[Senate Hearing 110-1014]
[From the U.S. Government Publishing Office]
S. Hrg. 110-1014
TURMOIL IN THE U.S. CREDIT MARKETS: EXAMINING RECENT REGULATORY
RESPONSES
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
THE STEPS THE REGULATORS HAVE TAKEN TO IMPLEMENT THE HOPE FOR
HOMEOWNERS ACT, WHICH PASSED AS PART OF THE HOUSING AND ECONOMIC
RECOVERY ACT (HERA), AND THE TROUBLED ASSETS RELIEF PROGRAM (TARP),
WHICH WAS AUTHORIZED AND FUNDED BY THE EMERGENCY ECONOMIC STABILIZATION
ACT OF 2008 (EESA), BOTH WITH REGARDS TO PROVIDING CAPITAL AND
LIQUIDITY TO THE FINANCIAL SYSTEM AND PREVENTING FORECLOSURES THROUGH
THE EXERCISE OF THE AUTHORITIES PROVIDED
__________
THURSDAY, OCTOBER 23, 2008
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
U.S. GOVERNMENT PRINTING OFFICE
50-416 WASHINGTON : 2010
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania MEL MARTINEZ, Florida
JON TESTER, Montana BOB CORKER, Tennessee
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Amy S. Friend, Chief Counsel
Mark Osterle, Republican Counsel
Dawn Ratliff, Chief Clerk
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
C O N T E N T S
----------
THURSDAY, OCTOBER 23, 2008
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Johnson.............................................. 5
Senator Schumer.............................................. 5
Senator Menendez............................................. 7
Senator Corker............................................... 9
WITNESSES
Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation.. 10
Prepared statement........................................... 61
Response to written questions of:
Senator Dodd............................................. 105
Senator Enzi............................................. 112
Neel Kashkari, Interim Assistant Secretary for Financial
Stability, and Assistant Secretary for International Affairs,
Department of the Treasury..................................... 12
Prepared statement........................................... 77
Response to written questions of:
Senator Dodd............................................. 113
Brian D. Montgomery, Federal Housing Commissioner, and Assistant
Secretary for Housing, Department of Housing and Urban
Development.................................................... 14
Prepared statement........................................... 82
Response to written questions of:
Senator Dodd............................................. 123
James B. Lockhart, III, Director, Federal Housing Finance Agency. 16
Prepared statement........................................... 86
Response to written questions of:
Senator Dodd............................................. 137
Elizabeth A. Duke, Member, Board of Governor of the Federal
Reserve System................................................. 18
Prepared statement........................................... 99
Response to written questions of:
Senator Dodd............................................. 149
Senator Enzi............................................. 160
Senator Menendez......................................... 161
TURMOIL IN THE U.S. CREDIT MARKETS:
EXAMINING RECENT REGULATORY
RESPONSES
----------
THURSDAY, OCTOBER 23, 2008
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:08 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order.
Let me, first of all, thank our witnesses and my colleagues
for being here, and thank the audience that has joined us here
this morning for this hearing. This hearing is entitled
``Turmoil in U.S. Credit Markets: Examining Recent Regulatory
Responses,'' and I am very grateful to all of you for taking
the time out. I know you have other matters to be doing, so we
are going to try and move along as rapidly as we can. I
particularly want to thank Sheila Bair and Neel Kashkari. We
have got you working overtime, obviously, and so we don't want
to tie you up all day here with this. We will try and move
along as quickly as we can.
With that in mind, I am going to make a quick opening
statement, turn to Senator Shelby for any opening comments, and
then I would ask my colleagues if they could be very brief in
their opening comments. Sheila Bair has her board meeting today
in town, and so we want to be able to get her back to that
meeting, and I understand that, but we have some very important
questions.
Senator Shelby. It could be an important meeting.
Chairman Dodd. It could be important. So I will ask my
colleagues if they could be very brief or reserve their opening
statements for the questioning period when they get to it as a
way to get right to our witnesses and have a chance to hear
from them, which is critically important to all of us.
With that, let me begin with some brief opening comments
and then turn to Senator Shelby.
This morning, we consider the recent regulatory responses
to the ongoing turmoil in our national and global credit
markets. Those responses have included a series of measures
that are in many respects without precedent in our Nation's
history. These measures began, for the most part, with the
decision in March of this year to commit $30 billion in
taxpayer-backed funds to facilitate the acquisition of Bear
Stearns by JPMorgan Chase.
They also include the decision by the Federal Reserve
through the spring, summer, and fall to establish various
facilities and initiatives to promote liquidity in the markets,
including in the commercial paper markets. They include the
takeover of the Nation's largest insurer, AIG, committing over
$120 billion to this effort thus far. They include the decision
to put Fannie Mae and Freddie Mac into conservatorship and
provide them with $200 billion in Federal backstop.
They include the decisions to guarantee non-interest-
bearing deposit accounts at insured depository institutions and
to guarantee senior unsecured bank debt for a period of 3
years. And, most recently, they include the decision to invest
$250 billion into lending institutions, including some $125
billion in just nine large lenders, in an effort to promote
financial stability and liquidity.
According to one report, decisions taken or implemented by
Federal regulators in the past 7 months have committed no less
than $5 trillion in taxpayer money to stemming the tide of the
credit crisis. Five trillion dollars--that is an astounding
sum, equivalent to roughly one-third of our annual economy.
Taken together, these decisions have made the American taxpayer
a guarantor, owner, and shareholder in the financial sector of
our economy to a degree never before seen in our Nation's
history and rarely seen in any free market economy.
Certainly in recent months, no one can accuse Chairman
Bernanke, Secretary Paulson, Chairman Bair, and others of
timidity in the face of this crisis. Nearly 15 months ago,
Chairman Bernanke pledged to me that he would use all of the
tools at his disposal to maintain order, in a meeting we had in
my office in August of 2007, in order to maintain order,
stability, and liquidity in our capital markets. He has been
true to his word. Likewise, Secretary Paulson, Chairman Bair,
and Chairman Cox have all acted aggressively in recent weeks.
And while the jury is still out regarding the ultimate impact
of their actions, few if any doubt that those actions have
forestalled the worst-case scenario of a complete seizure in
the financial markets.
Nevertheless, one cannot escape hard truths about these
regulatory actions. First and foremost is the truth that they
have largely addressed the symptoms of the credit crisis rather
than its cause. For nearly 2 years, since I became Chairman of
this Committee, I have urged forceful and definitive action to
reverse the rising tide of foreclosures that began to wash over
our economy in 2007. I have not been alone in this call.
Colleagues on both sides of the political aisle here have been
sounding that same note for almost the same period of time. So
have economists and analysts from across the political
spectrum, including such distinguished individuals as former
Carter and Reagan Fed Chairman Paul Volcker, Nobel Prize
winners Joseph Stiglitz and Paul Krugman, former Reagan Chief
Economic Adviser Martin Feldstein, and Chairman of President
Bush's Council of Economic Advisers Glenn Hubbard, and American
Enterprise Institute Resident Fellow Alex Pollock.
These and other experts all agree that the key to our
Nation's economic recovery is the recovery of the housing
market, and that the key to the recovery of the housing market
is to reduce foreclosures. Without a solution to this central
problem, the record-setting foreclosure rate, more Americans
will continue to lose their homes and see the value of their
largest asset plummet to the point where homeowners owe more on
their mortgages than their homes are worth. Declining home
values, vacant properties, and reduced revenues will
destabilize more and more neighborhoods. As economist Mark
Zandi noted in March of this year, and I quote him, ``Only if
more homeowners are able to remain in their homes will the
negative cycle of foreclosures begetting house price declines
begetting more foreclosures be short-circuited. This in turn is
necessary to ending the downdraft in the housing market that is
weighing so heavily on the economy and financial system.''
Without addressing the cause of the crisis as swiftly,
aggressively, and decisively as the administration has tackled
the symptoms of the crisis, house prices will continue to fall
or stagnate, and the value of assets based on mortgages,
trillions of dollars of which are on the books of our major
financial institutions, will continue to be virtually
unknowable. To date, with few exceptions, we have not seen, in
my view, the required dedication.
The longer we allow foreclosures to erode family wealth,
neighborhood stability, and financial market liquidity, the
longer our economy will take to recover from this crisis. The
result will be the continuation of volatility and paralysis
that our regulatory leaders are working so feverishly to
address today.
A number of us have been working very hard on this problem.
The Hope for Homeowners Initiative that we created in the
Housing Economic Recovery Act was a good start. Ultimately, it
holds the promise of helping as many as 400,000 to a million
more Americans obtain safe, secure, affordable mortgages.
Similarly, the Emergency Economic Stabilization Act, which was
signed into law October 3rd, obligates the Treasury to
implement a plan to prevent foreseeable and avoidable
foreclosures. Very importantly, Section 109 of that legislation
authorizes the Secretary to use loan guarantees and credit
enhancements to facilitate loan modifications to prevent
avoidable foreclosures. This slender provision alone could help
countless deserving Americans escape the foreclosure trap set
up by predatory lenders.
This morning we look forward to asking our witnesses what
steps they are taking to implement these and other provisions
designed to stop the hemorrhaging in our housing markets that
has bled out into the wider economy of our country and across
the globe.
We also look forward to asking them what steps they are
taking to ensure that the American taxpayer is not just
bankrolling the banking industry, but benefiting as well in the
form of expanded lending activity. It is beyond troubling to
read in recent news reports that those lenders who will be
receiving billions of dollars from U.S. taxpayers are
considering using those dollars not to make loans but, rather,
to pursue some acquisition opportunities and to create a
capital cushion, on which they will comfortably sit while the
American consumer and small business person struggles. Reading
such a report, it is no surprise that a majority of Americans
surveyed in a CNN/Opinion Research Corporation poll this past
weekend disapproved of the regulators' actions that focus on
the banking industry. Doing more for homeowners is the one
policy solution that a majority of those Americans said they
would support. If there were ever a time that demanded that we
think anew, this is it. Now that the administration has taken
strong measures to stabilize financial institutions, it is
absolutely imperative, in my view, that we apply the same sharp
and urgent focus to help the individual homeowners whose plight
is at the root cause of this crisis and to the small business
owners who are valiantly struggling to stay afloat in these
times.
We are very fortunate, as I said at the outset, to have a
very distinguished panel of witnesses with us this morning. We
look forward, as always, to hearing their thoughts on what
steps we can and must take to turn from the failed policies and
flawed thinking of the past and instead turn to our hopeful and
prosperous future for our country.
With that, let me turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
I believe today's hearing provides an important opportunity
for this Committee to conduct much needed oversight of the
administration's efforts to address the considerable problems
in our financial markets. Foremost among these efforts is the
Treasury Department's Troubled Asset Relief Program, or TARP.
When first announced, this program was to be used to purchase
troubled assets from financial institutions. As market
conditions have changed, however, the program has evolved
considerably.
On October the 14th, the Department of the Treasury
announced that it was going to use $250 billion from the
program to purchase equity stakes in financial institutions.
Half of this amount has already been used to take positions in
nine of the largest domestic financial companies. The remaining
$125 billion, it is my understanding, has been set aside and is
available for use by thousands of other smaller financial
institutions. And while we all recognize that markets move with
incredible speed and that circumstances can change
dramatically, in purchasing equity stakes in publicly held
companies Treasury has deviated significantly from its original
course.
We need here to examine closely the reason for this change
and to understand how and why the nine specific firms were
chosen to receive the initial $125 billion. We also need to
understand here in this Committee how the remaining funds are
going to be made available to the thousands of firms who may be
eligible to receive them. Finally, we must also ensure, I
believe, that the appropriate oversight scheme is in place
because hundreds of billions of dollars of taxpayer money are
at risk here.
The hearing here also gives us an opportunity to examine
other recent initiatives intended to address the troubled
marketplace. Senator Dodd has already mentioned Hope for
Homeowners, but I can tell you--I believe he is on point here--
that unless we do something or can do something to address the
underlying fundamentals of dealing with the mortgage
foreclosures and real estate, we are going to be wasting
perhaps a lot of money.
Mr. Chairman, I look forward to the hearing, and I
appreciate your calling it.
Chairman Dodd. Thank you very much.
Let me turn to Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Chairman Dodd, for holding this
important hearing. In addition to the passage of the Emergency
Economic Stabilization Act, there has been a rash of other
actions by the Treasury, Fed, FDIC, and others to stabilize our
economic situation. Today, we will take a closer look at these
actions.
There is a common thread between all of the actions taken
in recent weeks: they are temporary. While I believe the
Government's actions should be ``emergency'' measures, these
are no small efforts. Within a few months, our country will
have a new administration, and within a year these measures
will expire. These actions make significant changes to our
financial services regulatory structure, and this Committee
needs to know what the end game is for these steps.
Going forward, it is important to begin reviewing the
structure of our financial system and developing regulation to
create the kind of transparency, accountability, and consumer
protection that now is lacking. I will continue fighting for
good, effective regulation that balances consumer protection
and sustainable economic growth.
I am concerned we are not yet at the end of the road in
terms of financial difficulties, but I am hopeful that the many
actions taken in the past weeks will help stem our economic
troubles.
Chairman Dodd. Thank you very much, Senator.
Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman. As you
have requested, I will withhold until the question period.
Chairman Dodd. I thank you for that.
Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you, Chairman Dodd, for holding this
important hearing to focus on the financial crisis and the
administration's response.
As we made clear in our negotiations with the
administration over the Emergency Economic Stabilization Act,
congressional oversight is essential in order to make sure the
taxpayers' money is being used well and wisely, and these
hearings are a vital and important element of that oversight,
and I salute you for having them in a timely way.
The unfortunate truth is that the financial crisis we are
facing today is not the result of an act of God or a natural
disaster, some completely unforeseeable set of entirely
unpredictable circumstances. It is the product of two
completely avoidable failures: the failure of regulatory
agencies to do their job and properly oversee the industries
and firms under their purview, and the failure of banks,
mortgage brokers, rating agencies, and other financial
institutions to appropriately measure risk and to act
accordingly.
The collapse of the housing bubble, which is at the root of
all of this, as Senator Dodd has mentioned, was not the shock
that many people want to make it out to be. There was plenty of
evidence we were in the midst of a bubble and plenty of warning
from a lot of smart people that it was going to pop sooner or
later. But what it comes down to is that too many people were
making too much money too easily and too quickly. Mortgage and
financial firms started to behave like spoiled teenagers whose
parents were on vacation. Once the party started, they didn't
want it to end. And if they trashed the house in the process,
well, maybe the maid would come and clean it up tomorrow. And
they were right about one part of it. Their parents weren't
home, because with the exception of Chairwoman Bair, who has
been the adult voice in all of this, the regulators who should
have put a stop to all of this nonsense before it got out of
hand were nowhere to be found.
This was not an accident. The problem at its root was the
lack of regulation. Certainly the Government can overregulate
and snuff out all entrepreneurial vigor for which this country
is known. But that was not the problem of this administration.
The explicit policy of this administration for the last 8 years
has been the view ``Deregulate, deregulate, deregulate.'' The
administration even appointed an SEC Commissioner and tried to
elevate him to Chairman of the FTC who wanted to repeal New
Deal regulations. And when that is not possible, the
administration tries not to enforce the regulations that are on
the books all too often.
We need thoughtful, smart, tough, and more unified
regulation, which I know under Chairman Dodd and Senator
Shelby's leadership we will endeavor to put in place early next
year.
Now, of course, we know who is stuck with the cleaning bill
for this mess: the American taxpayers. If each of us was left
to our own devices, each of us would have designed a different
rescue plan. Unfortunately, when left with the choice between
acting on this package or doing nothing, there wasn't really a
choice at all. We had to act. And Secretary Paulson, Chairman
Bernanke, and Chairwoman Bair all deserve credit for not
letting the ideology of do nothing, complete laissez-faire, get
in the way of working to bring us back from the brink of
absolute disaster.
But that does not mean my colleagues and I are happy about
what we have had to do, nor does it mean we do not have serious
questions remaining about how we are proceeding. I applaud
Secretary Paulson for recognizing, despite his initial
opposition, that the best approach to this crisis is the direct
injection of capital into banks. I have argued from the very
beginning that this is clearly the most effective way to
support the banks and the financial system more generally. The
history of our own Depression Era agency, the RFC, as well as
experiences of both Japan and Sweden in the past decades have
shown that, when done properly, capital infusions provide the
best bang for the buck.
But doing it properly is the key, and I continue to have a
number of serious questions about how this program is being
implemented. I remain especially concerned that in the
Treasury's zeal to make the capital injection program easily
digestible for the banks, we are feeding them a little too much
dessert and not making them eat enough of their vegetables.
Though you and I have spoken about this, Mr. Kashkari--and
I very much appreciate your position and your rising to take
this job at this crucial time--I am still not convinced that it
makes much sense for banks that accept capital from the
Government to continue paying dividends on their common stock.
There are far better uses of taxpayer dollars than continuing
the dividend payments to shareholders. And the program will
only be effective if it is put to good use.
With that in mind, I, along with my colleagues Senator Jack
Reed and Senator Menendez, have been urging the Treasury
Department to issue guidelines--not hard rules, not legal
regulations, but standards that will help guide institutions'
behavior now that taxpayer money has been invested. First and
foremost, I believe there should be guidelines on the use of
this capital. I would like the Treasury to set out goals,
perhaps based upon an institution's previous lending history,
for the amount of lending that each institution that receives
capital injection should be doing. This will help prevent
institutions from hoarding Government capital against future
losses and get the money quickly out to Main Street, which has
been our stated goal all along.
On the flip side of that coin, I think Treasury and the
financial regulators should issue guidance to discourage
institutions from using this funding to engage in the kinds of
risky and exotic financial activities that got us into this
mess. We are not investing in these institutions just to see
the financial wizards go back to playing their high stakes
game, this time with some taxpayer money.
Third, and finally, stronger standards of care for loan
modifications are needed. Chairman Bair has led the charge on
this front, and the rest of the regulators and Treasury should
follow her lead. There should be a requirement that any
institution receiving assistance under the TARP should have to
adopt a systematic and streamlined approach to loan
modifications, modeled on the approach that the FDIC has
utilized in institutions that it controls. Declining home
prices are the root cause of this economic crisis, and avoiding
foreclosures through loan modifications is perhaps the single
greatest step we can take to alleviate the current situation.
Finally, last but not least, I would like to see stronger
guidance issued to companies with regard to executive
compensation. Even under the rules issued by Treasury, in some
cases a great deal of discretion is left in the hands of the
compensation committees of each institution. The Treasury
Department should provide clarification and oversight for the
implementation of its own rules and also begin the process of
determining compensation best practices on a broader scale.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator.
Senator Hagel.
Senator Hagel. No, sir.
Chairman Dodd. Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman.
You know, Mr. Chairman, I woke up this morning and read a
quote from Secretary Paulson that said, ``I could have seen the
subprime problem coming earlier, but I am not saying I would
have done anything differently.''
Not done anything differently.
As one of the Members on this Committee who in March of
last year said at a hearing that you held we are going to have
a tsunami of foreclosures and the administration said that was
an exaggeration, I am concerned now that we are not dealing
with this much differently. The spark that led to this economic
fire was the housing market, and unless we attack it at its
root, it is not going to stop the wildfire that we are in.
In the month of August, over 9,800 homes entered
foreclosure every day. If this statistic was that 9,800 Wall
Street jobs were being lost every day, we would have ended this
a long time ago.
And today we learn that the number of foreclosure filings
grew by more than 70 percent in the third quarter of this year
compared with the same period in 2007. And, unfortunately, Mr.
Chairman, in New Jersey the news was even worse. It rose to 95
percent in foreclosure filings in the same period.
I believe, Mr. Chairman, we can no longer sit back and hope
that lenders do the right thing. We can no longer simply
encourage loan modifications. That clearly does not work. We
cannot ask them nicely to do this. That does not work. I had
one case in which a community development entity went to save a
home of someone. There was $175,000 owed on it. They made an
offer to the bank for $160,000. The bank turned it down. They
went to the foreclosure sale with the $175,000 check, certified
check to pay it off in full, and the bank bid it up to
$180,000.
The Securities and Exchange Commission expected Wall Street
to regulate itself and got burned. Now we are expecting lenders
to modify loans on their own. Do we really expect a different
result?
I do not believe Treasury is doing what is necessary to
modify loans in exchange for the infusion of taxpayer dollars.
And I think banks have to understand that these funds are not a
gift. If they do not want to play by our rules, then they
certainly do not need to cash the check. That is one set.
And then, finally, Mr. Chairman, the other set is people
and businesses on Main Street are counting on the banks to use
their capital that we have infused to free up lending, to
prevent foreclosures, and to stimulate the economy. If used
correctly, they are going to help small businesses stay open,
keep their employees on the payroll, help students get college
loans, families get auto loans, and homeowners modify
mortgages. But if, in fact, they do not use it as we hope and
unless we give them direction, if they stuff it under the
mattress, then ultimately we may have made a CEO's sleep at
night comfortable where we have done nothing about stimulating
Main Street.
Finally, Mr. Chairman, I do appreciate Mr. Kashkari's
efforts on minority participation here. I think it is
critically important, and we are going to continue to monitor
that.
And, last, I am gravely concerned about a situation where
banks are taking advantage of AIG's low credit rating to make a
windfall off of transactions they have with the Nation's mass
transit agencies. And we are asking Treasury--and we will
submit a question for the record, but because of the urgency of
it--to have someone senior work with our Nation's transit
agencies to make sure that they and the taxpayers' money are
being protected.
And with that, Mr. Chairman, I look forward to the
witnesses.
Chairman Dodd. Thank you very much, Senator.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Mr. Chairman, I will honor the not making a
long statement. I am troubled by some of the comments that I
have heard. I do appreciate the way some of the witnesses have
interacted with us over time, and I do not think we would be
having these hearings if it was solely because the housing
market had collapsed, which any reasonable person would have
expected that to do. The exuberance here was ridiculous. I
think it is because of the financial wizardry, and I hope that
we will not move off of focusing on that and try to focus on
the wrong things.
I am very concerned about many of the statements that have
been made, and I hope this hearing will shed light on the
direction that we ought to be going. But thank you very much
for having this hearing.
Chairman Dodd. I thank you, Senator.
Let me thank our colleagues, by the way, on both sides of
the aisle for making the effort to be here today, too, as well,
only 12 days away from our national election. The fact that
people are back from their States and participating in this
very important hearing is something I appreciate, taking time
away from their campaigns in the case of several people,
actually candidates on a ballot. So being here is something
that I am deeply grateful to my colleagues for as well.
