[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]



 
                RECENT EVENTS IN THE CREDIT AND MORTGAGE


                 MARKETS AND POSSIBLE IMPLICATIONS FOR


                 U.S. CONSUMERS AND THE GLOBAL ECONOMY

=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 5, 2007

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-58




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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            RICHARD H. BAKER, Louisiana
CAROLYN B. MALONEY, New York         DEBORAH PRYCE, Ohio
LUIS V. GUTIERREZ, Illinois          MICHAEL N. CASTLE, Delaware
NYDIA M. VELAZQUEZ, New York         PETER T. KING, New York
MELVIN L. WATT, North Carolina       EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York           FRANK D. LUCAS, Oklahoma
JULIA CARSON, Indiana                RON PAUL, Texas
BRAD SHERMAN, California             PAUL E. GILLMOR, Ohio
GREGORY W. MEEKS, New York           STEVEN C. LaTOURETTE, Ohio
DENNIS MOORE, Kansas                 DONALD A. MANZULLO, Illinois
MICHAEL E. CAPUANO, Massachusetts    WALTER B. JONES, Jr., North 
RUBEN HINOJOSA, Texas                    Carolina
WM. LACY CLAY, Missouri              JUDY BIGGERT, Illinois
CAROLYN McCARTHY, New York           CHRISTOPHER SHAYS, Connecticut
JOE BACA, California                 GARY G. MILLER, California
STEPHEN F. LYNCH, Massachusetts      SHELLEY MOORE CAPITO, West 
BRAD MILLER, North Carolina              Virginia
DAVID SCOTT, Georgia                 TOM FEENEY, Florida
AL GREEN, Texas                      JEB HENSARLING, Texas
EMANUEL CLEAVER, Missouri            SCOTT GARRETT, New Jersey
MELISSA L. BEAN, Illinois            GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin,               J. GRESHAM BARRETT, South Carolina
LINCOLN DAVIS, Tennessee             JIM GERLACH, Pennsylvania
ALBIO SIRES, New Jersey              STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut   MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    September 5, 2007............................................     1
Appendix:
    September 5, 2007............................................    65

                               WITNESSES
                      Wednesday, September 5, 2007

Bair, Hon. Sheila C., Chairman Federal Deposit Insurance 
  Corporation....................................................    23
Dugan, Hon. John C., Comptroller of the Currency, Office of the 
  Comptroller of the Currency....................................    21
Sirri, Erik R., Director, Division of Market Regulation, 
  Securities and Exchange Commission.............................    24
Steel, Hon. Robert K., Under Secretary for Domestic Finance, U.S. 
  Department of the Treasury.....................................    19

                                APPENDIX

Prepared statements:
    Ackerman, Hon. Gary L........................................    66
    Brown-Waite, Hon. Ginny......................................    70
    Kanjorski, Hon. Paul E.......................................    71
    Price, Hon. Tom..............................................    74
    Bair, Hon. Sheila C..........................................    76
    Dugan, Hon. John C...........................................    98
    Sirri, Erik R................................................   121
    Steel, Hon. Robert K.........................................   129

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    Press release dated September 4, 2007........................   135


