I believe we must adopt it.

Since September of 2008, we have had to spend more than $150 billion to bail out these GSEs. By some estimates, this amount exceeds the total cost of the savings and loan bailouts that occurred in the late 1980s and early 1990s. Let me repeat that. Bailing out the GSEs has now cost as much or more than the entire savings and loan crisis, and it is continuing.

Having spent such considerable amounts of taxpayer dollars, one would think that the GSEs would be topic No. 1 as we consider financial reform. Unfortunately, that is not the case. As recently reported by Gretchen Morgenson, a Pulitzer Prize writer of the New York Times:

Freddie [has] warned that its credit losses were likely to continue rising throughout 2010.

Even more troubling, while the GSEs have considerable legacy problems associated with the older loans in their portfolios, they are being used by the Obama Administration to take on additional risks.

On Christmas Day of last year, the Obama administration announced it would relax important taxpayer protections at GSEs, and it would prop them up with unlimited taxpayer funding. That is exactly what they are doing today.

The administration took this step so it would have the flexibility to continue its efforts to support the housing market. Some now are questioning those efforts. In the New York Times piece I mentioned, Ms. Morgenson quotes Dean Baker, codirector of the Center for Economic and Policy Research, who noted:

I do not understand why people are not talking about it [referring to Freddie's losses] ..... it seems to me the most fundamental question is, have they on an ongoing basis been paying too much for loans ever since they went into conservatorship?

This begs the question of why the GSEs would overpay at this point. What is to be gained? Ms. Morgenson posits a rather compelling theory:

Mr. Baker's concern that Freddie may be racking up losses by overpaying for mortgages derives from his suspicion that the government might be encouraging it to do so as a way to bolster the operations of mortgage lenders.

I hope not. In the past, those huge piles of money that have consistently been spent found their way into the pockets of Democratic operatives such as Frank Raines, Jim Johnson, Jamie Gorelick, Tim Howard, and President Obama's Chief of Staff, Rahm Emanuel. Now similar piles are floating around, not necessarily to Democrats but certainly on behalf of their pet initiatives.

The only constant in either scenario has been the taxpayer has been stuck with footing the bill. I believe this afternoon this must end. It is finally time to protect the taxpayer. The McCain-Shelby-Gregg amendment will do that.

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