With that, Sheila, we will begin with you, and let me just
briefly introduce everybody so we can move quickly. Sheila
Bair, as everyone knows, is the Chair of the Federal Deposit
Insurance Corporation, no strange to this Committee at all. As
Chair of the FDIC, she has taken a very proactive and very
helpful role. I think several Members have made this point, and
I want to add my words as well. Everyone has been working very
hard, but in addition to hard work, you have been very creative
and imaginative, I think, in terms of ideas that are coming
forward, and I am going to be focusing my questions to you on
the ideas you have, talking with Mr. Kashkari as well, about
Treasury's response, the legislation we adopted, the
authorities given. So just to have you be thinking about this,
there are a lot of issues, and Bob Corker is absolutely
correct. That is not the only subject matter. But certainly in
my view, dealing with foreclosure issues is a critical one, so
we thank you very, very much for being here.
Neel Kashkari is the Interim Assistant Secretary for
Financial Stability and Assistant Secretary for International
Affairs at the U.S. Department of the Treasury. That is a long
title, for the fact that you have been asked to sort of handle
this large issue and the Troubled Asset Relief Program, the
TARP program. And I want to note that Mr. Kashkari played a
very critical role in negotiating the details of these. We
spent a lot of hours together over 13 days beginning on
September 17th to October 1. The 13 days of September are ones
that none of us will ever forget in terms of what happened, and
you were very influential and supportive of those efforts that
Senator Schumer has talked about earlier this morning.
Our next witness is the Honorable Brian Montgomery, again,
no stranger to the Committee--Brian, we thank you for being
here--the Federal Housing Commissioner and Assistant Secretary
at the U.S. Department of Housing and Urban Development. Mr.
Montgomery is currently responsible for the FHA program, which
creates stable homeownership opportunities. He oversees
FHASecure and Hope for Homeowners as well, designed to help
families avoid foreclosure. I spoke yesterday to the Bristol,
Connecticut, Chamber of Commerce, and several people stood up
and had great reviews to say about the modernization of FHA and
how FHA is working today. So people out in the street across
the country are reacting to what has been going on. So we thank
you for your work as well.
Jim Lockhart is the Director of the Federal Housing Finance
Agency, assumed that position with the signing of the Housing
and Economic Recovery Act in July of this year; and prior to
that, he was the Director of the Office of Federal Housing
Enterprise Oversight, or OFHEO. I would be remiss if I did not
mention that Mr. Lockhart is also a native of Connecticut.
Politics is always local, Mr. Lockhart, right? I welcome you
here.
And our last witness, Elizabeth Duke, is the Governor of
the Board of Governors of the Federal Reserve System. She took
her office on August 5, 2008, and is serving out a term that
expires on January 31, 2012, and we thank you as well, Ms.
Duke, for being with us this morning.
We will begin with you. All statements, all supporting
documents will be included in the record, and we welcome your
statements.
STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE COMPANY
Ms. Bair. Thank you, Mr. Chairman, Senator Shelby, and
members of the Committee. I appreciate the opportunity to
testify on recent efforts to stabilize the Nation's financial
markets and to reduce foreclosures.
Conditions in the financial markets have deeply shaken the
confidence of people around the world in their financial
systems. The events of the past several weeks are
unprecedented, to say the least. The Government has taken a
number of extraordinary steps to bolster public confidence in
the U.S. banking system.
The most recent were the measures last week to recapitalize
our banks and provide temporary liquidity support to unlock
credit markets, especially interbank lending. These moves match
similar actions taken in Europe. Working with the Treasury
Department and other bank regulators, the FDIC is prepared to
do whatever it takes to preserve the public's trust in the
financial system.
Despite the current challenges, the bulk of the U.S.
banking industry remains well capitalized. What we now face is
a confidence problem, largely caused by uncertainty about the
value of mortgage assets, which has made banks reluctant to
lend to each other, as well as to consumers and businesses.
Our efforts at the FDIC have been focused on liquidity.
Last week, the FDIC Board and the Federal Reserve Board
recommended that the Secretary of the Treasury invoke the
``systemic risk exception,'' which he did, after consulting
with the President. The FDIC Board then used the authority to
create a Temporary Liquidity Guarantee Program. This program
has two features. The first guarantees new, senior unsecured
debt issued by banks and thrifts and by most bank and thrift
holding companies. This will help the banks fund their
operations. Both term and overnight funding of banks have come
under extreme pressure in recent weeks, with interest rates for
short-term lending ballooning to several hundred basis points
over the rate for comparable U.S. Treasuries. The guarantee
will allow banks to roll maturing senior debt into new issues
fully backed by the FDIC.
The second feature of the new program provides insurance
coverage for all deposits in non-interest bearing transaction
accounts at participating institutions. These accounts are
mainly for payment processing, such as payroll accounts used by
businesses. Frequently, they exceed the $250,000 insurance
limit and many smaller, healthy banks had expressed concerns
about major outflows from these accounts. This guarantee, which
runs through the end of next year, should stabilize those
accounts and help us avoid having to close otherwise viable
banks because of deposit withdrawals.
This aspect of the program allows bank customers to conduct
normal business knowing that their cash accounts are safe and
sound. This is the fundamental goal of deposit insurance,
safeguarding people's money, and it is vital to public
confidence in the banking system.
It is important to note that the new program does not use
taxpayer money or the Deposit Insurance Fund. Instead, it will
be paid for by direct user fees.
We also remain focused on the borrower side of the
equation. Everyone agrees that more needs to be done for
homeowners. We need to prevent unnecessary foreclosures and we
need to modify loans at a much faster pace. Preventing
unnecessary foreclosures will be essential to stabilizing home
prices and providing stability to mortgage markets and the
overall economy.
As you know, a number of steps have already been taken in
this direction, but I think it is clear by now that a
systematic approach is needed to help us finally get ahead of
the curve. The FDIC is working closely and creatively with
Treasury on ways to use the recent rescue law to create a clear
framework and economic incentives for systematically modifying
loans. The aim is for loan servicers to offer homeowners more
affordable and sustainable mortgages.
In sharing ideas with Treasury, we have drawn from the
program that we are using for modifying loans at IndyMac
Federal Bank since we took control of that bank in July. We
have introduced a streamlined process to systematically modify
troubled home mortgages owned or serviced by IndyMac. As we
have done in some past bank failures, we initially suspended
most foreclosures in order to evaluate the portfolio and to
identify the best ways to maximize the value of the
institution.
Through this week, IndyMac has mailed more than 15,000 loan
modification proposals to borrowers. More than 70 percent have
already responded to the initial mailings in August. More than
3,500 borrowers to date have accepted the offers and thousands
more are being processed.
The hope is that our mortgage relief program can be a model
and a catalyst to spur loan modifications across the country.
It is a process that most servicers can use under existing
legal arrangements.
In conclusion, the FDIC is fully engaged in preserving
trust and stability in the banking system. The FDIC remains
committed to achieving what has been our core mission since we
were created 75 years ago in the wake of the Great Depression,
protecting depositors and maintaining public confidence in the
financial system.
Thank you very much.
Chairman Dodd. Thank you very much.
Mr. Kashkari.
STATEMENT OF NEEL KASHKARI, INTERIM ASSISTANT SECRETARY FOR
FINANCIAL STABILITY AND ASSISTANT SECRETARY FOR INTERNATIONAL
AFFAIRS, DEPARTMENT OF TREASURY
Mr. Kashkari. Chairman Dodd, Senator Shelby, and members of
the Committee, good morning and thank you for the opportunity
to appear before you today.
I would like to provide you with an update on the Treasury
Department's progress implementing our authorities under the
Emergency Economic Stabilization Act of 2008. My written
testimony includes a much more detailed description of where we
are, but I am going to give a summary right now.
Every American depends on the flow of money through our
financial system. They depend on it for car loans, for home
loans, for student loans, and to meet their basic family needs.
Employers rely on credit to pay their employees. In recent
months, as you know, our credit markets froze up and lending
became extremely impaired.
Congress, led by this Committee and others, recognized the
threat the frozen credit markets posed to Americans and to our
economy as a whole. Secretary Paulson is implementing the
Department's new authorities with one simple goal: to restore
capital flows to the consumers and businesses that form the
core of our economy.
The Treasury has moved quickly since enactment of the bill
to implement programs that will provide stability to our
markets, protect the taxpayers to the maximum extent possible,
and help our financial institutions to support our consumers
and businesses across the country.
Since the announcement of our capital purchase program, we
have seen numerous signs of improvement in our markets and in
the confidence of our financial institutions. While there have
been recent positive developments, our markets remain fragile.
I would like to spend just a quick few moments outlining
steps we have taken to implement the TARP. We have seven policy
teams driving forward and they are making rapid progress.
First, our mortgage-backed securities purchase program. We
selected the Bank of New York Mellon to serve as a custodian
and expect to hire asset managers in the coming days. A
Treasury team has been working around the clock to design the
auction, identify which mortgage-backed securities to purchase,
and to determine how best to reach the thousands of financial
institutions who may be bidding.
Two, whole loan purchase program. This team is working with
bank regulators to identify which types of loans to purchase
first, how to value them, and which purchase mechanism will
best meet our policy objectives. They also expect to hire asset
managers very soon.
Third, insurance program. We are establishing a program to
insure trouble mortgage-related assets. We have submitted a
request for comment to the Federal Register and are seeking the
best ideas on structuring options for that program.
Four, equity purchase program. Treasury worked very closely
with the four banking regulatory agencies to design and
announce a voluntary capital purchase program to encourage U.S.
financial institutions to raise capital to increase the flow of
financing to U.S. businesses and consumers and to support the
U.S. economy. Treasury will purchase up to $250 billion of
senior preferred shares on standardized terms. This is an
investment. The Government will not only own shares that we
expect will result in a reasonable return, but will also
receive warrants for common stock in participating
institutions.
The program is available to qualifying U.S. depository
institutions. We are working very hard to publish the legal
documentation required so that private banks can participate on
the same terms as public institutions. We have allocated
sufficient capital so that all qualifying banks can fully
participate.
Treasury and the banking regulatory agencies have announced
a streamlined and systematic process to apply for the capital
program. Financial institutions should first consult with their
primary Federal regulator and then use the single standardized
application form that's available on their regulator's website.
Once the regulator has reviewed the application, they will send
the application to the Treasury Department. Treasury will give
considerable weight to the recommendations of the regulators
and decide ultimately whether or not to make the capital
purchase. All completed transactions will be announced to the
public within 48 hours, but we will not announce any
applications that are withdrawn or denied.
No. 5, homeownership preservation. We have begun working
with the Department of Housing and Urban Development and HOPE
NOW to maximize the opportunities to help as many homeowners as
possible while also protecting the taxpayers. We have hired
Donna Gambrell, who is the Director of the Community
Development Financial Institution Fund and former Deputy
Director of Consumer Protection and Community Affairs at the
FDIC to oversee this effort and serve as our interim Chief of
Homeownership Preservation.
When we purchase mortgages or mortgage-backed securities,
we will look for every opportunity possible to help homeowners.
No. 6, executive compensation. Companies participating in
Treasury's programs must adopt the Treasury Department
standards for executive compensation and corporate governance.
And No. 7, compliance. Treasury is committed to
transparency and oversight in all aspects of this program. We
have been meeting regularly with the Government Accountability
Office to monitor the program and GAO is establishing an office
onsite at Treasury. The Financial Stability Oversight Board has
already met several times and they selected Chairman Bernanke
to serve as Chairman of the Oversight Board. The Administration
is also working to identify potential candidates to serve as
Special Inspector General. In the interim, Treasury is working
with our own Inspector General to monitor our progress.
Now let me spend just a moment on procurement. Our approach
to procurement is based on the following strategy: first, in
order to protect the taxpayers, we will seek the very best
private sector expertise to help us execute this program.
Second, to the extent possible, opportunities to compete
for contracts and to provide services should be available to
small businesses, veteran-owned businesses, minority, and
women-owned businesses.
And third, we are taking appropriate steps to mitigate and
manage potential conflicts of interest. Firms competing to
provide services must disclose their potential conflicts of
interest and recommend specific steps to manage those
conflicts. Treasury will only hire firms when we are confident
in our ability and their ability to successfully manage those
conflicts. Our Chief Compliance Officer will be responsible for
making certain that firms comply with the agreed upon
mitigation steps.
Chairman, as you can see, we have accomplished a great deal
in a short period of time, but our work is only beginning. A
program as large and complex as this would normally take months
or even years to establish. But we do not have months or years.
Hence, we are moving to implement the TARP as quickly as
possible while working to ensure high quality execution.
Thank you.
Chairman Dodd. Thank you very much, Mr. Kashkari.
Mr. Montgomery.
STATEMENT OF BRIAN MONTGOMERY, FEDERAL HOUSING COMMISSIONER AND
ASSISTANT SECRETARY, DEPARTMENT OF HOUSING AND URBAN
DEVELOPMENT
Mr. Montgomery. Chairman Dodd, Senator Shelby, members of
the Committee, thank you for the opportunity to address you
this morning on the role of the Department of Housing and Urban
Development and, more particularly, the Federal Housing
Administration, in addressing the mortgage crisis.
I would like to focus my brief remarks this morning on the
recently launched Hope for Homeowners program, as well as a
counter cyclical role that FHA plays in the market, starting
with the latter.
It was just 2 years ago that FHA was viewed as all but
irrelevant. Subprime and Alt-A loans were the products of
choice and we at FHA were left standing on the sidelines,
hoping that the first time home buyers, who would have been
better served by FHA, would find the means to survive the risky
and costly products they chose instead.
As you well know, we voiced our concerns throughout this
period, publicly asserting that families who could not qualify
for prime rate mortgage products should access market rate
financing through the FHA rather than paying more in their
interest rates.
As you know, unfortunately, the crisis overtook the market
and FHA became important once again as a result of the overall
tightening and private conforming and the evaporation of non-
prime products.
As a result of this contraction, in just the last 2 years
FHA's market share has grown from 2 percent to 17 percent of
the mortgage market. That is overall mortgage market. Specific
to new construction, our market is now 25 percent. Let me put
this increase in perspective with real numbers. In fiscal year
2007, we endorsed about 425,000 single family loans, including
purchase loans, by the way, and refis. In fiscal year 2008, we
endorsed more than 1.2 million, including 632,000 purchase
loans. If you think about it, in the middle of this turmoil, we
did 632,000 purchase loans last fiscal year.
In other words, our overall business has more than doubled
this year. And we project that next year that number will be
about 1.4 million. In fact, we have pumped close to $200
billion of much needed liquidity into the mortgage market
during that time.
Let me just also say that our application rate is on a
trajectory of 3 million applications a year, and these are
levels that we have not seen in more than 10 years.
A lot of this business has been coming in through the
FHASecure product, which many of you are familiar with. I
remember testifying before this Committee about a year ago that
I thought we might reach 240,000 borrowers in fiscal year 2008.
I was off with that estimate. Since we announced the FHASecure
product a little more than a year ago close to 400,000 families
have refinanced out of a burdensome mortgage into a safe,
affordable FHA product. We think that number will push close to
500,000 by the end of the calendar year.
Let me just talk briefly about what we have done to help
our FHA-insured borrowers who are experiencing troubles. In
fiscal year 2008, FHA servicers completed more than 100,000
loss mitigation actions. Of these, 96,500 are currently
retaining homeownership. This is an 11.5 percent increase in
homeownership retention over 2007. And overall the expected
retention rate of these borrowers is 87 percent. In fact, our
loss mitigation efforts by HUD have helped more than 300,000
families over the last 3 years.
I am happy to say that we also now have the Hope for
Homeowners refinance rescue product available. The Oversight
for H4H, as we call it, composed of the agencies represented
here today, accomplished the goal of getting this program up
and running by October the 1st, only 60 days after passage of
the law.
As a result of this tremendous team effort, we now have the
additional rescue program available to the lending community
and to borrowers alike.
I'm sure you are wondering when we will see the first loan
insured, the first family saved, and another tool to help us
see the beginning of the end of this crisis. Let me say that I
know that all of us up here today testifying before you feel
the same sense of urgency. But it will take time for the
lending community to get the program up and running. The unique
statutory requirements make the program very different from any
other FHA product and require lenders to take additional time
and care to set up the program and the operations in a way that
supports the program fully.
We have devoted a lot of resources over the last 2 weeks,
reaching out and educating the lending community and counselors
about this program. This is what we have heard from them: while
they are all very interested in offering the product, they need
to be vigilant and want to be vigilant about the implementation
process. Lenders and counselors alike need to train staff. They
need to change protocols, modify systems, and take other steps
to ensure that their companies are complying with the terms of
the new program.
In addition, lenders must modify their internal IT systems
and protocols to ensure that they support the product fully
before they move to full implementation. This kind of activity
is time consuming and we should all embrace the efforts by the
lending community to handle this program in a way that ensures
its success.
I feel very confident that FHA will continue to play a
critical role in helping families in need of refinance loans to
save their homes, and also families who need safe market rate
financing to purchase a home.
I thank you for the opportunity to testify here today.
Chairman Dodd. Thank you very much, Mr. Montgomery.
Mr. Lockhart.
STATEMENT OF JAMES B. LOCKHART, III, DIRECTOR, FEDERAL HOUSING
FINANCE AGENCY
Mr. Lockhart. Chairman Dodd, Senator Shelby, and members of
the Committee, thank you for the opportunity to testify on the
Federal Housing Finance Agency's response to the turmoil in the
credit markets.
I will begin by talking about our activities as the
regulator of Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks, and then turn to TARP.
There is no doubt that the mortgage market pendulum swung
extremely widely toward easy credit, poor underwriting, risky
mortgages, and even fraud. The market had to correct. But we
need to prevent the pendulum from swinging too far in the other
direction. Fannie Mae, Freddie Mac, and the 12 Federal Home
Loan Banks have played a critical role in dampening that
pendulum swing.
In mid-2006, their market share of all new mortgage
originations was less than 40 percent. With the demise of the
private label mortgage-backed security market, their share is
now 80 percent.
On September 6th, FHFA placed Fannie Mae and Freddie Mac
into conservatorship. Market conditions, compounded by a weak
regulatory capital structure, meant that they were unable to
fulfill their mission of providing stability, liquidity, and
affordability to the mortgage market.
A critical component of the conservatorship was the three
Treasury facilities that were put in place. The most important
one is a Senior Preferred Agreement, which ensures that the
Enterprises always will have a positive net worth. These $100
billion each facilities, which have not been withdrawn on yet,
are well over three times the statutory minimum capital
requirements and last until all liabilities are paid off.
Effectively, it is a government guarantee of their existing and
future debt in mortgage-backed securities. Both can grow their
portfolios by over $100 billion, which will further support the
mortgage market, as will Treasury's mortgage-backed security
purchase facility.
Treasury has also provided the Enterprises and the Federal
Home Loan Banks credit facilities to provide liquidity if
needed. The Federal Home Loan Banks counter-cyclical capital
structure has allowed them to play a critical role in
supporting financial institutions and mortgage lending over the
last year. Their secured advances to financial institutions
have just reached $1 trillion, which is about 58 percent up
from June of last year.
The new legislation added the Enterprises affordable
housing goals and mission enforcement to the responsibilities
of the agency. I have instructed both CEOs to examine their
underwriting standards and pricing. Earlier this month, Fannie
Mae and Freddie Mac canceled a planned doubling of an adverse
market delivery fee. I expect future changes to reflect both
safe and sound business strategy and attentiveness to their
mission.
A critical component of stabilizing the mortgage market is
assisting borrowers at risk of losing their homes by preventing
foreclosures. Keeping people in their homes is critical, not
only for the families and the neighborhoods, but for the
overall housing market.
Through August, the Enterprises have done $130,000 in loss
mitigation activities, but they have to do a lot more. A more
systematic approach to loan modifications is essential. Well
before the conservatorship actions, we had asked the
Enterprises to accelerate their loan modifications with
features that included potential principal write downs and
forbearance. We encouraged them to join the FDIC's IndyMac loan
modification program. I expect loan modifications to be a
priority, both as a matter of good business and supporting
their mission.
During this difficult time in our financial markets, the
FHFA has been working with the Treasury, the Fed, the SEC, and
the Federal banking agencies to monitor market conditions and
coordinate regulatory activities. We have been assisting the
Treasury Department as it develops ideas for the TARP. I also
serve as a Director on the Financial Stability Oversight Board.
Foreclosure mitigation is an important objective under the
TARP program. The objective applies to all Federal agencies
that hold troubled assets, including FHFA as conservator of
Fannie Mae and Freddie Mac. In support of the TARP, and as a
Federal property manager, FHFA will work to ensure the
successes of these foreclosure minimization programs.
In conclusion, FHFA and the housing GSEs have a critical
role in returning the mortgage market to stability and
preventing foreclosures. It will take time but I believe the
many steps that have been taken will provide a much more solid
foundation for creating a stable future for the mortgage
markets and, most importantly, American homeowners, renters,
workers, and investors.
I look forward to working with the Committee and all of
Congress in achieving this goal.
Thank you.
Chairman Dodd. Thank you very much, Mr. Lockhart.
Ms. Duke, welcome to the Committee.
STATEMENT OF ELIZABETH A. DUKE, GOVERNOR, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Ms. Duke. Thank you.
Chairman Dodd, Senator Shelby, and other members of the
Committee, I appreciate this opportunity to discuss recent
actions taken to stabilize financial markets and foreclosure
prevention efforts. My oral remarks today all focus primarily
on actions taken by the Federal Reserve. My colleagues are all
focusing on other important initiatives at their agencies.
Financial markets have been strained for more than a year,
as house prices declined, economic activity slowed and
investors pulled back from risk taking. These strains
intensified in recent weeks. Lending to banks and other
financial institutions beyond a few days virtually shut down.
Withdrawals from money market mutual funds and prospects that
net asset values would fall further severely disrupted
commercial paper and other short-term funding markets. Longer
term credit became much more costly as credit spreads for bonds
jumped and interest rates rose.
These problems and increasing concerns about the economy
caused equity prices to swing sharply and decline notably.
Policymakers here and in other countries have taken a series of
extraordinary actions in recent weeks to restore market
functioning and improve investor confidence.
The Federal Reserve has continued to address ongoing
problems in interbank funding markets by expanding its existing
lending facilities and recently increased the quantity of term
funds at auctions to banks and accommodated greater demand for
funds from banks and primary dealers.
We also increased our currency swap lines with foreign
central banks. To alleviate pressure on money market mutual
funds and commercial paper issuers we implemented several
important temporary facilities, including one to provide
financing to banks to purchase high quality asset-backed
commercial paper for money funds, and another to provide a
backstop to commercial paper markets by purchasing highly rated
commercial paper directly from businesses at a term of 3
months.
On Tuesday of this week we announced another program in
which we will provide senior secured financing to conduits that
purchase certain highly rated commercial paper and certificates
of deposit from money market mutual funds.