                    RECENT EVENTS IN THE CREDIT AND



                     MORTGAGE MARKETS AND POSSIBLE



                    IMPLICATIONS FOR U.S. CONSUMERS



                         AND THE GLOBAL ECONOMY

                              ----------                              


                      Wednesday, September 5, 2007

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:33 a.m., in 
room 2128, Rayburn House Office Building, Hon. Barney Frank, 
[chairman of the committee] presiding.
    Present: Representatives Frank, Kanjorski, Waters, Maloney, 
Velazquez, Watt, Ackerman, Sherman, Meeks, Moore of Kansas, 
Capuano, Hinojosa, Clay, McCarthy, Baca, Lynch, Miller of North 
Carolina, Scott, Green, Cleaver, Bean, Moore of Wisconsin, 
Davis of Tennessee, Sires, Hodes, Ellison, Klein, Perlmutter, 
Murphy, Donnelly; Bachus, Baker, Castle, Biggert, Miller of 
California, Capito, Feeney, Hensarling, Garrett, Pearce, 
Neugebauer, Price, Davis of Kentucky, McHenry, Campbell, 
Roskam, and Marchant.
    The Chairman. This hearing of the Committee on Financial 
Services will come to order. I'm going to make an opening 
statement, but then I'm going to leave temporarily. There is a 
hearing before the Committee on Education and Labor on a bill 
that would ban discrimination in employment based on sexual 
orientation. I trust people will understand why I will 
temporarily absent myself. You notice that given these two 
important issues today, I am wearing pinstripes and a lavender 
tie.
    [Laughter]
    The Chairman. I did not want to indicate any set preference 
for which issue I was going to deal with. But I will make my 
statement. There will be other opening statements, and we will 
then get back.
    Before I get into the substance, I just want to say that I 
apologize: we originally had been scheduled for a two-panel 
hearing. I apologize to my colleagues on the other side because 
they helped us to prepare, and I apologize to those who were 
asked to testify. We will get to them. But there was some 
miscommunication and I take responsibility for that. I was not 
able to do what I thought we should be doing.
    But secondly, and this is another important reason for the 
change. On Friday, as you know, the President announced a new 
initiative in connection with the subprime issue. That would 
have been part of our second panel. And so, since the President 
announced that proposal, we will not be getting into that issue 
today.
    We will be focusing today on the question of what happened 
in the market situation, and my concern is this: For some time 
now, we have seen the subprime crisis. I believe that those in 
charge were a little bit surprised that the subprime crisis 
spilled over as much as it did into other parts of the mortgage 
market. And more specifically, you know, you are supposed to 
pretend that you don't like to say, ``I told you so.'' But as I 
have said before, I find that to be one of the few pleasures 
that come with age.
    In other words, there was an underestimated extent to which 
the subprime crisis would spill over into the rest of the 
mortgage market. But I think the far greater surprise was the 
extent to which the residential mortgage crisis had a negative 
impact on the market in general. I don't know anyone who was 
predicting that a failure in subprime was going to lead to a 
problem in selling commercial paper, and yet it has.
    It doesn't seem that any of us charged with responsibility 
for knowing what was going on anticipated this. Now I hope this 
is containable, and we will be working together to try to deal 
with the subprime part of it and other parts of it. But what we 
have to address, what I want to focus on today, is an important 
question.
    I guess my initial view of it, in the subprime market, it 
is clear that financial innovation outstripped regulation. 
Twenty years ago mortgage loans were made by institutions that 
were regulated by the Comptroller, by the FDIC, and by the OTS. 
They have been doing a good job, and I have acknowledged that 
the institutions represented here and the OTS have done a good 
job.
    We then developed a new model for mortgages. Mortgage 
brokers and people who sold to the market, what Ben Bernanke 
called in his Jackson Hole speech last Friday, the ``originate-
to-distribute model.'' That was the innovation. And it was an 
innovation that brought a lot of good, that increased funding 
in the market, that helped a lot of people buy homes.
    But it was largely unregulated. And I think we have had a 
test case recently about regulation, sensible and intelligent 
regulation, which is I think what we get from the Comptroller, 
from the FDIC and the OTS, and from the Federal Reserve. Part 
of our job is to see if we can extend that sensible regulation, 
not overdoing it, but regulating.
    Similarly, I think there is some consensus now that what's 
gone on in the secondary market without any regulation at all 
is problematic. And again, Chairman Bernanke, who is rarely 
confused with Ralph Nader, said in his Jackson Hole speech that 
the originate-to-distribute model must be modified, is being 
modified, to include more investor protection and disincentive 
for irresponsibility.
    I read today in the Financial Times, Martin Wolf, again, 
people who have come from a generally more conservative 
perspective, say, mortgages by the stricter regulation--talking 
about securitization. The second objective of regulation is to 
insulate financial markets from the sort of panic seen in 
recent weeks. The only way to do that may be to re-regulate 
them comprehensively. Restrictions would have to be imposed on 
products sold or the ability of institutions to engage in 
transactions.
    You don't get operation. I understand. But just as it seems 
clear now, and I think there's a consensus, and the President 
essentially became part of that on Friday, there is a consensus 
that regulation in the mortgage market has not kept up with 
innovation. And that when innovation greatly outstrips 
regulation, then regulation should catch up, but regulation has 
to be sensible. Regulation cannot be too negative. But one of 
the arguments against regulation, for instance regulation of 
the secondary mortgage market earlier was, well, if you do 
that, you impinge on the market. You will kill the market. 
Well, that market is at least in a deep coma, and the notion 
that regulation of the secondary mortgage market is somehow 
going to interfere with a thriving market doesn't seem so 
persuasive.
    And in fact, and I think this is what Martin Wolf is 
saying, and it is what Chairman Bernanke was saying, it is what 
we know about mortgages, the right kind of regulation may be 
able to respond to one of the greatest needs we have today in 
the market: investor confidence. What we have is a severe lack 
of investor confidence, even in things where they shouldn't 
lack confidence.
    Giving the investor some assurance of quality in what he or 
she is being asked to invest in is part of the role of 
regulation. It's not negative. It can help the market. And so, 
one, there is some consensus that we need to do that in the 
mortgage market, and I think the President is saying that and 
Chairman Bernanke is saying that. The open question for us is, 
do we now, in the broader market, have to deal with that? And I 
notice Secretary Steel talks about the proposals that will be 
coming forward.
    I think this is the question before us: Has innovation in 
the broader financial market been made possible by technology, 
enhanced by the increased liquidity in the world, with 
globalization? Yes. It produces a great deal of advantages. I'm 
a great believer in the capitalist system. I don't think 
phenomena occur unless they meet some real need and provide 
some real good. People are not fundamentally irrational. And 
the question is not whether these innovations were beneficial 
or not but whether or not allowing the innovations to go 
forward with no regulation on the innovative sector produces 
some harm. And can we, if that's the case, can we come up with 
regulation that will diminish the harm without killing the 
whole operation? I know there are some who believe that 
regulation will always just damage the market. And regulation 
will always just be terrible. And there are people who say, you 
know what? You may think that there are abuses. There have been 
abuses. But if you regulate this, you're going to kill it. And 
if you really want to read those arguments made passionately 
and openly, go to the Congressional Record and read the debates 
on the establishment of the Securities and Exchange Commission 
in the 1930's, because they are similar arguments.
    My understanding is that you can have bad regulation. But I 
do think that the subprime market and what we address today is 
innovation has come and is useful, but there is a problem. And 
in particular, as I said, we clearly have a problem with a lack 
of investor confidence. Maybe that's short term, but I will say 
this: I know that we have tried to talk the investors out of 
being nervous, and I don't think that works very well. I don't 
think trying to bolster confidence by talking to them is 
enough. There have been steps beyond that. There have been 
increases by the Fed in money being available. There are other 
things that we have talked about doing.
    I guess the fundamental question I hope we would be 
addressing today, and going forward, is this, just to repeat. 
Giving the innovation that we have--and by the way, I should 
say one other thing. This does not to me focus on the 
institutions that are doing the innovating. The institutional 
form, whether it's private equity or a traditional investment 
bank or a hedge fund, seems to me far less important than the 
substance of what they are doing, of the great growth of 
derivatives and the fact that technology has made volatility 
more of a potential problem, because people can do so much 
more, leverage.
    Those are the issues. And no matter who is engaging in 
them, and the question is, yes, they have--the innovations that 
have helped in many ways. But they may well have gone beyond 
reasonable regulation. And the question is what, if anything, 
should we do in our regulatory structure to catch up? I will 
say it does seem to be clear. I was not pleased that so many of 
us were surprised by the impact that the subprime crisis had on 
the entire financial system. I don't want to be surprised. I 
don't want the Federal Reserve to be surprised. I don't want 
Treasury to be surprised. This is not an individual failing. It 
may be that there is a systemic problem here and that we at 
least need more information.
    So that is the area on which I want to focus. As I said, I 
know there will be questions specifically about subprime. 
Members can obviously ask whatever questions they want, but I 
do want to reiterate that on September 20th, we will be having 
a hearing on the President's proposal on subprime and other 
proposals. We will discuss that in great detail then, so I 
would hope that today we could focus to a great extent on what 
the implications of the past few months are for that broader 
question: Has innovation in the financial system so far 
outstripped our regulatory system that the time has come to 
examine that regulatory system and try to come up with ways to 
catch up without obviously diminishing the advantages?
    With that, I am going to leave, and I am going to ask Mrs. 
Maloney, the chairwoman of the Financial Institutions 
Subcommittee, to take over. We will finish the opening 
statements, and I hope to be back in time. I apologize again 
for leaving.
    Mrs. Maloney. [presiding] The Chair recognizes Mr. Bachus 
for his opening statement.
    Mr. Bachus. I thank the lady. And I thank the chairman for 
convening this hearing. This hearing is really about the 
mortgage market and the disruptions we've seen in the mortgage 
market. But as we talk about the mortgage market, we all need 
to understand that 95 percent of the mortgages in America are 
being paid. They're in good shape. So what we're talking about 
is some subprime mortgages, and we're not talking about even a 
majority or close to a majority of those.
    And last week, the President and the Administration and 
private institutions talked about beginning to work out some of 
these mortgages. So, for many of these people who are late on 
paying their mortgages, in fact, all of them who really should 
have been in loans in the first place, that had an ability to 
pay, I think in almost all cases, they're going to be given an 
ability to pay with better terms. So there is some good news, 
some news that really ought to shore up confidence in the 
mortgage market.
    Now the concerns in the subprime market, as the chairman 
said, we all know what's happened. They've caused, number one, 
some liquidity problems. Some people call it a crisis. This 
hearing is called, ``turmoil in the mortgage market.'' That's a 
little overdone. Because people who have good credit, people 
who are paying their bills on time, people who have a 
downpayment, they're able to walk in right now and get a loan 
at very low rates, lower rates than I could get when I bought 
my first home, when the rate at that time was 12 percent. Today 
the rate is 6 percent. So there's an awful lot of good news out 
there.
    When you look at unemployment, we talk about the markets--
is a recession coming? Unemployment is at a 6-year low. Real 
wages are rising. You look at all the figures; they're all 
good. I mean, I can remember times when inflation was 10 and 12 
and 14 percent. Senior citizens were seeing their money, their 
buying power disappear. It's very low. It's under control
    Exports continue to be up. So we have a sound economy. I 
know that there are some market challenges. There have been 
some excesses in the market. There have been some deals that 
probably shouldn't have been made. Investors listen. Banks have 
a tendency sometimes to pull liquidity in.
    But, if anything, I'd say about the mortgage market, you 
look at where there are no serious problems, and that's the 
vast majority of mortgages. There are no serious problems. And 
those are loans made by banks, thrifts, in some instances 
credit unions, where they know their customers or they have 
become familiar with their customers. They've assessed their 
credit history, and they've made loans according to sound 
underwriting principles, made loans according to the guidance 
of the regulators. Those loans are not in trouble.
    Where we have problems is where they push the limit. The 
chairman says where they've used innovative things. I'll use, 
by ``innovative,'' where they didn't get an appraiser, or they 
had no documentation on financial information, or the people 
had no source of income. Now that is innovation. When you make 
a loan to someone with no income, that's innovation. When you 
make a loan to someone and they have no income and you tell 
them they don't have to pay the taxes or they don't have to 
escrow insurance payments for a year or 2 years, that's 
innovation. And that was bound to fail.
    And I will say this. The chairman and I and some other 
members of this committee got together a year or two ago and we 
had really no resistance from the regulators. And we talked 
about changing some things. We talked about the fact that in 95 
percent of these cases, we were dealing with the same mortgage 
originators, whether they were bankers or brokers. They were 
being kicked out of one State, moving to another State, making 
these same bad loans, and yet we have a State system that we 
could incorporate and call for national registration. We didn't 
do it. So these bad actors continued to go to community after 
community and do the same thing over and over, and they left a 
wake of these bad mortgages.
    The Appraisers Association has called for--and I have 
introduced legislation to call for--better appraisals, for some 
standards there. We ought to do that. We ought to look at when 
we don't require people to escrow taxes and insurance, 
particularly people who have no stream of income or no ability 
to suddenly come up with taxes and insurance.
    But the one thing we shouldn't do is rush out and change a 
market that is working and working well, and has brought 
homeownership to historic highs. We should not panic. This 
morning we got some job figures that are low, but they are 
coming off very high job creation. We're going to continue to 
get times of weaknesses and strength, but what we do not want 
to do, what we can't do, is panic. We need to take a measured 
approach.
    Characteristic of this Congress in the past has been a rush 
to legislation in times of crisis, which has left us all with a 
hangover when it was over, because the regulation had 
unintended consequences. It might have boosted confidence. What 
do you do, and do something, do something now. And it may have 
made people feel good, but long-term, it resulted in too much 
regulation. We found that regulation has costs for consumers, 
costs for mortgages, and it eliminates some of the choices that 
people have made. In fact, the majority of people who have used 
new, ``innovative'' products, at least where they had an 
ability to pay, those people are in those homes, they're making 
those payments, and they have homeownership. And if we cut out 
some of those innovative products, they wouldn't have 
homeownership.
    We welcome our witnesses. We look forward to hearing from 
you. But I go out there and I find that basically we have a 
strong economy. We have some investor confidence problems. We 
have some liquidity problems. But this economy is strong, and 
we should not panic ourselves into a recession.
    Thank you.
    Mrs. Maloney. I thank the gentleman. Pursuant to committee 
rules, the Chair will extend the time for opening statements 
for 10 minutes on the Democratic side, and the Republicans will 
likewise have an extension of time. And I now recognize 
Congressman Kanjorski for 5 minutes.
    Mr. Kanjorski. Madam Chairwoman, I commend you for 
convening this timely hearing. As we begin our fall legislative 
session, it is very appropriate for us to examine what 
transpired in the capital markets during the last month or so. 
The apprehensions of many participants in our financial markets 
about their exposures to financial products backed by American 
subprime mortgages helped to trigger significant volatility in 
our credit markets at home and abroad. This instability 
affected not only housing markets, but it also seeped over into 
other commercial sectors.
    Today's hearing will help us to understand at least some of 
the factors that contributed to this turmoil and the response 
of our regulators to these problems. It will also help us to 
discern whether Congress needs to take further actions to 
restore the confidence of investors in America's dynamic 
capital markets. Although I have not yet arrived at any 
conclusions, I have already identified at least three concerns 
I expect we will begin to address today.
    First, I would like to learn more about the transparency of 
our capital markets related to subprime mortgage-backed 
securities, consolidated debt obligations, credit default 
swaps, and the parties that package and hold these increasingly 
sophisticated financial products.
    From what I have read, it appears that the participants in 
our capital markets, as well as their regulators, have had 
significant difficulties in determining exposures to subprime 
mortgages that have defaulted or will likely default. We know 
from past experience that transparency and access to 
information provide the lubricant for our capital markets to 
work well.
    Second, I, like you, Madam Chairwoman, am very interested 
in exploring the role that credit rating agencies played in 
contributing to these events. Many have already criticized 
their assessments of the creditworthiness of the financial 
products backed by subprime loans. Some have suggested that 
their actions may have contributed to engineering the faulty 
financial products.
    While we took action last year to reform the oversight of 
rating agencies, we may still need to do more. The testimony 
provided by our witnesses today will help shape the hearings 
that the Capital Markets Subcommittee will hold on these issues 
in the coming months.
    Third, I am very interested in examining how well the 
regulators, created in the last century, are responding to the 
problems of the new century. Our capital markets have 
significantly evolved since the creation of these overseers. 
After all, no one had conceived of mortgage-backed securities 
at the time we created the Federal Reserve and the Securities 
and Exchange Commission. Moreover, banks traditionally engaged 
in the role of making mortgages based on the amount of assets 
they needed on their books.
    Today, financial companies accessing our capital markets 
often help families to buy homes. As a result, the traditional 
lines between prudent regulation, investor protection, and 
consumer protection have blurred. Regulators now have multiple 
missions, such as the Commission's safety and soundness 
oversight of investment banks.
    In other instances, regulators are responding to problems 
in our capital markets using indirect means such as the 
decision last month of the Federal Reserve to lower the 
discount rate in response to marketplace uncertainty. 
Consequently, I intend to focus increasingly on whether our 
present regulatory architecture can anticipate and manage the 
risks of the modern financial system as the Capital Markets 
Subcommittee proceeds with its business during the remainder of 
the 110th Congress.
    I look forward to working with everyone interested in these 
issues in the coming months and invite them to share their 
ideas on these matters.
    In sum, Mr. Chairman, we live in an increasingly complex 
and interconnected financial marketplace. We need to move 
deliberately and strategically to explore whether we need to 
update the regulatory architecture of our financial system. If 
we come to the conclusion that we do need to pursue such a 
change, we must also move carefully to modify the system in a 
way that protects investors and ensures the long-term stability 
and viability of our financial system.
    These are complex problems and questions, and I look 
forward to exploring them. Thank you, Mr. Chairman.
    Mrs. Maloney. Thank you. Mr. Baker, for 4 minutes.
    Mr. Baker. I think the chairwoman for her recognition. I 
know that it has been made clear that the economic fundamentals 
are excellent outside the mortgage-impacted sector of the 
market. The global economy is very strong. Exports are up. 
There are a lot of good things to talk about, and the aberrant 
circumstance we now face in the mortgage market is certainly 
disappointing, but not all that unexpected.
    When one looks at the pressure from investors to seek 
higher rates of return and the diversification of tools to 
spread mortgage risk across broader sections of the market, and 
to do so in a global fashion, it created a hunger in the 
investing world that naturally the provider of product would 
going to attempt to meet.
    At the same time, the ability to acquire a home loan at 
historically record low cost enabled people to step into that 
next level of home or that first-time home buying opportunity 
on the belief that before the adjustable rate trigger was 
pulled, escalating values would continue and the takeout would 
come from the realization of profit from that sale before 
income constraints caused the aberrant result.
    It was a good plan. I came from Louisiana in the 1980's. We 
had a thing called an S&L in those days. And you used to walk 
across the parking lot and make a deal with your banker on a 
new development in 20 minutes. It seems like history is 
repeating itself here to some extent, in that over-aggressive 
lending fueled the ability for more people to buy, which fueled 
an increase in home prices, which built the view that this was 
all very solidly constructed, so investors were comfortable in 
throwing more money into the market for the chance of a greater 
rate of return. And somehow we are surprised that we now have a 
correction.
    I don't come to that conclusion. I recognize that business 
cycles are cycles, and that at some point, regulatory review or 
market pressure, and in this case, I am, to some extent, not 
surprised that it's an international response. Many homeowners 
are now coming to an understanding of the definition of LIBOR, 
not even knowing that their rate trigger was tied to the London 
rate. And there is now for the first time in many years a 
divergence between treasuries and LIBOR which is 
uncharacteristic, but to a great extent, it's because European 
lenders are now worried about counterparty risk. It's whether 
or not we will be able to pay our obligations back to European 
lenders.
    This is not something I believe should cause a great 
surprise or frustration with our mortgage market. Certainly we 
should have the highest standards of disclosure. We should 
expect nothing but professional conduct from mortgage brokers 
and other originators, and where we find those practices are 
deficient, certainly actions should be taken. But I suggest 
that most of the tools to respond to those crises or problems 
are well within the hands of the Treasury or the Federal 
Reserve.
    And so I urge great caution in having the Congress ham-
handedly interject more risk in the American taxpayer 
pocketbook or constructing more constrictive rules that will in 
essence preclude a more logical market-based recovery. 
Certainly there is risk in the world, and you can't protect 
everyone from every conceivable risk. You should discuss it. 
You should disclose it. You should do your best to explain it. 
But at the end of the day, all you can do is explain it; you 
can't understand it for people. And as a result of 
inappropriate risk-taking, if people lose money, that should 
not come as a big market surprise in a capital market system.
    This review, I think, is highly appropriate. But before 
this Congress acts to take on unwarranted response to a market 
disappointment, we should be very careful to understand the 
consequences of our action.
    I yield back.
    Mrs. Maloney. Thank you. The Chair recognizes herself for 3 
minutes. First of all, I want to thank our chairman, Mr. Frank, 
for holding this hearing on really the biggest financial story 
of the year: The turmoil in the credit and mortgage markets, 
and its impact on consumers and the economy.
    After Hurricane Katrina, over 300,000 people lost their 
homes. About 10 times as many people may lose their homes to 
foreclosure due to the subprime crisis.
    The response from the Administration has been slow. 
Therefore, I was extremely pleased to hear the President's 
announcement last week. His proposed changes at FHA to provide 
refinancing options to more homeowners and to help borrowers by 
refinancing them into FHA loans is an important first step. I 
also support his proposed temporary legislative fix to change 
tax law so that canceled mortgage debt is not treated as 
income. Individuals facing foreclosure should not get the 
double whammy of paying taxes on the loss in value of their 
home.
    These are helpful actions that Congress can take 
immediately, and I support them, but it is not enough. Another 
item that can be quickly achieved is GSE reform. Fannie Mae and 
Freddie Mac are providing much needed liquidity in the prime 
market right now. If there was ever a time when they should 
expand their activities, even if it's temporary, it is now. We 
need to raise the ceiling on the amount of mortgage that can be 
refinanced and raise caps temporarily. We passed a GSE reform 
bill in the House. It needs to pass the Senate, or the 
Administration needs to take action to raise the limits.
    I have always said that markets depend as much on 
confidence as on capital. Right now there is a loss of 
confidence in rating agencies, and they deserve it. Large 
amounts of debt that are or have been highly rated are headed 
for default. As with Enron, the rating agencies have been dead 
wrong. Investment guidelines and capital standards need to be 
more accurate. We need to review the way rating agencies are 
compensated by their clients and look for ways to strengthen 
regulatory oversight of these agencies.
    We also need a uniform national standard to fight predatory 
lending. We need to set a single consumer protection standard 
for the mortgage market. The Fed has taken important steps in 
regulation, but we need to do more. We have a great deal to do, 
and I look forward to the testimony from our distinguished 
panel.
    I now recognize Congressman Miller for 2 minutes.
