[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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39-537 PDF WASHINGTON DC: 2007
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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
September 5, 2007
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