The financial rescue package recently enacted by Congress,
the Emergency Economic Stabilization Act (EESA), provides
critically important new tools to address financial market
problems. EESA authorized the Troubled Asset Relief Program
(TARP), which allows Treasury to buy troubled assets, to
provide guarantees, and to inject capital to strengthen the
balance sheets of financial institutions. As provided in the
Act, the Federal Reserve Board and its staff are consulting
with Treasury regarding the TARP and Chairman Bernanke serves
as Chairman of the Oversight Board for TARP.
Last week the first use of TARP funds was announced. The
Treasury announced a voluntary capital purchase program and
nine of the Nation's largest financial institutions agreed to
participate. A second complementary use of TARP funds will be
used to purchase mortgage assets in order to remove uncertainty
from lenders' balance sheets and to restore confidence in their
viability.
Another objective is to improve the modification efforts of
services on these loans to prevent more avoidable foreclosures.
The Federal Reserve System is also working to develop
solutions to rising foreclosures. For example, the Federal
Reserve has worked with other agencies to put in place the
standards and procedures for the new Hope for Homeowners
program, and I serve on that Oversight Board. These loans can
help borrowers who might otherwise face foreclosure because the
new loan payments are affordable and the homeowner gets some
equity in their homes. Lenders and servicers are analyzing
their borrowers for good candidates for the H4H program. The
FHA and its authorized lenders are poised to process
applications.
We do appreciate the additional flexibility provided in the
program by Congress in EESA, in particular allowing up front
payments to junior lien holders that agree to release their
claims.
In addition, the Federal Reserve System is strategically
utilizing its presence around the country through its regional
Federal Reserve Banks and their branches to address
foreclosures. We have employed economic research and analysis
to target scarce resources to the communities most in need of
assistance.
The Federal Reserve System has sponsored or cosponsored
more than 80 events related to foreclosures since last summer,
reaching more than 6,000 lenders, counselors, community
development specialists, and policymakers. For example, we
sponsored five ``Recovery, Renewal, Rebuilding'' forums this
year in which key experts discuss the challenges related to REO
inventories and vacant properties and explored solutions.
We also cosponsored an event at Gillette Stadium in August
that brought together more than 2,100 borrowers seeking help
with servicers and housing counselors.
In conclusion, the Federal Reserve has taken a range of
actions to stabilize financial markets and to help borrowers
and communities. Taken together, these measures should help
rebuild confidence in the financial system, increase the
liquidity of financial markets, and improve the ability of
financial institutions to raise capital from private sources.
Efforts to stem avoidable foreclosures, I believe, will
also help homeowners and communities. These steps are important
to help stabilize our financial institutions and the housing
market and will facilitate a return to more normal functioning
and extension of credit.
Thank you.
Chairman Dodd. Thank you, Ms. Duke.
We have been joined on the Committee by Senator Bob Casey
of Pennsylvania as well. Bob, we thank you for being here this
morning.
I will begin the questioning here. I want to have the clock
on for 5 minutes, so we will try to be brief in our questions
here so everyone gets a chance to participate, knowing full
well we have got a couple of people who are going to have some
other demands.
Let me begin. I want to pick up--Bob Menendez, I thought--
whether anyone wants to agree with his conclusions or not, I
think the fact that he has framed it well in terms of getting
action, getting things moving. We have had a lot of strong
rhetoric, a lot of urging. As my colleague from New Jersey will
recall on this Committee, this is the 76th hearing, by the way,
we have had, a third of which have been on this subject matter
alone in the last 20 months, but sitting here urging people to
meet, having meetings, in fact, in this room with stakeholders,
urging them to do workouts when it came to mortgage foreclosure
issues. And as he points out, we have not seen as much as we
would like.
I appreciate the testimony that there still is some
movement, and others may disagree. But I have felt for the last
20 months, since this effort began, that the foreclosure issue
is still very much at the heart of all of this, that we have
got to get to the bottom of this. Until you find that bottom,
while credit is beginning to move, it is still going to be
timid, to put it mildly. And so this is really an essential
element, in my view, of this effort.
So I want to focus a little bit on that. It is not the only
issue, obviously, and there are other questions we have to get
to. But I want to start with this one, if I can. And let me
begin with you, Ms. Bair, if I can.
You note in your testimony that EESA grants authorization
to Secretary Paulson to use loan guarantees and credit
enhancements to facilitate loan modifications. In fact, this is
not just--this is Section 109 of EESA. We cannot always say
this. I am familiar with it because we wrote it, you and I did.
As the author of the language specifically, I know exactly what
I intended with that language.
One of the concerns we had at the time in writing the bill
on September 20th, 24 hours after receiving the bill on
September 19th, was to make sure that, in addition to the
accountability questions, dealing with the golden parachutes,
dealing with taxpayer protections, was the foreclosure issue.
What could we write in this bill that would give the authority
to get more than just rhetorical response to the foreclosure
issue?
And so Section 109 was written to give that kind of power
and authority, broad authority, which is what we intended with
this bill. One of the things we all felt strongly about was to
make sure we gave the needed regulatory agencies the broad
authority and the resources they needed in order to respond,
without Congress trying to write them for them. That certainly
is beyond our capacity as an institution of 535 members to
start dictating specifically. But wrote the language
specifically for broad authority here.
And so I feel very strongly about that language because I
know how important you felt it was and I felt it was to include
it as part of the bill.
So I wonder if you might, first of all, since you have been
talking about this over the last couple of days, just answer
some very quick questions on this. One, could you describe
briefly, if you can, how the program might work? Do you think
the FDIC has the capacity to get such a program up and running
quickly? And would the FDIC be willing to take on this task?
And then, Mr. Kashkari, I want to come back to you. I spoke
with the Secretary of the Treasury this morning, as you may
know, about this very matter, and, again, understanding there
are some details to be worked on, but I certainly was left with
the impression that Treasury likes this idea, would like to get
it going. And I am going to make some comments about Section
102 in a minute because I know there is some pushback on that
section of the bill, which I am also very familiar with. But
the idea that Section 102 relates to Section 109 of the bill is
baloney, in my view. But, nonetheless, would you please respond
to my questions?
Ms. Bair. Well, we are having very good discussions with
Treasury, and I think Treasury is doing their due diligence,
and we are sharing some ideas. And they are looking at some
other things as well, and we want to respect that process and
adhere to that process because, at the end of the day this
would be a Treasury program, an Administration program. It
would not be an FDIC program, though we are certainly willing
to serve as contractor, under another provision of the bill.
And, consistent with discussions we had earlier during the
consideration of this legislation, yes, we think credit
enhancements certainly should be looked at as a policy option
because you can leverage them. With whole loan purchases, you
have got to buy the whole loan. With some type of credit
enhancement program, you can perhaps leverage your resources to
reach a broader array--reaching a larger number of loans by
providing incentives for modifications.
We think, in looking at credit enhancements, one area to
look at in particular is uncertainty regarding the redefault
rate, and that gets a little bit into the weeds of the loan
modification process. But, based on our experience at IndyMac,
we are finding a lot of investor pushback, and some of the
economic analysis that servicers do to justify loan
modification is complicated by uncertainty about redefaults. So
once they modify the loan, what happens if the borrower still
defaults on payments subsequently? And then they have to try to
liquidate, and the losses are greater. So I think that is one
area where greater certainty could be provided, which would
make the economic decision to modify a lot more powerful, if
not irresistible. So that is one area.
And I think this kind of authority should be coupled with a
systematic infrastructure to do this. I think another
impediment to private servicers doing these loan modifications
is--they are just doing it ad hoc. They are doing it borrower
by borrower. There is no industry-wide framework. I think with
the IndyMac protocols we have helped that along, and the
Countrywide-Bank of America agreement with the State Attorneys
General is a protocol very similar to ours. So I think we have
a workable model.
Also, I think another reason to look at credit enhancements
is because a lot of these loans are in securitization trusts.
Under the REMIC rules, I am not sure you can buy the whole loan
out. So for portfolio lenders, perhaps whole loan sales or
purchases would be more of an option. For loans in
securitization trusts, however, you can refinance them out,
which is the FHA program, but this approach has got some
limitations. You have to try to provide incentives to get these
loans modified while they stay in the trusts. It is very
difficult to buy them out.
So, those are the general areas we are looking at. Again, I
think we are having very good discussions with Treasury.
Treasury and the Administration want to be careful with this,
but I know Secretary Paulson is very committed. And I do not
want to speak for him. Neel can. But I know from my discussions
with him, he is concerned about this as much as anybody. He
wants to leverage resources to the extent he can to prevent
unnecessary foreclosures. I think the entire Administration
feels that way. So there is a policy process underway. I think
it will happen quickly, and hopefully we will be able to make
some public announcements in the not too distant future.
Chairman Dodd. You have the resources to do this, and FDIC
is willing to do this.
Ms. Bair. Yes, we would be happy to serve as contractor,
absolutely.
Chairman Dodd. Now, let me just--because I wanted to make
that record. In talking about--I want to talk about 109 and
102. You can glaze over the eyes of people, but just to make it
clear what we are talking about. Section 109 of the bill was to
use loan guarantees and other credit enhancements to facilitate
loan modifications. It is very separate and apart, in my view,
from Section 102. The 102 provision was intended to serve as a
potential alternative to the old idea of purchasing toxic
assets. The provisions of this section were not meant to apply
to the authority provided in 109. As the author of the loan
modification provisions, I want to make it clear that this was
not the intent of the law, nor do we read it as the letter of
the law. So in terms of at least for legislative history, for
those of us engaged in the crafting of it, those two sections
were very separate. One came much later. Section 102 came
afterwards, 109, in the order of how these were brought up. So
I raise that with you.
Now, Mr. Kashkari, let me--and, again, I do not believe in
revealing details of conversations I have had with the
Secretary, but, nonetheless, we talked about this, this morning
at some length. And as I understand it--and you have heard Ms.
Bair say this as well--it is the intent of the Treasury to get
this program up and working. There are things you need to work
through. I am not suggesting that is done yet. But is that the
position of the Treasury Department?
Mr. Kashkari. Chairman, we are passionate about doing
everything we can to avoid preventable foreclosures and
encouraging loan modifications. We are, I would call us at this
stage, in a policy process, understanding the proposal,
understanding the details. As you know, this Committee played a
real leadership role in the Hope for Homeowners program. We
need to understand how this new proposal would interact, for
example, with existing programs that are in place to make sure
we have a thoughtful, comprehensive solution.
So we are in a policy process. We are moving very quickly,
and we are looking very hard at it at this point.
Chairman Dodd. We are still getting around 10,000
foreclosures a day, so every day we wait, another 10,000
families end up in tough shape. So I appreciate wanting to do
it carefully, but there is a sense of urgency that I think
needs to be demonstrated here in order to get this really
moving.
I am not asking you not to be lacking prudence in all of
this, but I hope there is a deep appreciation of what is
happening far removed from this city alone, across this
country, and we need to get moving on this to get to the heart
of all of this.
Mr. Kashkari. Absolutely, Chairman. We share your sense of
urgency.
Chairman Dodd. Now let me jump quickly to the issue of
the--the banks issue. On October 20th, Monday, the Secretary
said that the infusion of capital through preferred stock--
talking about the equity investment here--``to increase the
confidence of our banks''--I am quoting him now--``so that they
will deploy not hoard their capital, and we expect them to do
so.''
Many have assumed that this new capital would be used to
make more loans which are necessary to enable business to
operate. However, recently the press has reported that several
banks receiving the taxpayers' money intend to use it to buy
other banks. The Washington Post reported, and I quote,
``JPMorgan Chase, BB&T, and Zions Bancorporation have all said
in recent days that they are considering using some of their
Federal money to buy other banks. About 10 financial
institutions belonging to the Financial Services Roundtable,
which represents 100 of the Nation's largest financial services
firms, are also considering making acquisitions with the
money.''
Now, I don't want to rule out acquisition as a step, and I
think the word ``hoarding'' is the word that I sort of glomp
onto. I appreciate the Secretary's comments because I can just
tell you there will be a vehement response up here if that is
what is perceived with these dollars is hoarding this money,
providing that kind of cushion. So I appreciate the comments,
but I think Senator Menendez said it well.
What can you tell us, what guarantees, what assurances,
what commitments are Treasury going to extract from these
lending institutions that they are not going to do this other
than rhetorically begging them not to do it? I think we need
more than just begging at this point.
Mr. Kashkari. Chairman, we share your view. It is a very
important point. We want our financial institutions lending in
our communities. It is essential. And so if you look at some of
the details--terms around the preferred stock purchase
agreement, there are specific contractual provisions on how
they can and cannot use the capital.
As an example, we are preventing increases in dividends
because we do not think it is appropriate to take Government
capital, the taxpayers' money, and then increase dividends.
That does not increase capital in the financial system, so that
is prohibited.
Second, share repurchases are also prohibited. We do not
want to put Government capital in and then boost the stock
price by buying back a bunch of shares. That is contractually
prohibited.
In addition, we have got other language in there focusing
on commitments around increasing lending, working hard to help
homeowners. Some of them are contractual provisions. Others are
more guidance in nature. But we share your view 100 percent. We
want these institutions in our communities lending.
Chairman Dodd. Are we going to insist upon it, not want it?
Mr. Kashkari. Well, we are insisting upon it through all of
our actions, through all of our--every dialog we have with
these institutions. If you take the example of mergers and
acquisitions that people have raised in the past week or so, we
should look very carefully at that, because if we have a small
bank, a failing bank in a community, that bank is not in a
position to write loans for its small businesses, its
homeowners. If a larger bank, a stronger bank, is able to
acquire that and capital is put into that combined entity, that
community is now better served. And so we have to be very
careful about not discouraging prudent acquisitions because
that can actually help us get through this troubled time that
we are in right now.
Chairman Dodd. I agree. They said that. I am not ruling out
acquisitions. The hoarding notion is the one that really is
distracting.
Senator Shelby.
Senator Shelby. Thank you.
Secretary Kashkari, why did Treasury not attach a
requirement to increase lending as a price for receiving the
Government money? In other words, we are talking about lending
to keep our economy going, are we not?
Mr. Kashkari. We are, Senator. Again, we completely agree
with the spirit of that, and we want our banks to lend. But we
also did not want to be in a position of micromanaging our
banks. We wanted to create a program where thousands of
institutions across our country would volunteer to participate,
and if we came in with very specific guidance on ``you must do
this, you must do that,'' we were afraid that we would
discourage firms, discourage healthy institutions from
participating. And it is the healthy institutions that we want
to take the capital because they are going to be in the best
position to lend.
Senator Shelby. One of the big rationales from Treasury in
injecting this money into these nine large banks was to make
them perhaps more solvent and have more capital to lend. Is
that central to the whole scheme here?
Mr. Kashkari. It is central, Senator.
Senator Shelby. So if it is central to the whole scheme,
why aren't you insisting on in a macro sense that they not
hoard the money, as Senator Dodd said?
Mr. Kashkari. I would return, Senator, to the provisions I
talked about, about prohibiting share repurchases and
increasing dividends. If you put a bunch of capital in a bank
and they cannot return the capital through a share repurchase
or dividend----
Senator Shelby. We understand.
Mr. Kashkari [continuing]. The return on capital reduces.
There are strong economic incentives for them to take that
capital and put it to good use. Their own shareholders will
demand it; otherwise, their own returns are going to come down.
So we feel that the provisions we put into the agreements
provide the economic incentives for them to lend.
Senator Shelby. Another question. It is my understanding
under the capital program nine banks will receive a total of
$125 billion. Is that correct?
Mr. Kashkari. That is correct.
Senator Shelby. The remainder of the $250 billion that
Treasury intends to spend on capital purchases is to be
allocated among the thousands of other banks.
Mr. Kashkari. That is correct.
Senator Shelby. It has been suggested that some of the
banks receiving funds under the program of the $125 billion do
not need it and did not want it. Was requiring participation by
the nine banks simply a symbolic gesture intended to mask the
financial weaknesses of some of the banks? In other words, why
would you want to push money on people that did not need it? In
fact, if they did need it, that is what the program was about.
Mr. Kashkari. Well, Senator, if you will allow me to say a
couple points, first of all, the terms for the first nine are
identical for the terms for number 10, number 100, and number
1,000. There is a range of capital that a firm can take down, 1
percent of risk-weighted assets up to 3 percent of risk-
weighted assets.
Senator Shelby. OK.
Mr. Kashkari. So the 125 seems like a lot for nine
institutions, but those nine institutions have 50 percent of
the deposits in the country. So it is the same proportion for
the first nine and number 4,000. There is no preference, first
of all.
Second, again, this is a program, we want healthy
institutions to use the capital. And we encourage the
institutions to participate so that there would be no stigma.
The healthy institutions who were in a strong position today
can become even stronger and make even more loans. That is
better for our system as a whole, Senator.
Senator Shelby. But the Comptroller of the Currency, FDIC,
the Federal Reserve--we have Governor Duke here--these are all
regulators of the banking system. When one bank acquires
another one, you have to get approval from the regulator. So
you still have that whip in there to deal with any acquisition
of any bank, either kind of suggested, forced, or voluntary, do
you not? All of you. Is that fair, Chairman?
Allowing firms to fail, Mr. Secretary, over the past year,
Treasury, the Fed, and FDIC have devised a broad array of
programs to help prevent the failure of various financial
institutions, including banks, money market funds, broker-
dealers, and insurance companies. To what extent have these
programs propped up insolvent firms and prolonged the current
economic crisis by delaying their inevitable failure? Because
some firms are going to fail whatever you do to them. How long
can we--the Government, the taxpayer--continue to prop up so
many institutions? And at what point does it become more cost-
effective to allow firms to fail? Chairman Bair, you have to do
that from time to time, and you have. First, you.
Ms. Bair. Well, we do, and it is always a difficult
decision, and the primary federal regulator actually is one
that makes the decision. We have back-up authority to close
banks, but we almost always defer to the primary regulator. The
primary regulator makes the decision.
I think banks are a little different than other sectors of
the financial services system. I think it needs to be repeated,
reiterated that banks overall are very well capitalized. Yes,
we have some banks with some challenges, but the vast majority
are well capitalized. This is not a solvency crisis along the
lines of what we saw during the S&L days. We are dealing with
liquidity issues right now, and liquidity issues are harder.
Sometimes the liquidity issue is the market signaling a longer-
term capital solvency problem. But as the confidence problem
has grown and grown, irrational fear has overtaken us somewhat.
So we see institutions that otherwise are viable being
threatened with closure because they cannot meet their
obligations.
So that is the balancing act we are trying to strike here.
With the additional liquidity guarantees and the additional
capital infusion, we are trying to keep banks, that are
otherwise viable, healthy and lending and to prevent
unnecessary closures because of liquidity drains for
institutions that otherwise have plenty of capital.
Senator Shelby. But there are still going to be plenty of
failures out there----
Ms. Bair. There will be.
Senator Shelby [continuing]. Whatever you do. Correct?
Ms. Bair. And we agree with you, Senator. When it is there
and it is clear, we want them closed early, because if we wait
it will increase our resolution costs. We absolutely agree with
that.
Senator Shelby. Secretary Kashkari, as the Treasury moves
assets from institutions by way of the TARP program, the
participating institutions will have already taken out
insurance on those assets in the form of credit default swaps.
Will Treasury allow firms to retain the credit default swaps
that they have used to hedge the securities that they sell to
the Government?
Mr. Kashkari. Senator, at this point we do not have a firm
policy on what to do with any hedges associated with the
assets. I think that those are complex issues that we are
working through with the regulators. Once we identify exactly
which assets we are going to buy and the purchasing mechanism,
those are important details that we are going to work through.
Senator Shelby. But the firms that sell their assets to the
Government under the plan you are talking about, TARP, they
would stand to profit if those assets default under the credit
default swaps, would they not?
Mr. Kashkari. That is true in the credit default swap
market broadly. Many participants are writing insurance
contracts on assets they may or may not own. So I think that
that is a very important issue that we are sensitive to. I
think it is an issue that we all need to wrestle with more
broadly.
Senator Shelby. Last question. What specific factors will
the Treasury consider when determining whether it will make an
equity purchase in a bank? What types of banks do you expect to
be the best candidates for equity purchases? Those with solid
balance sheets? Those with a high percentage of trouble assets?
And will insolvent banks be prohibited from participating in
your program?
Mr. Kashkari. Senator, we have spent a lot of time working
with the four banking regulators for them to come up with a
standardized process that they are going to be reviewing
applications and then making a recommendation to the Treasury
Department. The regulators in many cases have their
professionals in these institutions and have been working with
them for years. So the regulators are best positioned to judge
the viability of an institution and how healthy it is.
Ultimately, it will be the Treasury Department's determination,
but we are going to rely very heavily on the judgment of the
regulators.
Senator Shelby. Thank you.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Johnson.
Senator Johnson. Ms. Bair, thank you for coming by my
office to discuss deposit insurance issues yesterday.
Throughout the next year, Congress will have to make some
decisions on permanent changes regarding deposit insurance
coverage. Should the new $250,000 level be made permanent? And
will banks be able to afford the higher premiums?
Ms. Bair. That is a very good question. Congress sets our
deposit insurance limits, and the base limit has been
temporarily increased by Congress to $250,000 through the end
of 2009.
I think that we will need to gauge the situation at that
point. I am concerned if we still are working through our
challenges that we would not want to create a cliff effect
where there would be a massive exodus of money because of the
drop down. So I think that is an issue that is going to have to
be handled very carefully. If Congress would like to take it
back down perhaps it should be done in a phased approach. But
certainly I think if you keep the higher limit it needs to be
built into the premium structure, and we can do that over a
period of time to ease the premium impact. While we are
industry-funded, we do have wide latitude to borrow from
Treasury for short-term liquidity needs if we need it. We have
not had to do that, and I hope we will not have to do that. But
I think to maintain the principle of industry funding, it
should be built into the premium structure if Congress decides
to make the $250,000 permanent.
Senator Johnson. Continuing on, we have seen over a million
loans reworked by HOPE NOW, and efforts are underway for the
Hope for Homeowners program. But there are some concerns that
these programs are not making a large enough difference for
those facing foreclosure. How would you change what the
Government and institutions are currently doing to make
modifications more meaningful?
Ms. Bair. I think we have been having excellent discussions
with Treasury and our fellow bank regulators and the housing
authorities about this. I think there are lots of authorities
to explore. One which Chairman Dodd mentioned earlier, using
credit guarantees or credit enhancements, may be an additional
tool we should use. But we are behind the curve. There has been
some progress, but it has not been enough. We need to act, and
we need to act quickly and dramatically to have wide-scale
systematic modifications with standard industry metric applied
across the board. And if economic incentives need to be
provided to help make the economics of those modifications
work, especially for these loans that are in securitization
trusts, then I think that is what we need to do.