    Mr. Miller of California. Thank you very much. I commend 
Chairman Frank and Ranking Member Bachus for holding this 
hearing today. This is a--if we look back at recessions, this 
is a lot different than the mid-1970's, 1980's recession. 
Remember prime was in the 20's, so if you could get a 12 
percent fixed rate 30-year loan, people would close your house 
immediately. I mean, you can sell them. The 1990's recession, 
high unemployment, the same situation. It seems like the press 
beat this issue to death for several years before they could 
get a decent housing recession going, and finally it really 
occurred. It's interesting when you look at buyers. If there's 
a line forming, they'll get in line to buy a house, yet they'll 
walk by a house that's a good deal when the bad time occurs and 
never even make an offer.
    But the situation we're facing today in the subprime 
marketplace, we've talked about defining subprime and predatory 
in recent years. And I think today is a good example of what 
predatory is when you see it in reality. When you make a 
subprime loan and you lend money to a person that they're never 
going to be able to repay on a normal marketplace, that's 
predatory. But they have gotten by with it in recent years 
because when a house increases in value 10 to 15 percent a 
year, when you buy a $200,000 home, 5 years later it's worth 
$325,000, you can sell it and still make a profit even if you 
can't make the payment in 5 years. But today we have a lot of 
people who are stuck with a loan they made--they borrowed from 
a lender, and now they can't remake the payment.
    We spent a lot of time in this committee in recent years 
worrying about safety and soundness on GSEs as Freddie Mac and 
Fannie Mae, and it seems like in the marketplace today, they're 
not the ones who are having the problem. It seems to be the 
subprime and the jumbo marketplace. And if you look at the 
situation in the jumbo and subprime, only about 18.2 percent of 
the loans are fixed 30-year loans. In the GSEs, 82 percent of 
the loans are fixed 30-year loans, and that's why they're doing 
very, very well.
    I think we can do something to help the market today, 
especially in high-cost areas, in raising conforming limits. 
You have a liquidity situation occurring out there in these 
high-cost areas. In my district, for example, I'll give you an 
example, FHA. In 5 years, from 2000 to 2005, the FHA loans 
dropped 99 percent. In my district in 2000, they made 7,000 
loans. In 2005, they made 80 loans. If you look at FHA overall 
in California, it went from 109,000 to 5,137.
    Now I'm not talking about going out and making risky loans. 
But if you use reasonable underwriting criteria and standards, 
you can make a high-cost loan in those areas that's very safe 
and very sound. That's something that I think we need to look 
to.
    I yield back.
    Mrs. Maloney. I thank the gentleman. The Chair recognizes 
Congressman Baca for 3 minutes.
    Mr. Baca. Thank you, Madam Chairwoman, and I want to thank 
Barney Frank and the minority leader for having this important 
hearing. As chair of the Congressional Hispanic Caucus, as a 
member of the Financial Services Committee, I am especially 
concerned about the impact the foreclosure epidemic is having 
on our families, and all of us are very much concerned. We've 
seen what has happened nationwide. We've seen what's happened 
in our area. The fact is, subprime lending is concentrated in 
minority populations and in minority neighborhoods, and that's 
a concern to a lot of us as we've seen what has happened.
    And I'd like to relate that, especially in my district, 
minority homeowners were more likely to receive higher rate 
loans than white homeowners, even with the same income level. 
And when you look at the same income level, but the disparity 
in terms of minorities receiving the higher rates, some or most 
of these families could have qualified for better or more 
affordable loans but were instead steered into subprime loans 
by the lender or broker to make a profit, and this continues to 
go on.
    And we need to have accountability. We need to make sure 
that this does not happen. Because when someone loses their 
home, this is the American Dream for someone to obtain a home, 
have a home, and all of a sudden, they are being steered in the 
wrong direction. And most of these families, you know, need to 
be in these homes. According to the Center for Responsible 
Lending, almost 20 percent out of 375 subprime loans made to 
Hispanics in the year 2000 are likely to foreclose. And that's 
a high number when you look at it, not to mention the impact 
it's also having on the African-American community, that more 
than likely will end up losing their homes.
    In my district, the Inland Empire has the fourth highest 
foreclosure filing in the Nation among the larger metro areas, 
and was the hardest hit in California through the first half of 
2007. In San Bernardino alone, there were 19,185 foreclosures 
filing in the first half, representing a staggering 345 percent 
increase from the previous year.
    Overall, there is one foreclosure filing in every 33 
households in the Inland Empire. That's a lot. One out of 33 
households are filing. So if you look at your neighborhood, the 
market value, the closure, the impact it's having in our area, 
that's a direct impact. And a lot of us, when you look at the 
neighborhoods too, within the area, what is it doing to the 
rest of the market with a lot of foreclosures that it's having 
in our area? So one out of 33 households. I drive down, 
foreclosure sign.
    No one gains when people are thrown out of their homes, the 
housing market falls, and entire neighborhoods are affected. 
This is having a terrible impact on our national economy, as I 
stated, and also within our neighborhood and the cleanups in 
the areas.
    I look forward to hearing the witnesses' testimony today. 
Thank you very much, Madam Chairwoman.
    Mrs. Maloney. Thank you very much. The Chair recognizes 
Congressman Hensarling for 2 minutes.
    Mr. Hensarling. Thank you, Madam Chairwoman. And, I, too, 
want to thank our chairman for calling this hearing. As we 
contemplate perhaps some kind of legislative remedy, I once 
again want to remind our colleagues we should always be careful 
about our unintended consequences. And I want to associate 
myself with the comments of our ranking member to put the 
challenge in the proper context. That is, I still believe, last 
I looked, that subprime lending was roughly 13 to 15 percent of 
the entire mortgage market. And of that, 83 percent are still 
paying on time. So we need to make sure we put this in the 
proper context.
    Now clearly, there may be broader threats to the economy, 
and that's something that deserves a serious look. We need to 
also take a look at why it is that borrowers default on their 
loans. Well, the number one reason still continues to be 
personal setbacks--job loss, illness, or disability. That's why 
we have the social safety net. Some may fail to understand the 
consequences of their action, and clearly there may be more 
opportunity for this committee in the area of financial 
literacy, not to mention more effective disclosure, since I do 
believe that on occasion less could be more.
    Fraud is certainly out there. Fraud has been there since 
the dawn of man, and we need to examine, is there proper 
enforcement? But there's another reason that borrowers default, 
and that is, is that they do foolish things. And perhaps part 
of personal freedom is the freedom to do something that may be 
foolish.
    The question is, did some borrowers in the appreciation, in 
the housing appreciation, use their homes as a personal ATM 
machine? And what does it mean for national policy for us to go 
and bail these people out? Will we incent even more bad 
behavior? So I think we have to take a very serious look at 
that for the greater macroeconomic implications. We do need to 
see that perhaps the tools that are available to the Fed and 
Treasury are not adequate to the task.
    So I would caution us once again, Madam Chairwoman, to be 
very wary of unintended consequences, and I yield back the 
balance of my time.
    The Chairman. I thank the gentleman. I would note that the 
hearing has changed, and while we did discuss transgender 
issues at the other hearing, we're back to a more conventional 
format here today.
    The gentleman from New Jersey is recognized for 2 minutes.
    Mr. Garrett. Thank you. As indicated, we have recently seen 
a steep decline in two specific sections of the market. We 
talked about the subprime market, and also the jumbo mortgages. 
However, most housing data shows that these numbers, while they 
are rising dramatically, are expected to peak basically in the 
next several months. And the problems that we see are basically 
due to bad prior underwriting practices. And Chairman Bernanke 
indicated some of the causes when he stated increased reliance 
on securitization has led to a greater separation between 
mortgages and mortgage investing.
    I think you have to step back for a second and realize that 
the push by some in Congress and the Administration and society 
in general to increase homeownership rates has led to more 
lenders expanding into various segments of the mortgage market, 
especially subprime, and to be able to better serve this 
market, there have been large numbers of newly created and 
increasingly complex products. And if you add to that the 
lowering underwriting standards and incorrect or questionable 
ratings of borrowers, it increased the risk incurred to that 
segment of the market and homeownership.
    But you have to ask yourselves something. Owning your home 
is an extremely noble goal, is long part of the definition of 
the American Dream, but not everyone in the current financial 
conditions is allowed to have that in their own reality. The 
Federal Reserve states that the United States is at full 
employment when the unemployment rate is between 4 and 5 
percent. So we have to ask, at what point do we define the 
country at full homeownership? Now, while it is essential for 
Congress to examine what led to the situation and what steps 
either the Administration or Congress or both should take to 
ensure that these problems do not expand into the rest of the 
marketplace, we have to, as Mr. Hensarling just said, put this 
in perspective. And the perspective is this: The subprime 
market makes up around 13 percent of the entire housing market, 
and the problem in the subprime area is around 12 or 13 
percent, so we are looking at dealing with something a little 
less than 2 percent of the overall entire market.
    And finally, we must remember again what Chairman Bernanke 
recently said, that the failure of investors to provide 
adequate oversight of originators and to ensure that 
originators' incentives were properly aligned was the major 
cause of the problem that we see today in the subprime market.
    But he continued, finally, and said, in recent months, we 
have seen a reassessment of the problems in maintaining 
adequate monitoring and incentives in the lending practices. In 
essence, the market has worked itself out to deal with those 
poor underwriting practices of the past.
    And with that, Mr. Chairman, I yield back.
    The Chairman. The gentleman from Texas is recognized for 2 
minutes.
    Mr. Neugebauer. I thank the chairman. I want to associate 
myself with a lot of the remarks that have already been made, 
but, you know, one of the things I want to point out is that 
this is not an issue that we haven't seen before. Those of us 
who have been in the housing business for a number of years 
remember the 1980's, and where we saw some of the similar kind 
of problems with, as the gentleman said, an endangered species 
called savings and loans. They're not endangered anymore. 
They're not here anymore, and they're not here anymore because, 
quite honestly, they asked for some expanded responsibilities 
and abilities that they were not able to manage.
    And so where we are faced today is with problems with an 
industry that got very aggressive, very ``innovative,'' is the 
word that has been used, and now what we need today is to let 
the marketplace work this problem out. One of the things we do, 
though, I think is a huge mistake, we have some of the players 
that were a big help for us in the 1980's, and that was Fannie 
Mae and Ginnie Mae, their ability to come in and provide some 
liquidity and some mortgage abilities in the 1980's really 
helped keep--mitigate the 1980's from being any worse than they 
were, although I don't know how they could have gotten much 
worse than they did.
    But I think what we need to look at today, and I'm going to 
be interested to hear from the panel, is how we give the 
marketplace a little flexibility and liquidity here to work 
through this process without, as many of our colleagues have 
already said, undermining the greatest housing system in the 
world. Countries all over the world look to America as the 
leader in how to develop housing and housing finance, and so I 
hope that we'll be able to look at that.
    One of the things that I think we have today is Ginnie Mae 
and Fannie Mae, because of the limitations. We've been having 
discussions here in this committee over the last few months 
about putting limitations on the people who probably know more 
about mortgage lending than anybody in the world, when we 
probably should have been talking about limitations on some 
folks that didn't know as much about mortgage lending as Fannie 
Mae and Ginnie Mae do.
    You know, the term ``subprime''--I think even my third-
grade grandson understands what ``subprime'' is. And he can't 
go home and explain to his parents that he got subprime grades 
because of the interpretations and criteria that the 
marketplace was using at that particular time. And so I think 
what we have to understand is that subprime is subprime, and 
that the marketplace looked the other way. It took a different 
view. I mean, those of us in the housing business have marveled 
at the innovation that has gone on in the last 2 years of 
people getting home loans how they could have never--couldn't 
even get car loans in many cases, and were able to get home 
loans. And so, hopefully over the next few hours here, we can 
hear from the experts and hear some ways that we--how we fix 
this without wrecking a very efficient system, one allowed to 
work in a market-based way.
    The Chairman. The gentlewoman from California is recognized 
for 3 minutes.
    Ms. Waters. Thank you very much. I want to thank Chairman 
Frank and Ranking Member Bachus for holding today's hearing. I 
believe this hearing is timely, because of the recent turmoil 
in financial markets here and abroad related to subprime 
mortgage-backed securities.
    Let me just say, Chairman Frank and members, about a year-
and-a- half ago, I was in Cleveland, Ohio, in Congresswoman 
Stephanie Tubbs Jones' district. There was a big town hall 
meeting there, and at that town hall meeting, the citizens 
described that there were blocks and blocks of boarded-up 
housing and that those who remained were at great risk because 
the boarded-up housing was under the control, sometimes, of 
criminals, that the deterioration of those homes was causing 
the price of their homes to go down, and on and on and on.
    None of us really understood what was going on, and 
surprisingly, none of our regulators were able to understand 
what was going on and to try and inform us so that we could at 
least try to provide some assistance to people who were getting 
into some of these subprime loans, who did not understand what 
they were getting into.
    Now what is so disturbing about all of this is this: For 
those of us who have worked for years to try and open up 
opportunities for people who have been locked out of the 
mortgage market, folks that we really believed that, given a 
chance--they may not be able to have a downpayment. They may 
have even had some credit problems, but people who work every 
day, who pay their rent, and who pay their electric bills, 
we've always wanted them to have an opportunity, and we fought 
with the financial services in order to do this.
    And we welcomed subprime. And we agreed that subprime did 
not have to be predatory, that there was a case to be made that 
people who presented some risk, not extraordinary risk, should 
be afforded a mortgage and that they should be expected to pay 
on time, and that the subprime market could charge them a 
little bit more for that loan. We all agreed to that. And we 
thought that the regulators not only were watching what 
happened with loans that were delinquent that were on the books 
of these financial institutions, we thought that they would 
know when something went wrong.
    And evidently, they did not know, and we're all kind of 
surprised to find out that once the originators discovered that 
they could package anything and have it packaged and 
securitized and the investors would put money into it, that 
they could just throw anything into the package.
    And so all of these exotic products, it's not simply no 
downpayment, but we're talking about products where you don't 
even verify the employment of the individual, particularly with 
some of these jumbos that were going out. And we still don't 
know today how they would get a handle on these products that 
came into being that have created this unsettling of the 
market. And so I remember when Federal Reserve Chairman 
Bernanke was here with testimony to the full committee in 2007 
on the mid-year Monetary Policy Report, and I raised these 
concerns, and he did not have any answers.
    So the bottom line is, it seems for those of us who fight 
for opportunities for people who should have loans, it's either 
feast or famine. So now we're going to get to a point where 
nobody is going to be able to get a loan. And I really want our 
regulators to tell us why they didn't know, and what can be 
done about it, and how we don't have to, you know, revert to 
drying up the opportunities for everybody because we've gone 
into this situation.
    I yield back the balance of my time.
    The Chairman. The gentleman from California. We went a 
little long in the opening statements today, but we only have 
the one panel, so I think we'll be able to sustain an attention 
span through that. The gentleman from California, for 2 
minutes.
    Mr. Campbell. Thank you, Mr. Chairman. I want to join the 
chairman in saying that I, too, thought some weeks ago that 
this subprime problem would be contained, and I represent the 
district where it was pointed out that there have been more 
subprime failures on Jamboree Road in Irvine, California, my 
district, than in any other State. So I'm pretty familiar 
with--and pretty close to some of what's gone on here.
    And, you know, Chairman Bernanke before this committee 
several times had said that his greatest concern for the 
economy in the future would be a hardfall in the housing 
market. The housing market was clearly teetering before the 
subprime problem spread to Alt A and through to--through now 
into AAA housing loans and credit. And, frankly, from what I 
understand, it has spread through into commercial real estate 
loans and is impacting that, too.
    So I come into this hearing and in fact back to this 
Congress today with no preconceived notions on what we should 
do or what we shouldn't do, but in fact to listen. Because I 
come in with great concern for this economy and for what effect 
a hardfall in the housing market led into by this credit 
problem and/or in commercial real estate could lead to as far 
as our national economy.
    It seems to me just as an observer that there is a risk 
premium that is being put on by investors around the world now 
on loans, on packages of loans securitized by real estate in 
the United States, and that that risk premium is there because 
they no longer trust what is coming out of this market, what 
these loans are purported to be and what checks have been done 
or not done, and that perhaps one of the things--and I'll be 
very interested to hear from the panel--is that--is what can we 
do to restore some confidence or to add some confidence or some 
transparency so that that risk premium goes down, and so that 
investors around the world once again can look at a package of 
real estate loans from the United States as being something 
that is worthy of investing in without an inordinate risk 
premium there.
    I look forward to hearing the testimony from the panel, and 
I thank the chairman.
    The Chairman. The gentleman from Georgia, for 2 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman. And I, too, 
am looking forward to this hearing. But I wanted to just make a 
few brief remarks if I could because I'm anxious to hear what 
you have to say. I represent the Atlanta region, Atlanta, 
Georgia, which right now has the second highest number of 
foreclosures anywhere in the United States, and this is not a 
new phenomenon.
    I heard very clearly some of the points that were raised on 
the other side about laissez faire, let the market take care of 
itself, but this is not something new. This has been going on a 
long, long time, certainly in my region, and I think it's wise 
of us to look at some of the basic issues of why this is 
happening. I think we need to prepare legislation or 
initiatives, whatever, in a very calm and responsive way, but 
certainly we have to look at what's causing this. Number one, 
what's causing this is loans are being made to people who ought 
not to get these loans. Something ought to be done about that. 
Something ought to be done about loan originators who are 
sitting and they know that these people do not have the 
capacity to pay. They know that they have weak credit 
histories, but yet, they are still making the loans to these 
individuals.
    Secondly, we have over-aggressive, eager loan originators. 
And then thirdly, we have consumers--and this is really the 
heart of the matter--we have consumers in this country, most of 
whom, who are just woefully lacking in financial literacy and 
education before they sign on the dotted line. And we have 
moved very slowly--as a matter of fact, we have not moved at 
all--in putting forward a very aggressive financial literacy 
program with at least a toll-free number where people who are 
on the margins, who are in these subprime markets, who are most 
at risk, can at least have a place to call before signing on 
the dotted line.
    And so it is my hope that in the hearing today, we will be 
able to discuss some of these issues. But I also want to put my 
two cents in for taking an intelligent look to see what our 
institutions can do that are there. The President has already 
moved with the FHA and first-time home buyers and giving them 
some help, which I applaud. But we have Fannie Mae and Freddie 
Mac, whose limits should be lifted. And let me also commend our 
banks, that are doing an excellent job, particularly Atlanta 
Federal Home Loan Bank in my hometown, of getting more money 
into the market to help with the liquidity problem.
    Thank you, Mr. Chairman.
    The Chairman. Finally, I will recognize the ranking member 
for a unanimous consent request.
    Mr. Bachus. I thank the chairman. Mr. Chairman, the ranking 
member of the subcommittee, Mrs. Biggert, is presently in a 
conference in the Senate on the student loan bill, and she has 
played a significant role in addressing subprime problems, and 
I would like to ask unanimous consent to submit her statement 
into the record in Mrs. Biggert's absence.
    The Chairman. Without objection, it is so ordered.
    And we will now turn to our witnesses. Before we do, I want 
to enter into the record a press release dated yesterday: 
``Federal Financial Agencies and Conference of State Bank 
Supervisors Issue Statement on Loss Mitigation Strategies for 
Services of Residential Mortgages.''
    Catchy title, guys. But it's a very important statement. It 
is from the bank regulators, the Conference of State Bank 
Supervisors, and it's a very encouraging example of Federal-
State cooperation and the National Credit Union Administration. 
It is really quite important; I think it builds in part on some 
of the work that we have done in conjunction with the SEC where 
mortgages are held in portfolios of institutions, and you can 
get workouts at least directly.
    A large part of the problem has been that the mortgage is 
held after securitization, and it has not gotten enough 
attention, I think, that the SEC, to its credit, at our 
request, got the Financial Accounting Standards Board, to its 
credit, to make clear that the appropriate accounting standard 
allows the servicer of securities to show flexibility if the 
holders will be better off.
    As we know, increasingly now, with increased property 
values, with the kind of domino effect, it is better in many 
cases to forego every last right of the contract which would 
lead to foreclosure and instead do a workout. I very much 
appreciate what we have here, and I thank the regulators, some 
of whom are represented here. They have now written to the--
they've issued this statement, and they are telling the 
securitizers to please take advantage of the flexibility. So 
this is one more example.
    And for those who are paying attention to this, to members, 
this is something--we're going to send this around to all 
members. If you are talking to people in your districts who 
have these mortgage problems, if you are talking to the 
advocacy groups, many of which are doing a very good job, the 
counseling groups, they should know both about what the 
Financial Accounting Standards Board just said, and the fact 
that all of the regulators have urged them to go forward with 
it.
    With that--and I ask that this be put into the record. 
Without objection, it will be.
    And with that, we will begin the testimony with Secretary 
Steel. Well, one last explanatory point. There is one missing 
face at the table today, if we look at institutions with 
responsibility. It's the Federal Reserve System. Originally I 
had invited the Federal Reserve, but there is a Federal Open 
Market Committee meeting on the 18th of September. The Federal 
Reserve System asked us if they could defer appearing, given 
how close it is to an FOMC meeting, because they fear that 
people might draw the inference that whatever they did at the 
September 18th meeting might have been influenced by what was 
said today. Though, frankly, I will ask for the indulgence, 
that seems to me less of a terrible thing than to others. This 
is an institution, the House of Representatives, that can vote 
on the most intimate and important questions affecting 
humanity; war and peace and life and death, and all manner of 
other things. But apparently, God forbid we should ever talk 
about a quarter percent on the interest rates, because that is 
beyond the competence of a democratic institution. I don't 
agree with that, but I have deferred to it in this instance. We 
will get back to the Fed later.
    The gentleman from Alabama.
    Mr. Bachus. Mr. Chairman, you noted the absence of the 
Federal Reserve. I also would like to say that the director of 
the OTS--
    The Chairman. Yes.
    Mr. Bachus. --John Reich, is not here, and of course, they 
regulate our thrifts, including Countrywide and--
    The Chairman. Will the gentleman yield? The gentleman is 
right. I was hoping that this hearing would not focus so much 
on subprime, that we would be doing that on mortgages at the 
September 20th hearing, and that this would get to the broader 
ones. And we do have two of the bank regulators because they 
have regulatory authorities that go beyond that. The thrifts 
is--the OTS has done a good job, and I acknowledge that. They 
will be at the next hearing.
    Mr. Bachus. And actually, I guess my reason for pointing 
that out is that he has done a good job.
    The Chairman. No question.
    Mr. Bachus. You and I have both discussed privately that 
the OTS--
    The Chairman. Yes. And OTS is part of this group, and I 
agree with that. I would note just for the purpose of symmetry, 
that they used to have a practice in the House called 
``pairing,'' where a Member on one side of an issue and a 
Member on the other side of an issue could both be absent, and 
they would kind of get credit for canceling each other out.
    I would note that while we don't have the Federal Reserve 
here today, neither do we have the gentleman from Texas, Mr. 
Paul. And I think from the standpoint of people who know Mr. 
Paul, having both the Federal Reserve and Mr. Paul not here is 
a reversion to the old pairing system, so we have managed to 
reach some parity there.
    Mr. Secretary, please begin your testimony.