It can be done. I think we are showing at IndyMac it can be
done. I am very grateful that the Bank of America settlement
also uses a protocol similar to ours. The trick is to provide
the appropriate incentives, the carrots and the sticks, if you
will, to make sure it is done on a more industry-wide basis.
Senator Johnson. This is a question for all the panel.
Beginning to restructure the financial services regulatory
structure is a complicated undertaking. What do each of you
believe is the starting point for restructuring? What is the
No. 1 structural regulatory deficiency in your opinion that
needs to be corrected by Congress? Ms. Bair?
Ms. Bair. At the top of my list would be regulatory
arbitrage, which I think has taken a number of forms. There is
uneven regulation. And it is true with mortgage lending
standards. We did not have across-the-board mortgage lending
standards, and we ended up seeing negative competition, with
non-banks being very aggressive with their loan originations
and that created competitive pressure on the banks to start
doing the same.
I think another area is capital standards. We have had
relatively strong capital standards for insured depository
institutions, less so with other parts of the financial
services sector. Where you are seeing the most profound
distress at the institutional level is with the institutions
that are most leveraged. So, again, ending that uneven
regulatory treatment and having some consistency across the
board and leverage constrained is another area that I hope
Congress will be looking at next year. We need to have more
even regulation applying to a wide range of institutions, and
we also need to have resolution mechanisms--which we have for
banks, but currently not for these other institutions. This is
why Treasury and the New York Federal Reserve Bank had to
develop a process for the Lehman Brothers and AIGs of the
world, because the process for it right now just does not
exist.
Senator Johnson. Mr. Kashkari, can you add anything to
that?
Mr. Kashkari. I agree with Chairman Bair and would add two
things. One is, in March, the Treasury Department published a
comprehensive proposal on how to restructure the regulatory
system. It is a long-term approach.
I would also add to what she said and comment on mortgage
origination standards, not just in the banks but mortgage
brokers, which right now it is not done on the national level
and there is not consistency. And I think bringing some type of
national Federal oversight and consistent would be helpful.
Senator Johnson. Mr. Montgomery?
Mr. Montgomery. Yes, sir. While not a banking regulator, I
can say going forward that reform of the Real Estate Settlement
Procedures Act--RESPA, as it is known--which, after a 6-year
effort, we are on the verge of getting that out in the next 2
to 3 weeks, I think that will bring more closely into the light
of day what consumers pay at the closing table, what are the
terms of their loans, what are the settlement costs, things of
that nature. And we think that will definitely help the process
going forward.
Senator Johnson. Mr. Lockhart?
Mr. Lockhart. I certainly support the Treasury blueprint
and, actually, Congress in July, when they passed the law
combining OFHEO with the Federal Housing Finance Board and also
taking the HUD mission, it was a major step forward in the
housing area of pulling the regulators together and having a
much more comprehensive approach.
One thing that was left off in that legislation, as it
moved through, was we were going to be put on as a member or a
participant with the financial regulators and their FFIEC
activity. I believe that that should be added at some point.
Senator Johnson. Ms. Duke?
Ms. Duke. I think I would echo the need to draw regulation
more widely, to look at probably the business models as they
will develop, because I don't think the business model that we
used in the past of originate to distribute will continue; but
to make sure that all participants in the financial transaction
chain are regulated in the same manner. Also, I think
supervision and enforcement in addition to regulation are key
pieces of it. And I would echo the need to have some resolution
protocols for institutions that fall outside of the insured
depositories. I think it is an important point that we have a
mechanism for insured depositories, but we did not have
anything for those that were outside of it. And the bankruptcy
court did not seem to be the right place to try to deal with
some of those issues.
Senator Johnson. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Sheila Bair, I just could not resist that idea of that
across-the-board regulation, and for those of us who were
involved in 1994 with the crafting of the HOEPA legislation,
that legislation required all lenders--State-chartered,
federally chartered institutions--to apply standards against
deceptive and fraudulent practices. Not a single regulation was
ever promulgated under that law for 15 years. And more than any
other single thing I can think of, had that regulation been
promulgated and someone enforcing them on lenders across the
board, I think we would be in a very different place today.
Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman.
Mr. Kashkari, I want to direct my first question to you,
and I want to follow up on the line of questioning that our
Chairman and our Ranking Member went into with regard to the
$250 billion of liquidity that has been provided to the banks.
Their focus there was to make sure that those dollars were not
hoarded and that the actual result would be the lending that we
would like to see happening. And I understand that, and I
appreciate your answers with regard to that part of the
program.
The question I have goes to the toxic asset purchase issue.
It seems to me that the plan to utilize these resources that
Congress has provided for the purchase of toxic assets has the
opposite impact. In other words, it creates an incentive for
investors to stay on the sidelines for a while and watch what
the Government is going to do and then maybe step in at some
later date and either buy or finance purchases from the
Government. And I just wonder what your thoughts are on that
aspect of the proposal.
Mr. Kashkari. Senator, thank you for the question. The
question you ask is fundamental to the design of the program.
The program is intended not only to buy troubled assets, but in
doing so to provide price transparency to the market, because
our view is that there is a lot of money on the sidelines who
are interested in investing in our institutions and in these
assets themselves. And our hope is that by the Federal
Government taking the first step through a very open,
transparent process, that will encourage private capital to
come in. That is the exact intention of the program. So we
agree with the spirit that you raise.
Senator Crapo. But isn't the fact that the Federal
Government is going to step in in such a major way going to
create just the opposite result, namely that the private
capital will sit back, stay on the sidelines, and watch for a
while to see what will develop?
Mr. Kashkari. I think it is a very good question, and I
think there is some merit to that point up until we get
started. And that is why we are moving as fast as we can. But
once we get started--and we are going to get started slowly,
methodically, let people and let the markets see what we are
doing. We expect them to understand it very quickly and then
start to come in.
Senator Crapo. All right. Thank you.
Chairman Bair, I also am concerned that the direction we
are heading with this, particularly with the numbers of
guarantees that we are now seeing put into place, has
essentially driven us far down the road toward a situation in
which financial institutions are basically becoming
disconnected from the risk of lending. Could you address that?
Ms. Bair. I agree with you. These guarantees make me
uncomfortable. We had a compressed timeframe to make a
decision. We evaluated the pros and cons, the risks and the
benefits. But at the end of the day, especially given what was
going on in Europe, we did not think we had an alternative. We
needed to move ahead.
I am aware of the additional moral hazard, obviously, with
expanded guarantees. We have in place a heightened supervisory
process on the use of these, and very tight controls over
weaker institutions using these, if they use them at all. So we
can compensate through the supervisory process for some of the
additional moral hazard. The other key is to make sure they are
temporary. And, believe me, I am determined that these will be
temporary. And we are charging a premium, I would hasten to
add. This is not just something we are providing. We are
charging a premium for it.
Senator Crapo. Your point on the temporary nature I think
is very important. In fact, one of my questions was going to
be, How do you take the guarantee away?
Ms. Bair. Well, we are. We are out there now saying that it
is going away June 30th. And I understand there might be some
pressure to continue it. I do not think anybody should assume
it is going to be continued. It is not. My every expectation is
that it will go away.
There are things, if you needed to have some type of phased
process as opposed to a clipped process, I think you can do
that by reducing the cap, ratcheting up the premiums, so there
are ways to ease out if we want to have a slower process. But I
am resolved to end these expanded guarantees because of the
additional moral hazard that they create for us.
Senator Crapo. Thank you.
And, Mr. Kashkari, back to you. With regard, again, to the
toxic asset purchase--and I am focusing now on the underlying
mortgages and the question I have is: How will the servicing of
the loans be handled? Will it be handled by the current
servicing managers? Or are we going to create a new system or a
new--I was going to say ``bureaucracy''--a new set of managers
and re-create the system that we have now?
Mr. Kashkari. At this point, Senator, our intention is,
where possible, to keep the servicing with the existing
servicer, but send to them very specific instructions, a plan
on how we want them to conduct the servicing consistent with
our objectives.
Senator Crapo. All right. Thank you. And another question I
have is I appreciate the fact that Treasury has submitted a
request for ideas on how we can establish the insurance program
that was involved in the legislation that we had. And as you
know, the liquidity crisis is not limited to the residential
mortgage arena. It is expanding into a number of other areas,
and the one I am thinking of right now is the commercial
mortgage arena.
Has Treasury considered using the insurance program to
provide a Government guarantee or an insurance for the safest
part of or for some part of the commercial mortgage market?
Mr. Kashkari. Senator, that is a very good point. We have
heard a lot of the same perspectives that you raise, both from
the banking regulators and from individual institutions. If you
look out in the regional bank market, in particular, they have
a lot of mortgages, whole loans, commercial mortgages on their
balance sheets. So we think that the insurance program may well
be applicable there, and these are just the very ideas that we
are soliciting right now.
Our initial focus is on residential, but we are very aware
of and focused as a second step on commercial
Senator Crapo. All right. Thank you very much. And one last
question I wanted to ask is you had talked a moment ago about
credit default swaps and the fact that there are a number of
those in which one of the swapping parties does not have an
ownership interest in the underlying asset. That has been an
issue that we have discussed in hearings in the Agriculture
Committee on derivatives. And the question I have is: Is there
no purpose for those types of swaps? I understand one of the
arguments that is being made is that even though the swapping
parties may not have an ownership interest, they may have a
very strong financial interest in the outcome of--or in the
strength of the company that is engaged in the underlying
transaction, or some other type of reason for wanting to be
sure that that transaction is insured.
Mr. Kashkari. Senator, I will say, first of all, I am not
an expert in the credit default swap market, so let me just set
expectations. But I think you are right. I think that there are
many reasons why financial institutions or financial
counterparties may want to hedge certain risks that they may or
may not own directly the underlying asset. So I think that is
right, and I think that we need to have the experts take a hard
look at that.
Senator Crapo. All right. Thank you very much.
Chairman Dodd. Thank you, Senator. Good questions. I
appreciate it very much.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman.
My first question is for Mr. Kashkari. I would just like to
follow up on my opening statement. I know Senator Dodd talked a
little bit about this, to ensure that the capital that TARP
provides to banks is effective in achieving the joint goals--
stability in the financial markets, but also the unfreezing of
the credit markets to deal with Main Street. So I have asked
you for a while, and Senators Reed and Menendez joined me in
this. What about the idea of setting some guidelines? If you
have public guidelines out there--now, I realize you cannot do
one size fits all, nor do I think you can mandate these things.
But the idea of guidelines to help importune banks which are
sensitive institutions to public--given that they are a
regulated industry to public pressure would make sense. Can you
please tell us if you intend or Treasury intends to put out
such guidelines on, first of all, a general, a ballpark figure
of how much of this capital should be lent out? You know,
obviously, it would accelerate--there is a multiplier effect
because for every dollar of capital you can, obviously, more
than a dollar or two of lending.
Mr. Kashkari. Well, Senator, as you and I have discussed,
we share the spirit of your question completely and want these
institutions to lend and provide credit to our communities. In
fact, it is not published yet, but when the final purchase
agreement is put out there between the Treasury and the
individual institutions, there is specific language in the
purchase agreement about lending and about taking aggressive
steps on foreclosure mitigation. It is not a legally binding
contract.
Senator Schumer. Right.
Mr. Kashkari. Neither would guidelines be. But it does
considerably more----
Senator Schumer. Is it more than just a general
exhortation?
Mr. Kashkari. Well, forgive me, I am not an attorney so I
cannot tell you----
Senator Schumer. I am not asking you as an attorney. I am
just saying if it says we encourage the banks to lend the
money, it is not going to be much. If we say, you know, for
every dollar of capital they get, we would expect there would
be two or three or four--you know, something like that, we
would expect, not mandate.
Mr. Kashkari. Again, we do expect, but we are hesitant to
put a specific dollar figure because these financial
institutions--again, as you know, Senator, we are talking about
very large financial institutions and very small. One size fits
all is----
Senator Schumer. What are you going to do for banks that do
not increase their lending at all that take this capital?
Mr. Kashkari. Sure. As I mentioned previously, Senator, I
think that the provisions on preventing dividend increases and
stopping share buybacks provides very strongincentive for these
institutions to want to lend again.
Senator Schumer. But we have had a couple of leading
executives talk about they think that the banks--and they were
talking not about their own specific institution alone--are
going to just sort of hoard the money for a while, and they
thought was in their best interest, and that worries me.
Mr. Kashkari. It worries us, too. We want these
institutions to lend, absolutely, but also recognize the
situation we are all in right now is the situation of
unprecedented lack of confidence in the system.
Senator Schumer. Understood
Mr. Kashkari. And so the immediate reactions may be more
reserved. I think as things--as the markets begin to sort
themselves out, I would expect to see these institutions
lending.
Senator Schumer. I would urge you to consider putting out
these guidelines. And then there is one that may be easier.
What about guidelines inveighing against new investments in
these exotic financial instruments that brought so many of the
institutions down to begin with? That is an easier one for you
to write.
Mr. Kashkari. It is a very good point, and we certainly do
not want institutions taking undue risks. But, candidly,
Senator, I think that my banking regulator colleagues are
probably in the best position to help guide their regulated
entities in the actions and steps that they should be taking.
Senator Schumer. Well, that is about all institutions. I am
talking specifically about institutions that are benefiting
from the capital injection.
Mr. Kashkari. Yes, and, again, I think our perspective has
been we want as many institutions as possible to participate
and not wanting to be overly prescriptive in keeping away the
healthy----
Senator Schumer. I know. But as I said, I think you are
leaning too far in giving them dessert and not enough in making
them eat their vegetables. So I hope you will consider that.
For Ms. Bair--you know, as I mentioned in my opening
statement, I have tremendous respect for you. Here is something
that befuddles me. We have for a year been sort of chasing our
tail in terms of relieving the foreclosure problem with all
these kinds of voluntary programs. And they just do not work,
by and large. If the institution has the whole mortgage, they
work. But for the majority of mortgages and the majority of
subprime and all these that are chopped up in 40 pieces, you
have the problem of one of the tranche holders--probably the
riskiest piece--saying, ``I am not going to participate.'' And
we have tried and tried--Secretary Paulson, I salute Senator
Dodd and Chairman Frank for their efforts. But everyone will
agree none of them are really going to work. And yet we still
come back to this exhortation process, and then 3 or 4 months
later, we are disappointed that it has not worked.
Isn't it really true--and help me understand this--that the
only way we are going to make major, major progress in limiting
foreclosures and getting refinancings is changing the
bankruptcy law, which is the only constitutional way to require
that 40th tranche holder to come to the table and say, ``Hey,
under bankruptcy, I will get zero, so I will negotiate for 5
cents on the dollar or 10 cents on the dollar,'' or whatever. I
am befuddled by the fact that that fact, which seemed so
obvious to me, is not governing our actions on this. It seems
almost--you know, I forgot who said, but it is hope over
reality if you do it the other way in any kind of voluntary
way.
Could you please address that for me?
Ms. Bair. Well, I would agree, I think some of the
voluntary efforts have helped, but they have clearly not helped
enough. We are falling badly behind.
Senator Schumer. As you said.
Ms. Bair. And more needs to be done. I would agree with
that. I think there are authorities in EESA that can be used
with a carrot as well as a stick approach to getthis done on a
more broad-scale basis.
We have not taken a position on the Bankruptcy Code change.
I do think, though, that whether that is or is not a good
tool to put into the arsenal, hopefully we would also have a
process that, prior to a borrower having to threaten bankruptcy
or go into bankruptcy, we could get that loan modified.
Senator Schumer. Do you have any hope for--I am sorry. My
time is up. Just a last question. Do you have any hope for a
voluntary model? I do not.
Ms. Bair. No. No, there needs to be a package of carrot and
stick incentives. I agree with that.
Senator Schumer. Thank you, Mr. Chairman.
Chairman Dodd. And let me say to my colleague from New
York, I mentioned this before, but we may end up in a lame-duck
session, and there may be various proposals. I think we have
come to the point once again where I think legislatively we
have to try this again as part of some other ideas. And so I am
putting together a package of ideas that I will ask my
colleagues to take a look at, obviously all of us here in
November, as part of--whether it is a stimulus package or
whatever else, but some steps we might take instead of waiting
until after January to get back to maybe deal with some of
these issues. And that is one of them.
Senator Hagel.
Senator Hagel. Thank you, Mr. Chairman.
Secretary Kashkari, in your statement you noted that
Treasury announced recently a streamlined, systematic process
for all banks wishing to assess the $250 billion infusion
program. And you further noted that qualified and interested
publicly held financial institutions will use a single
application form. You talked a little bit about that. You will
factor in the recommendations of the regulators, and you will
publish the required legal documents so private banks can
participate as well as the same economic terms as the public--
on the same economic terms as public banks. And you talk about
allocating sufficient capital, which you believe $250 billion
is enough, so that all qualifying banks can participate.
My question is, then: What is the criteria that you are
going to use? Because as I understand it, it will get down to a
final judgment, essentially an arbitrary judgment. You are
factoring in qualifications to start with. You are factoring in
input from the regulators. But, in essence, it will be yours or
Paulson's or someone at Treasury's decision who gets the money
and who does not. So here are a couple of the points that I
would hope that you could address for me.
Do all the qualifying banks that apply, will they get into
the program? If they qualify, will they get in? Is bank
consolidation a factor when you start deciding who gets the
money? For example, bank consolidation could be used as a
lever, it could be used as a threat to force consolidation.
Will you take those first two issues and give us what you can
on this? Thank you.
Mr. Kashkari. Yes, Senator, thank you for the question. The
regulators are going to be the first screen for institutions,
so, for example, a bank may send an application to the FDIC as
an example, and the FDIC may review that application and
determine that this bank is not a good candidate for a capital
purchase program and may send that back to the institution, and
Treasury will never see that application.
For the applications that we see with the recommendations
of the regulators, in most cases I would imagine, we are going
to take the guidance of the regulators because they are the
ones who know these institutions very well.
There could be other factors that are also considered. So,
for example, if an institution had a private capital raising at
the same time that they were also seeking public capital, that
would also weigh into our analysis as wedetermine is this a
good use of taxpayer resources.
At the end of the day, this is a program that is meant for
healthy institutions. We want them to lend. And so working very
closely with our colleagues in the regulatory agencies, we
think that that is the right approach.
To the point of consolidation, I do not think we have any
specific program focus on consolidation. Again, I think it will
be a case-by-case analysis with our regulatory colleagues. The
example I gave I think is a good one. If you had a small
failing institution that was being acquired by a much
healthier, stronger institution, the idea of putting
Government/taxpayer dollars into that combined entity, we think
that is a good use of taxpayer dollars because that community
is well served now by that combined stronger institution.
Senator Hagel. Could you envision a scenario, with the
regulator or without the regular, where you would offline in
private conversations--because I suspect there will be some
private conversations on these things. I have been told, as a
matter of fact, that there have been by banks inquiring,
checking in, how do we apply, on what basis are you going to
make these determinations. Could you envision a situation where
you say to a bank if you would be willing to seriously look at
consolidation on whatever terms with whichever institutions,
then we might well look favorably on your participation in the
program?
Mr. Kashkari. I would imagine that those types of
conversations may happen between the regulators and the
entities, but I would defer to my regulatory colleagues more so
than----
Senator Hagel. Chairman Bair, can you help us on this?
Ms. Bair. Well, as Neel alluded to earlier, I think you
need to distinguish between an acquisition that stabilizes a
bank having some challenges versus using the additional capital
to build your empire, as opposed to making loans. The former I
think is something we want to encourage, and I think there may
be some institutions where, on a stand-alone basis, it may not
be a good investment for the Treasury, but on an acquisition
basis, it might be very good. So I think that kind of healthy
acquisition activity is something that should be encouraged.
And, again, to the extent it would prevent failures or the risk
of failure for institutions later on, that can help protect the
deposit insurance fund.
Senator Hagel. When do you think that this program will
actually be in place so that you will start to make some
decisions?
Mr. Kashkari. It is in place now.
Senator Hagel. Aside from the nine big banks.
Mr. Kashkari. On Monday, the regulators posted application
forms on their websites.
Senator Hagel. So the banks, the institutions are now
filling out the application, three pages, is that right?
Mr. Kashkari. It is two or three pages.
Senator Hagel. Filling out applications, working through
their regulators. They are now coming into your office.
Mr. Kashkari. And then the regulators have already begun
submitting recommendations to us today on institutions that we
are going to evaluate and make decisions.
Senator Hagel. Have you made any discussions beyond the
nine big banks?
Mr. Kashkari. I do not believe at this point we have made
any.
Senator Hagel. I have not seen any. Have you made any--when
would you make the next group of decisions?
Mr. Kashkari. We are in the process within Treasury of
formalizing our review process and procedures and finalizing
those and begin processing those applications immediately. But
I will also comment, the announcement that I talked about
within 48 hours is when the contracts are finally signed. An
initial approval to an institution will not trigger the
official announcement. It is only when we get further down the
process and we are actually signing contracts with the
institutions. That is what will triggerthe formal announcement
within 48 hours.
Senator Hagel. When would you think that the first
additional banks beyond the first nine might be announced? A
week? Two weeks?
Mr. Kashkari. Well, announcement, again, forgive me,
announcements of the actual transaction----
Senator Hagel. Well, just get me to where we need to be,
and that is, money on the street. When will they get their
money?
Mr. Kashkari. Our goal is to have the $250 billion out the
door by the end of the year.
Senator Hagel. But give me a better answer than that. You
tell me the process is already underway. You are accepting
applications. When, then, can you tell this Committee that we
will have some money in the hands of this next series of banks?
A week? Two? You will make decisions. Contracts, whatever the
process is. Not your intent, your hope.
Mr. Kashkari. Understood.
Senator Hagel. But where are we?
Mr. Kashkari. My expectation is a few weeks because it will
take time for the banks themselves to do their work, work with
their attorneys, meet with their boards as necessary, before
they are in a position to sign the final contracts with
Treasury. So we are going to give them initial indications very
quickly so they can do all the legal work they need to do on
their end before we can fund these transactions.
Senator Hagel. But you are looking at a few weeks at best
before the final deal is made. Then I assume that that means
the bank gets the money?
Mr. Kashkari. Correct.
Senator Hagel. Over the next few weeks.
Mr. Kashkari. I think it will be a few weeks before the
next batch are actually funded.
Senator Hagel. Thank you.
Chairman Dodd. Thank you for that, Senator. I appreciate
it.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman, and thank you
all for your service, and I hope you all understand the
questions and the line--we all have a common goal here, and
maybe some of us are trying to spur you to look at some things
that either you are looking at but maybe not with the intensity
that many of us think you should, in fact, look at it. And so I
hope you are taking them in that spirit.
Mr. Kashkari, you said in your statement you expect that
all participating banks--expect all participating banks to
continue to strengthen their efforts to help struggling
homeowners avoid preventable foreclosures. We expect that, too,
but that has not happened. And we have servicers who seem to be
incentivized in a different direction. My office has been
dealing with a whole host of people in foreclosure, and the
servicers--you know, we have one case in which one servicer
said, ``Absolutely not, can't do anything to help you,'' and
then we called back and got a different entity within that
servicing entity, and they offered a deal that actually was
something that could save the home. We have other that seem to
be incentivized to go to foreclosure.
So, you know, I have a real problem in saying that we
expect as we are infusing large amounts of capital. What would
be wrong with, for example, Treasury promulgating guidelines on
loan modifications for institutions that are participating in
the capital purchase program, you know, similar to what the
FDIC's existing loan modification program is?
Mr. Kashkari. Well, Senator, we share your concern and your
focus on this issue. I personally have spent the past 14 months
working with servicers and with counselors to try to reach
homeowners and encourage loan modifications, and we have made a
lot of progress. The industry is now at a pace of around
200,000 workouts a month, which is a huge increase from where
they were when we started. But we agree with you, it is not
enough. We need to do more.
So I think that the actions that we have taken and
wecontinue to take working with these companies and with servicers, we
continue--we just need to press them and push them to do everything
that they can.
The hardest part about a loan modification is not the
calculation. A first-year finance student could do the calculus
of which is better. It is getting to the homeowner. It is
getting them to pick up the phone and call. And we have worked
very hard.
For example, if you will indulge me for a moment, if there
is any homeowner out there that is concerned about losing their
home, the worst thing they can do is do nothing. They should
pick up the phone. We have got a hotline, a national hotline,
888-995-HOPE. They should call.
Chairman Dodd. Mr. Secretary, could I interrupt you 1
second? Why can't the lender make that call, too? They know
they have got a customer, a borrower in trouble. They know
that. Why don't they pick up the phone and call that borrower
and try and track them down. Why doesn't it work that way as
well?
Mr. Kashkari. Well, they absolutely are, and we are pushing
them to do that. In fact, over the summer--I believe it was in
June----
Chairman Dodd. Sorry, Bob. I didn't mean to----
Mr. Kashkari [continuing]. We worked with the servicers and
the counselors together in HOPE NOW to create guidelines and
standards for loss mitigation for the industry that said
exactly that, Chairman. They need to be sending letters in
advance of rate resets. They need to be making these phone
calls in advance of borrowers going in delinquency. A lot of
times what you will find is there is a real challenge we have.
The bank is doing their duty to their investors by making calls
saying, ``You are behind in your payments. You are behind in
your payments.'' That is the collection----
Senator Menendez. But what about--Mr. Secretary, I hate to
have all my time eaten up by this, but let me just ask you
this: What about the bank that I told you about? And this is--
we have a lot of people coming to seek help. I tell you, my
office is inundated. We have had five foreclosure clinics that
I have conducted myself in the State of New Jersey. We have got
a lot of people seeking help, so maybe there are some who are
hiding or afraid and in the bunker. But we have got a lot of
people seeking help. And so we have got Reverend Soaries in New
Jersey who does a very good job through a community development
financial institution, and he is trying to help constituencies
to be able to keep their homes. He goes and offers the bank
$160,000 out of $175,000. They say no. He goes to the
foreclosure with a full certified check, and then the bank bids
up. Tell me how that is in keeping with the spirit that we are
trying to work out these mortgages. It is not. And so I do not
quite understand what is wrong with issuing guidelines by
Treasury, particularly for those participating in these
programs, that does similar to the FDIC.
And, second, you know, about hoarding the money, I am
concerned about it. I know that you say that the inability to
buy back shares or to issue dividends is enough an incentive.
But, you know, they are going to pay--what?--5 percent dividend
in the shares that we have purchased from them--I mean that we
have lent to them. So I am not quite sure that that is the
incentive to ultimately not sit on their money as they build
their overall standing. I think you need to have some set of
very clear guidelines. They are not mandatory. But it is the
expectation. You know, I cannot judge an employee if I do not
tell them what the standards are. And I cannot tell the banks
whether or not they have fairly used the collective money of
the people of the United States in achieving the goal that we
all want for them and to create liquidity in the marketplace,
particularly for Main Street, if I do not give them a set of
standards of what I am looking for to accomplish. I do not
quite understand what the reticence of that is.
Mr. Kashkari. Senator, we share your perspective, and we
want these banks to lend, and I do not think we havereticence
to it. I think we will look at this with our regulatory colleagues.
Ultimately, the regulatory----
Senator Menendez. Why not set a standard, then? Why not set
a set of standards by which people could judge by?
Mr. Kashkari. Again, I think a set of standards could be a
very useful tool. We need to be careful not to be too
prescriptive. Again, we are trying to strike the right balance,
not just getting the big banks to participate, but getting the
1,000th bank, the 3,000th bank in our communities to
participate. And setting a one-size-fits-all standard may not
be the right approach, but we need to look at it.
Senator Menendez. All right. One last question. It goes to
both you and Governor Duke. You know, we gave AIG $85 billion
and then--lent it, I should say, not gave it. And then we
further agreed to extend an additional $38 billion in credit.
Now, our Nation's public transit agencies are potentially
liable in payments in the hundreds of millions of dollars to
banks due to the downgrading of AIG through LILO and SILO
leverages leases.
Does the Treasury and the Fed think it appropriate for
these banks to be in a position to make a windfall at the
expense of these public agencies which ultimately would have a
huge consequence--a huge consequence--to the ridership and to
the States that ultimately operate these public agencies?
Without action by the Treasury's banks, you know, to intervene,
they stand to gain all of the benefits the IRS has declared to
be inappropriate and, you know, it seems to me that we have a
very huge and pending challenge here. And I hope that both the
Federal Reserve and the Treasury Department are going to look
at this, or else we are going to see a very huge consequence to
hundreds of public transit agencies across the country, and
that would be devastating at a time in which we are seeking to
move more people into the opportunities that exist today in the
marketplace, that we are trying to do something about our
energy questions, and at a time in which State entities would
ultimately be faced with even greater amounts of moneys that
have to come up front. I think it is wrong, and certainly the
banks that we are lending to here should not take advantage at
the same time that we are propping up AIG.
Mr. Kashkari. Senator, this is an issue that came to my
attention very recently, and my colleagues and I at the
Treasury are going to look at it. I would be happy to get back
to you on it.
Senator Menendez. I appreciate it. If you would get back to
me, I would be very interested.
Mr. Kashkari. Absolutely.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Senator Corker? And let me just say for the record, too, I
want to thank Bob Corker. During those 13 days, there were a
number of people--obviously, everyone was involved, but some
more adamantly and directly than others, and Bob Corker was one
of them. I just say, we would not have gotten to that final
result without your help and support, so I appreciate it
personally and I want to say publicly how much I appreciate
your involvement.
Senator Corker. Thank you, Mr. Chairman. I very much
enjoyed it and want to work with other Members of this
Committee all the way through this process. I know the
implementation is equally important to the legislation, and
then coming back in January to regulate appropriately. We have
a 20th century regulatory system and I think we understand that
and we will be focused on the 21st. I look forward to being
hopefully equally constructive, and I thank you.
I do want to maintain the focus on the fact that certainly
housing prices have shown problems in our financial industry. I
think the exuberance, if you will, that we had in the housing
industry for so many years, you know, most people could
probably see that at some point, this had to fall. I mean, it
was crazy, what was happening,especially in some of the States
like California and others where people were paying three and four
times just over a few years what they were paying before.
We knew there was going to be a decline, and I hope we will
maintain our focus on the fact that, really, this whole issue
around foreclosures today has to do with the way financial
markets work now. It is no longer the case of people going into
their local financial institution and having a loan with their
local banker that they see at the Rotary Club or other places
and maintaining that relationship, and if they get behind, they
have the opportunity to talk with them about that. That just
doesn't exist now, and so that is one of the frustrations, I
know.
The other huge issue, obviously, are these exotic
derivatives and other kinds of things that exist that no one
knew existed, and candidly, we wouldn't be having this hearing
today, I don't think, if it weren't for that. So that is
really, when we are talking about the root of the problem, it
is sort of the chicken and egg, I guess, but I hope that that
is where we will maintain our focus over the next year or so.
Now, having said that, this foreclosure issue, I listened
to Senator Schumer's comments, and candidly, in fairness, I do
think most of what we are doing is hope. I mean, the way the
disconnect exists right now between the borrower and the lender
is so confusing that the average citizen who gets up every day
having to work and raise kids, I mean, it is hope, and I
understand that, and I think at some point we will be looking
at this in a different way than we are right now.
I appreciate so much your efforts, Ms. Bair. In the
conversations we have had, I think you have addressed the FDIC
insurance issues appropriately all the way through. I did hear
you mention stabilizing. I think foreclosure is a problem and I
think we need to figure out a way to deal with that.
Stabilizing, I don't know. That bothers me some. I think,
unfortunately, there is a ways for that to fall now. We still
have not hit bottom and I think anything we do that is
stabilizing in ways that don't make sense really just caused
the market to be sluggish for a long, long time.
And I am wondering if just very briefly you might respond
to that. Maybe you were just talking about foreclosures.
Stabilizing--the word ``stabilizing'' bothers me some because I
think we move into a prolonged time of sort of fictitious
prices that don't allow us to hit bottom as quickly as we
should, and I wonder if you might expand on that.
Ms. Bair. Yes. The markets need to correct. We do need to
find the bottom. And markets will eventually find the bottom.
What I am concerned about is that we are going to overshoot
because we are in this self-reinforcing cycle now where
economic decisions to modify loans are not being made. It may
be in everyone's economic self-interest to modify that loan,
but it is still going into foreclosure because of skewed
economic incentives, in large part stemming from the different
interests in the securitization trust. So loans that
economically should not be going into foreclosure are, which is
creating more downward pressure on home prices, which is
creating more distress in the housing market, which is creating
more need for foreclosures----
Senator Corker. So it is really more on the foreclosure
point----
Ms. Bair. It is absolutely.
Senator Corker. OK.
Ms. Bair. That is exactly right.
Senator Corker. And I think we have had a lot of
discussions. I know even Chairman Dodd alluded to some of the
meetings we had. There are some politically--there have been in
the past some politically unacceptable ways of dealing with
that for both sides to come together, but I think at present,
we all understand even prescriptive things are not going to
solve this until we get to a point where the lender has some
ability to quickly deal with this issue, and I don't want to
expand on that right now. We might do that some more privately.
Ms. Duke, we are going to be dealing with a lot of
unintended consequences. I mean, at the end of the day, any
time there is government intervention, there are unintended
consequences, and I think that is going to be one of the
biggest issues we deal with during implementation and even
beyond.
I know you have already been asked one question about that
from Senator Menendez, but we are having some issues where, let
us face it, manufacturing is a very important part of our
country's employment. We have had stress on manufacturing for
years now. We have actually had a little bit of a breakthrough
over the last 6 or 8 months just because the value of the
dollar is changing some now.
But at the end of the day, you all are doing some good
things and you are taking A1/P1 paper here, I think, beginning
very shortly. You have just set up a facility to do that. What
that means is that manufacturers that have A2/P2 paper are
getting nailed, and all of a sudden, they have got like a 500
basis point problem that they are dealing with. I have talked
to Chairman Bernanke about that.
I wonder if you could just bring us up to date as to what
might be happening, because we have one manufacturer that has
A1/P1 and all of a sudden they are good because you are taking
them. We have A2/P2, and all of a sudden they are at a 500
basis point disadvantage and basically getting ready to lay
people off. And I am sure you have some way of solving that
very soon. I am looking forward to hearing what that is.
Ms. Duke. Senator, I wish I could tell you I had a way to
solve it immediately. The objective behind the commercial paper
programs and the A1/P1 are to get the markets for commercial
paper moving again. The objective is that once they start
moving, then that will move the other parts of the market, as
well. But we are monitoring all parts of the financial markets
and looking for ways to unclog the pipes, if you will, on all
parts of the market. We are aware of A2/P2. We are aware of a
number of different markets where they are having difficulty.
The other thing I would say, unfortunately, for many years,
risk was not priced, and so I think for all borrowers and all
issuers, even when financial flows return to normal, pricing is
going to be higher than it was a couple of years ago, but we
are working----
Senator Corker. For both A1/P1 and A2/P2?
Ms. Duke. For all borrowers. And as I said, we are watching
them. We are operating within our own restrictions in terms of
credit risk that we can take. We are addressing that in terms
of collateral that we take at our discount window borrowings in
every way that we can.
Senator Corker. We think you have the ability to take the
A2/P2. I hope that very soon you will figure out a way to deal
with that appropriately, and I very much understand what you
are saying about the risk and I think it is very good that you
send that signal out now, that at the end of the day, risk
wasn't being priced and borrowing costs probably are going to
have greater spreads in them than they have had in the past.
Just briefly with Mr. Montgomery, I know we are running out
of time and Ms. Bair has a board meeting. Mr. Montgomery, I
think it is really great that we are increasing through FHA the
amount of lending that is occurring. I hope that that is not
occurring because banks are dumping their worst loans on the
FHA and that we are going to have another hearing down the road
dealing with that. I don't know if you would take 15, maybe 10
seconds to respond to that, but I just want to throw that flag
out there and thank you for your actions but hoping that you
are not taking us down the road of other problems down the
road.
Mr. Montgomery. Well, that is one of ten things that wake
us all up in the middle of the night. The reason why FHA didn't
take part in the boom, there are a lot of them. One is we did
not lower our underwriting criteria. We had this crazy notion
that people should verify their income. They should produce tax
returns. They needed to have atleast 2 years with their current
employer. And we have not lowered those standards. And our ratios, our
front-end ratios, our back-end ratios exist for a reason. I think
because of that, I think you will see FHA continue to perform admirably
over here on the long term.
If I could just interject one thing here real quick, sir,
on the servicing, FHA, and I referenced this number before, the
last 3 years, we have saved 300,000 FHA borrowers from
foreclosure, 300,000. That is a number you have not read
anywhere. You don't see that, and it is because our loss
mitigation program, which Congress put into place 10 years ago,
is working, and the main reason it works is because we require
it. Lenders and servicers know this. The borrowers know this.
The investors know this. They are required to do loss
mitigation. If they don't do that, they face treble damages
from FHA and I think that is one of the keys to why this has
been successful. You have not read about those borrowers going
to foreclosure because they have not been.
Senator Corker. Thank you, and if I could just--we have all
traveled a long ways to be here and we thank you for having
this hearing.
Mr. Kashkari, I have to tell you that the concern about
the--first of all, thank you for what you are doing and I
appreciate the conversations that we have had. I do think the
concern about the loans is somewhat unfounded. I mean, at the
end of the day, people are paying 5 percent for this money. I
know it raises at some point to 9 percent. At some point, the
banks have to make a profit. I mean, they can't just hoard
cash. I mean, it is pretty self-evident, is it not, that the
way that money is going to be made is lending that money, and
while there may be an initial hoarding, at some point, this
money has to go out. Otherwise, these enterprises are not
making money. I mean, that is just sort of self-evident.
I wonder if you could just take maybe 10 seconds to address
that issue. It concerns me. Obviously, I supported this measure
and was involved in it. One of the things in the back of my
mind was, once the camel nose goes under the tent and you get a
bunch of Senators and a bunch of House members involved in the
business of banking, all of a sudden, we are telling the banks
what to do, which, let us face it, part of our problem with
Fannie and Freddie, and I don't want to go into that now, we
will deal with it after the election, but was that very thing,
OK. And so I am very concerned about us making prescriptive
arrangements with these banks. I don't think you are going to
get many participants in that regard, but we are going to
destroy our banking system if we do that.
I appreciate the balance you are trying to create, but is
it not self-evident that with paying for these through
dividends--it is basically a loan, let us face it, that they
can show as equity--they have got to make loans to make money
and be in business. Is that a yes or no answer?
Mr. Kashkari. Yes. I think the economic incentives are
strong and clear.
Senator Corker. OK. So I understand it is nice to raise
these concerns. Let me just, speaking of sort of the camel nose
under the tent, and none of us know what is going to happen
into the future. We don't know who the next Treasury Secretary
is. Hopefully, it will be someone who understands what
derivatives are and mortgage-backed securities and all of that.
But the allocation process today as you see it going
forward, you are talking about $250 billion for senior
preferred. Do you have any sense now--I know we talked 10 days
or so, maybe a week or so ago about this--do you have any
greater sense of the allocation of this $700 billion today? And
the second part of the question, since I am way over time, how
much of it do you think may be actually spent by January 20 or
so?
Mr. Kashkari. Senator, obviously, we have already allocated
$250 billion. We have sent a notification to Congress for
another $100 billion to take us to $350 billion. The allocation
has not been determined betweenmore equity or mortgage-backed
securities or whole loans at this point. We are trying to design the
tools and we will use them and adjust them as we go forward. And there
has been no determination made on when any notification would be sent
to Congress on the final $350 billion. We would work with the committee
at the appropriate time to look at that.
Chairman Dodd. Thank you, Senator.
Senator Corker. Thank you. I think if I were in your case,
I would probably be vague on that, too. I would, offline, like
to get a better sense of what you think that may actually be. I
will not repeat it publicly if you tell me that.
Mr. Chairman, thank you for this hearing and thank you for
letting me play a role in the shaping of this.
Chairman Dodd. Not at all, and let me just say to my
colleague from Tennessee, we raise these issues about--the word
``hoarding'' was used by the Secretary of the Treasury. That
wasn't my word, it was his word, and I didn't raise it to be
nice. There have been articles about it. And I don't disagree
with the acquisition notion. I don't want to prohibit that. But
there is a concern, not to just sit on it--obviously, that is
not going to happen--but how those dollars are being used.
There are a number of ways you can use the dollars, and
obviously lending is critical and that is what we are looking
for here. But that is not the exclusive use of the money. We
want to make sure we channel that to the extent we can
encourage that is part of the goal in mind.
Let me turn to Senator Casey.
Senator Casey. Mr. Chairman, thank you for calling this
hearing in the midst of both an election and a financial crisis
for the country. I want to thank our witnesses for your
testimony and your work, your public service.
There are a lot of ways to describe the challenge we have
with regard to foreclosures. The numbers keep coming in. We saw
today in one story that foreclosure filings for the third
quarter are up 71 percent. In Pennsylvania, the third quarter
foreclosure filings were up 73 percent from the 2007 third
quarter to 2008. Maybe the most difficult number for
Pennsylvanians to look at with regard to this is Pennsylvania
filings rose 18 percent from second quarter to third quarter of
this year, whereas the national number was a lot lower than
that, 3.5 percent.
I was struck by a number of parts of the testimony.
Chairman Bair, this probably describes this better than
numbers, your statements about the impact of foreclosures, and
these are descriptions that others have used and said in
different ways, but I thought it was important to highlight
them, and I am quoting from page eight. ``Foreclosure is often
a very lengthy, costly, and destructive process that puts
downward pressure on the price of nearby homes.'' Later on page
eight, you say, ``Foreclosures may result in vacant homes that
may invite crime and create an appearance of market distress,
diminishing the market value of other nearby properties.'' Well
said.
I guess in light of that problem that we have, which is a
foundational problem for why we are all here, I wanted to ask
Assistant Secretary Kashkari about Section 109 that our
Chairman pointed to earlier. Section 109(a) of the Emergency
Economic Stabilization Act has a ``shall'' and a ``may.'' The
shall part says the Secretary shall implement a plan that seeks
to maximize assistance for homeowners and use the authority to
encourage the servicers of the underlying mortgages to take
advantage of Hope for Homeowners, the program we have to modify
mortgages. Section 109(a) also says the Secretary may use loan
guarantees and credit enhancements to facilitate modifications.
I am struck by the contrast between especially the
mandatory language, the ``shall implement a plan'' language of
109, versus your testimony where--and I am being critical here,
but I don't want to be casual about this--your testimony is
about four-and-a-half pages. You cover what you have a
responsibility to implement, principally theTroubled Asset
Relief Program, and I realize that is a difficult challenge for anyone
and any group of people.
But the homeowner preservation section is one small
paragraph. You talk about maximizing opportunities to help as
many homeowners as possible. You talk about appointing an
interim Chief of Home Ownership Preservation. That is good. We
appreciate that you did that. And looking for other
opportunities to help homeowners. I am summarizing a brief
paragraph.
But I am struck by the contrast between that seeming, at
least in the testimony, the verbiage of the testimony, the
seeming deemphasis or lack of detail on home ownership
preservation versus the mandatory language of 109. I want to
just get your reaction to my assessment of that.
Mr. Kashkari. Thank you, Senator. As I have said
previously, we are very, very focused on this issue of avoiding
preventable foreclosures. The testimony was written in a manner
to give an update to the Congress, to this committee, and to
the people on our progress, and different paths identified
seven work streams, have made further progress, and others,
there is a lot of work being done but we haven't made major
announcements yet. So most of the testimony is focused on the
capital program because we have already announced that program
and are executing it.
We have a team of people working interagency on the home
ownership preservation piece led by Donna Gambrell, and when
their work product is complete, we are going to come out in
just as much detail as we did on the capital program.
Senator Casey. Let me ask you this, a couple of very
specific questions. The statute says that you shall implement a
plan. Tell me when you think that plan will be completed and
what progress you are making toward that, when the plan will be
completed and when will it be implemented.
Mr. Kashkari. The plan is under development now with Donna
and our team working with HUD, with the FDIC and others to look
at these different alternatives. The first implementation of
that plan is going to be put into place when we have bought
mortgages and mortgage-backed securities as instructions that
we are going to be sending to the servicers. So that is going
to be the vehicle for implementing that plan.
Senator Casey. And when would that be?
Mr. Kashkari. As soon--we are running--working around the
clock to get these programs up and running. I think it is
weeks, it is not days, but it is also not several months. So we
are working very hard to get that up and running.
Senator Casey. So you are talking about weeks in terms of
implementing the plan contemplated by Section 109(a)?
Mr. Kashkari. I think it is weeks in terms of when we are
going to have mortgages and mortgage-backed securities, and
then we will be submitting detailed instructions to the
servicers of those loans on the aggressive loss mitigation
techniques we want them to take.
Senator Casey. I want to get back to you in a second. I
also want to ask Chairman Bair, with regard to the ``may''
section, may use loan guarantees, I am assuming that the
language that is in 109--on page 11 of your testimony, you
speak to, in the last paragraph under the foreclosure section,
loan guarantees could be used as an incentive for servicers to
modify loans. The government could establish standards for loan
modifications. You go on from there.
I am assuming you are saying, A, that there is authority
under Section 109(a) to do this, and B, that you would
recommend it, is that right?