STATEMENT OF THE HONORABLE ROBERT K. STEEL, UNDER SECRETARY FOR 
       DOMESTIC FINANCE, U.S. DEPARTMENT OF THE TREASURY

    Mr. Steel. Chairman Frank, Ranking Member Bachus, and 
members of the committee, I very much appreciate the 
opportunity to appear before you today to present the Treasury 
Department's perspective on the recent events in the credit and 
mortgage markets and their impact upon consumers and the 
economy. The Treasury Department and Secretary Paulson know 
these events are of considerable interest to the American 
people, this committee, and other Members of Congress.
    To give context to the current market situation, let me 
begin my remarks today with a brief description of both 
domestic and global economic conditions. In the United States, 
the unemployment rate is 4.6 percent, closest to its lowest 
reading in 6 years. Real GDP growth was 4 percent in the second 
quarter, supported by strong gains in business investment and 
in exports. Core inflation is under control. Since August of 
2003, 8.3 million jobs have been created, more jobs than all of 
the major industrial countries combined.
    The global economy continues to grow at around 5 percent 
annually with many emerging market economies growing even more 
rapidly than the global average. Over the past several years, 
these favorable economic conditions--low unemployment, low 
inflation, low interest rates--serve to fuel a demand for 
credit and investment, and the marketplace responded with a 
vast supply of both to satisfy consumers and the sophisticated 
market participants.
    At the consumer level, this demand was very noticeable in 
the mortgage industry, and in recent years particularly, the 
subprime area. For the first time in the early 1990's, 
consumers with lower incomes and challenged credit histories, 
typical subprime borrowers, were able to access mortgage credit 
at interest rates a few percentage points higher than prime 
borrower rates. Homeownership became more widely available in 
the United States, growing from 64 percent in 1994 to 69 
percent today.
    Mortgage securitization has played a significant role in 
this growth. Typically, the mortgage originator distributes its 
loans to a securitization sponsor, who pools together the 
mortgages into mortgage-backed securities. Investor demand for 
mortgage-backed securities provided capital to mortgage 
originators, who were then able to use this capital to make 
more loans.
    Throughout most of the 1990's, annual mortgage origination 
stood at approximately $1 trillion. With the historical low 
interest rate environment of 2001 to 2003, mortgage origination 
climbed to almost $4 trillion in 2003. Infrastructure buildup 
and the entry of many new participants into the mortgage 
industry matched this increase. As interest rates began to rise 
in 2004, mortgage origination fell to just under $3 trillion. 
With this decline, there was significant overcapacity in the 
mortgage industry.
    To satisfy continued investor demand for mortgage-backed 
securities and their excess capacity, some mortgage originators 
relaxed their underwriting standards, lending to individuals 
with a lower standard of documentation, and thereby selling 
mortgage products which for some buyers would become 
unaffordable.
    The combination of rising interest rates and mortgages 
resetting at higher rates, and a decline in house price 
appreciation, led to rising delinquencies and defaults among 
subprime borrowers, first widely evidenced in the autumn of 
2006. In 2007, this trend has continued.
    In turn, the mortgage-backed securities investor has felt 
the repercussions of the weakness in the mortgage assets 
underlying some of these securitized products. Over the past 
several months, a small number of U.S. and foreign financial 
institutions and hedge funds invested in mortgage-backed 
securities have reported large losses. Some have suspended or 
limited redemptions consistent with their authority, while 
others have liquidated or received capital infusions so as to 
continue.
    The uncertainty regarding the future prospects of these 
mortgage-backed securities compelled investors to reassess the 
risk of these securities and subsequently reassess price. This 
reappraisal has spread across other parts of the credit market 
spectrum, first affecting residential mortgage-backed 
securities and then spreading to other asset classes, and in 
particular, securitized products.
    This reappraisal of risk is normal and typically follows 
periods of widely available credit when markets have 
undervalued risk. As in other times of reappraisal, investors 
adverse to risk and protective of their capital, have fled to 
quality assets, demanding and driving up the prices, and in 
turn driving down the rates of securities such as Treasury 
bills.
    In early August, this uncertainty and subsequent 
illiquidity began to spread to asset-backed commercial paper, 
typically a highly liquid market. In response, the Federal 
Reserve took several measures to increase liquidity and promote 
the orderly functioning of financial markets. The Federal 
Reserve provided additional reserves through open market 
operations in order to promote trading in Fed funds markets at 
rates close to the target rate. The Federal Reserve also 
lowered the discount rate and changed the Federal Reserve's 
usual practices to allow the provision of term funding at the 
discount window. Such actions have helped to stabilize the 
markets.
    The ultimate impact of these different events on the 
economy has yet to play out. At the time of its discount rate 
cut, the Federal Reserve noted, ``the downside risks to growth 
have increased appreciably.''
    The Treasury Department respects the independent action and 
leadership of the Federal Reserve. Like the Federal Reserve, 
the Treasury Department shares the perspective that recent 
market developments pose downside risks to economic growth. 
However, the economy was in strong condition going into the 
recent period of volatility, and while certain sectors like 
housing are undergoing a transition, overall economic 
fundamentals remain strong. And while recent difficulties in 
the subprime mortgage market are having and will continue to 
have a profound effect for many families, the underlying 
strength of the economy should allow for continued growth.
    The Treasury Department closely monitors the global capital 
markets on a daily basis. Under Secretary Paulson's leadership, 
the President's Working Group on Financial Markets will examine 
some of the broader market issues underlying the recent market 
events, including the impact of securitization and the role of 
rating agencies in the credit and mortgage markets.
    The Treasury Department will also be releasing early next 
year a blueprint of structural reforms to make financial 
services industry regulation more effective, taking into 
account consumer and investor protection and the need to 
maintain U.S. capital markets' competitiveness.
    Most important, in addition to efforts to fully understand 
the current situation in the financial markets, last week, the 
President announced a series of market-based initiatives to 
help homeowners keep their homes. For example, the 
Administration, led by the Treasury Department and the 
Department of Housing and Urban Development, has undertaken 
several actions to provide assistance to homeowners, including 
the Administration's continued pursuit of legislation 
modernizing the Federal Housing Administration.
    Coordinating with HUD, the Treasury Department will also 
reach out to a wide variety of entities, such as NeighborWorks 
America, mortgage originators and servicers, and government-
sponsored entities like Fannie Mae and Freddie Mac, to identify 
struggling homeowners and expand their mortgage financing 
options. The Treasury Department looks forward to working with 
Congress in the days ahead on these important issues.
    In conclusion, it is crucial that policymakers understand 
these issues and their underlying causes, and continue to 
enhance the capital markets' regulatory structure to adapt to 
market developments.
    I appreciate having the opportunity to present the Treasury 
Department's perspective on these important issues and I look 
forward to your questions.
    [The prepared statement of Under Secretary Steel can be 
found on page 129 of the appendix.]
    The Chairman. Thank you. Next, we have the Comptroller of 
the Currency.
    Mr. Dugan?

 STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER OF THE 
      CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY

    Mr. Dugan. Chairman Frank, Ranking Member Bachus, and 
members of the committee, I appreciate this opportunity to 
provide the OCC's perspective on recent events in the credit 
and mortgage markets.
    As you know, we are the primary supervisor for the very 
largest commercial banks that play critical roles in virtually 
all aspects of today's capital markets, including the credit 
markets for mortgages, leveraged loans and asset-backed 
commercial paper that have received so much attention. The OCC 
maintains teams of examiners onsite at each of these 
institutions to monitor their activities.
    More broadly, for the last 20 years, national banks across 
the country have become very substantial participants in 
residential mortgage markets where they originate, hold, sell, 
buy, service, and securitize most types of mortgages. These of 
course include subprime mortgages, but let me emphasize that 
national banks have proportionally been less involved in that 
market, originating less than 10 percent of all subprime 
mortgages in 2006, and have experienced default rates that are 
significantly lower than the national average.
    Given the large aggregate credit exposure of national 
banks, the recent volatility in credit markets has clearly been 
a concern for both the OCC and the banks that we supervise. 
These challenging market conditions affect all market 
participants, including not just the largest national banks 
that participate actively in capital markets, but also the many 
mid-size and community national banks that engage in mortgage 
activities across the country.
    Let me be very clear, however, that the worst problems that 
we have seen in markets--insufficient liquidity resulting in 
substantial declines in capital and sometimes in failure of 
individual firms--have occurred outside the commercial banking 
sector. The national banking system remains safe and sound. 
Unlike many non-bank lenders, national banks generally have 
strong levels of capital, stable sources of liquidity, and 
well-diversified lines of business, all of which have allowed 
them to weather these adverse market conditions.
    As a result, national banks remain active in major markets 
and continue to extend credit to corporate and retail 
customers, including mortgage credit.
    With respect to general market conditions, I am encouraged 
by the recent actions to restore liquidity that have been 
undertaken by the Federal Reserve, other central banks, and 
various market players, including some major national banks. 
Nevertheless, the situation does remain fluid and it may take 
some time until markets fully stabilize.
    We are therefore continuing to watch conditions very 
closely and talking on a regular basis with other financial 
regulators to address issues that may arise. While recent 
market conditions have certainly been painful, and may continue 
to be painful for some time, we believe they are likely to 
cause some positive changes in the longer term as markets re-
evaluate and reprice risk.
    Part of today's problems in credit markets resulted from 
underwriting standards that had relaxed too much, whether in 
subprime loans or leverage lending, to pick two examples, which 
was at least partly the result of investor willingness to 
assume greater risk to achieve higher yields.
    In both cases, market participants are now demanding 
changes in the form of more conservatism. While legitimate 
concerns remain about the pendulum swinging too far and too 
suddenly in the opposite direction, we remain hopeful that 
markets will stabilize at an equilibrium where lending 
standards are more rational and pricing more accurately 
reflects risk.
    Such a positive outcome would apply in the future to loans 
that are yet to be made. Unfortunately, the same cannot be said 
for many loans that have already been made, and in particular 
for many homeowners holding subprime mortgages.
    For those Americans who may be facing unmanageable mortgage 
obligations, recent events are far more serious than a simple 
market correct. They may instead result in foreclosure and all 
its potentially devastating effects on families and 
communities.
    The OCC recognizes the need to do all we can to reduce the 
inevitability of that outcome. We have taken concrete steps to 
encourage both lenders and borrowers to respond to these 
situations in ways that minimize the likelihood of foreclosure 
while preserving safety and soundness.
    Just yesterday, as the chairman stated, the banking 
agencies jointly released a statement encouraging lenders and 
servicers to work with borrowers to take appropriate steps to 
avoid foreclosure even where loans have been securitized. With 
the prospect of significantly increasing foreclosures looming 
on the horizon, we are fully committed to working with all 
interested parties to help address the many significant issues 
that could arise.
    Thank you very much.
    [The prepared statement of Comptroller Dugan can be found 
on page 98 of the appendix.]
    The Chairman. Thank you, Mr Dugan.
    Now, the chairman of the FDIC, Ms. Bair.

  STATEMENT OF THE HONORABLE SHEILA C. BAIR, CHAIRMAN FEDERAL 
                 DEPOSIT INSURANCE CORPORATION

    Ms. Bair. Chairman Frank, Ranking Member Bachus, and 
members of the committee, I appreciate the opportunity to 
testify on behalf of the Federal Deposit Insurance Corporation 
on the credit and mortgage markets.
    Events in the financial markets over the summer present all 
of us here today with significant challenges. My written 
testimony gives details about the developments that led to the 
current market disruptions.
    I would like to focus my comments this morning on the 
condition of the banking industry and the role banks can play 
in addressing the current credit challenges. Recent events 
underscored my longstanding view that consumer protection and 
safe and sound lending are really two sides of the same coin. 
Failure to uphold uniform high standards across our 
increasingly diverse mortgage lending industry has resulted in 
serious adverse consequences for consumers, lenders, and 
potentially, the U.S. economy.
    Insured financial institutions entered this period of 
uncertainty with strong earnings and capital, which put them in 
a better position both to absorb the current stresses and to 
provide much needed credit as other sources withdraw. Also in 
times of financial stress like these, the full benefit of 
Federal deposit insurance becomes evident.
    Insured deposit accounts give consumers a safe place to put 
their money during times of uncertainty, and confidence in the 
safety of their deposits helps to preserve the liquidity and 
integrity of the financial system.
    Last month, the FDIC released second quarter 2007 financial 
results for the 8,615 FDIC-insured commercial banks and savings 
institutions. These showed an industry with very solid 
performance. Second quarter earnings were the fourth highest 
quarterly total on record, only 3.5 percent below the all-time 
high, and more than 90 percent of all FDIC-insured institutions 
were profitable.
    While the overall financial results are positive, the data 
also included some worrisome information. The interest rate 
environment continues to be difficult for financial 
institutions. Of most concern, credit quality is likely to get 
worse before it gets better.
    Noncurrent one to four family residential mortgage loans 
represented 1.26 percent of all such loans at the end of June, 
the highest noncurrent rate for these loans since the first 
quarter of 1994.
    Many credit needs of both businesses and individuals will 
need to be funded in the coming months. This will present both 
challenges and opportunities for FDIC-insured depository 
institutions.
    Among the challenges for the industry are increased credit 
losses. If the housing downturn continues, some institutions 
that are currently in good shape could face capital challenges 
resulting from losses in mortgage-related assets.
    At the same time, this situation may create opportunities 
for insured institutions to expand market share and to improve 
interest margins, as funding that was previously provided by 
the secondary market begins to shift to banks and thrifts.
    Growth of portfolios, if it occurs, would pose a risk-
management challenge for many institutions. Institutions that 
grow their loan portfolios will have to maintain sufficient 
capital to support that growth, however the currently strong 
capital base of the industry puts it in a position to be a more 
important source of financing for U.S. economic activity during 
this difficult period.
    The recent events in the financial markets also remind us 
that strong capital requirements are essential and that models 
have their limitations in the assessment of risk. These are 
important lessons to remember as we approach implementation of 
Basel II.
    Finally, it is crucial that we use all available tools to 
assist deserving borrowers who will soon be facing problems as 
mortgages reset in the coming months. It is also important that 
regulators do all they can to improve consumer protection and 
make certain that rules for all market participants are 
consistent.
    I applaud the fact that Chairman Bernanke has promised to 
propose HOEPA rules before the end of the year to impose more 
uniform standards on bank and nonbank mortgage market 
participants.
    The uncertainty that now pervades the marketplace, which in 
many respects is attributable to underwriting practices that 
were sometimes speculative, predatory, or abusive has seriously 
disrupted the functioning of the securitization market as well 
as the availability of mortgage credit for some borrowers.
    The FDIC will continue to work with our colleagues and the 
regulatory community to address these issues. That concludes my 
testimony. I would be happy to respond to questions. Thank you.
    [The prepared statement of Chairman Bair can be found on 
page 76 of the appendix.]
    The Chairman. We will now hear from Mr. Sirri, with the 
SEC.

   STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF MARKET 
         REGULATION, SECURITIES AND EXCHANGE COMMISSION

    Mr. Sirri. Chairman Frank, Ranking Member Bachus, and 
members of the committee, thank you for inviting me here to 
testify on behalf of the Securities and Exchange Commission 
about recent events in the subprime mortgage and credit markets 
and the Commission's responses.
    There is no question that over the past 2 months, the 
defaults by homeowners with subprime credit and mortgage 
obligations has had a broad and significant impact. In addition 
to the difficulties that this has caused borrowers and others 
in their communities, the sharp rise in defaults has 
reverberated throughout the financial markets.
    As default levels on subprime mortgages exceeded 
expectations, market participants began to question the value 
of a variety of financial products. And as valuations came into 
doubt, liquidity in these products fell sharply, which further 
complicated the task of valuing particularly complex 
instruments.
    Derivative referencing mortgages were not the only 
instruments that experienced an unexpected decline in 
liquidity. A variety of other complex financial products that 
involved non-mortgage assets suffered diminished liquidity as 
well.
    As liquidity for structured products diminished, market 
participants needing to raise funds to meet margin calls or 
investor redemptions sold their less complex financial 
instruments such as equities and municipal securities, placing 
downward pressure on prices in these markets.
    Overall, these dynamics have significantly impacted a wide 
range of market participants from individual investors to 
systemically important financial institutions.
    In this environment, as in more benign environments, the 
Commission seeks to fulfill its basic mandates: to protect 
investors; maintain fair and orderly markets; and facilitate 
capital formation.
    My written statement describes a full range of issues on 
which the Commission is engaged, but in my oral statement, I 
will focus on three things: our outreach to a variety of market 
participants to understand potential exposures to subprime 
mortgages and related products and to evaluate operational and 
liquidity issues that could require regulatory response; our 
implementation of the rules governing nationally recognized 
statistical rating organizations, NRSROs; and our oversight of 
consolidated supervised entities.
    As a matter of course, the Commission and its staff are in 
regular contact with the industry to gather information and 
determine where regulatory action is needed. This is 
particularly true now, given the current state of credit 
markets. Similarly, we regularly confer with the President's 
Working Group agencies to discuss market conditions and share 
observations about issues facing those market participants 
under the PWG's members' respective jurisdictions.
    All of this discussion and information sharing has 
ultimately led to a more consistent and coordinated response to 
the credit market events across markets and their participants. 
In June of this year, the Commission adopted rule governing 
NRSROs. The purpose of the rating agency act is to improve 
ratings quality for the protection of investors and to serve 
the public interest by fostering accountability, transparency, 
and competition in the credit rating industry.
    The Commission believes that disclosures required by the 
credit rating agency act and its implementing rules will assist 
users of credit ratings in assessing the reliability of an 
NRSRO's ratings over time and will provide transparency with 
respect to the accuracy of a credit rating agency's ratings in 
connection with structured financial products related to 
subprime mortgages.
    Given recent events in the subprime mortgage and credit 
markets, the Commission has begun a review of NRSRO policies 
and procedures regarding ratings of residential mortgage-backed 
securities and CDOs, the advisory services that may have been 
provided to underwriters and--provided to underwriters and 
mortgage originators, their conflicts of interest, disclosures 
of the rating processes, the agencies' rating performance after 
issuance, and the meanings of the assigned ratings.
    Also important to systemic health of the financial services 
sector is the vitality of the largest financial services firms. 
The Commission supervises five securities firms on a groupwide 
basis: Bear Stearns; Goldman Sachs; Lehman Brothers; Merrill 
Lynch; and Morgan Stanley. For these CSE firms, the Commission 
provides holding company supervision in a manner that is 
broadly consistent with the oversight of bank holding companies 
by the Federal Reserve.
    The program's aim is to diminish the likelihood that 
weakness in the holding company itself or any unregulated 
affiliates would place a regulated entity such as a bank or a 
broker dealer or the broader financial system at risk.
    CSEs are subject to a number of requirements under the 
program, including monthly computation of capital adequacy 
measure consistent with the Basel II standard, maintenance of 
substantial amounts of liquidity at the holding company, and 
documentation of a comprehensive system of internal controls 
that are the subject of Commission inspection.
    Further, the holding company must provide the Commission, 
on a regular basis, with extensive information about capital 
and risk exposures, including market and credit exposures. 
Given the recent events in mortgage and credit markets and 
their potential impact on financial institutions, the 
Commission's staff is monitoring the liquidity available to the 
CSE parent with greater frequency than normal during these 
periods of unusual market stress.
    In addition, the Commission staff is also monitoring 
contingencies that might place additional strains on the 
balance sheets of CSE firms. These include the potential 
unwinding of off balance sheet funding structures, such as 
conduit structures. We are also monitoring the potential 
funding requirements and certain leverage lending commitments 
that are made by the CSE firms, typically to fund corporate 
acquisitions or restructuring.
    The Commission staff is also engaged in the ongoing 
oversight on valuation at the CSE firms. Current market 
conditions have increased the challenge of marking certain 
complex positions to market. We are reviewing the valuation 
methods that are used by each firm to ensure that they are 
robust and consistently applied across all of the firm's 
business.
    I hope my remarks today have highlighted the Commission's 
ongoing and heightened activities. In light of the recent 
mortgage market events, I believe that the regulatory committee 
must continue to engage with the systemically important banks 
and securities firms, encouraging additional efforts to improve 
and expand risk management capabilities. We will work with our 
PWG colleagues and other market participants to further this 
agenda.
    Thank you for the opportunity to testify and I would 
welcome any questions.
    [The prepared statement of Mr. Sirri can be found on page 
121 of the appendix.]
    The Chairman. Thank you, Mr. Sirri, and now we will begin 
the questioning.
    And again, I will remind members--obviously members can do 
what they want--but with specific reference to the current 
subprime crisis, the potential foreclosures, we will be having 
a hearing entirely on that subject on September 20th with 
Treasury, HUD, OTS, the bank regulators, and others to talk 
about the President's proposal and what we can do.
    My own intention is to focus on some of the implications 
that we may have for the broader questions. As I said, members 
are free to ask what they want, but in fairness to the 
witnesses, they didn't come, I think, briefed to fully talk 
about the President's program, and that will be coming up a 
little after that.
    I am most concerned at this point about the potential 
broader implications, and it does seem clear that we have a set 
of financial markets today that are very different than they 
were 10 years ago, but our regulatory structure is essentially 
the same as it was 10 years ago.
    We are not talking about more regulation necessarily, we 
are talking about more appropriate regulation, regulation that 
responds to what we now have. And again, I was particularly 
pleased, Mr. Dugan, in your testimony, and I was glad to see 
those figures.
    It is clear, with regard to subprime, that the regulated 
sector of the mortgage industry clearly has performed in a much 
more responsible fashion than the unregulated sector. There are 
a large number of very responsible people in the unregulated 
sector. The difference is that the minority that might be 
inclined to be irresponsible ran into fewer obstacles there 
than they did in the regulated sector.
    And it is not my impression that the FDIC, the OTS, the 
OCC, and the Credit Union Administration, also not here, but 
part of this, it's not in my experience that they refuse loans 
that should have been made. In other words, people have said, 
``Oh, sure, they don't make bad loans, but they don't let 
anybody make any good loans.''
    The fact is that I think the balance of making the loans 
that should be made and not making those that shouldn't be made 
was approximated much better thanks to sensible regulation. And 
that's--I want to just talk about--we've been told earlier--Mr. 
Steel, maybe I'm misreading this a little bit, but I was struck 
by your statement, ``The Treasury Department will also be 
releasing early next year a blueprint of structural reforms to 
make financial services industry regulation more effective, 
taking into account consumer and investor protection and the 
need to maintain U.S. capital markets competitiveness.''
    Maybe I'm overanalyzing this. Maybe this is the old new 
criticism of years ago in the literary world hanging on. That 
was big when I was going to college; they're all dead now. But 
it did seem to me the emphasis on consumer and investor 
protection getting equal attention with competitiveness, I'm 
not sure I would have seen that earlier.
    That is, we did hear a lot earlier this year, last year, 
about the need to improve the competitiveness of our financial 
markets, and the general argument was--the thrust of it was 
that we've over-regulated some. People said, ``Why can't you be 
like that nice FSA,'' that Financial Services Authority. 
``Don't be so nitpicky.'' ``Why don't you talk principles to 
us?'' ``Why are you always making all these rules on us?'' and 
``Why do you have so many regulators?''
    I mean if this was England, this hearing would have been 
over because there would have been one of you, so that would 
have been much easier. People think that would have been a good 
deal. We don't know which one of you it would be, maybe one of 
those three. You'd still be here, Mr. Steel.
    But the tone does seem to me to have shifted. The notion 
that the overwhelming need is for us to reduce regulation so 
that we can be more competitive with less regulatory regimes 
elsewhere, particularly England, I think there has been a 
shift, and I welcome that. That doesn't mean we need to be 
heavy handed.
    And indeed, we're getting that even from England. In the 
New York Times last Wednesday, August 29th, there was a quote 
from Chris Rexworthy--easy for them to say--director of 
advanced regulatory services at IMS Consulting, a former 
regulator with the Financial Services Authority.
    Mr. Rexworthy said that regulators talk about the 
importance of stress testing; recent development creates 
concerns that ``institutions are either not investing enough 
effort in this, getting it wrong, or just producing things too 
complex for their risk assessment models to cope with.'' 
Continuing the quote, ``greater cooperation on the 
international stage between regulators is undoubtedly one of 
the things we need to see more of.'' And it says U.S. 
regulators were.
    I quoted Martin Wolfe earlier in the Financial Times 
saying, ``the only way to insulate financial markets against 
the sort of panic seen in recent weeks may be to reregulate 
them comprehensively.'' He then expressed his skepticism about 
our ability to do that.
    And I guess, again, the issue is not increasing regulation 
of those things that we have always regulated but addressing 
the question, have the markets now come up with new things for 
which we don't have an appropriate set of regulatory tools, the 
leveraging derivatives. And it is not simply that they have 
come up with new things but that precisely because they are 
leveraged, etc., that the potential negative may be even 
greater, that people have come up with the ability to do more, 
make more money but also perhaps incur more risk.
    And I am particularly driven by that because it does seem 
clear that we did not expect the subprime issue to have the 
broader negative issues it has. So I just wonder if any of the 
members of the panel--let me ask all of you just briefly to 
address that.
    Mr. Steel, let me begin with you.
    Mr. Steel. I would agree with your description and when 
Secretary Paulson focused on this issue of competitiveness, 
then one of the first things that he raised was the issue of 
the regulatory structure in our country. And it's something 
that he's focused on and has asked people at Treasury to work 
hard to deliver a blueprint: what we think it should look like 
if we were starting fresh.
    Point two, I don't view a review of the status quo to mean 
necessarily less regulation. I think the issue is appropriate 
regulation. Business models have changed and the markets have 
changed. Really, that's in the wrong order. Basically, business 
models have changed to meet the markets, and as a result, our 
goal is to look at this afresh and focus on the issues. And I 
don't think that means less investor protection or less 
consumer protection, it means having the right lens on these 
issues. And today, the patchwork nature of what has developed 
over decades, since the last century, is just not as attuned as 
it should be.
    Point two is last Friday the President specifically tasked 
Secretary Paulson to look at the ingredients of this latest 
period of turmoil, securitization, rating agencies, and to also 
have a fresh look on that. As I said to you in the past on 
other issues, there should be no acceptance of the status quo. 
Innovation acquires adaptation, and we have to keep moving with 
the innovation and to present the right regulatory focus.
    The Chairman. The gentleman from Pennsylvania, the chairman 
of the Capital Market Subcommittee, is planning hearings on the 
credit rating agencies' piece of this. It's an issue that he 
has been working on for some time. He has been somewhat 
pressured to be concerned about that when some others were not, 
and so he will be continuing that fairly soon.
    Is there any comment?
    Mr. Dugan. Yes, Mr. Chairman. I mean I think the issue you 
raised is the unevenness of Federal regulation and then 
regulation in the markets that mortgages were not being 
provided by federally-regulated entities. I think personally I 
believe there is a need for some kind of uniform standard. The 
question is what is the best means to get there.
    I think right now the market itself has corrected and many 
of the most aggressive products are simply not being offered: 
2/28s, for example, declined substantially in the marketplace. 
But I think even in terms of a standard, Federal regulators 
have come out with guidance, as you know. The States have 
embarked upon a serious effort to adopt a same kind of 
guidance. And if they do that on a uniform basis, that can help 
address that need. The Federal Reserve has also indicated its 
willingness to go forward with regulations under HOEPA by the 
end of the year.
    That will be a uniform standard. The question is, do you 
need to go beyond that? Will that be enough? I think that's the 
question you're grappling with and it is a difficult and a 
delicate balance because of the fear of going too far, but the 
issues that are being put into play, you're having the hearing 
on on the 20th, I think, is totally appropriate.
    The Chairman. Thank you. And you said the market is 
corrected, and I do think we would agree. Unfortunately, it is 
over-corrected right now. And the only thing I'm saying is 
there is a potential problem of over-regulation, but among the 
fears that do not keep me awake very long are that the Federal 
Reserve will overdo consumer protection. That one I'm not too 
worried about.
    Ms. Bair?
    Ms. Bair. Well, I think the FSA model does have some 
advantages in that all financial services regulation is under 
one umbrella. We compensate for that, though, through our 
informal communications. The FDIC hosted a series of 
securitization roundtables. The servicer statement we issued 
yesterday was an outgrowth of that. Those were jointly hosted 
with the other bank regulators; they also included the SEC, 
OFHEO, and Treasury. Bob Steel was there.
    So I think through informal mechanisms, we do a lot of 
communication. The President's Working Group on Financial 
Markets is also an umbrella group that I think helps ensure 
that there is appropriate coordination, even though we have 
these multiple, separate regulatory structures. As I've told 
Bob, we'd love to have a little more involvement of the FDIC in 
the President's Working Group.
    But I think they are very competently handling a lot of the 
policy and market issues that are arising in this context. So I 
think overall it's not perfect. If you were starting from 
scratch, you might do something different, but overall, it 
works pretty well.
    The Chairman. Mr. Sirri?
    Mr. Sirri. Chairman Frank, you make an important point that 
innovation and regulation have a tough time together, and as a 
regulator, we sense that, I think, on a regular basis.
    We do have some tools at our disposal. So for example with 
systemically important, large broker-dealers, we meet that 
challenge with liquidity. We require tremendous amounts of 
liquidity at the holding company level, so when there's 
uncertainty, when we don't know what's going to happen, there's 
liquidity available to ensure the solvency of those firms and 
to protect against defaults.
    But there are also things that have changed here. Congress, 
for instance, provided us new authority into the Credit Rating 
Agency Reform Act. This will for the first time give us the 
ability to register, regulate, and inspect credit rating 
agencies. That's new for us and I think it's an appropriate 
piece of legislation and we look forward to implementing it.
    The Chairman. Thank you.
    The gentleman from Alabama is recognized.
    Mr. Bachus. Thank you.
    I'd first like to start by commending Chairwoman Bair.
    Congressman Scott mentioned earlier the importance of 
financial literacy and Mr. Hinojosa and Ms. Biggert and Mr. 
Scott have talked about the importance of that. I want to 
commend you on your book for elementary school children where 
you used the two animal figures to really teach planning ahead 
and setting aside. It's a very good book.
    One of the positive things that may come out of all this is 
that book, or something like it, may be offered in elementary 
schools. It's something I probably should have read earlier, 
too.
    Let me also say, we talked about the credit rating agencies 
and I'm going to direct this to Director Sirri. The three main 
credit reporting agencies, Moody's, S&P, and Fetch, receive 
substantial revenues from their structured finance businesses. 
Unfortunately, it appears that in this instance, the rating 
agencies failed to re-evaluate the ratings given to mortgage-
backed securities until their losses were already widely known 
in the market.
    In some cases, these securities received ratings that made 
them appear safe as Treasury bills. As the principal regulator 
of the rating agencies, what is the SEC's plan to deal with the 
conflicts of interest inherent in a system where rating 
agencies are compensated by the issuers of the securities being 
rated? And I know the President's Working Group worked on that 
too, and if you have a comment, Secretary Steel?
    Mr. Sirri. Thank you.
    We are charged under the statute with looking at issues 
relating to conflicts of interest. There are two important 
conflicts of interest that I think merit particular attention. 
The first is the one that you cite, how credit rating agencies 
are paid. Typically, they're paid by the underwriter or the 
issuer. That presents a conflict, but we believe that conflict 
is manageable.
    Firms should have credit rating agencies policies and 
procedures in place and they should adhere to those policies 
and procedures when they evaluate deals. We are going in to 
look at those firms now, to look at their policies and 
procedures and to look at the actual ratings and their 
practices to understand what was actually done.
    The second important conflict is one that could arise with 
respect to the disclosure of their methods and the meaning of 
ratings. Again, credit rating agencies should be clear about 
those and they should adhere to those practices as they rate 
particular securities.
    If we see conflicts, if we see that they're not following 
their procedures with respect to information, then again we 
would be empowered to follow-up there.
    Mr. Bachus. Secretary Steel, Friday, when the President and 
the Secretary outlined their proposal on helping homeowners, 
one of their proposals was a plan supporting the State-based 
efforts to create a comprehensive mortgage broker registration 
system. Mr. Scott earlier said something about it twice. He 
mentioned mortgage originators. I will tell you that not all of 
these bad loans are mortgage brokers; a lot of them are 
mortgage bankers. They are people inside banks, so they are 
federally-regulated.
    I've introduced, along with Mr. Gillmor, Mr. Price, Mr. 
Miller, and Ms. Biggert, legislation to establish a national 
registration system for all mortgage originators. It is very 
similar to what I think the President outlined last Friday, but 
would you comment on the need for the creation of such a 
system? And I think Mr. Scott in his opening statement pretty 
much told you about the problem we had with just a small group 
of mortgage originators.
    Mr. Steel. Well, sir, I think that as the President said on 
Friday, and I would confirm to you today, this is an issue that 
requires attention and people shouldn't be able to move from 
jurisdiction to jurisdiction. And bad actors need to be 
catalogued and followed. I am familiar with your legislation 
and others, and we at Treasury would be completely consistent 
with the ideas of what you're trying to accomplish. I think 
that what we need to work on and consult with you and other 
people on the table today is what is the best way to accomplish 
that. And the devil is in the details on this, but you should 
rest assured that the idea of cataloguing and being on top of 
this so people cannot move, bad actors cannot pack up and move 
to a new jurisdiction and act badly again, it is something we 
should track down and eliminate.
    Mr. Bachus. Well, the States already have a system that 
works if we required it in all States as opposed to 
establishing something all new. And it applies to both 
originators and brokers, and I know that the Federal regulators 
have resisted that. But let me tell you that a lot of people 
have suffered as a result of not having a national registration 
that people can go to and quickly see. I know that Chairman 
Frank talked about the need for this, and we've discussed it, 
and it's in our legislation. It was in the legislation that he 
and I proposed last year.
    Mr. Steel. Thank you.
    Mr. Bachus. My final question.
    Comptroller Dugan, you were over in the Senate. You were a 
lawyer at the Senate Banking Committee during the S&L crisis. 
You were heavily involved in the government's response during 
the first Bush Administration to the savings and loan crisis in 
the late 1980's. Based on that experience, I know earlier you 
talked about unintended consequences and the government making 
things worse, and I think that certainly happened with savings 
and loans.
    Would you like to share any advice for us as we attempt to 
address these issues on how we might avoid some mistakes of the 
past?
    Mr. Dugan. Certainly, and I do think this situation today 
is quite a bit different than the one that we had with the 
savings and loan crisis.
    Mr. Bachus. Oh, absolutely, and let me say, I'm not in any 
way equating the seriousness of that situation. The economy is 
very strong today. The fundamentals are very good, so I 
associate with Secretary Steel in his talk about how strong the 
fundamentals are. And I know that we've all talked about the 
strength of the banking system.
    Mr. Dugan. I think there were some good things that the 
government did when it got to the point of responding to that 
problem. There were some things that were issues. I think one 
of the lessons learned was when we waited so long to respond, 
and when I say we, I mean the entire Federal Government. 
Whether it was Congress or the regulators, it meant that the 
reaction in some cases wasn't overcorrection and resulted 
afterwards in allegations of a credit crunch and people being 
too conservative in the kind of credit that they were willing 
to provide to consumers.
    And that's why I do think in the current environment, we 
have tried to stay on top of this at the Federal level, at the 
supervisory level, to impose guidance and new standards. We 
have to be sensitive not to pushing that too far so that people 
don't stop altogether providing the kind of credit to 
creditworthy subprime borrowers over time. We don't want that 
to happen.
    And so I think staying on top of things in an orderly way 
and addressing problems as they arise instead of waiting too 
long to react, I think, is absolutely critical.
    Mr. Bachus. Thank you.
    The Chairman. Thank you. Actually, I'd forgotten that you 
had been counsel to the Senate Banking Committee and any advice 
you can give us on how we can improve our relations with that 
entity would also be very good.
    [Laughter]
    Mr. Dugan. Where you stand is where you sit. I'm not 
touching that one.
    The Chairman. I'm not saying that. I'm just saying, since 
you sit where you sit after they voted, I don't expect you to 
answer the question as a confirmed appointee.
    The gentleman from Pennsylvania.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Having been in recess for the month of August, it was 
interesting to see the credit crisis unfold, and, with our not 
being in Washington, unable to get any responses or 
understandings, I suspect all of us have come up with different 
conclusions of what caused the problem, what some of the 
solutions may be, and what I am most interested in--the long 
term ramifications of what may happen if other things 
exacerbate the situation.
    For instance, if the real estate prices were to continue to 
fall precipitously, if we were to move into a recession, if the 
resets in the mortgages will come due in 2008 and 2009, are we 
doing an analysis to come up with a methodology of how to 
handle those problems or are we just going to breathe more 
simply within a month? The credit crunch seems to be over and 
we go back to the normal state that we were in before the past 
2 months?
    As regulators, what are your intentions along those lines?
    Mr. Steel. Oh, I'll start sir. From the seat that I occupy, 
I think of this just exactly along the same lines as you do. I 
think there are four issues that are the gating points for us.
    Number one, there are principles that should drive what we 
think about in the near term. And number one, the first and 
foremost thing to focus on, is how to have the most successful 
efforts to keep American homeowners in their homes. Number one.
    Number two is in the process of doing that, we should be 
sure not to provide any rescue or bailout to investors or 
lenders who made these loans.
    Number three, we should quickly get at the issues that seem 
to be party ingredients of these challenging market conditions: 
securitization; rating agencies; and things like that.
    And the fourth thing is to take what we learn in the third 
bucket and apply it to the longer-term perspective of what the 
right, regulatory framework is for the financial system. Those 
would be the four ways that I would think through the issue, 
and that's the time sequence too. First and foremost is how can 
we help people who were facing the resets stay in their homes?
    Mr. Kanjorski. Okay, let me, along those lines, suggest 
something because we mentioned the historic nature of the S&L 
crisis, which I do see a parallel to, although the panel does 
not seem to see it. I don't see that it is nearly the nature of 
the same crisis, but the solutions that are being batted 
around, perhaps in the Administration, sound somewhat similar 
to the S&L crisis.
    If you recall, in the late 1980's, somebody came up with 
the brilliant scheme of supervisory goodwill. Does anybody 
remember that dirty word? And we took the good S&Ls and forced 
them to put supervisory goodwill on their books and forced them 
to take bad S&Ls. And I think there has been some analysis of 
the S&L problem at the late period of the 1980's showing that 
it would have been only a $20 billion problem if we had 
addressed it at that time. For $20 billion from one source or 
another, all of the bad mortgages and bad situations in the 
S&Ls could have been resolved. But instead, we used the 
supervisory goodwill concept, and we infected good S&Ls with 
bad S&Ls and bad paper. And, ultimately, within 2 or 3 years, 
the problem became a $200 billion problem.
    Now, I hear people talking about those two great 
institutions, or three great institutions already out there, 
but particularly Freddie Mac and Fannie Mae. The people are 
suggesting we get these folks involved and have them empowered 
to buy some of this bad paper or bad mortgages. I have great 
fear in doing that because the very same scenario, which I 
suggested in my earlier question, should we do that, would put 
them at risk and certainly strain their positions. And then we 
would have the real estate market really go awry and have us go 
into a recession. And then all hell is going to break loose and 
we are going to have a multi-trillion-dollar disaster or 
perhaps a systemic failure on our hands.
    Are the regulators talking about that? Are you 
discouraging, in the Administration, the talk of using Fannie 
Mae and Freddie Mac as the lone ranger here?
    Mr. Steel. I guess it's back to me. I think that dealing 
with this issue in my mind is a three-part process. Number one, 
working with the servicers to identify those loans that are 
facing resets and basically getting direct line of sight early 
for borrowers who are facing resets. Number one.
    Number two is getting those borrowers, once they've been 
identified, connected with qualified counselors, for example 
NeighborWorks, so they can get good, impartial advice on where 
they stand and what the best solution is to their situation. 