Ms. Bair. Yes, our lawyers think there is authority to do
it, and yes, we definitely think it is a policy option. We are
in discussions with Treasury. There is a policy process
underway. But yes, we think there are a number of advantages in
combination with other tools, especially for loans that are in
securitization trusts, to use a guarantee as leverage to get
the loans modified. It is also advantageous to implement
systemwide protocols to streamline this process and get it
going on a much broader scale.
Senator Casey. And I think people around the countryare
happy that you are discussing this. Tell me--either of you can answer,
or both--tell me, what is the time line for the completion at least of
discussions which may lead to the implementation of a loan guarantee
strategy?
Ms. Bair. Well, I understand--quickly. I think there are
meetings and discussions actively going on right now and----
Senator Casey. When you say ``quickly,'' do you mean weeks?
Ms. Bair. The Treasury Department is the implementor of the
TARP program, so we are sharing ideas with them about this
particular aspect. It is an Administration process and we want
to be respectful of that, but I really think that Neel and
Secretary Paulson are very committed to this and moving in a
very timely way.
Senator Casey. Mr. Assistant Secretary, is that an accurate
characterization of the Treasury Department's position at this
point, that you are in agreement with what Chairman Bair has
proposed on page 11 of her testimony with regard to loan
guarantees?
Mr. Kashkari. We are looking at it very closely and working
with our colleagues around the administration to understand the
plan, understand how it would be implemented, what effect we
think it would have, and how it would interact with the other
programs. And so it is something we are very seriously
considering.
Senator Casey. When will we know the results of your
serious consideration?
Mr. Kashkari. It is hard to give a specific date, Senator.
We are working on it, as the Chairman said, Chairman Bair said,
in real time right now, and as soon as decisions are made and
we are in a position to make any announcements, we will do so.
Senator Casey. So are we talking weeks in terms of this
determination you have to make?
Mr. Kashkari. Again, Senator, I am not trying to be
evasive. It is hard to predict the policy process. I don't know
if it is days or if it is weeks. It is something we are very
focused on right now.
Senator Casey. Well, I would urge you and I would urge the
administration to move with dispatch, because one thing, as
Senator Dodd has said and others, is that there is a sense of a
lack of urgency. I realize this stuff takes--this work, I
should say, takes a lot of close examination and it is not easy
to develop new programs. But when you juxtapose the foreclosure
filing reality, the impact that is having on neighborhoods, the
jobless rate numbers, which keep spiking up--we are headed to
maybe a million job losses this year. In Pennsylvania, we have
got 67 counties, almost half of them have unemployment rates
above 6 percent. About 15 of them have unemployment rates above
seven as of the last monthly county-by-county number.
And then you also have a lot of taxpayers looking to
Washington and they don't--and I am just saying this as an
opinion of mine, but I think it is shared by a number of
people--they don't have a lot of confidence in the current
President to be able to deal with this. We have two candidates
for President, neither of which has the authority to deal with
this. They look to the Congress and they are not sure they can
identify one person there.
So what Treasury does and what every institution
represented at this table does is critically important in any
context, but especially in the context of the juxtaposition of
big problems in people's lives and a vacuum or a lack of
leadership that is focused on a singular person or a single
institution. So your actions and your decisions and your sense
of urgency is critically important to inspiring--I know you
have got to worry about market confidence, but I think also
taxpayer confidence has worn pretty thin.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator Casey.
Let me underscore the point that Senator Casey has made,
and Bob, I think maybe before you walked in, this wasthe very
first issue I raised, as well, in a conversation between Sheila Bair
and Neel Kashkari, and I talked to the Secretary of the Treasury this
morning about this, as well. And again, we don't need to go back and
forth on asking you specific questions and trying to get it, but I
think you leave here--I hope you leave here--I left the conversation
this morning, as I heard, without getting into the details of it, that
the Secretary of the Treasury is determined to get this program up and
running. Now, that is what I was left with. Again, I know there are
things to work out, but I want you to go back, Mr. Assistant Secretary,
and convey the reactions here about our determination to get this up.
It is very important.
And I didn't raise this earlier, but when you ran down your
list of priorities, one through ten or 11 or whatever it was,
No. 5 was foreclosure mitigation. I wrote it down here on my
notepad. None of us want to sit here and go back and flyspeck,
and this may seem trivial, but to people out there with that
10,000 a day losing their homes, it is not trivial at all. And
the idea that that is No. 5 on our list--I understand you have
got a lot of things to do. It would help a lot to have a
heightened sense of urgency about this issue, and there is a
plan. We wrote it into the law specifically.
We worked hard to write 109 into the law. That was not just
throw-away language. It was very specifically written. And I
know where 102 comes from and I know what that was intended to
do. I was involved in every dotted ``I'' and crossed ``t'' in
that bill, as you know, and as Sheila Bair knows. And so when
people come back to me and say, well, 102 impacts on 109, no,
it doesn't. I know the history of that. That is a ruse to delay
the import of Section 102, in my view.
So I would really hope that having heard this, you will go
forward.
I have one question before we let both of you go, and then
I have got a couple of questions for our remaining panelists.
It was raised by Senator Corker--I will give you a chance to
respond to my last point, Secretary, if you want to, as well--
and that is this idea, the auction process and the taking
equity position, and again, I am not going to ask you to give
me an exact percentage, but I was sort of left with the
impression as of the beginning of last week when there was a
shift and it was the source of the major headlines in the
country that we were moving toward the capital infusion idea
and moving further away from the auction idea, not abandoning
it at all.
And, in fact, I know in my conversations with the Treasury
Department, I think there was a deep appreciation that when we
wrote the legislation, the EESA legislation, we wrote a lot of
flexibility and broad authority. The original proposal which
you sent up to us that Saturday on the 19th of September only
allowed the auction process, the authority for that. And we
responded by saying, that is not the only idea. There are
others. We have other ideas. We ought to give you broader
authority. That is where that language came from.
I was left with the impression that there has been a major
shift at least away from the auction process toward the equity
side of this. Am I wrong in reading that, without apportioning
a percentage to how the 350 gets used?
Mr. Kashkari. Mr. Chairman, we, first of all, agreed with
you and worked very hard with you to design that flexibility,
and I think that as the Secretary has said, we moved toward the
capital program first because markets deteriorated much more
quickly than we had expected, and putting in capital was a
faster way--buying equity was a faster way to put capital in
the system.
Nonetheless, we think that there are multiple complementary
tools to get at this fundamental capital problem and purchasing
assets, whether it be through an auction mechanism or it is
buying whole loans, is another important complementary tool,
especially to attract private capital to come in and help
capitalize our system.
So, again, as you said, we are not going to putpercentages
on each, but we are pushing very hard on all fronts so that we have all
the tools available as we need and deem appropriate.
Chairman Dodd. I think the reason was raised--and, again,
you have spent your adulthood working on these issues. But the
old idea, in the auction process you are getting a dollar one
for in, you buy an asset for one dollar, you get a dollar value
out of it--or hopefully you do; whereas in the equity side you
put that dollar in, you may leverage $10 or $100 off that. And
so it seems like a more attractive idea if the goal is here to
excite the capital markets to begin moving. And as between the
two--and I understand the value of having the option of dealing
with the auction process. But in terms of the overall goal to
provide that kind of--that shock, the electro-shock to the
system, to get that circulatory process working, the auction--
excuse me, the equity position seems to be more designed to do
that than the auction process.
Mr. Kashkari. Well, there is no question, Senator. A dollar
of equity goes a lot further than a dollar of asset purchases.
Chairman Dodd. Right.
Mr. Kashkari. That is why we started there. But we think
that they all have a complementary role to play.
Chairman Dodd. Yes, I agree with that as well. You both
have been very, very--the last one I wanted to make to you on
this, and it goes back to the question of Senator Menendez. I
just want to read you something. This is from a lawyer in
Staten Island. I should probably have let Senator Schumer read
this because it is from his constituent. But we worked with
this family regarding the mitigation problems, and this is just
a quote. He said, ``One of the biggest hurdles''--this is a
lawyer representing some people on foreclosure. ``One of the
biggest hurdles we encounter is the lenders'' inability to
respond to our requests in a timely manner. The other problem
is the lenders assign new negotiators and loan mitigation
specialists several times over the course of the negotiations,
thereby starting the review process all over again. Our office
has a staff working on these files 7 days a week, and it may
still take us months to get any sort of response from lenders.
It is virtually impossible for homeowners to deal with these
negotiations on their own. The lenders are creating such a time
constraint that by the time they issue the approval, the buyer
has walked away from the deal. The system is designed to
fail.''
Now, again, this is one we worked on, and they spend their
law firm doing this. Again, I just want you to take that kind
of back with you, because I presume it is not an isolated case
of what is going on, the practicalities of this. And that is
why I think it is so important that that lender--you mentioned
earlier--I did not mean to jump in a sense, but obviously the
borrower should step up. I agree with you. But also that lender
needs to understand that that borrower in that situation of a
highly distressed mortgage probably has 20 other problems going
on. They may be in the process of losing their job. They have
got all sorts of other things occurring. It is not sort of a
stovepipe; I have got just a foreclosure problem. I will almost
guarantee you that family has a lot of other issues they are
grappling with.
And so the idea that they are going to kind of pick up that
phone casually as if somehow it is as if they need a new set of
tires on their care I think is different. And I think the
borrower--or the lender, rather, has to understand that. If we
are really going to get at this, it seems to me there has to be
a deeper appreciation of what is going on with that family that
is about to lose their home. So I would hope you would just
take that back and work on that.
Let me ask, Tim, do you have any questions for either
Sheila or--or, Bob, do you have any quick questions for either
one before the----
Senator Johnson. For the entire panel, do you think our
economy needs another economic stimulus? Yes or no. Sheila.
Ms. Bair. Well, that is a little bit outside my bailiwick.
I think I will defer on that. It is really not a type of issue
that the FDIC really weighs in. I think you probably have much
greater expertise than I in making----
Senator Johnson. The President and the Fed Chairman have,
as you know, said yes to the concept. Neel.
Mr. Kashkari. Respectfully, Senator, I also am not an
expert on that. I am spending 100 percent of my time on
implementing the TARP, so I would defer to some of my
colleagues.
Senator Johnson. Brian.
Mr. Montgomery. I assume we are going down the line here. A
little out of my world. I can assure you we have our own
economic stimulus that we are doing through FHA. You heard some
of the numbers I referenced earlier.
Thank you, sir.
Mr. Lockhart. What we need to me from the mortgage markets
in particular is to get the capital markets working again, and
that is the bank liquidity being put in. We need to be able to
bring down mortgage rates. We need to be able to borrow longer
term for some of these financial institutions. The key thing to
me is to stimulate the financial institutions so they can start
lending again.
Ms. Duke. And given that it is my turn to defer, I will
defer to the Chairman of the Federal Reserve, who on Monday did
express support.
Senator Johnson. Mr. Lockhart, what guidance have you given
Fannie Mae and Freddie Mac regarding loan restructuring? And
what efforts are being made by Freddie and Fannie to
restructure loans?
Mr. Lockhart. We have been extensively talking with----
Chairman Dodd. Could I just interrupt just for 1 second? I
promised Sheila Bair I would get her out an hour ago, and it is
an hour, and I apologize to you. Also, Neel, we have held you
up now. It is 2\1/2\ hours, and we are grateful for your being
here. Let me underscore the points that were made by Bob
Menendez. Our questions are not--if there seems to be an edge
on them, it is only because that is what our constituents and
the country are feeling. And so it is not pointed at anyone
except a sense of urgency that people are feeling about all of
this. But we are very grateful to all of you for the work you
are doing and grateful to have you here this morning.
Do you mind, Tim, if they----
Senator Johnson. Yes.
Chairman Dodd. I promised them they could go. So thank you
both very much.
Mr. Kashkari. Thank you, Chairman.
Chairman Dodd. Go ahead, Tim. I am sorry.
Senator Johnson. Mr. Lockhart, that was the last question I
had.
Mr. Lockhart. Do you want me to continue answering the
question, Mr. Chairman?
Fannie and Freddie have loan servicers working on their
loans. They hold over $30 million loans in this country, so
they have probably have the majority of the loans in this
country. The good news is that their book of business is
significantly better than the average book of business. Their
delinquencies are less. But just because of the amount of loans
that they have, there is a tremendous amount of activity going
on in loan modifications and foreclosure prevention.
We are continuing to work with them. Fannie Mae just
announced a program earlier this week called ``Second Look,''
where the idea is to contact the people that are about ready to
be foreclosed and give them one more chance to work it out.
A key thing here is really to get to the people, and it may
be more than a phone call. You may have to actually go to the
door of the house to find these people. It really is critical
to contact the people and work with them. They are going to
continue to do that, and they will be cranking that effort up
significantly.
Senator Johnson. Thank you.
Chairman Dodd. Thank you very much.
Let me ask just a couple of quick questions. Mr.
Montgomery, I want to compliment you again as well. Keeping
those underwriting standards may have been a painful process.
Everyone was probably saying, ``Why aren't we doing more to get
more of this business?'' But we are all very grateful you stuck
to the principles on that. And you are rightly proud as well to
have been able to launch the Hope for Homeowners plan in such a
short time. That is really rather amazing going from July to
October 1, and I want to commend you for it. And I hope it is
just more than hope as well, but we have plan here that could
really make a difference with some people.
In the end, of course, the goal is to help homeowners.
Please just update us on what you are doing to maximize the use
of this program. What steps have you taken to sign up lenders?
What steps have you taken to ensure borrowers know about the
program? And what impediments do you see in the use of this
program?
And let me just add anecdotally, again, going back to
people we are hearing from, when they make that call, the first
advice is ``Call your lender.'' Now, I appreciate that, but too
often what happens then is you get into that calling your
lender and you end up along the lines that lawyer in Staten
Island talked about, representing a number of people facing
foreclosure. So would you please respond to those?
Mr. Montgomery. Absolutely. We are proceeding on a hundred
different fronts as far as outreach, between our call center,
between direct mail, homebuyer events across the country,
working with our lenders. You know, certainly I suppose we
could always use more funds for it, but luckily the H4H program
did give us some funds to do education and outreach, and I can
assure you we are using those funds.
As to the impediments, we hosted a roundtable on Monday
with lenders, and they told us some of the impediments they are
hearing about. I would say probably the one at the top would be
the cost of it. The 3-percent up-front premium, the 1.5-percent
annual premium, just to put that 1.5-percent annual premium in
perspective, on a $180,000 loan that is about $225 a month. And
by the time--the other concern they had is explaining the
shared equity and explaining the shared appreciation. This is
something a lot of them do not have experience in doing. They
are concerned with consumers, and this is to my earlier point
about the training. They take it very seriously. They want to
get the training correct. But imagine sitting down with a
consumer and trying to explain the shared equity, that they
would owe 50 percent of that, and also explaining the shared
appreciation that in year 7 and year 20 and year 25, you will
still owe Uncle Sam at least 50 percent of the appreciation on
that loan.
That is not to say it cannot be workable. That is not to
say that we do not want to continue to work with you on some
fixes, because we do. But I am just letting you know from their
perspective, this is what lenders are telling us.
Chairman Dodd. I appreciate that, and that is not easy and
so we thank you. We want you to keep us--we will be working
with you as well, and if you have these kinds of concerns, we
ought to stay in close touch, the Committee staff and others,
with you.
Let me, if I can, Ms. Duke, let me ask you, we talked about
all the other Federal entities that own a significant number of
mortgages that are receiving resources and backing. In the
financial rescue legislation that Congress passed, we require
each of your agencies to actually work to modify mortgages
here. Governor Duke, the Fed owns a significant number of these
mortgages, many of which are subprime and delinquent as a
result of the $30 billion of the assets that the Fed acquired
from Bear Stearns back in March. And yet I notice that you do
not mention those mortgages in your testimony.
What specific steps has the Fed undertaken to conduct
mortgage workouts of those loans that the Fed acquired as a
result of the Bear Stearns issue? And how many of the loan
modifications or workouts have been done?
Ms. Duke. Mr. Chairman, I am going to have to confess I do
not know about the assets that are in that $30 billion
portfolio. It is my understanding that they are pledged as
collateral and that they would be actually mortgage-backed
security assets. If I could respond to you in writing?
Chairman Dodd. I appreciate that, but I was a little
disappointed that we did not get something on that. This is,
again, one of these--that was the first step back in March, and
that $30 billion is out there. And, again, a lot of it is hope,
and in the long term, there will be a payback on that. But in
the meantime, it seems to me these loan modifications are
critically important as well.
Last, I want to ask you about the oversight of AIG. Senator
Martinez of this Committee and Senator Feinstein were the
authors of a provision in the legislation dealing with the
licensing of brokers as part of the bill. Last week, the Wall
Street Journal reported, and I quote, ``Even after receiving an
emergency loan that gave the Government an 80-percent ownership
stake, AIG is spending money to lobby States to soften new
controls on the mortgage industry. AIG is currently working to
ease some provisions in the new Federal law establishing strict
oversight of mortgage originators.''
Now, I presume they are referring to the provision here
dealing with the licensing requirements in the bill that was
passed in July, the Housing and Economic Recovery Act, signed
into law in late July.
So the question I have for you is this: Has the Federal
Reserve taken any action to suspend AIG's lobbying activities
and other activities of the company, such as the spa trip,
which was detailed in the press? And I want to ask the other
panelists as well, what has been done to ensure that entities
receiving Federal assistance and are continuing to lobby
against--and I should have asked this, of course, of Mr.
Kashkari, but I will ask him in writing--against the important
protections for borrowers? And did we put any lobbying
restrictions in all of these activities?
This is the kind of thing that just sends the American
public through the ceiling, the idea that they are using their
tax money all of a sudden to turn around and undermine a
provision in the law specifically designed to try and plug up a
gaping hole that allowed an awful lot of these bad lending
practices to go forward. And the idea that any part of taxpayer
money is being used to undermine the very provisions which did
not exist that contributed significantly to this problem is, to
put it mildly, infuriating.
Ms. Duke. I absolutely understand that concern, and we have
had conversations with management of AIG. We do not manage AIG
day to day. We have had those conversations, and I believe
yesterday or the day before, management of AIG has come out
with a series of steps that they have taken to curb that sort
of spending, to set up a special governance committee, and to
limit their lobbying activities to monitoring of legislation
rather than active----
Chairman Dodd. Well, I appreciate what AIG--but what is the
Fed doing? I need to know what you are doing. Are we insisting
upon this? We do not have to have the stories come out, but it
seems to me that rather than reading about this, why isn't
there some demand occuring even before that happens?
Ms. Duke. I understand that frustration. The loan to AIG
came up very quickly. It is not something that we were
accustomed to doing. We have had people inside AIG primarily
monitoring the financial flows and the valuation of assets. In
the last couple of weeks, we have actually stepped up our
conversations with management, which is new management, as you
know, and they are very much concerned about this as well, and
take----
Chairman Dodd. Well, staff reminds me that the second loan
was made after the spa story. It would seem to me that that
story might have been enough to provoke the Fed to take some
action, that second tranche was at least going to be
conditioned better than it was. Well, I wish you would carry
this back.
Ms. Duke. I will. I will
Chairman Dodd. Because this is really important, again.
Ms. Duke. Yes, sir.
Chairman Dodd. We are trying to build public confidence in
the direction we are trying to head, and it doesn't help--let
me put it to you very bluntly here. The confidence of the
American public that we are on the right track with all of us
this is going to be critical. And if they hear their money is
being used for these kinds of things, we lose that confidence,
and that makes this all the more difficult to move forward on.
Well, again, I thank you for--the GSE loan modifications
you sort of addressed with Senator Johnson's question, Mr.
Lockhart. Did you want to add anything to that at all? What
steps has FHFA taken to require enterprises to do these loan
modifications?
Mr. Lockhart. It has been an ongoing activity. We are now
putting out a quarterly report, which will move to a monthly
report. This will put a lot of transparency around that.
Everybody will be able to tell what is going on in their
modifications.
Up to now, it has not been as rigorous as we would have
hoped. Now that they are in conservatorship, these activities
will increase significantly. As I said in my testimony, they
are working with the FDIC IndyMac program so that they are
looking at that technique. They are actually running an
experiment where they are doing some on their program and some
on the FDIC program to see which are more successful.
They have a whole series of different loan modification
activities going on. It is critical to prevent those
foreclosures. The new CEOs have made it a very high priority.
As I said, Fannie Mae has this new Second Look program that
before they move to foreclosure, they are opening up those
files again, trying to contact the people in the houses, and
seeing if there is anything they can do to prevent
foreclosures.
We will be working very closely with them. We are a Federal
property manager under the legislation. We are going to be
appointing people within the organization to have that specific
duty to work in the conservatorship.
Chairman Dodd. I should have asked the others this
question, too, but I will ask it of you and submit it in
writing to the others. Are you lacking any authority that you
would otherwise need from us here? Are there existing statutory
or regulatory provisions you have that would make it possible
for you to demand more accountability in this area?
Mr. Lockhart. In that we are the conservator now over
Fannie and Freddie, we have the authority, yes, sir.
Chairman Dodd. Well, we are going to have you back up here
in a few weeks. This is not the last time we are going to see
each other on these matters. So when you come back up again, at
least as one Member of the Committee, I want to hear more about
what we are expecting and more of what is happening.
Mr. Lockhart. I will be more than happy to.
Chairman Dodd. I appreciate that.
Senator Corker.
Senator Corker. Mr. Chairman, thank you. I appreciate the
opportunity to ask a few additional questions.
Ms. Duke, on the AIG issue, I know there has been a lot of
consternation about the fact that AIG is paying--look, by the
way, I agree with all the concerns that have been raised about
their behavior and think it is reprehensible based on where
they are. But then on the flip side of that, as far as moving
them away from Government, I know there has been a lot of
speculation about actually this is a pretty usurious
arrangement in some ways and that they might be better off, if
you will, either in bankruptcy or seeking other ways out of
this.
Any sense of where we are? They are a public company. You
are a public entity. I am sure you can talk about those pretty
freely with us. Where are we as it relates to anexit strategy
and moving them away from where they are today?
Ms. Duke. AIG has a plan and had from the very beginning a
plan to sell assets to repay the loans from the Federal
Reserve----
Senator Corker. And let me just ask you, I mean, I
understand about selling assets so, in essence, you end up with
sort of nothing left. There is a growing concern there. I would
love any editorial comments as to whether that is even the best
result or whether seeking equity in other ways at this point,
now that people can ascertain what the real risk is and have
had time to do that, I would love editorial comments as to
whether their plan is even the right plan.