And the third part is trying to develop innovative products, 
both with private sector participants, public sector, like FHA, 
and also with the GSEs. At Treasury, we have reached out to 
GSEs to talk about specific products that they can offer. These 
are products that should be based on marketplace values, not in 
a subsidy form. And I'm convinced that by focusing on these 
three aspects: one, servicers; two, counseling; and then three, 
new products that actually can allow them to work, will be the 
right way to focus on it.
    Mr. Kanjorski. Mr. Steel, I appreciate that, and I have a 
great deal of respect for you, as an individual. But, one, your 
Administration is not going to be in office when the full 
impact of our financial crisis hits, probably in 2 years, 2\1/
2\ years, or 3 years from now. And two, I find it very hard to 
believe that somebody sitting somewhere in a position of 
regulatory authority did not start to raise the question that 
liars' loans may not be the best banking practices anyone ever 
heard of, or that 110 percent financing of mortgages may not be 
the most positive thing that people ever heard of.
    The excesses that were allowed to build up and occur strike 
me as almost panic, get on board, and get all you can while the 
good days last. And I do not have a great deal of confidence 
that you're all going to be able to predict what is going to 
happen over the next 2, 3, 4, or 5 years to the safety of the 
system if you have missed identifying that we are on our way to 
a very serious problem when all this occurred.
    I mean, I am not at all surprised that it happened. As a 
matter of fact, it is probably more delayed. I thought that it 
was going to happen a little sooner than it has happened. I 
still can't conceive of people buying securities based on 110 
percent financed loans of applications made by people who did 
not have the capacity to pay the initial loan. I have only sat 
on a small bank board, but I can't ever remember that type of 
loan getting the approval of the board of that bank. But 
apparently, it got the approval of some of the regulators.
    Is that correct, or not?
    Mr. Dugan. Well, I would just say from the point of view of 
the SEC, and I think it's true of the other Federal regulators, 
there were concerns registered by the regulators that we 
advised the institutions we supervised. We did have concern 
with a number of the practices that you just described, and 
particularly the combination of those practices.
    And that is the kind of advice that we begin giving our 
examiners that then spread to the guidance that we put into 
place with the non-traditional mortgage guidance which began in 
2005 and then was ultimately adopted last year and then the 
subprime guidance. There has been a process about that. I think 
it goes back to something Chairman Frank said earlier. More of 
that was being done by the Federal banking regulators than was 
going on outside of the bank regulatory system.
    The Chairman. Ms. Bair, do you want to respond?
    Ms. Bair. Yes. I think the bank regulators have issued very 
strong guidance, both with regard to non-traditional mortgages 
as well as subprime, requiring things like underwriting at the 
fully-indexed rate, and placing severe restrictions on stated 
income loans. The Fed now has a very unique opportunity to 
extend those types of rules to the non-bank sector, and that is 
exactly what Chairman Bernanke has proposed. They will be 
moving with it before the end of the year, so I think we are 
moving ahead with the tools that we have.
    The Chairman. The gentleman from Louisiana.
    Mr. Baker. Thank you, Mr. Chairman.
    Mr. Steel, I read with great interest your narrative about 
the process which has led us to the current circumstance and 
with regard to regulated financial institutions, there appears 
to have been guidance issued by regulators and apparent 
exposure and actual losses are significantly less than other 
sectors of the market that were non-traditional lenders. But 
now we see the contagion moving over to the commercial paper 
side, because of much of the collateral being provided by real 
property. And we're not sure how far the liquidity squeeze will 
actually go, thereby denying people access to credit, not even 
mortgage borrowers, just traditional businesses.
    I read with some concern that a vacuum cleaner company 
withdrew its intended plans for a debt issuance because of 
market conditions, and it's one after another that are now 
reigning in their expected growth plans. And that will have 
another layer of effect with lack of jobs that would have been 
created, construction opportunities, and so this will continue 
to have some effect, unknown to one extent.
    My question is, isn't it generally true that market 
operatives are going to act on that information much more 
quickly than a regulatory regime and the regulators' role is to 
observe, watch, and advise. But it's to stem the contagion as 
best we can once it starts, because the guys who were putting 
their money up and writing the check, who were looking across 
the table at the guy who's selling them the product, are the 
ones to be asking the right questions before the contractual 
obligation is entered into.
    My observation is that there is very little, I think, that 
the United States Congress could put into effect to keep people 
from making bad business judgments unless we're going to 
require Federal Government representatives on corporate boards. 
I mean, where are we going with this?
    I understand that businesses make money. I also understand 
businesses lose money. Our job is to just watch and make sure 
it doesn't get into innocent third parties who had no 
participation, no judgment, did not condone, have knowledge of, 
and make sure they're not hurt. But as to gains or losses 
within the normal world of businesses, is there a role, in your 
view, for the Federal Government to step beyond where we are 
today?
    Mr. Steel. Well, Congressman, I think the way that I would 
reference back my comments earlier that I made with regard to 
Chairman Frank's opening observations, and that is that the 
regulatory structure we have to our view could use a fresh 
relook. That's what we at Treasury plan to do, and I can't tell 
you where that will go. Let's do the work before we have the 
conclusions.
    Mr. Baker. But in the world of lending, if you wish to come 
to my institution, and you have a poor credit history, and 
you're buying a modest home, and I choose to make you the loan, 
and you signed the deal, there's not a governmental role in 
prohibiting that activity. Certainly, we should make the 
borrower aware of what he's getting into. We should condone 
professional conduct by the lender, but we can't prohibit 
somebody from entering into an ill-advised deal.
    Mr. Steel. Judgment and risk taking are part of the process 
and people exercise good judgment and sometimes less good 
judgment.
    Mr. Baker. Is there anything that we could require in the 
way of disclosure between business participants in the mortgage 
world because of the significant implications to the broader 
economy that is now not disclosable to parties to transactions?
    Mr. Steel. Well, I think that the regulators, both Federal 
and State, have given several different examples since earlier 
this year. Whether it's the issue about the subprime standards 
that should be used for underwriting and just lately, 
yesterday, the way in which modifications and refinancings can 
be reviewed.
    I think in the same basis, the Federal Reserve Board 
intends to provide comment by the end of the year on both TILA 
and HOEPA, and these are forward looking reviews of how we're 
doing currently. And I would think that those are the right 
places to place the bets for the best feedback on these issues.
    Mr. Baker. Well, I just hope we will use our best financial 
judgment in moving forward with such recommendations. I want to 
join with my colleague from Pennsylvania with regard to the 
expression of concern about the expansion of responsibility of 
Fannie and Freddie, and Federal Home Loan Bank for that matter.
    I would add on to his observation about the S&L crisis, the 
next step in resolution was to create the RTC, the Resolution 
Trust Corporation, whose mission in life was to take a dollar's 
worth of assets and sell them for 13 cents. It was a heck of a 
job and it only ensured that we had inordinately larger 
taxpayer losses than we would have had, had we used I would 
call common sense asset disposition methodologies.
    And this is bad stuff. People are losing money. Homeowners 
will be denied access to credit. Businesses are going to be 
adversely impacted and I think it is a business lesson learned 
that when you go too far out on the risk of chasing greater 
return, there are consequences. And, unfortunately, I think 
that's what this episode is teaching us.
    One last thing: from the early identification of defaults 
which I think you alluded in your testimony was October or 
November of last year, until the time the broad market 
liquidity crunch occurred, how quickly did one follow the 
other?
    Mr. Steel. Well, I think that all of us--excuse me. Let me 
speak for myself. I think that the way in which the credit 
questions spread from subprime mortgages to other types of 
collateralized mortgages into other types of securitized 
product was faster and swifter than I would have imagined. And 
so that happened more quickly. But we had talked and I feel as 
though there was a lot of voice given to the fact that in 
general, the economy, people had become quite risk-comfortable 
in lots of ways. In almost every asset class you go through, 
people were demanding less and less return for accepting 
marginal risk.
    So I think the tinder was dry for something like this to 
begin, and where it would begin and how it would spread is 
pretty unpredictable. But I think the risk premium and the way 
that was being priced made it apparent that we were at risk of 
people having taken too much risk and then retrenching from 
that risk-taking process, which is where we are now. But now 
there are signs that the risk-taking is beginning to come back 
into the system.
    Mr. Baker. But it wasn't an irrational jump to risk. It was 
more of a slide into risk over a period of time.
    Mr. Steel. Yes, and I think as I said in my written 
testimony, usually the ingredients to this are increasing 
comfort with risk and periods of economic activity, low 
interest rates, etc., make people comfortable. Investors, 
basically, are stretching for return and therefore accepting 
more risk, and borrowers take advantage of that situation and 
you have this cycle that works in that fashion.
    The Chairman. The gentleman from North Carolina.
    Mr. Watt. Thank you, Mr. Chairman.
    Actually, we got exactly to the point where I wanted to 
pick up anyway, because Mr. Dugan has on a couple of occasions 
used the benchmark as the conventional institutions that the 
Comptroller of the Currency regulates have done much, much 
better in terms in this foreclosure process than others, which 
I think is a relevant criteria, but leaves open the question of 
how have those institutions done in this crisis in comparison 
to prior times?
    Is the level of foreclosures as a result of this comfort 
with taking more and more risk, how has that played itself out, 
not in comparison to subprimes, but in comparison to historical 
patterns?
    Mr. Dugan. So the question is on foreclosures, generally, 
across the whole mortgage market. Well, I would say that 
clearly the trend line is up overall. It is not at the record 
levels that we have seen in the middle of recessions like we 
had in 2001, for example.
    Mr. Watt. But the President told me we weren't in the 
middle of a recession. So in comparison to like times, did this 
comfort that Mr. Steel has described with taking more and more 
risk, did it result in the traditional mortgage market 
accepting more and more risk in comparison to like periods of 
time in history?
    Mr. Dugan. Well, I think if you look at, and I have a graph 
here that I actually could show you, if you look at the actual 
aggregate level of delinquencies and defaults, it hasn't gone 
up that much historically. The real spike has been more on the 
subprime area. But you are right that the level has gone quite 
a bit higher than it has been in non-recessionary times, which 
is an indication of the nature of these products, the lax risk 
underwriting that Secretary Steel was just referring to.
    So, it's sort of a combination of both. We have not seen 
the same leakage of problems to other parts of the prime.
    Mr. Watt. You made that point several times. I just wanted 
to make sure that in saying that we don't hide the fact that 
across the market the acceptance of risk has been, I guess, in 
the former Secretary's words, there was an irrational 
exuberance in the mortgage or lending market for a period of 
time.
    Is that generally accepted now?
    Mr. Dugan. Well, I guess I would say that there were 
certainly parts of the market, not including the subprime that 
we tried to address in the non-traditional mortgage guidance 
where there were certain features about negative amortization 
and interest-only loans, and somewhat lower downpayments that 
we were raising concerns about that we hadn't seen previously.
    So, to that extent, I would agree with you.
    Mr. Watt. Okay. And one of the concerns that some of us 
have expressed and tried to get to the bottom of is the extent 
to which institutions that are regulated by the OCC at some 
level are owners or investors, or have subsidiaries that deal 
in subprime mortgages substantially.
    To what extent are you all monitoring that, because one of 
the concerns I had with one of my own institutions--two of my 
own institutions--from my congressional district buying into 
Countrywide, for example, was that they were going into an area 
of the market that might not be subject to the same level of 
regulation.
    Mr. Dugan. Well, if it's a national bank or a subsidiary of 
a national bank, we regulate it the same. We regularly give it 
full-blown, on-site banking supervision.
    If it's an affiliate of the bank through the holding 
company, then that's regulated by the Federal Reserve. And in 
the case of Countrywide, that's a thrift, and the entire 
organization is subject to regulation by the Office of Thrift 
Supervision. So I can only speak specifically to the ones that 
we regulate directly.
    Mr. Watt. All right, my time has expired, apparently. So 
I'll leave that alone.
    Mr. Kanjorski. [presiding] The gentleman from Texas.
    Mr. Hensarling. Thank you, Mr. Chairman. Again, I share the 
concern of many on this committee with the broader capital 
markets' reaction to what we see in the subprime mortgage 
market.
    To ensure that we have the facts, since in some previous 
testimony it has been mentioned in several opening statements, 
but as I understand it, subprime borrowing accounts for roughly 
13 percent of the outstanding mortgage debt in the United 
States, and the latest data that has come across my desk show 
that 83 percent of all subprime borrowers are paying on time, 
which means 17 percent were either delinquent or in 
foreclosure.
    I think somebody, and perhaps it was Ranking Member Bachus 
or another member, I do not recall, did the math and said that 
we have roughly 2 to 3 percent of the mortgages that are in 
foreclosure.
    I would like to ask anybody on the panel, do you have a 
different set of facts? I am just trying to assess the scope of 
the problem within the subprime mortgage market. Are those 
roughly accurate facts?
    I see a nodding of the head in the vertical position.
    Mr. Dugan. Yes.
    Mr. Hensarling. Those are roughly the facts. I do not want 
to put words in anybody's mouth. I think I heard, Secretary 
Steel, you say something along the lines that we have seen some 
positive changes in that market, and something along the lines 
of investors are demanding changes. I think I heard the 
Comptroller say the market has corrected some of the worse 
abuses.
    Is that an accurate assessment of what I heard earlier 
today? Can you give us a little bit of greater detail on 
exactly what market players are doing?
    Mr. Dugan. Yes. I guess there would be two aspects. If you 
look at underwriting standards in the subprime market, I think 
there clearly has been a move away from low documentation 
mortgages to demand more documentation.
    There has been a move towards going away from low or 
virtually non-existent down payments to higher down payments.
    There has been a move away from the shorter dated 2/28 and 
3/27 mortgages to longer term mortgages.
    Just to be clear, that was happening but in the most recent 
liquidity situation where so much of the subprime market 
depended on the securitization, there really are not many 
subprime loans being originated that cannot be held on the 
balance sheet of depository institutions at the moment.
    Mr. Hensarling. Mr. Steel?
    Mr. Steel. I think your characterization is correct and 
there is--let's pick one more example. It has been written 
about to a great degree, that there were a large amount of 
leverage loans that were in the process of being distributed 
that basically did not get distributed because of the market 
turmoil.
    Those loans came to rest on the balance sheets of 
institutions and now, just as we sit here today, they are 
beginning to move and be distributed at prices different, 
lower, than they were originally bought by the financial 
institutions. That is happening, to use my words earlier, as 
credit is being re-priced and returns are being offered at a 
more appropriate level as opposed to the level where people 
might have hoped they could be distributed earlier.
    That seems to be happening in that example in an orderly 
way and just beginning. There will be losses by the financial 
institutions that took them onto their books, but the 
distribution should happen over the weeks and months ahead and 
in what I would describe as an orderly way.
    I defer to the regulators because they are looking at their 
books. That would be my description of the situation.
    Mr. Dugan. I would agree with that.
    Mr. Hensarling. I think there is general acceptance from 
most people on the committee that risk based pricing of credit 
in certain innovative products within the mortgage market have 
helped lead to some of the highest rates of home ownership that 
we have had in the history of our Nation.
    I know there are some advocacy groups who have come to this 
committee to essentially outlaw certain mortgage transactions, 
like the 2/28, that they think are particularly abusive to the 
consumers.
    Are there certain mortgage products that you see that have 
such a threat perhaps to our economy that this committee should 
just consider outlawing certain mortgage products, and if so, 
what standard of judgment should we use? Whomever would like to 
answer that one.
    Comptroller Dugan?
    Mr. Dugan. I guess I will start. I, for one, would be quite 
reluctant to outlaw any particular product normally speaking. 
Having said that, I do think there are some terms which we 
thought were so potentially questionable and abusive, we did 
add it to our guidance on subprime, for example, having 
prepayment penalties that extend beyond reset periods to me is 
something that goes beyond the pale of what a normal market 
should operate.
    Secondly, I think there is a very good case that a lot of 
these loans with these features were not being adequately 
disclosed, and I think it is absolutely critical that they be 
disclosed and there be a competent system for disclosing them.
    In terms of actual products, I think there are many 
different kinds of innovations that have led to positive things 
and sorting out which ones are the most positive and somewhat 
less positive is generally not something that the Federal 
Government is good at doing.
    Ms. Bair. If I could, back to your earlier question, those 
statistics are certainly ones I would agree with and have used 
myself.
    I do think it is important to understand the context. A lot 
of those current loans are current at the starter rate of these 
2/28s and 3/27s. We will be having a lot of resets, which is 
why we got the servicer guidance out. We think there will be 
about 1.5 million mortgages throughout this year and next that 
will be resetting where borrowers cannot make the higher 
payment. That is one of the reasons we got the servicer 
guidance out.
    I would agree with John. I think it is very problematic to 
just try to prohibit products. I do not think that is 
particularly helpful.
    The approach we used in the subprime and the NTM guidance 
regarding adjustable rate or so-called teaser rate mortgages, 
is requiring underwriting at the fully indexed rate. So you can 
make the loan, but just make sure that the borrower can re-pay 
the loan.
    I think that is a pretty basic underwriting standard. For 
banks, it is certainly familiar. I think it will be helpful and 
should be applied across the board.
    Certainly, prepayment penalties have been subject to a lot 
of abuse and that might be one good area where you might just 
want to add certain categories of inappropriate practices.
    Mr. Hensarling. Thank you. I am out of time.
    Mr. Kanjorski. The gentleman from New York, Mr. Ackerman.
    Mr. Ackerman. Thank you, Mr. Chairman.
    I am one of those who are surprised that everybody seemed 
surprised with what has happened in the market. While I would 
agree with the math that several of our colleagues have cited 
of the very small percentage of subprime loans that have 
evidently set off the chain reaction of things that have 
happened, one percent of one percent of a problem with a clot 
in your bloodstream causes the end of the total system.
    Despite the fact that the math might argue that it is only 
a small percent, the consequences in certain systems can be 
absolutely dire. I think that is what we have here.
    I am really surprised at the surprise. If we had allowed 
State motor vehicle bureaus to operate and have an independent 
system of basically unregulated originators of driver's 
licenses, and they went out and had advertising to potential 
drivers who wanted licenses that said, ``Need a driver's 
license, cannot drive? No problem. No test needed. Road rage 
convictions? Legally blind? Do not worry.''
    Then we were shocked to see accidents up and down the 
highway, most of them involving a lot of good drivers, all 
caught up in a catastrophic situation.
    We have all seen the ads, yet, I do not know if alarm bells 
went off in people's heads or they just ignored it. I do not 
know if anybody has taken a look at where the problem is with 
the small percentage as cited of subprime borrowers who cause 
the problem versus others and whether these so-called subprime 
loans were originated by bank banks or non-banks to see where 
we should be focusing our attention.
    I guess the first question I would ask is, when these 
people advertise, whom are they trying to reach? I guess it is 
a question that is more rhetorical than anything else, when you 
advertise ``Cannot get credit, no problem. Bankrupt? No 
problem. No background check. No income verification.''
    You see this in ad after ad after ad. Then we are wondering 
why these people who have been seduced by the very important 
lure of home ownership wind up in the tragic situation of 
losing everything, besides the damage that it has done to the 
financial markets.
    My first question would be, who is supposed to do the 
oversight of the people who are doing this kind of advertising, 
the results of which should have sounded the alarm bells?
    Ms. Bair. I think the Federal Reserve Board has the 
authority for unfair and deceptive acts and practices which can 
include deceptive communications. That is shared jointly with 
the FTC.
    I share your concern. I still see them. I have some 
friendly mortgage originators who spam fax me at least twice a 
week; I am still getting them.
    Mr. Ackerman. Which agency has done anything about it?
    Ms. Bair. I think the Federal Reserve, under its HOEPA and 
TILA authority, can address unfair and deceptive communications 
to consumers.
    Mr. Ackerman. They can, but have they?
    Ms. Bair. And the FTC may, as well.
    Mr. Ackerman. ``Can,'' but have they?
    Ms. Bair. I do not know that they have specifically 
addressed teaser rate advertising, but we are certainly hoping 
that will be one area they will be looking at as part of this 
package of rules they are currently working on under HOEPA.
    I think advertising a teaser rate without fully disclosing 
the fully indexed rate compared to a 30-year benchmark 
comparison is something that is highly problematic. In our 
guidance to our own banks in terms of consumer communications, 
we have said that the communications need to be balanced, that 
you should not disclose a teaser rate without also disclosing 
the fully indexed rate.
    Mr. Ackerman. It is not just disclosing. If they are 
advertising no background checks, if they are advertising if 
you do not have good credit, do not worry about it, we are 
going to get you a mortgage, it is obvious that they are 
marketing to people who are going to have problems.
    They are not trying to deceive anybody necessarily. They 
think they are going to be able to make the mortgage payments 
and do not understand what is going to happen in the market 
when the interest rates go up.
    Ms. Bair. Those are bait-and-switch tactics, and we see 
these. I ask my staff sometimes to follow up, to find out what 
is going on. Frequently, it is a bait-and-switch, where they 
say you can get the credit under these circumstances, and of 
course, you cannot, once you call.
    That type of bait-and-switch is generally regulated by the 
FTC. If they are not banks, we really cannot do much about it. 
I do not think those are banks that are doing those types of 
communications.
    Mr. Ackerman. I suspect you are right on that. Just to get 
an idea, what do you think if your agency has some oversight 
responsibility in this area?
    Ms. Bair. For non-banks?
    Mr. Ackerman. For anybody that--
    The Chairman. Will the gentleman try to phrase his question 
in a way that the recorder can more accurately capture it? I do 
not think hand raising makes its way into the record.
    Mr. Dugan. I think all of us have the power to take action 
for unfair and deceptive practices on an enforcement basis.
    Mr. Ackerman. Have we?
    The Chairman. If the gentleman would yield, is that not 
only for banks? You can do it for national banks, FDIC, the 
State banks, but the issue is if they are not a bank.
    Mr. Dugan. That is right. If they are a bank, we can, but 
we cannot write rules about it. That is the other issue.
    Mr. Ackerman. If they are not a bank, who oversees this?
    Mr. Dugan. The Federal Trade Commission.
    Ms. Bair. Right.
    Mr. Ackerman. And they are not here?
    Mr. Dugan. Correct.
    Mr. Ackerman. I see my time has expired.
    The Chairman. I do want to make it clear that the Federal 
Reserve asked not to be here today. They will be here after the 
hearing on September 20th, 2 days after the Open Market 
Committee. It would be about as far away from an FOMC meeting 
as we could get.
    The Federal Reserve is the one agency to whom we would ask 
those questions. Maybe it should be the FTC, too. Primary 
jurisdiction of the FTC is with our friends in Energy and 
Commerce. They agreed before that they would not object if we 
had them here. We should probably add the FTC for the September 
20th panel.
    Mr. Ackerman. I thank the chairman. I ask unanimous 
consent, I have an opening statement that I would like to place 
in the record.
    The Chairman. Yes, so moved.
    The gentleman from California.
    Mr. Campbell. Thank you, Mr. Chairman. I am going to focus 
my questions less on the damage that has been done and more on 
the potential damage that could be done, which would be much 
much greater if this whole thing leads to an economic slump.
    Secretary Steel, you mentioned the same thing I mentioned 
in my opening statement, about this risk premium that exists 
out there for all kinds of loans now, commercial real estate, 
residential real estate, etc.
    If people coming into the market cannot get new loans or 
the loan rate to buy that house that has been foreclosed or 
whatever is too high, then that is the sort of thing that will 
lead to a drop in housing prices which can then lead to lots of 
undesirable things.
    Do we want to do anything to try to deal with that risk 
premium and is there anything we can do to try to deal with 
that risk premium in this committee?
    Mr. Steel. Let me comment, to try to answer the question, 
in a broad sense, and then I am not sure about this committee, 
but let me just speak--
    Mr. Campbell. Yes, I should have made it broader.
    Mr. Steel. My experience would suggest that this is a 
process that basically has to work itself through. Right now, 
as I tried to say earlier, when the questions about the 
subprime market spread to other securitized products, then at 
some point people just said I do not care for any risk right 
now, I will take a time out. The market effect was that when 
you saw the price of Treasury bills move up dramatically and 
rates go down, people chose to kind of find the safest harbor 
to be part of.
    What we are seeing now--that went on for a short period of 
time. Now what we are seeing is liquidity return to the market 
and begin to look to take on risk, but at different prices with 
greater returns than they might have had 6 weeks ago.
    The example I gave of the leverage loans that were issued 
at 100, bought at 98, and maybe now will be distributed at 95.
    What happened is that asset is still a good asset but it is 
a more attractive asset at the clearing price as the market 
digests all the ingredients and goes to a new level of risk 
premium.
    Mr. Campbell. I guess my question, to delve further into it 
is, is there adequate transparency on the real risk? Some of 
what I have heard is people say we thought this was AAA paper, 
we thought this, we thought that, we did not know you were not 
using docs, we did not know this, we did not know all this 
other stuff.
    Therefore, they are now making that risk which may or may 
not be appropriate into virtually everything that is out there.
    Mr. Steel. This might be unpopular but that is okay. I 
think there is also some attention needed on investors. 
Investors basically were at the scene of the situation and 
maybe they should have asked for more information. I think what 
you will see in addition to the re-pricing of risk will be a 
re-basing of information and diligence on behalf of investors, 
which will also be a good thing to have develop here.
    I think it is quite logical that as the market evolves and 
adapts, people might decide they want better--investors might 
decide they want better line of sight on descriptions, on 
characteristics, and on understanding before they invest, and 
move to the strategy of maybe investigate before you invest, 
and do it more directly as opposed to third party verifiers.
    Do not take somebody else's perspective, maybe look 