Ms. Duke. Let me try to answer your question without
getting into any non-public information about the company. We
have been working with them ever since the loan was made. First
of all, the reason the loan was made originally was a concern
about systemic risk and risk to the financial markets. And we
did not at that time fully know or understand exactly where all
of those risks might be and what the magnitude of them might
be. And so we are spending a lot of time trying to understand
exactly what the risk is. If we are going to hold up the tent,
if you will, we want to find out exactly what the risk is that
we are protecting against. And then what steps it will take to
get us to the other side. How quickly are those risks
unwinding? And also what steps will it take to bring this to a
conclusion to have AIG take the steps that it needs to take to
repay the----
Senator Corker. And is the best step for them to sell off
all the parts? Or is the best step for them, now that people
have a better sense of what the real risk is, a different type
of equity injection?
Ms. Duke. I think our best effort is to make sure that the
overall outcome to the public is the best outcome to the
financial markets generally, not necessarily for the single
institution.
Senator Corker. And I understand that, and that is why we
are all up here. So I guess what you are saying is your are
semi-agnostic in that regard, and if selling assets pays the
$85 billion back plus the additional injection you just made,
or the other, either way, that we get away from the immediate
taxpayer risk, but then on top of that, maybe even more
importantly, or equally important--I should not say ``more''--
is the system risk.
Ms. Duke. The systemic risk is the key to it, and while we
are certainly mindful of having our loan repaid, it is not just
a pure credit decision. This is also one of trying to monitor
the----
Senator Corker. And since you can't give publicly some of
the discussions that you are having, is there a sense that
there is something working right now that will move them away
from your institution and into a different scenario that does
alleviate that systemic risk?
Ms. Duke. The sense is that there are an awful lot of
people working toward that end, and the company is so large and
there are so many subsidiary companies, and the markets in
which they operate are so complex that I think it is going to
take quite a bit of working through to that conclusion.
Senator Corker. Thank you.
Mr. Lockhart, I just could not resist with you being here.
How much time is left in your term?
Mr. Lockhart. The law passed in July made me the Director
of FHFA until another Director was nominated and approved by
the Senate.
Senator Corker. It could be long, could be short.
Mr. Lockhart. It could be long, could be short.
Senator Corker. It is my goal that--or it is my hope that
you will work yourself out of a job pretty quickly. I know the
biggest part of your portfolio is Fannie and Freddie; the
others sort of lesser, if you will.
Is there any need for--I have a strong prejudice in this
regard, but is there any need for Federal involvement in Fannie
and Freddie? My sense is absolutely not. I knowwe have had some
conversations in our office about that, and I am just wondering what
your answer to that might be. And if not, if the markets can deal--I
mean, housing finance is not particularly complex. It really is not.
Any sense as to how soon we might be out of the business, if you will,
of having these Government-sponsored entities and you maybe being on
the beach someplace?
Mr. Lockhart. That would be nice. Certainly, there needs to
be Federal involvement from the standpoint of there needs to be
supervision.
Senator Corker. No doubt supervision. I am glad you finally
have the ability to supervise and have powers to do that.
Mr. Lockhart. Right, and we obviously did not, before the
law was passed, have strong enough powers. Going forward, it is
going to be up to Congress to make a decision about what the
future of these companies should be.
Senator Corker. Of course, but is there any need for that--
I know Congress likes to play in these things, and that is what
has created the problem.
Mr. Lockhart. There is a need for a secondary mortgage
market player in this country. There is a very significant
need. Hopefully, it could be provided by the private sector.
The private label security market failed in doing that, in
fact. I am hopeful it will be re-created over time.
Senator Corker. And also the GSEs failed in that, too,
right? So both the public and private sector failed, if you
will----
Mr. Lockhart. The GSEs continued to provide liquidity in
the secondary mortgage market.
Senator Corker. Because of us.
Mr. Lockhart. They failed because they had an inadequate
capital structure and an inadequate regulatory structure. The
law that set up our old agency was not strong enough. Their
structure, no doubt, Senator, needs to be rethought going
forward. Whether it should be a GSE structure or a purely
private sector structure, I believe is a very important issue
that should be addressed.
Senator Corker. Senator Dodd, Mr. Chairman, if you need to
go to lunch or something, we need to close this out. Please let
me know. Or I will chair the meeting for a while if you wish.
[Laughter.]
Senator Corker. I would never do that.
Chairman Dodd. We are in a pro forma session. You may
decide to do something here. I have got to keep an eye on you.
Senator Corker. Is there any need for the Federal
Government whatsoever to be involved in the secondary market?
It is a simple, easy--I mean, it makes our exotic derivatives
look like, you know, elementary stuff. Is there any reason
whatsoever for the Federal Government to be involved in the
secondary market?
Mr. Lockhart. First, they are through FHA. My colleague to
my right----
Senator Corker. Through the GSEs. Through the GSEs. Is
there any reason whatsoever for the Federal Government to be
involved in--other than we like to be, some of us like to be.
Mr. Lockhart. The mortgage structure in this country is
built around a 30-year mortgage. There needs to be some
mechanism to bring a 30-year mortgage to the marketplace. That
can again be through a GSE structure. It could be through a
private sector structure. The secondary mortgage market is
extremely important to get these mortgages off balance sheets
of the banks so that they can relend money going forward and
liquify themselves. There needs to be a mechanism to bring them
off the banks' balance sheets and spread them out to investors
around the world. Again, that can be done through a private
sector mechanism or a government mechanism.
Senator Corker. From what you are saying in your
supervisory role, almost as a bystanding for some timebecause
you did not really have the authority you needed; now you have it.
And----
Mr. Lockhart. We took some authority we did not have,
actually, and we kept their capital requirements much higher
than the law said. We kept their portfolios shrunk.
Senator Corker. Since, in fact, there are ways for the
private sector to deal with 30-year mortgages, and since, in
fact, there is a way for there to be a secondary market totally
through the private sector, is there any real sense that the
borrower has benefited really that much from the slightly lower
rate, if you will, the GSEs get because of this implied
backing--and as it has turned out, real backing--that the
Federal Government has given? Has there been really enough of a
benefit there for us to be mucking it all up by being involved
in the way we are?
Mr. Lockhart. There have been studies and there is back and
forth in those studies, as most academic studies are. There is
debate. I really haven't seen the definitive answer on the
question.
Senator Corker. Well, if you, the regulator and the
supervisor and now the conservator--that is a pretty stunning
comment to make, and I hope the world is listening to you at
this moment. I understand there are some other interesting
hearings happening, but that is a pretty stunning comment.
Mr. Lockhart. What they do do, and this is the important
thing, is that they provide liquidity to the mortgage market.
Without them, our mortgage market would be in total chaos.
Senator Corker. But they monopolize, and obviously if they
were not in the business, somebody would be filling that
vacuum. But the question I asked----
Mr. Lockhart. In this market, I am not so sure.
Senator Corker. Well, maybe not in this market----
Chairman Dodd. Who fills the vacuum? Where would it be
today without this right now? You just said it. I would like to
repeat that. What would happen if this did not--what condition
would we be in today in the absence of that?
Mr. Lockhart. They are providing 80 percent of----
Chairman Dodd. And in the absence of that, what would this
be like?
Mr. Lockhart. In the absence of that, we would have an
extremely, extremely serious problem providing liquidity. We
would just have to buildup a much, much bigger TARP.
Chairman Dodd. So while theoretically talking about some
alternative is a great idea, but, nonetheless, the suggestion
somehow that we would be better off today without it I think
needs to be emphasized.
Mr. Lockhart. They do hold over $5 trillion worth of
mortgages in this country. There would have to be some other
mechanism. At this point, it is not there.
Senator Corker. If I could, since the Chairman jumped in on
my questioning--and I appreciate that. The fact is, though,
that there is nothing to--there is no reason to believe that
other private entities that were in the middle of this right
now that were not, on the other hand, dealing with all these
other issues we are talking about would not continue to be
doing the same thing. There is no reason not to believe that.
But I think the most stunning comment that has been made, if I
understand it correctly, is the supervisor, the Director now of
this new organization, does not--he cannot really tell whether
there is any benefit whatsoever to the borrower. That is pretty
stunning to me, and that the purpose of this was to allow these
two GSEs to borrow money less expensively in order to make
homeownership more affordable. And I guess--and this is, I am
sure, an ongoing dialog we will have in the ensuing years.
What worries me is that by having these organizations, we
probably did encourage, because we were sponsoring them, if you
will, we encouraged them to do things that were not good. And
at the same time, we had that ability--excuse me,Congress had
that ability, but really the borrower was not necessarily benefiting
from lower rates. OK? We will talk about this at another time, but I
thank you for----
Chairman Dodd. Well, in fairness to Mr. Lockhart, as I
understood you to say, you were talking about the academics.
Mr. Lockhart. Right.
Chairman Dodd. There was division back and forth. And I
think what you were saying and suggesting is that there has
been a debate about that particular question.
Mr. Lockhart. That is what I was saying.
Chairman Dodd. That is the way I thought you answered the
question.
Mr. Lockhart. Right.
Chairman Dodd. Is there any other----
Senator Corker. Well, he himself has not been able to
discern as to whether the borrowers had benefited in any way.
That to me is a pretty strong----
Chairman Dodd. That is called a diplomatic answer to your
question.
Senator Corker. Well, I do not think it is diplomatic. We
have had meetings in our office. I think it is a realistic
answer. But I would love for him to answer for himself since we
are doing a good job of answering for him.
Mr. Lockhart. I think the Chairman is right that there are
some dueling academic studies on the issue and, frankly, I have
not spent a lot of time on that issue. I have been really full
out trying to regulate them and trying at this point to
rehabilitate them.
I believe it is critical at this point that we need to fix
them up. We need to get them out of conservatorship. It is a
very critical, important issue that you raise, Senator, what
the future of these two companies should be. I feel that will
be a debate in Congress. We will certainly provide all the
information we can to help that debate.
Senator Corker. Well, I think--and I can tell by the body
language of the Chairman out of the corner of my eye it is time
for this meeting to end. But let me just say we have worked
together on numbers of things very constructively. I know that
on this issue in particular we probably have a philosophical
difference----
Chairman Dodd. Not necessarily
Senator Corker. But I do hope that as you are working
through this and there is transition occurring, I do hope there
is a vision in the very, very near future that these two
organizations have nothing whatsoever to do with Government.
And I hope that is at least one of the plans that we are
working on. I know a lot of people like to attribute everything
that is happening to this. That is obviously unfair. But the
fact is that this is--as we move ahead, we have the camel's
nose under the tent here already, and obviously, the camel
occupies the tent now because of where we are. We have the
camel's nose under the tent occurring right now with the--I
guess we are calling it ``the rescue plan'' now. I hope that we
will not edge into areas that we are not supposed to be edging
into there, and I look forward to your leadership as hopefully
we move these organizations off, cause them to be lofted on
their own into the future and we figure out other ways for the
private sector to deal with the secondary market. And I hope
that finds you retired very soon.
Thank you for your service.
Mr. Lockhart. Thank you.
Chairman Dodd. Well, thank you. Let me just end on that
note. As you point out, Mr. Lockhart, a lot of our problems was
the private secondary market here that contributed
significantly to bad lending practices. Clearly, we need to
change this notion. But as I understand it, the only country in
the world that has provided a 30-year fixed-rate mortgage was
the United States. I do not know of any example around the
world. And to attribute all of the problems, in fact, as you
point out, in the absence of the liquidity provided today by
this, we would be in a very, very difficult, far more difficult
situation than we are in.
Now, clearly, we are going to change. We are going forward.
What replaces this? That will be a debate. There are various
ideas on how to do it. But one of the things I take exception
to is the notion somehow that it has been a bad idea to take
relatively poor people and make it possible for them to get
into homeownership. We have greatly benefited as a country,
what it has meant to a family, a neighborhood, what it has
meant to our economy. And as long as you have got good, strong,
underwriting standards that demand accountability by that
borrower in the process, it has worked. And I hope we do not
retreat from that. It has been a great wealth creator for many
millions of people in this country over the years, and
providing the means by which we do it.
Now, there are a variety of means by which you can do it,
but one of my fears will be, as we see here, the assumption
somehow because there is a Government-sponsored enterprise of
one kind, whether it is a utility idea, as Secretary Paulson
has suggested, or others, clearly the present model does not
work. And that has to change without any question whatsoever.
And there is a legitimate debate about whether or not--which
side you replace it with. But I just want to point out that we
would not be in the mess we are in today were it not for the
fact that there was an improper or lack of regulation in that
private secondary market as well. So I want to be careful
before people jump to that option without some serious
considerations as well as the way we are headed.
This has been a very worthwhile hearing, and we thank you.
We are going to come back again and again, obviously, on this,
and some of the issues involving foreclosure we want to
continue to raise with you as well. But I am very grateful to
all of you, and I appreciate the work that you are doing.
The Committee will stand adjourned.
[Whereupon, at 1:10 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM SHEILA C.
BAIR
Q.1. Please provide the legal justification for establishing
the Temporary Liquidity Guarantee Program under the systemic
risk exception in the Federal Deposit Insurance Act.
A.1. The legal authority for establishing the Temporary
Liquidity Guarantee Program (TLGP) is set forth in 12 U.S.C.
1823(c)(4)(G). Based on information regarding the unprecedented
disruption in credit markets and the resulting effects on the
ability of banks to fund themselves and the likelihood that the
FDIC's compliance with the least-cost requirements of the
Federal Deposit Insurance Act (12 U.S.C. 1823(c)(4)(A) and (E))
would have serious adverse effects on economic conditions or
financial stability by increasing market uncertainty, the Board
of Directors of the FDIC and the Board of Directors of the
Federal Reserve System made written recommendations to the
Secretary of the Treasury that the FDIC's creation of the TLGP
program to guarantee bank depositors and senior unsecured
creditors against loss under certain described circumstances
would avoid or mitigate such effects. After consultation with
the President, as required by the statute, the Secretary of the
Treasury made the systemic risk determination that provided the
FDIC with the authority to implement the TLGP.
Q.2. According to press reports, the emergency actions taken by
the FDIC to guarantee unsecured senior debt issued by FDIC-
insured depository institutions has had the unintended
consequence of driving up the costs of borrowing for Fannie
Mae, Freddie Mac and the Federal Home Loan Banks (FHLBs). Was
this taken into account as a possible consequence as you
formulated this course of action?
A.2. As noted in the press, the spread of debt issued by
Government-sponsored enterprises (GSEs), including Fannie Mae,
Freddie Mac and Federal Home Loan Banks (FHLBs), over
Treasuries increased considerably in October and November
although the overall cost of funding declined. According to
Merrill Lynch data on U.S. bond yields, the spread between AAA-
rated agency debt and Treasuries increased by nearly 40 basis
points between September and November 2008. We believe these
developments primarily reflect broad financial market
uncertainty and a generally unfavorable market sentiment
towards financial firms. In fact, the spread of debt guaranteed
by the FDIC under the Temporary Liquidity Guarantee Program
over Treasuries is larger than the spread on GSE debt.
Financial firms, including those with a AAA-rating, saw
their borrowing costs increase sharply, both in absolute terms
and relative to Treasury yields, during the same two months,
even as the Federal Reserve continued to lower the federal
funds target rate. Merrill Lynch data show that the effective
yield on AAA-rated corporate debt issued by financial firms
increased by 140 basis points between September and October,
before declining somewhat in November. Lower-rated corporate
debt experienced even more significant increases over the same
period of time.
The primary purpose of the FDIC's Temporary Liquidity
Guarantee Program is to provide liquidity in the inter-bank
lending market and promote stability in the long-term funding
market where liquidity has been lacking during much of the past
year. While the FDIC's action was focused primarily on helping
to restore a stable funding source for banks and thrifts, we
believe that such liquidity can, in turn, help promote lending
to consumers and small businesses, which would have a
considerable benefit to the U.S. economy, in general, and
financial firms, including mortgage lenders and GSEs.
Nevertheless, partly to mitigate any potential effect of the
FDIC guarantee on funding costs for GSEs, the federal banking
agencies have agreed to assign a 20 percent risk weight to debt
guaranteed by the FDIC (rather than the zero risk weighting
that is assigned to debt guaranteed by a U.S. Government agency
that is an instrumentality of the U.S. Government and whose
obligations are fully and explicitly guaranteed as to the
timely repayment of principal and interest by the full faith
and credit of the U.S. Government).
Q.3. The FFIEC has proposed a rule that would lower the capital
risk weighting that banks assign to Fannie Mae and Freddie Mac
debt from 20 to 10 percent, but does not change the treatment
for FHLB debt. Has any consideration been given to giving the
same treatment to FHLB debt? Will FDIC-guaranteed unsecured
bank debt have a comparable risk weight?
A.3. On September 6, 2008, the Treasury and Federal Housing
Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into
conservatorship, administered by the FHFA. The next day,
September 7, 2008, the Treasury announced the establishment of
the Government Enterprise Credit Facility and entered into
senior preferred stock purchase agreements (the Agreements)
with Fannie Mae and Freddie Mac. These Agreements are intended
to ensure that Fannie Mae and Freddie Mac maintain a positive
net worth and effectively support investors that hold debt and
mortgage-backed securities issued or guaranteed by these
entities.
On October 27, 2008, the Federal Deposit Insurance
Corporation, Board of Governors of the Federal Reserve System,
Office of the Comptroller of the Currency, and Office of Thrift
Supervision (together, the Agencies) published in the Federal
Register a Notice of Proposed Rulemaking that would permit a
banking organization to reduce to 10 percent from 20 percent
the risk weight assigned to claims on, and the portions of
claims guaranteed by, Fannie Mae and Freddie Mac (the NPR).\1\
As proposed, the NPR would permit a banking organization to
hold less capital against debt issued or guaranteed by Fannie
and Freddie. The preferential risk weight would be available
for the duration of the Treasury's Agreements.
---------------------------------------------------------------------------
\1\73 Fed. Reg. 63656.
---------------------------------------------------------------------------
The NPR requested comment on the proposed regulatory
capital treatment for debt issued or guaranteed by Fannie Mae
and Freddie Mac and whether the Agencies should extend this
capital treatment to debt issued or guaranteed by other
government-sponsored entities (GSEs), such as the Federal Home
Loan Banks (FHLBanks). The comment period for the NPR closed on
November 26, 2008, and the Agencies received more than 200
public comments. Most of the commenters support lowering the
risk weight for debt issued or guaranteed by the FHLBanks to
narrow the credit spread between Fannie Mae and Freddie Mac
debt and FHLBank debt. TheAgencies are reviewing the comments
and determining whether a 10 percent risk weight is appropriate for a
banking organization's exposure to a GSE.
On November 26, 2008, the FDIC published in the Federal
Register a final rule implementing the Temporary Liquidity
Guarantee Program.\2\ Under the Temporary Liquidity Guarantee
Program, the FDIC will guarantee the payment of certain newly
issued senior unsecured debt issued by banking organizations
and other ``eligible'' entities. Consistent with the existing
regulatory capital treatment for FDIC-insured deposits, the
Agencies will assign a 20 percent risk weight to debt
guaranteed by the FDIC.
---------------------------------------------------------------------------
\2\ 73 Fed. Reg. 72244.
Q.4. I commend you for aggressively pursuing loan modifications
of the IndyMac loans that the FDIC now services. Please
elaborate on the following three points that you make in your
testimony that I want to explore further:
Q.4.a. You state that you have established a program to
systematically modify troubled loans that IndyMac serviced.
Please give us more details about this approach and how it
differs from modifying loans on a case-by-case basis. Is there
really such a thing as a systematic approach to loan
modification, or do you have to touch every loan as you would
on a case-by-case basis?
A.4.a. The FDIC's loan modification program at IndyMac provides
a streamlined and systematic approach to implementing
affordable and sustainable loan modifications. By establishing
clear guidelines for loan modifications determined by an
affordability metric based on mortgage debt-to-gross income,
the loan modification program allows servicers to apply the
model to thousands of mortgages quickly, while defining for
each loan how to achieve the targeted DTI. By using a waterfall
of three basic loan modification tools--interest rate
reductions, term or amortization extensions, and principal
deferment--it is relatively simple to run thousands of loans
through a computerized analysis of the necessary combination of
tools needed to achieve an affordable and sustainable payment.
A standardized net present value analysis, also computerized,
allows IndyMac to ensure that its modifications provide a
better value to the FDIC or investors in securitized or
purchased loans. All IndyMac modifications are based on
verified income information from third party sources such as
the Internal Revenue Service or employers.
This is very different from the loan-by-loan approach used
by most servicers, which seeks to gather detailed financial
information from borrowers--usually based on verbal
statements--and get the highest possible monthly payment while
leaving the borrower with a set amount of `disposable income.'
While this approach may appear to offer a more customized
approach, it has often meant that servicers relied on stated
income and stated expenses to achieve a short-term solution
that continued to place the borrower in a precarious and
unsustainable payment. The difficulty with this approach is
demonstrated by the high redefault rates reported by some
servicers.
The FDIC Loan Modification Program at IndyMac achieves an
affordable payment through a three step waterfall process:
Interest Rate Reduction: Cap the interest rate at
the Freddie Mac Weekly Survey Rate for the balance of the loan
term and, if needed to reach the DTI target, reduce the
interest rate incrementally to as low as 3 percent and re-
amortize the principal balance over the remaining amortization
term. The interest rate charged will not be greater than the
current Freddie Mac Weekly Survey Rate at the time of
modification. The reduced rate remains in effect for at least 5
years.
If the target debt-to-income ratio has not been achieved,
proceed to the next step.
Extended Amortization Term: For loans with
original terms of 30 years or less, re-amortize the principal
balance at the reduced interest rate (3 percent floor) over an
extended amortization term of 40 years from the original first
payment date.
If the target debt-to-income ratio has not been achieved,
proceed to the next step.
Partial Principal Forbearance: Defer a portion of
the principal balance for amortization purposes, and amortize
over a 40-year period at the reduced interest rate (3 percent
floor). The remaining principal balance remains as a zero
interest, zero payment portion of the loan. The repayment of
the deferred principal will be due when the loan is paid in
full.
Of the loan modification offers made at IndyMac thus far,
73 percent required rate reduction only, 21 percent required
rate reduction and term extension, and 6 percent required rate
reduction, term extension, and principal forbearance.
Q.4.b. Your testimony says that modifications are only offered
where they are profitable to IndyMac or investors in
securitized or whole loans. Are you finding that most
modifications are profitable, and if so, please explain how you
determine that they are more profitable than foreclosures?
A.4.b. Yes. While there are always some proportion of
delinquent mortgages where a modification will not provide the
best alternative to preserve value for the mortgage, many
mortgages can be modified successfully while gaining the best
value compared to foreclosure. One illustration of this fact is
the net present value comparisons between the modified mortgage
and foreclosure for the more than 8,500 completed modifications
at IndyMac. To date, on average, the net present value of
completed modifications at IndyMac has exceeded the net present
value of foreclosure by $49,918 for total savings compared to
foreclosure of more than $423 million.