yourself to see what is under the portfolio as opposed to 
taking somebody else's word. I view that as a good and logical 
process, and the investors not doing their work is consistent 
with what I tried to describe of the syndrome that developed--
    Mr. Campbell. Can we help that process?
    Mr. Steel. I think the things we are trying to do in the 
Administration were basically to look at some of the root 
causes, and my third point to Mr. Kanjorski's question was what 
are some of the issues here where better diligence, where we 
can be helpful, securitization, rating agencies, and things 
like that, and trying to bring diligence to those audiences.
    Mr. Campbell. I am running out of time. If I can quickly 
get one more question for Mr. Dugan and Ms. Bair.
    Relative to the regulated entities, my question is broadly 
what level of concern should we have relative to the financial 
health of regulated entities with questions like do any of the 
regulating entities, banks and so forth, have recourse on some 
of the loans that they packaged and sold?
    Did they have resource with originators who no longer exist 
perhaps for things that were packaged and sold, and do you 
analyze or look at any regulated entities' loan portfolio, how 
much of it is resetting and to what degree it has a greater 
percentage of resets with maybe Alt-A or some other sort of 
credit risk that bears a risk to their portfolio?
    Ms. Bair. We have been closely monitoring this on a number 
of fronts. The first thing we did several months ago was to 
identify our institutions that had significant and direct 
exposure to subprime and Alt-A.
    Again, as indicated earlier, a lot of this lending, 
especially the very weak underwriting, was done outside the 
banking sector. We had some banks. We identified a couple of 
banks. Those have undergone heightened monitoring and 
examination processes. There have been some put-backs of loans 
that had early defaults or violated covenants or whatever. We 
closely monitored that.
    I think the good news and bad news of securitization was 
that the risk has been more dispersed. A lot of this lending 
was done outside banks, and even when the banks were doing it, 
it was securitized, and most of it now has been put back.
    There is not a lot of concentration on the balance sheets 
of the banks for which we are the primary regulator.
    We are closely monitoring. We are doing special exams of 
those that we think have particular exposures. Overall, we 
think the banks are in pretty good shape.
    Mr. Campbell. They are not holding recourse on paper that 
is not on their books?
    Ms. Bair. Are you referring to the ABCP market? John might 
want to address that. If you are talking about the commercial 
paper market, there are liquidity and credit supports that 
large banks provide. In the asset-backed commercial paper 
market, there has been a lot of press about some of those 
assets coming back on the balance sheet of the larger banks.
    Mr. Dugan. I think there are some circumstances in which 
there are contingent funding lines, for example, that may need 
to be drawn down. Banks do have to hold capital even on that 
contingency. They would have to hold more capital to the extent 
they brought it directly back on their balance sheet.
    With respect to some of the subprime loans that you were 
asking about which were originated and sold by them, in most 
cases, we believe there is no legal recourse that would require 
them to take the mass of those assets back on their balance 
sheets.
    It is something that we look at, and as Chairman Bair 
indicated, we do think it is a manageable level of credit 
exposure to subprime loans that the national banks now have.
    The Chairman. If the gentleman would yield, does that have 
any relevance to the entities that you supervise under your 
consolidated supervision?
    Mr. Sirri. I think from our point of view, we are mostly 
concerned again about issues about liquidity at the holding 
company level. Right now, as we have gone into these firms and 
looked at them, we have been quite content that they have 
adequate risk management procedures and liquidity in place.
    The Chairman. The ones you supervise are not threatened by 
this?
    Mr. Sirri. No.
    The Chairman. The gentleman from California.
    Mr. Sherman. Let's talk about these no income verification 
loans. There are kind of two financial worlds out there, the 
world of securities that you folks represent, and the world of 
taxation that Mr. Steel may bump into if he walks down the hall 
of Treasury.
    The question is why have you, as regulators of the 
financial markets, turned a blind eye to the fact that those 
you are regulating were facilitating tax fraud or at least 
insulating those who chose to commit tax fraud from any 
inconvenience when they went to get a loan?
    Did you take into account in deciding to allow and to 
continue to allow these no income verification loans the effect 
that has on whether paying taxes continues to be the norm in 
our society or more and more taxpayers just begin to think that 
they are suckers for filling out an honest return?
    I will start with Mr. Steel. You had a chance to make it 
more difficult for those who chose to commit tax fraud, did you 
take into consideration the effect of your decision on the 
overall tax system?
    Mr. Steel. At Treasury, we are not making the specific 
rules that--
    Mr. Sherman. Let's move on, to Mr. Dugan.
    Mr. Dugan. I just want to be clear about the question. When 
you say ``tax fraud,'' I am not quite sure what you mean.
    Mr. Sherman. When you have a no income verification loan, 
this is basically a loan for those who have decided to commit 
tax fraud, those who decided not to file, those who decided to 
file phony returns. People saying I have money to pay the 
mortgage, I just have not told the IRS about it.
    Why do the folks who regulate the financial field--why did 
they not take into consideration the effect on our tax system 
of allowing the very kind of advertisements that Mr. Ackerman 
was talking about and the general impression that those who 
commit tax fraud will not be impeded in their effort to get a 
home with no credit?
    Mr. Dugan. I guess our view on this is a little bit 
different. If there is no obligation to collect income in order 
to make a loan ever, theoretically, if someone had $1 million 
and they wanted a $10,000 loan, and they had it in their bank 
account, you would never have to look at their income.
    On the other hand, there are many in most cases where 
income really is quite important to--
    Mr. Sherman. If I can interrupt. These are all stated 
income loans. It does not say income, we do not know. There is 
a standard number that is not subject. They are not asking 
about a no income stated loan. I am asking about no income 
verification loans.
    The loan docs have a number and you deliberately advertise 
that you are not going to verify it, this is a loan packaged 
for those who choose not to complete an accurate tax return. 
Why did you allow it?
    Mr. Dugan. I think our concern is more that people would 
pretend or potentially invite them to pretend they made more 
income than they actually made in order to get a bigger loan 
that they could not repay, and that is something--
    Mr. Sherman. That is what you also invite with this.
    Mr. Dugan. That is where we look at, will this loan get 
repaid? It is something we have very strong concerns about. I 
gave a speech about this about 6 months ago.
    Mr. Sherman. Strong concerns. Did the agencies prohibit 
those under their umbrella from buying and holding and 
processing these no income verification loans?
    Mr. Dugan. I think what we would say is that this practice 
began to creep into the mortgage underwriting practice as a 
more and more standard practice, particularly in the subprime 
and the Alt-A area, and over time, we began issuing stronger 
and stronger directives against it, culminating in the most 
recent subprime guidance.
    Mr. Sherman. After the hurricane hit, you decided to issue 
something saying they should be built to standard. You could 
have prohibited this practice 10 years ago. It was going on 10 
years ago. Why did you not?
    Mr. Dugan. I am not sure actually that it was going on, to 
a great extent, 10 years ago. It has developed over a period of 
time where some lenders maintain that they can determine the 
repayment capacity solely from--
    Mr. Sherman. Ms. Bair, are you going to tell us that we did 
not have no income verification loans until just the last 
couple of years? Have you been looking at this at all?
    Ms. Bair. In the interest of self-defense, I have only been 
here a little over a year in this job. John is relatively new 
as well. I would say John has been one of the leading critics 
of stated income and was very active in making sure we had very 
strong standards against stated income in our guidance.
    Mr. Sherman. They were still making stated income loans 3 
months ago. A strong press release is not action.
    Ms. Bair. Not in banks. Not in our banks. If we find out, 
we do not allow it. We have cited banks. I do not think those 
are banks that are doing it now.
    Mr. Sherman. Let me go to Mr. Sirri. Why do we allow the 
financial markets to trade in no income verification loans and 
why do we allow them to be highly rated?
    Mr. Sirri. The one thing that we do not tolerate in 
securities markets is fraud. What we have to be clear about is 
what is the disclosure that surrounds these instruments.
    Our authority is limited. We will not tolerate fraud and we 
will follow through where that appears to be the case. For 
there to be fraud, there has to be some type of 
misrepresentation or omission associated with the offering of 
the security.
    Mr. Sherman. Is not misrepresenting a security--when it is 
backed by quite a number of loans issued by people or taken out 
by people who are attracted by lenders who advertise if you 
want to lie about your income to either the IRS or to us, 
please come in, you are the kind of customer we want, why would 
such loans be part of A rated pools?
    Mr. Sirri. It is a difficult question. The issue evolves 
around the facts of the particular offering. It depends upon 
the disclosure. For example, the underwriter may state, we do 
not attempt to verify any of the characteristics about the 
collateral. Where they state that, the case for fraud may be 
more difficult.
    It is very, very difficult to make a general statement 
about this.
    Mr. Sherman. I believe my time has expired.
    The Chairman. I thank the gentleman. The gentleman from 
North Carolina.
    Mr. McHenry. Thank you, Mr. Chairman. Thank you all for 
being here today.
    What the chairman said in his opening remarks, the 
discussion on a disincentive for irresponsibility, and when we 
see not those that many of you regulate but some in the 
subprime mortgage sector going bankrupt, I think that shows the 
real disincentive for irresponsibility. Bad judgments. Bad 
business calls.
    This discussion about the income and everything else, that 
is an area where the marketplace is regulating itself and 
righting itself.
    The question is, what do we do as a body, as a Congress, as 
a government, do we overreact in this time and further clamp 
down credit which will, I believe, exacerbate the problem going 
ahead when people are going through these resets and trying to 
access the credit markets again.
    To make sure the market can actually work and function so 
we can get some of these folks when the reset comes, get them 
into mortgages that they will not automatically default on 
again, or just simply default on the mortgages they currently 
have.
    I think we actually need to make sure that when and if we 
do act, we have to do it in a sensible way and a measured way. 
We cannot overreact.
    Ms. Bair, in your testimony you state that non-traditional 
loans ``invite unscrupulous lenders to impose onerous terms on 
less sophisticated borrowers who might not fully understand the 
true costs and risks of these loans.''
    In June, the Federal Trade Commission released a very 
interesting study, and I think an important study about 
mortgage disclosures, including, ``The current disclosures fail 
to convey key mortgage costs to many consumers,'' and ``In both 
prime and subprime, borrowers failed to understand key loan 
terms.''
    In their study they found, as you well know, that about a 
third of borrowers could not identify their interest rate; half 
could not correctly identify the loan amount; two-thirds could 
not recognize that they would be charged a prepayment penalty; 
and nine-tenths could not identify the total amount of up-front 
charges.
    I know there is some corrective action taken from the Fed 
and other Federal agencies. What is happening on that? How is 
that working? What can be done?
    Ms. Bair. I think, clearly, mortgage disclosure needs an 
overhaul. I do not think we can solve it all with disclosure. I 
think there are certain basic core underwriting standards that 
need to be affirmed across the market, not just with banks.
    The disclosure clearly needs to be more understandable and 
more meaningful. I think this needs to be joint with the Fed 
and HUD because HUD has part of the jurisdiction over this.
    To the question earlier as well, about misleading teaser 
rate advertising, we not only need to make sure we 
affirmatively require helpful and understandable disclosures, 
but also get more aggressive in terms of prohibiting marketing 
practices that are deceptive.
    Mr. McHenry. I am just asking about mortgage disclosures. 
This is a huge component of it. When you have a stack of paper 
in front of you, you are signing a legal document for the 
largest financial transaction most Americans will ever make in 
their lives, and people walk away not having any inkling of 
what they signed.
    What can be done administratively to correct this mortgage 
disclosure issue or what should be done constructively, 
legislatively, to ensure there is real disclosure?
    Ms. Bair. The Fed has jurisdiction over this under HOEPA 
and TILA, and HUD under RESPA, for closing documents. It is 
something again for insured banks. We certainly require they 
make balanced fair disclosures in terms of clear disclosures, 
understandable disclosures. A lot of this is in the non-bank 
sector and we do not have jurisdiction.
    Mr. McHenry. My time is running out. Mr. Steel, the 
President announced his policy on Friday, that I am sure you 
were a major part of constructing.
    What is being done within the regulatory process to 
actually fix that issue or should Congress act to ensure there 
is a key amount of disclosure so people understand the key 
terms of the loans they are making or they are signing and 
agreeing to?
    Mr. Steel. I think this idea of understanding really, the 
President charged the Secretary of the Treasury to focus on 
this and come back and report. The Federal Reserve is also 
working on this. This is another aspect also that has been part 
of the program mentioned on Friday of financial literacy.
    The Secretary of the Treasury has been charged to look into 
this. The Federal Reserve is working, and financial literacy is 
part of the same issue. We look forward to collecting ideas, 
working with Congress, and figuring out the best way to bring 
light on this issue.
    Mr. McHenry. Thank you.
    The Chairman. As I recall, it was part of the President's 
plan to do a re-do of RESPA, so on September 20th, we will get 
some more answers. We will hold the parties on notice that 
there is interest on that piece of it, improvement to convey 
information. That will come before us again on September 20th 
and HUD will be here then.
    The gentleman from Kansas.
    Mr. Moore of Kansas. Thank you, Mr. Chairman.
    Mr. Steel, the Fannie Mae portfolio is currently capped at 
$727 billion, according to the consent decree by Fannie and its 
regulator, OFHEO; is that correct?
    Mr. Steel. Yes, sir.
    Mr. Moore of Kansas. Can you explain the factors that were 
involved in determining this dollar level? What was the 
rationale or what is the significance of this $727 billion cap?
    Mr. Steel. I was not here at the time, but let me tell you 
what I know from having studied this. Basically, there were 
several factors and there were a list of seven or eight that 
went into the calculation. This was negotiated between the 
safety and soundness regulator, OFHEO, as you correctly 
described, and the two entities.
    There were adjustments made to the capital required, a 
premium capital was required. There were specifics as to the 
business model they could pursue and limitations on growth in 
the portfolio until certain conditions were met. This was 
negotiated between the safety and soundness regulator and the 
entities themselves.
    Mr. Moore of Kansas. Do you know what kind of conditions 
you are talking about here?
    Mr. Steel. Specifically, I can give you an example of one. 
There was a premium of capital required, where the normal 
amount of capital would be ``X,'' then in this case it was 
``1.3X'' until certain conditions were met, so as to allow them 
to move back into a more normalized state.
    Mr. Moore of Kansas. As you just indicated, the consent 
decree says that since this portfolio cap for Fannie Mae, it 
lays out several scenarios that might warrant temporary 
flexibility. One of the scenario's is for market liquidity 
issues; is that correct? Do you know?
    Mr. Steel. I do not know that specific language, but that 
sounds correct, sir.
    Mr. Moore of Kansas. There appears to be a real problem of 
liquidity in the secondary markets right now and we are seeing 
many lenders change their credit criteria for the loans they 
will make, some to the point where it is even affecting the 
terms and availability of credit for customers with good credit 
histories.
    I think it is important that we improve the regulation of 
the GSEs and I hope the Senate will soon vote for legislation 
like the House has passed that would accomplish this goal, but 
I also think the GSEs could play a positive role in helping 
alleviate some of the problems that we are experiencing in the 
market today.
    Given the Administration's position against a temporary 
increase in the cap, should the committee conclude that your 
position is that our Nation is not facing a market liquidity 
issue that could be benefitted by Fannie refinancing more of 
these loans? Should there be more flexibility there?
    Mr. Steel. There are three or four questions. Let me try, 
and please help me if I do not speak to the issue on your mind.
    Mr. Moore of Kansas. I will.
    Mr. Steel. The issue of the size of the portfolios is an 
issue for the independent safety and soundness regulator. I am 
not privy to the request that was made or to the response 
provided by the independent regulator to the regulatee. I know 
what I have read just as you have.
    There is the ability--the issue of increasing the caps on 
performing loans really lies with Congress. That is the issue.
    There are flexibilities that Fannie and Freddie can decide 
relative to their business model and they have announced 
initiatives to try to be helpful.
    The last point I would make is that at Treasury, we have 
had a constructive dialogue with Fannie Mae and Freddie Mac 
about the issues going on in the mortgage market and how they 
might be helpful, given the current guidelines under which they 
operate.
    They are constructive people, and we are trying to work 
with them to imagine when I described earlier what I view as 
the three-part dance of identification, counseling, and 
products; hopefully, the GSEs can be part of this product 
solution within the current construct of how they are allowed 
to operate.
    Mr. Moore of Kansas. Can Fannie and Freddie help improve 
liquidity through an increased cap to refinance more mortgages? 
Do you believe that is a possibility?
    Mr. Steel. I think the area they are prescribed to operate 
in, the conforming loan market, has been one that has been 
working among the best of the different markets, and that one 
has been working well.
    Mr. Moore of Kansas. Thank you, sir.
    The Chairman. Interesting point. You say the area where 
they are allowed to operate has been working well and the areas 
where they are not allowed to operate have not been working so 
well. Would not the logical thing be to suggest that maybe we 
should expand the area of their activity so that other places 
could work well, like in the jumbo area?
    Mr. Steel. I think that your question is a fair one and I 
thought about it a great deal. I think the issue here, sir, is 
a balance between--
    The Chairman. I like that. That is good. I will take it. 
The gentleman from New Mexico.
    Mr. Pearce. Thank you, Mr. Chairman.
    Mr. Steel, I do not want to spend too long on this, if we 
are to look at risk reward and the opposite of reward is pain, 
if we could, and I do not think we can, but if we could 
categorize all the pain that has been felt from the situation, 
that is the opposite of reward, who has borne what percent of 
the pain?
    In other words, loan originators have probably experienced 
some of the pain. Capital market investors feel some of the 
pain. Probably some of the large funds.
    If you can kind of categorize how much pain has been felt 
by what sector and do not leave the consumer out either.
    Mr. Steel. I think that was going to be my starting point, 
sir. If you look at this issue, the people, as I said earlier 
when I walked through the focus of the Administration, the 
first issue is to focus on homeowners.
    Mr. Pearce. No, I am not asking what we are going to focus 
on. I am asking where the real pain has been experienced in the 
past in this circumstance that has already occurred. Is that 
even too complex to even address?
    Mr. Steel. I will do my best. I wanted to make the first 
point that I think the most pain is being felt by the 
homeowners. Now I will move onto the question in the 
marketplace, who has been affected.
    I think we saw this first spread in mortgage backed 
securities where basically the market has re-valued those types 
of assets, and in particular, those dominated by subprime. That 
is where the most market value has been re-evaluated. If you 
looked at that, that would be second. We know the size of that 
relates to the different pieces of the mortgage market.
    Secondly, you would have to say that the next risky 
category of mortgages has felt some distress also, but there 
have been ripple effects out into other parts of the system, as 
I alluded to earlier in leveraged loan areas.
    Mr. Pearce. Mr. Dugan, if I go to your report and I am 
looking on page two, I read a very straightforward comment that 
insufficient liquidity has occurred outside the commercial 
banking sector and the national banking system remains safe and 
sound.
    For me as a pilot, vibrations are something that sometimes 
you get a little tremor and that is it, that is the last you 
feel of it. Your wing might be about to fall off, but it is the 
only indication you are going to have.
    When I go to Ms. Bair's page 20, she gets to the real 
concern I have that this tremor indicates maybe our banking 
system is not quite so sound. She talks about the lower capital 
levels required under Basel II, and she begins to say on page 
21 that the entire assumption is insufficient given poor 
performance, and in fact the risks and stresses are impossible 
to quantify.
    What we have done under Basel is we have scooted the risk 
derivatives and all those things that none of us know exactly 
about except you guys at the table, we have scooted those 
outside the measurement criteria.
    I do not think it is possible for us any longer to say that 
our banking system is really in good shape, because the risk 
criteria is not measured by you all in the banking system. It 
is someone else's problem just outside there.
    Long term capital management brought us very close to a 
realization that the system is very high-strung, it is very 
highly-wound, and small tremors can mean large problems.
    Mr. Sirri also addresses that same problem, the diminished 
liquidity, on page one of his testimony.
    We hear your testimony saying everything is great, the 
banking system is really sound, but I see these warning signs 
from the others. Can you address that if you would, please?
    Mr. Dugan. Sure. I guess what I was trying to say in the 
testimony is that the liquidity issue that we have seen in the 
market has been far more pronounced outside the banking system 
than it has been inside the banking system because inside the 
banking system, you have insured deposits. You have a federally 
regulated scheme. You have the Federal Reserve's discount 
window standing behind certain kinds of loans. All of those 
things have meant that institutions that are banks have had far 
greater access to liquidity--
    Mr. Pearce. I am about to run out of time here.
    Ms. Bair, if we are going to take that, that the liquidity 
is sound inside the system, is it possible for illiquidity, 
non-liquidity, whatever we are going to call it, to transpose 
itself right through those barriers, that is the banking 
system, is that possible or is that a fear that I have that is 
just not possible?
    Ms. Bair. I would not say it is impossible. I would not 
want to suggest it would happen either. I think all 
institutions are being challenged right now. There is no doubt 
about it.
    But one advantage banks have over non-banks is the ability 
to access deposit funding as well as other sources of liquidity 
such as the Fed's discount window. I think those are tools that 
put banks in a better position. But everybody is being 
challenged right now.
    Mr. Pearce. They have access to capital based on the 
capital requirements and the capital requirements continue to 
drop and drop.
    Ms. Bair. Not yet. We are still on Basel I. Regarding Basel 
II implementation, we will do a parallel run next year and then 
start up implementation a year after that. So we are still on 
Basel I. The leverage ratio is over 8 percent, which is 
historically a very strong high level. Banks have $255 billion 
in excess capital. That is a level above an aggregate that 
they--
    Mr. Pearce. Is Europe on Basel II?
    Mr. Bair. Europe is implementing now.
    Mr. Pearce. I think it was Mr. Sirri's comments that we are 
in an international market. Their illiquidity is going to 
transpose right across the system.
    Maybe this tremor was just a slight tremor and maybe the 
wing is not going to fall off. I hope, Mr. Dugan, you are 
correct. I am going to lie awake at night for a while longer.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman from California.
    Mr. Baca. Thank you very much, Mr. Chairman.
    The first question I would like to ask is for Sheila Bair. 
Please describe the law that prevents brokers from selling 
people loans that are mostly costly when borrowers could 
qualify for better loans? This also applies to Mr. Dugan. Could 
you also respond?
    Do mortgage brokers have any duty to offer consumers the 
best loan available to them? Question number one. What Federal 
safeguard should mortgage brokers and lenders put in place to 
ensure that all subprime borrowers are not taken advantage of 
and receive substantial loans.
    The next question will be to all of you. Are any of you 
concerned that mortgage brokers are not federally regulated?
    Ms. Bair. I think a lot of these issues can and will be 
addressed by the Fed. We do not, but the Fed does have 
rulemaking authority for all participants in the mortgage 
process, whether it is banks or non-banks. I think there is 
latitude to address practices by brokers, even though they are 
not lenders.
    I think disclosure, if you are going to do a teaser rate 
loan, requiring disclosure of the fully indexed rate as well as 
a 30-year benchmark is absolutely essential. Safeguards against 
steering are absolutely essential.
    The thing that frustrates me about the hybrid ARM market is 
if you look at the rate sheets of a lot of these subprime 
lenders, the 30 year fixed rate is not that much higher than 
the starter rate of the 2/28, and I think a lot of these folks 
could have qualified for a 30 year fixed without the payment 
shock, maybe $50 or $100 more a month, which I think would have 
been manageable and preferable to having these payment shock 
loans that were underwritten under the premise that they would 
just refinance in a couple of years.
    I think the guidance that we put out for subprime is a 
starting place for standards that should apply across the board 
and I think that can address a lot of the abuses that we have 
seen going forward.
    Mr. Baca. Mr. Dugan?
    Mr. Dugan. I agree with those remarks. We have tried to 
address what we believed were the significant abuses as it 
relates to the institutions that we regulate.
    I think the issue that has come up in a number of contexts 
about the most aggressive, most egregious practices, were 
occurring outside of the federally regulated sphere, and I 
think the central question confronting the Congress and the 
public policymakers alike is how to get a uniform standard in 
place so that the regulation matches what we now have at the 
Federal level.
    As we were talking earlier, I think the notion is the 
States are trying to implement something new in that area to 
come up to that standard. I think the question of when the 
Federal Reserve will act by regulation, which I am sure you 
will talk about, and then the further question is, is that 
enough, whether you will need additional legislation, and I 
think that is the question that will be very much on the 
committee's mind.
    Mr. Baca. Is there an oversight that looks at when you 
identify a subprime or mortgage loaner that actually gives the 
higher loan, is there some kind of an oversight to make changes 
to protect that consumer as well that may have signed on, once 
they have signed a contract?
    Ms. Bair. I think there are some short term rescission 
rights, but I think longer term, again, the ones I have seen 
were underwritten based on the assumption of continued low 
interest rates and home price appreciation, so there is never 
an expectation that a borrower could make the payment when it 
reset.
    I think our push has been to try to encourage responsible 
subprime lending. Fixed rate mortgages are more appropriate, I 
think. Subprimes by definition are likely to have had less 
experience, or trouble with their financial management. To give 
them a product that makes them make guess about the direction 
of home prices as well as the direction of interest rates, I do 
not even want to do that. I think that is pretty challenging.
    I think the direction is we want to encourage responsible 
subprime lending and come up with standards that will make the 
market more conducive to fixed rate products that are more 
appropriate.
    Mr. Baca. I know I asked the question of all of you but I 
am just about to run out of time. I want to ask the following 
question.
    What is your response to the home mortgage disclosure data 
that show that over half of African Americans and nearly half 
of Latinos are in subprime loans compared to 17 percent of 
white families, and have you looked into the cases of this, and 
are you concerned about its implication, and what do you think 
the Federal banking regulators, such as yourselves, or the 
Federal enforcement agency, could make more of an impact in 
fighting discrimination against Latinos, African Americans or 
protected classes?
    Mr. Dugan. Congressman, there was a hearing here last month 
about home mortgage disclosure and this very issue was front 
and center. It is a concern for all of us when we see that raw 
data suggesting that African Americans and other minorities are 
receiving a disproportionate share of higher-priced loans.
    I do think it is quite important and it is part of our job 
to get behind that initial data, to make sure you are comparing 
people who are similarly situated to see the same kinds of 
loans.
    We have not found the kind of discrimination that initial 
data would suggest, but it is something that every time we see 
that data, we need to re-double our efforts to make sure we are 
looking at the right loan characteristics.
    Mr. Baca. Thank you.
    The Chairman. The gentleman from Texas.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Before I get started, I know most of the people here know, 
but we lost a dear colleague today, a member of this committee, 
Congressman Gillmor. My prayers and thoughts--and those of 
everyone on this committee and this Congress, I am sure--go out 
to his family.
    I want to change direction a little bit and talk a little 
bit about how we fix some of the current situations that are 
involved in the marketplace today.
    One of the things I said earlier was if we provide enough 
liquidity and capital into the market, that will give the 
marketplace time to work this out.
    In the 1980's, we formed the RTC and we did some things 
which ended up being very costly for the American taxpayers and 
brought quite a bit of disruption to the real estate 
marketplace.
    What I think we want to try to do is let the marketplace 
clean this up with the least amount of disruption to really a 
very important part of our economy, and that is our real estate 
economy.
    One of the things that I know is different between now and 
the 1980's is we were dealing with financial institutions, and 
now we are dealing with people who are holding pieces of paper, 
and in many cases, people holding pieces of pieces of paper.
    As we have these people who would probably be in the 
marketplace to buy some of these individual mortgages or pieces 
of these tranches and so forth, because of the documents and 
the relationships between the master servicers and the 
trustees, there is probably not a lot of flexibility.
    We certainly do not want to go down the road of the Federal 
Government un-doing agreements in the marketplace that would 
cause a tremendous amount of disruption.
    What I am wondering is, in the banking and financial 
marketplace today, are there any things that would be in place 
or inhibitions for the banking system to be able to help 
facilitate and finance, breaking these pieces up, because there 
is tremendous opportunity up side for people that are buying 
some of these discounted mortgages, if you can get them back 
into a conforming situation, and obviously that increases the 
value of that underlying mortgage, and then obviously the 
security as a whole.
    What I am told is because of the different pieces, that a 
lot of these master agreements do not allow a lot of 
flexibility for the individual mortgages in the underlying 
paper to be worked out or payment modifications or rate 
modifications.
    If there was liquidity in the marketplace, say for the 
banking industry or something like that, to help finance some 
of these entities that are willing to go in and look at being 
able to break out portions of those mortgages, is there 
anything that would be prohibitive in the current structure 
that would cause a bank to say, I do not want to get involved 
in that because that is going to be a classified loan, or it is 
going to change my capital structure?
    I throw that out as a question.
    Mr. Dugan. That was one of the reasons why the agencies put 
out the recent guidance. I think there has been a lot of mis-
information about the flexibility that servicers have to 
restructure individual loans once they have been sold.
    I think this committee sent letters to the SEC and the SEC 
and the FASB have responded to clarify there is flexibility. We 
as bank regulators issued a statement to servicers under our 
jurisdiction jointly to urge them to take advantage of that 
flexibility more generally.
    I think once you go beyond that, it is always governed by 
the terms of the service agreement, that contract with 
investors, and sometimes they do impose limits beyond the kinds 
of limits I was just describing.
    I think to the extent that there are not such limits, there 
is quite a bit of flexibility. I think in some cases loans can 
be restructured in ways that the lender, or in this case the 
investor, would end up losing less money than they would if 
there was a foreclosure, so there is an economic incentive to 
do so.
    I think in other circumstances, there will be some creative 
thinking required about different kinds of products, and I 
think that is what the Administration has been talking about, 
something they are going to be looking at very hard.
    Mr. Steel. I would only add that I think you are on exactly 
the right track. We need to encourage the servicers to take 
full advantage of the flexibility that might be in their 
documents and to pursue that, and the guidance provided by the 
regulators has encouraged that.
    Then we need to look for additional ways to try to have as 
many of these loans reorganized to a market-based level as we 
possibly can, and put a thumb on the scale on behalf of the 
homeowner, would be our perspective.
    The Chairman. There are going to be some votes fairly soon, 
so we are going to hold strictly to the 5-minute rule.
    Mr. Lynch?
    Mr. Lynch. Thank you, Mr. Chairman.
    I just want to go back to the other gentleman from Texas, 
Mr. Hensarling, who basically laid out a scenario that 
suggested that this problem was somewhat contained, and that 
most people, 87 percent of the people are still paying their 
mortgages, and that this problem is contained. He did not want 
to put words in your mouth, as he said, but he looked for your 
assent and he seemed to get it.
    Mr. Dugan, your testimony does not seem to say that. It 
says that more recent data indicate that 90 day or more 
delinquency rates for securitized subprime mortgages have 
increased to over 13 percent in June 2007, and your testimony 
also says that increased foreclosure activity continues to 
spread and intensify, and according to RealtyTrac Inc., new 
foreclosure filings across the Nation, including default 
notices, auction sale notices, and bank repo's, increased to 
180,000 in July 2007; that is 93 percent higher than reported 
in 2006. There is a fair degree of alarm here, and it is at 
odds, that exchange between yourself and the gentleman from 
Texas.
    I just want you to tell me if you think this thing is 
contained. You also say if problems in the general housing 
market continue, we expect to see a further increase in 
mortgage delinquencies.
    Where are we?
    Mr. Dugan. I would say two things, and I am sorry if there 
was a misunderstanding. I think with respect to the standards 
for new loans to be made to new borrowers, I think there has 
been something of a market correction, even an overcorrection, 
about the kinds of standards that would be put in place.
    Where I do think there is still an issue are people who 
have loans now, and I do think you are absolutely right that we 
are seeing a trend line in which more foreclosures are 
increasing, delinquencies are increasing.
    If you think about the way we look at it, a huge part of 
the subprime market where the most aggressive underwriting was 
taking place involved these 2/28 loans, and the period in which 
the standards were most lax was at the end of 2005 and all 
through 2006.
    If you fast forward 2 years from those dates, you will see 
that this quarter coming up, you are going to see more resets, 
extending all through next year. That is the period, I think, 
that we are all concerned about seeing an increase in 
foreclosures that we are trying to get our arms around.
    Mr. Lynch. Let me ask you, in comparing mortgage activity, 
it seemed that the riskier, the more innovative mortgage 
products that were out there were being written largely by 
private mortgage companies, and when you look at the 
performance of the GSEs, Fannie Mae, Freddie Mac, you saw a 
smaller share of those riskier mortgages being written, the 
subprime mortgages in general, being written by the GSEs.
    With respect to their portfolio cap, would it not be 
helpful, and I know it has been suggested by some that there be 
a modest increase in what their portfolio cap is right now by 
about 10 percent, would that not help the liquidity problem, to 
have them step in, in some way, to provide some relief there?
    Mr. Steel. The area that Fannie Mae and Freddie Mac focused 
on, the conforming loan market, as described, has been the area 
that has been working the best. They had the ability to help 
out in the top part of the subprime loan area.
    Someone has suggested here--people have suggested on a 
couple of occasions that a large number of subprime borrowers 
could have qualified for prime borrowing, and in those cases, 
the GSEs could help.
    They are operating under negotiated limits, if safety and 
soundness issues would have failed--the area in which they are 
proscribed to operate has been the one that has been operating 
best.
    Mr. Lynch. The negotiated limits were not made with a 
recognition of the situation we have right now. That is all I 
am asking for, some flexibility here. We have some proven 
entities here that could be helpful, yet we have an arbitrary 
limit that has been adopted largely by the President.
    I just think there is some relief here that could be had if 
we lifted that cap. That is all.
    Mr. Steel. Those limits were negotiated between the 
regulator and the regulated entities, and they also related to 
certain requirements have to be met and then the caps are 
lifted. Those characteristics are being worked through, and I 
think Fannie and Freddie are moving towards compliance.
    The Chairman. If the Senate were to take up the bill that 
passed the House, we would then have all those conditions 
satisfied.
    The gentleman from California.
    Mr. Miller of California. Thank you, Mr. Chairman.
    It seems like a lot of the problems that are created in the 
marketplace were caused by the huge amount of dollars coming 
out of the stock market that lenders wanted to take advantage 
of, and they used it for subprime.
    Chairman Bair, on page five, I really enjoyed your comment. 
You said, ``In the absence of GSE sponsorship,'' that means 
there was a lack of GSE product out in the stock market to buy. 
``ABS's,'' which are asset backed securities, ``were able to 
enhance marketability and obligations by restructuring 
theirs.''
    You also say there are trillions of dollars from investment 
grade mortgage backed securities that would have been better 
suited for hedge funds.
    Would you please explain that a little better?
    Ms. Bair. I think we were just trying to put this in 
historical context. I think the enhanced returns and enhanced 
risks of the private label securitizations, lower rated 
tranches--
    Mr. Miller of California. The rates they would give to 
normal GSE sponsorships, they were able to get to these other 
forms.
    Ms. Bair. These are non-conforming loans. They did not meet 
the criteria that Fannie and Freddie had.
    Mr. Miller of California. Absolutely. There is a huge 
demand in the marketplace for those types of loans.
    Ms. Bair. Certainly for the returns that were provided. 
Those loans now are not so popular.
    Mr. Miller of California. What normally would be sponsored 
by a GSE, there was a huge demand for those, and there was a 
huge void because they were not able to put out as many as they 
did so the private sector filled those with very questionable 
risky loans to basically get a return.
    Secretary Steel, you and I, I know we had a great 
conversation about what we thought the market should be and who 
should be playing in it. What do you think about the 
President's current position on raising FHA limits, when we 
talked last time, that was not even on the table?
    Do you think that is an appropriate move at this point in 
time?
    Mr. Steel. There are two or three parts to the proposed FHA 
modernization bill that the Administration has been supporting. 
It relates to risk based pricing and other aspects which will 
allow FHA to do more and to be more active. That is really the 
proposal that is--
    Mr. Miller of California. They have to have reasonable 
underwriting criteria, so these are very safe loans we are 
making.
    The problem I have, and many in this House have today with 
the GSE situation is, we think that it is being absolutely 
unfairly applied. What I mean by that is there are some members 
in whose districts the median home price is $150,000 and a GSE 
loan in that area is $400,000. That is almost triple what it 
should be, yet there are areas of the country that are high 
cost, like my area, for example. I gave statistics that in 5 
years, FHA loans dropped by 99 percent because they are high-
cost areas.
    I am going to ask you a fair and reasonable question, and I 
would like a reasonable answer based on the criteria.
    Do you think GSEs' underwriting criteria is adequate and 
their appraisal criteria to meet safety and soundness 
requirements today?
    Mr. Steel. I'm sorry.
    Mr. Miller of California. Do you think the underwriting 
criteria that GSEs apply to their loans and appraisal criteria 
are adequate for safety and soundness purposes?
    Mr. Steel. The loans that they are doing today are 
appropriate for safety and soundness, yes.
    Mr. Miller of California. Then my question is, when you 
look at areas of the country that have risen in price 
uncharacteristic of other parts of the country, but it is just 
because of supply and demand and the cost of land in the 
regions and stuff, do you not believe that if we apply the same 
safety and soundness criteria currently applicable to all other 
GSE loans, in those high-cost areas, there might be room to 
move up?
    The reason I am asking that is because one thing the market 
needs is immediate liquidity, but it needs long-term liquidity, 
to deal with the housing problems we are facing in this country 
today and the foreclosure problems, money for a year or two 
does not benefit anybody, the long term criteria loan is what 
the market needs.
    When you look at the GSE criteria, what they have done, 
they have lent money to people on 30 year fixed rate loans. It 
is what we need in the marketplace instead of these exotic 
loans that are out there.
    Do you not think there is room if we applied good 
underwriting standards and appraisal standards to move up in 
some of these areas?
    Mr. Steel. You were good enough to explain to me the last 
time I was here with visuals about the prices and how it 
affected your constituents, and even first responders in your 
area, and made that clear.
    I accept the point. When we worked through the GSE bill 
that passed the House, we worked with you to try to understand 
these issues.
    Our goal is to work with the Senate and together to have a 
GSE bill--
    The Chairman. Let me just interrupt. In fairness, when we 
outlined what we were talking about, we did agree, and it was 
last minute, I understand, the President did make these 
proposals. On September 20th, we are going to go over these in 
detail. I would hope that by September 20th, we can get some of 
these answered more.
    We did basically ask them to be ready to come and talk 
about this more on September 20th.
    Mr. Miller of California. Some of us, and I know Chairman 
Frank and I even believe that FHA should be higher in some of 
these areas. We would like to see that approach.
    I am just throwing it out. The GSE comment was not a matter 
of trying to be argumentative. In our areas, the high-cost 
areas, we are looking at if a GSE loan goes up to the amount we 
propose, people save about $175 to $180 a month in their 
payment. That is huge for people who might lose their home. I 
just wanted to throw that out as something for you to think 
about.
    Mr. Steel. I do not think that question is argumentative at 
all. I look forward to continuing the discussion.
    Mr. Miller of California. Thank you, sir.
    The Chairman. We will all stipulate this is one time the 
gentleman was not being argumentative.
    The gentleman from Georgia.
    Mr. Scott. Thank you, Mr. Chairman.
    I would like to ask very quickly each of you if you could 
respond to this first question. Who has been hurt the most by 
the subprime mortgage crisis?
    Mr. Steel. I will start, sir. I think as I answered the 
question for Mr. Pearce, that if you applied who would be most 
affected, I think it is the homeowners who were in the most 
perilous position.
    If I might add, relative to your opening statement, HUD 
does have a national hotline for subprime assistance, and that 
is available for people who want help with subprime issues.
    Mr. Scott. What we had in mind in terms of our hotline was 
a human being at the other end of the line, the people who were 
targeted most in predatory lending are largely unsophisticated 
and uneducated. They are people who need to call the hotline 
but have somebody ``hot'' at the end of the hotline.
    Mr. Steel. This has been connected to counseling services 
at HUD to try to help these people.
    Mr. Scott. Is that consistent with the others, the 
homeowners?
    [Panel nods affirmatively]
    Mr. Scott. What I cannot understand is this reluctance to 
provide at least in a moderate way Fannie Mae and Freddie Mac 
from having the flexibility in this area. It is particularly 
true when you look at the fact that it is a part of their 
charter obligation to provide liquidity and stability to the 
secondary mortgage market, particularly during periods of 
market dislocation.
    They have a consent order with OFHEO that allows for 
adjustments to the portfolio cap to address market 
dislocations.
    It is particularly needed, I think, and it could be 
temporary. It could be 10 percent. It could be 12 percent. It 
could be targeted. I think for the Administration to just clamp 
down and say no concerns me.
    The Chairman. Would the gentleman yield? This may have been 
my fault. I want to ask if we can defer that until the 20th 
when we have the hearing on the President's plan in context. 
Maybe I am hoping I will get an answer I will like more later. 
In fairness, we did say we would expect answers to that on 
September 20th.
    Mr. Scott. All right. With that in mind, that was basically 
the gist of my concern. I will wait until September 20th.
    The Chairman. I thank the gentleman. That was my cause of 
the confusion. The gentleman from Texas. I apologize for 
rushing you, but I would like to get to everybody.
    Mr. Green. Yes, Mr. Chairman. I will accelerate the pace. 
Let's talk quickly if we may about the risk layering that has 
been mentioned by you, Ms. Bair. Who is going to regulate this 
when you have all of these various and sundry risks being 
placed on top of each other?
    Right now, there is nothing regulating it. Who would you 
propose regulating this?
    Ms. Bair. We do regulate bank lending and we have through 
our guidance and supervisory activities put a lot of 
constraints on risk layering. Again, in the non-bank market, 
those are state regulated entities. The Federal Reserve does 
have the ability to impose national standards on the non-
banking--
    Mr. Green. If I may, you mention in your paper, and it is 
very well done, by the way, I enjoyed reading it, are you 
saying there is more that you will do in the area of risk 
layering?
    Ms. Bair. I think the risk layering was addressed, and I 
believe we are hopeful that the Fed will be able to address it 
as well under the HOEPA rules for non-bank lenders. We can only 
reach risk layering lending practices in the banking sector.
    Mr. Green. Who is going to deal with the 2/28s and 3/27s 
and the onerous prepayment penalties? Who will eventually step 
in and regulate that or deal with that?
    Ms. Bair. For the non-bank lenders, the States do have some 
authority. They worked with us in developing our guidance and 
are trying to apply it.
    The Federal Reserve Board, I think, is really going to be 
key here. They are undertaking a rulemaking right now.
    Mr. Green. If I may quickly, we have pension funds that are 
investing in hedge funds, hedge funds are investing in the 
subprime market fronts. Many of these pensioners do not really 
understand how at risk their pensions are.
    Who is going to look at this and make some determinations 
that maybe this area needs some sort of scrutiny because of the 
risk that the pensioners are placed at by virtue of the way 
this connectivity has developed?
    Mr. Steel. I can start if you wish and maybe defer to the 
SEC. This is an issue of private pools of capital that has been 
a focus of the President's Working Group. We believe there are 
four different actors in this situation.
    There are the regulators, the regulated entities that 
finance the private pools of capital, the managers themselves, 
and investors. All four need to be diligent and vigilant with 
regard to their responsibilities.
    When I spoke about this issue to Chairman Frank before, I 
said, and I remember quite clearly, the status quo is not 
acceptable. We are working hard now to increase the focus on 
this and develop best practices for each one of these people.
    Mr. Green. Thank you very much. I yield back, Mr. Chairman. 
I would like to say that I think the President has stepped up 
to the plate. I think the Fed Chair stepped up to the plate. 
People are expecting the Congress to step up to the plate as 
well. People understand there is a crisis notwithstanding what 
is being said. Thank you.
    Mrs. Maloney. [presiding] Thank you. The gentlelady from 
Illinois.
    Ms. Bean. Thank you, Madam Chairwoman.
    Mr. Steel, during the month of August, both the President 
and the Treasury Secretary publicly opposed raising the 
portfolio level for GSEs, which seems at odds with the 
President's recent announcement of lacking illiquidity, but is 
clearly inconsistent with the overwhelming bipartisan support 
of GSE reform earlier this year.
    Given there is general consensus about the importance of a 
strong independent GSE regulator and yet it was the President, 
not OFHEO, who publicly stated that the caps would not be 
lifted until Congress passed GSE reform, should we be concerned 
that Administration policy might be influencing or interfering 
with what is supposed to be an independent safety and soundness 
regulator's authority?
    Mr. Steel. I do not think so. I do not remember the exact 
timing, but if my memory is correct, OFHEO had already 
announced their decision and communicated it to the regulatee 
at the time this question was asked of the President.
    Ms. Bean. Thank you. Second question, does the Treasury 
have broader concerns about the impact of what started in the 
subprime space on the overall economy, not just for those who 
have subprime loans and those who are unfortunately dealing 
with foreclosures, but for those in our districts who 
historically have good credit but have in many cases taken 
their credit card debt and then gone and gotten a home equity 
loan at a better rate or they have refinanced their home by 
borrowing against the equity to reduce that debt and that has 
helped stimulate our consumer spending, given that now the 
value of homes has come down so there is less equity to borrow 
against, there is less credit available now in the new space of 
access to credit, and you also consider some of the recent 
articles about how incomes in many cases are below levels that 
they were in 2001.
    For many again who are historically good credit consumers, 
what is your concern about how that may affect the overall 
consumer spending?
    Mr. Steel. I think the second paragraph of my statement 
that I provided at the beginning really focused on the fact 
that the overall condition of the economy is quite good. If you 
pick any area, growth, inflation, employment, these are 
constructive things.
    We had a period in the marketplace that has been 
unsettling. There are some signs now that this unsettled 
feeling is beginning to improve. There will be other issues or 
challenges that I am sure will develop as this process 
continues of improving, but I would be optimistic that while 
there may be some penalty to growth, because of this turmoil in 
the markets over July and August, we are still on a projectory 
to have good solid growth in the second half of the year.
    Ms. Bean. No concerns that what could be a short term 
problem in the B to C space could roll into the B to B space 
long term?
    Mr. Steel. I promise you I am concerned every day, but I 
think the specifics of this in terms of basically trying to 
understand what the likely effect will be on the real economy, 
I would stand with the description I have provided.
    Ms. Bean. Thank you.
    Mrs. Maloney. Thank you. 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 the responses 
into the record.
    The Chair recognizes herself for 1 minute, and then the 
gentleman for 3 minutes. I just have to ask a question about my 
home State, New York. In July, Governor Spitzer announced a 
very aggressive program. He announced $100 million to help at-
risk families keep their homes, through partnering with Fannie 
Mae and Freddie Mac, who will be financing this initiative, the 
State of New York hopes to be able to refinance literally 
hundreds, possibly thousands of at-risk homeowners from the 2/
28s and 3/27s and the 30 and 40 year fixed rate mortgages at 
competitive interest rates and keep them in their homes.
    I understand that several other States have entered into 
relationships with Fannie and Freddie to do the same thing, 
specifically Ohio and Massachusetts.
    We are concerned that we are going to be right up against 
the cap, and this would hinder the ability of New York to work 
on a local level to help people stay in their homes.
    Again, it is a question that has been asked many times, but 
if there was ever a time that we should have more liquidity in 
the market and have more flexibility for Fannie and Freddie, it 
seems to be now.
    Secondly, I support the initiatives that have come forward 
from the President and the Administration, but by even your 
account, this will only help 80,000 borrowers stay in their 
homes. There are at least two to three million who face 
foreclosures in the next 2 years, by even the Administration's 
accounts.
    What are we going to do about them? We are concerned that 
because of Hurricane Katrina, 300,000 people lost their homes, 
but 10 times as many people may lose their homes in the 
subprime crisis. And what about the new guidance that came out, 
and it really responds to a letter from Congress on the 
servicers having more flexibility.
    That in no way is going to take care of all of this 
problem. First of all, the problem of New York and 
Massachusetts and Ohio, where they have this relationship that 
can help keep people in their homes, but they need the 
flexibility if Fannie and Freddie are up against the cap to be 
able to keep them in their homes through this refinancing 
program.
    Mr. Steel?
    Mr. Steel. Thank you. Let me try to start at the back and 
go forward. I am not familiar with the specifics of the New 
York proposal, so I look forward to learning about that and 
coming back to you.
    Mrs. Maloney. Very quickly, working with Fannie and Freddie 
that are financing that to help people stay in their homes, but 
they are going up against their cap, which means they may not 
be able to refinance them, to help them stay in their home.
    It is a big problem. We need to raise those caps even if it 
is temporary.
    Mr. Steel. I think we are meeting with Fannie and Freddie, 
too, to talk about creative solutions for how to deal with 
this. There are other alternatives besides just buying loans 
yourself, and there are other ways in which they can increase 
their capacity.
    With the second issue, 80,000 is the number of incremental 
FHA by the changes we have suggested. The total number is 
closer to 300,000.
    Also, there are two million resets we are facing over the 
next 18 months, roughly two million. That includes things that 
are speculators, and it includes numbers that are not owner-
occupied. We are focused on the homeowners basically 
themselves, individual single family owner occupied. That 
number is less than two million.
    The third point is there are lots of things we are working 
with to focus on the servicers, the counselors, and other 
products to attack the rest of them.
    I am optimistic that we will be successful to a great 
degree.
    Mrs. Maloney. Thank you very much. The Chair recognizes the 
gentleman from the great State of New York for 3 minutes.
    Mr. Meeks. I will only take 1 minute. Mr. Steel and Mr. 
Sirri, a quick question. This is the general market I am trying 
to find out about. Has the market reaction to holders of the 
subprime loans affected AAA rated money market mutual funds to 
your knowledge?
    Mr. Sirri. Money market mutual funds by definition have to 
hold very liquid paper. Under rule 287, which governs those 
funds, at a minimum, 95 percent of assets has to be in the 
highest rated paper, the other 5 percent can mean one notch 
lower. That is only a minimum. Besides that, the advisor has to 
go through their own credit analysis.
    I think at the moment, events have not had a substantial 
effect on money market funds. Were that to have an effect, we 
have rules in place that would allow advisors to purchase some 
of that paper. In addition, our staff stands ready to work with 
those funds in case there is any dislocation in that market.
    Mr. Meeks. So far, it seems safe. Someone told me some 
people are putting money in there as a safe haven, investing in 
these.
    Mr. Sirri. So far, we have detected no serious problems.
    Mr. Meeks. Thank you. Last question of the day.
    Mr. Steel. I agree with Mr. Sirri.
    Mr. Meeks. I have been hearing this for a long period of 
time now. Are we heading for a recession given what is 
happening? Are we headed for a recession, in your opinion?
    Mr. Steel. Our view at Treasury is that the economic growth 
that has been going on in the second quarter will continue at a 
positive projectory into the third and fourth quarters and the 
economy seems strong.
    Mrs. Maloney. That is a good point to end on. The meeting 
is adjourned. We have missed a vote. The economy is strong.
    [Whereupon, at 2:07 p.m., the hearing was adjourned.]
                            A P P E N D I X



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