As conservator, the FDIC has a responsibility to maximize
the value of the loans owned or serviced by IndyMac Federal.
Like any other servicer, IndyMac Federal must comply with
itscontractual duties in servicing loans owned by investors. Consistent
with these duties, we have implemented a loan modification program to
convert as many of these distressed loans as possible into performing
loans that are affordable and sustainable over the long term. This
action is based on the FDIC's experience in applying workout procedures
for troubled loans in a failed bank scenario, something the FDIC has
been doing since the 1980s. Our experience has been that performing
loans yield greater returns than non-performing loans.
The FDIC's Loan Modification Program at IndyMac is
primarily based on four principles:
(1) Affordable and sustainable modifications generally
provide better value than foreclosure to lenders and investors,
and to the IndyMac conservatorship and the FDIC's Deposit
Insurance Fund. Modifications that exceed the net present value
of foreclosure generally are consistent with servicing
agreements and protect the interests of investors in
securitized mortgages.
(2) Sustainable loan modifications must be affordable for
the life of the loan. As a result, the Loan Modification
Program is based on a first lien mortgage debt-to-gross income
ratio ranging from 38 percent to 31 percent. The modifications
use a combination of interest rate reductions, term extensions,
and principal deferment to achieve affordable payments. The
interest rate on the modified mortgages is capped at a prime
conforming loan rate reported by the Freddie Mac Weekly Survey.
The interest rate can be reduced to as low as 3 percent for
five years in order to achieve an affordable payment followed
by gradual interest rate increases of 1 percent per year until
the Freddie Mac Weekly Survey rate is reached.
(3) All modifications should be based on verified income
information, not stated income. This is essential to establish
affordability.
(4) A streamlined and systematic modification process is
essential to address the volume of delinquent mortgages in
today's market. The FDIC, along with many mortgage servicers,
has adopted a more streamlined process focused on modifying
troubled mortgages based on a simple debt-to-income ratio since
it is easy to apply and avoids costly and unnecessary
foreclosures for many more borrowers.
The Program results in a positive outcome for investors and
borrowers as investor loss is minimized and the borrower
receives a sustainable long-term modification solution. The
Program requires full income documentation in order to minimize
redefault and ensure the affordability standard is uniformly
implemented. The gross monthly income for all borrowers who
have signed the mortgage note must be supported by either the
prior year's tax returns or recent pay stubs.
Q.4.c. You state that securitization agreements typically
provide servicers with sufficient flexibility to apply the
modification approach you are taking for the IndyMac loans.
Given this flexibility, why are so few loan modifications being
made?
A.4.c. While the securitization agreements do typically provide
servicers with sufficient flexibility, many servicers have been
reluctant to adopt the streamlined modification protocols
necessary to stem the rate of unnecessary foreclosures due to
concerns about challenges from investors, a tendency to
continue prior practices of focusing on loan-by-loan customized
modifications, and by staffing limitations.
At IndyMac, of the more than 45,000 mortgages that were
potentially eligible for modification, IndyMac has mailed
modification offers to more than 32,000 borrowers. Some
proportion of the remainder do not pass the NPV test and others
must be addressed through more customized approaches. So far,
IndyMac has completed income verification on more than 8,500
modifications and thousands more have been accepted and are
being processed and verified.
As the FDIC has proven at IndyMac, streamlined modification
protocols can have a major impact in increasing the rates of
sustainable modifications. However, even there, challenges in
contacting borrowers and in getting acceptance of the
modification offers can inhibit the effectiveness of
modification efforts. These are challenges that we have sought
to address by working closely with HUD-approved, non-profit
homeownership counseling agencies, such as those affiliated
with NeighborWorks. In addition, we have sought to reach out to
local community leaders and provide cooperative efforts to
contact borrowers at risk of foreclosure. These efforts, which
many servicers are starting to pursue, should be a focus of
efforts by all servicers going forward.
In addition, servicers' concerns over challenges from
investors makes adoption of a national program to provide
incentives from federal funds a critical part of the strategy
to achieve the scale of modifications necessary to address our
housing crisis. To address conflicting economic incentives and
fears of re-default risk, the FDIC has proposed that the
government offer an administrative fee to servicers who
systematically modify troubled loans and provide loss sharing
to investors to cover losses associated with any redefaults.
These financial incentives should make servicers and investors
far more willing to modify loans. This proposal addresses the
biggest disincentive to modify troubled mortgages--the
potential for greater losses if a modified loan redefaults and
foreclosure is necessary some months in the future in a
declining housing market. As a result, the FDIC proposal is
designed to cover a portion of the losses that could result if
the modified mortgage redefaults. This will provide practical
protection to servicers by allowing easier proof for the value
of the modification and eliminate investors' primary objection
to streamlined modifications. We have estimated the costs of
this program to be about $25 billion. To protect taxpayers and
assure meaningful loan modifications, the program would require
that servicers truly reduce unaffordable loan payments to an
affordable level and verify current income, and that borrowers
make several timely payments on their modified loans before
those loans would qualify for coverage. This proposal is
derived from loss sharing arrangements the FDIC has long used
to maximize recoveries when we sell troubled loans. We believe
this or some similar program of financial incentives is
necessary to achieve loan modifications on a national scale to
halt the rising tide of foreclosures and the resulting economic
problems.
Q.5. Each agency represented at the hearing has aggressively
used the tools at their disposal in dealing with the crisis.
However, sometimes the use of those tools has led to unintended
consequences. For instance, when the Treasury Department
guaranteed money market funds, it led to a concern on deposit
insurance and bank accounts. When the FDIC guaranteed bank
debt, it had an effect on GSE borrowing costs, which in turn
directly affects mortgage rates.
Acknowledging that there is often a need to act quickly in
these circumstances, please explain what steps and processes
you have employed to inform other agencies about significant
actions you undertake to ensure that there are not serious
adverse unintended consequences and that your actions are
working in concert with theirs.
A.5. The FDIC's Temporary Liquidity Guarantee Program was
created during intensive discussions between the FDIC, the
Department of the Treasury and the Federal Reserve over the
Columbus Day weekend (October 11-13) and announced on October
14. Over the next several weeks, the FDIC adopted an Interim
Rule, an Amended Interim Rule and a Final Rule. The FDIC's
Interim Final Rule adopted on October 23 specifically requested
comments on the Temporary Liquidity Guarantee Program and the
FDIC received over 750 comments, including comments from other
government agencies. During this process, the FDIC had frequent
discussions with the Treasury, the Federal Reserve, the Office
of the Comptroller of the Currency and the Office of Thrift
Supervision about various aspects of the program and its
potential consequences.
With regard to concerns that the actions by the FDIC to
guarantee bank debt had an effect on GSE borrowing costs, as
discussed above, the spread of debt issued by Government-
sponsored enterprises (GSEs), including Fannie Mae, Freddie
Mac, and Federal Home Loan Banks (FHLBs), over Treasuries
increased considerably in October and November although the
overall cost of funding declined. According to Merrill Lynch
data on U.S. bond yields, the spread between AAA-rated agency
debt and Treasuries increased by nearly 40 basis points between
September and November 2008. We believe these developments
primarily reflect broad financial market uncertainty and a
generally unfavorable market sentiment towards financial firms.
In fact, the spread of debt guaranteed by the FDIC under the
Temporary Liquidity Guarantee Program over Treasuries is larger
than the spread on GSE debt.
Financial firms, including those with a AAA-rating, saw
their borrowing costs increase sharply, both in absolute terms
and relative to Treasury yields, during the same two months,
even as the Federal Reserve continued to lower the federal
funds target rate. Merrill Lynch data show that the effective
yield on AAA-rated corporate debt issued by financial firms
increased by 140 basis points between September and October,
before declining somewhat in November. Lower-rated corporate
debt experienced even more significant increases over the same
period of time. The primary purpose of the FDIC's Temporary
Liquidity Guarantee Program is to provide liquidity in the
inter-bank lending market and promote stability in the long-
term funding market where liquidity has been lacking during
much of the past year. While the FDIC's action was focused
primarily on helping to restore a stable funding source for
banks and thrifts, we believe that such liquidity can, in turn,
help promote lending to consumers and small businesses, which
would have a considerable benefit to the U.S. economy, in
general, and financial firms, including mortgage lenders and
GSEs. Nevertheless, partly to mitigate any potential effect of
the FDIC guarantee on funding costs for GSEs, the federal
banking agencies have agreed to assign a 20 percent risk weight
to debt guaranteed by the FDIC (rather than the zero risk
weighting that is assigned to debt guaranteed by a U.S.
Government agency that is an instrumentality of the U.S.
Government and whose obligations are fully and explicitly
guaranteed as to the timely repayment of principal and interest
by the full faith and credit of the U.S. Government).
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI FROM SHEILA C.
BAIR
Q.1. I was happy to note in your testimony that you discussed
the need to stop unnecessary foreclosures. You mentioned the
FDIC's work as conservator of IndyMac and your participation in
the Hope for Homeownership program as recent examples of your
effort. Does the FDIC plan to develop a new program to extend
loan modifications to a broader pool of mortgages than those
held by IndyMac? How would such a program work and what would
its impact be on mortgage investors? Where would the FDIC
derive authority for such a program?
A.1. In mid-November, the FDIC announced a new proposal for
loan modifications that is similar to the program we developed
at IndyMac. Both target borrowers who are 60 days or more past
due, and both seek to apply a consistent standard for
affordable first-lien mortgage payment. The new FDIC proposal
has a 31 percent debt-to-income ratio, whereas IndyMac
modifications are designed to achieve a 38 percent debt-to-
income ratio, but can go as low as 31 percent.
The FDIC's proposal is designed to promote wider adoption
of systematic loan modifications by servicers through the use
of payment incentives and loss-sharing agreements, and thus
reach more troubled borrowers. Specifically, to encourage
participation, funds from the Troubled Asset Relief Program
(TARP) would be used to pay servicers $1,000 to cover expenses
for each loan modified according to the required standards. In
addition, TARP funds would be used to provide guarantees
against the losses that lenders and investors could experience
if a modified loan should subsequently redefault. The guarantee
would be paid only if the modification met all prescribed
elements of the loan modification program, if the borrower made
at least 3 monthly payments under the modified loan, and if the
lender or servicer met the other elements of the program.
The impact of this new proposal will be less costly than
the lengthy and costly alternative of foreclosure, where direct
costs can total between 20 and 40 percent of a property's
market value. We expect about half of the projected 4.4 million
problem loans between now and year-end 2009 can be modified.
Assuming a redefault rate of 33 percent, this plan could reduce
the number of foreclosures during this period by some 1.5
million at a projected program cost of $24.4 billion.
We believe that Section 109 of the EESA provides authority
for this proposal. Section 109 provides that ``the Secretary
may use loan guarantees and credit enhancements to facilitate
loan modifications to prevent avoidable foreclosures.''
Q.2. Has the FDIC given any further consideration to the FDIC's
own Home Ownership Preservation Loan program? I believe this
program is a good way to avoid foreclosures and severe mortgage
modifications at the same time. If this program is no longer
being considered, why?
A.2. When the FDIC proposed the Home Ownership Preservation
(HOP) Loan program in May 2008, we noted that congressional
action would be required to authorize the Treasury Department
to make HOP loans. We believe that the HOP Loan program could
be an important tool for avoiding unnecessary foreclosures in
combination with other tools. As the housing market and home
prices have continued to decline, we have suggested the loss
guarantee approach discussed above as a way of streamlining and
increasing the scale of loan modifications.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD
FROM NEEL KASHKARI
Q.1. On October 20, 2008, Secretary Paulson said that
Treasury's infusion of capital in financial institutions
through the purchase of preferred stock is intended ``to
increase the confidence of our banks, so that they will deploy,
not hoard, their capital. And we expect them to do so.'' I
share that expectation. As I indicated at the hearing, I feel
that Treasury should ask banks that receive these capital
infusions provided by the taxpayers to make more loans to
entities in the community and to not hoard the money. You said
Treasury shares this view and that you ``want our financial
institutions lending in our communities.'' Within our
communities, small private colleges serve important roles and
many of them have borrowing relationships with banks. The
credit crisis has made some creditworthy schools concerned that
the banks from which they have borrowed in the past will be
unwilling to lend to them on reasonable terms in the future.
Q.1.a. Does Treasury believe that banks which receive capital
injections should be encouraged to continue to lend to the
creditworthy customers, including small private colleges and
universities, with which they have done business in the past?
If so, will Treasury encourage such lending?
A.1.a. Treasury believes that the banks that received
investments from the Capital Purchase Program (CPP) should
continue to make credit available in their communities. By
injecting new capital into healthy banks, the CPP has helped
banks maintain strong balance sheets and eased the pressure on
them to scale back their lending and investment activities.
However, we expect banks to continue their lending in a safe
and sound manner and that institutions must not repeat the poor
lending practices that were a root cause of today's problems.
To that effect, we firmly support the statement by bank
regulators on November 12, 2008 to that effect. The statement
emphasized that the extraordinary government actions taken to
strengthen the banking system are not one-sided; all banks--not
just those participating in CPP--have benefitted from the
government's actions. Banks, in turn, have obligations to their
communities to continue to make credit available to
creditworthy borrowers and to work with struggling borrowers to
avoid preventable foreclosures.
Q.1.b. What specific conditions or assurances has Treasury
required to ensure that banks do not hoard the capital?
A.1.b. The Treasury has not imposed specific conditions on how
banks can use funds obtained from the CPP. The purpose of the
CPP is to stabilize financial markets and restore confidence,
including by strengthening banks' balance sheets so that they
can better weather the deleveraging process associated with the
current economic downturn. The CPP funds were not costless to
the recipient institutions: the preferred shares carry a 5
percent dividend rate and the recipients will need to put those
funds to a productive use or they will lose money. The banks
will have strong economic incentives to deploy the capital
profitably. Banks are in the business of lending and they will
provide credit to sound borrowers whenever possible. They may
also use the capital to absorb losses as part of loan write-
downs and restructurings. If a bank doesn't put the new capital
to work earning a profit or reducing a loss, its returns for
its shareholders will suffer.
However, Treasury did design important features into our
investment contracts to limit what banks can do with the money:
one, Treasury barred any increase in dividends for 3 years;
two, Treasury restricted share repurchases. Increasing
dividends or buying back shares would undermine our policy
objective by taking capital out of the financial system.
In addition, Treasury has been working with the banking
regulators to design a program to measure the activities of
banks that have received TARP capital. We plan to use quarterly
call report data to study changes in the balance sheets and
intermediation activities of institutions we have invested in
and compare their activities to a comparable set of
institutions that have not received TARP capital investments.
Because call report data are collected infrequently, we also
plan to augment that analysis with a selection of data we plan
to collect monthly from the largest banks we have invested in
for a more frequent snapshot.
Thus, Treasury does not believe that banks will ``hoard''
the capital, but rather utilize this additional capital in a
safe and sound manner. We expect communities of all sizes to
benefit from the investments into these institutions, which now
have an enhanced capacity to perform their vital functions,
including lending to U.S. consumers and businesses and
promoting economic growth. The increased lending that is vital
to our economy will not materialize as fast as many of us would
like, but it will happen much faster as a result of deploying
resources from the TARP to stabilize the system and increase
capital in our banks.
Q.1.c. What assurances have you received from these banks that
they will employ the capital to prevent foreclosures?
A.1.c. Treasury believes that banks will employ this additional
capital in a manner that best benefits their communities. Some
institutions may use the funds to continue lending to community
institutions (such as private universities), while other
institutions may employ the funds to originate new residential
mortgages or to restructure existing mortgages. In our private
conversations with bankers receiving CPP funds, many
institutions have stated that preventing foreclosures is a high
priority for them.
Q.2. In implementing the Capital Purchase Program (CPP), what
steps has the Treasury Department taken to ensure that all
financial institutions that participate will receive similar
accounting treatment in the determination of the value of the
institution's risk weighted assets?
Q.2.a. What specific steps is the Treasury Department taking to
coordinate the assessments by the various primary regulators?
A.2.a. The federal banking agencies, working in conjunction
with the Treasury, developed a common application form that was
used by all qualified financial institutions to apply for CPP
funds. In addition, the Treasury worked closely with the bank
regulators to establish a standardized evaluation process, and
all regulators use the same standards to review all
applications to ensure consistency.
Applications are submitted to an institution's primary
federal regulator. Once a regulator has reviewed an
application, it will take one of the following three actions:
(1) for applications it does not recommend, it may encourage
the institution to withdraw the application; (2) for
applications it strongly believes should be included in the
program, it directly sends the application and its
recommendation to the TARP Investment Committee at the
Treasury; (3) for cases that are less clear, the regulator will
forward the application to a Regulatory Council, made up of
senior representatives of the four banking regulators, for a
joint review and recommendation.
The Treasury TARP Investment Committee reviews all
recommendations from the regulators. This committee includes
our top officials on financial markets, economic policy,
financial institutions, and financial stability, as well as the
Chief Investment Officer for the TARP, who chairs the
Committee. This is a Treasury program and Treasury makes the
final decision on any investments. The Investment Committee
gives considerable weight to the recommendations of the banking
regulators. In some cases, the Committee will send the
application back to the primary regulator for additional
information, or even remand it to the Regulatory Council for
further review. At the end of the evaluation process, Treasury
notifies all approved institutions.
Q.2.b. What lessons learned can you report from the assessment
process for the first nine institutions which participated in
the CPP?
A.2.b. This process has worked well. Each institution that has
received CPP funds has been thoroughly scrutinized. Although
the process is very labor and time intensive, the Treasury
believes it is necessary to fully protect the interests of the
taxpayer.
Q.3. A stated legislative purpose of EESA is that the Treasury
Department use the funds' in a manner that preserves
homeownership and promotes jobs and economic growth.'' What
specific steps has the Treasury Department undertaken to ensure
that the funds are being used to accomplish this objective?
A.3. The purpose of the EESA was to stabilize our financial
system and to strengthen it. It was not a panacea for all our
economic difficulties. The crisis in our financial system had
already spilled over into our economy and hurt it. It will take
a while to get lending going and to repair our financial
system, which is essential to economic recovery. However, this
will happen much faster as the result of TARP actions.
The most important thing Treasury can do to mitigate the
housing correction and reduce the number of foreclosures is to
stabilize financial markets, restoring the flow of credit and
increasing access to lower-cost mortgage lending. The actions
we have taken to stabilize and strengthen Fannie Mae and
Freddie Mac, and through them to increase the flow of mortgage
credit, together with the CPP, are powerful actions to promote
mortgage lending. Treasury is working actively to stabilize
housing markets and reduce preventable foreclosures, and has
succeeded by undertaking the following initiatives:
HOPE NOW: In October 2007, Treasury actively
helped facilitate the creation of the HOPE NOW Alliance, a
private sector coalition of mortgage market participants and
non-profit housing counselors. HOPE NOW servicers represent
more than 90 percent of the subprime mortgage market and 70
percent of the prime mortgage market. Since inception, HOPE NOW
has kept roughly 2.9 million homeowners in their homes through
modifications and repayment plans, and it is currently helping
more than 200,000 borrowers per month.
Stabilizing Fannie Mae and Freddie Mac: Treasury
took aggressive actions in 2008 to stabilize and strengthen
Fannie Mae and Freddie Mac, and prevent the collapse of two
institutions with $5.4 trillion in debt and mortgage-backed
securities held by investors and financial institutions
throughout the United States and the world. The systemic
importance of these two enterprises, and the systemic impact of
a collapse of either, cannot be overstated. Treasury's efforts
to stabilize them by effectively guaranteeing their debt has
increased the flow of mortgage credit and insulated mortgage
rates from the rapid increases and fluctuations in the cost of
other credit.
Hope for Homeowners: On October 1, 2008, HUD
implemented Hope for Homeowners, a new FHA program, available
to lenders and borrowers on a voluntary basis that insures
refinanced affordable mortgage loans for distressed borrowers
to support long-term sustainable homeownership.
Streamlined Loan Modification Program: On
November 11, 2008, Treasury joined with the FHFA, the GSEs, and
HOPE NOW to announce a major streamlined loan modification
program to move struggling homeowners into affordable
mortgages. The program, implemented on December 15, creates
sustainable monthly mortgage payments by targeting a benchmark
ratio of housing payments to monthly gross household income
(38%). Additionally, on November 20, Fannie Mae and Freddie Mac
announced that they would suspend foreclosure sales and cease
evictions of owner-occupied homes from Thanksgiving until
January 9th to allow time for implementation of the
modification program.
Subprime Fast-Track Loan Modification Framework:
Treasury worked with the American Securitization Forum to
develop a loan modification framework to allow servicers to
modify or refinance loans more quickly and systematically.
Subprime ARM borrowers who are current but ineligible to
refinance may be offered a loan modification freezing the loan
at the introductory rate for five years.
Q.4. If there were a troubled asset that threatened the
viability of critically important public infrastructure
systems, would EESA provide theTreasury Department the
authority to purchase such a troubled asset? Would you interpret such a
purchase to be consistent with the purposes of the Act?
A.4. According to the EESA, the Secretary of the Treasury may
purchase from a financial institution any financial instrument,
that he determines, after consultation with the Chairman of the
Board of Governors of the Federal Reserve System to be
necessary to promote financial market stability. In such an
instance, the Secretary must transmit such a determination to
the appropriate committees of Congress. The Secretary will make
those decisions on a case-by-case basis.
Q.5. During the discussions leading to the passage of the
Emergency Economic Stabilization Act of 2008, Treasury asked
for $700 billion primarily to purchase troubled assets at
auction. Secretary Paulson testified that ``This troubled asset
purchase program on its own is the single most effective thing
we can do to help homeowners, the American people and stimulate
our economy.'' [Senate Banking Committee hearing on September
23, 2008.] Days after enactment of the law, Treasury changed
its main focus from asset purchases and decided to first infuse
capital in large financial institutions. Please describe the
analysis that supported the initial Treasury plan and identify
the assumptions that later proved to be inaccurate, causing
Treasury to abruptly change the principle focus of the TARP to
buying preferred stock.
A.5. In the discussions with the Congress in mid-September
during consideration of the financial rescue package
legislation, Treasury focused on an initial plan to purchase
illiquid mortgage assets in order to remove the uncertainty
regarding banks' capital strength. At the same time, Treasury
worked hard with the Congress to build maximum flexibility into
the law to enable Treasury to adapt our policies and strategies
to address market challenges that may arise.
In the weeks after Secretary Paulson and Chairman Bernanke
first went to the Congress, global and domestic financial
market conditions deteriorated at an unprecedented and
accelerating rate. One key measure Treasury assessed was the
LIBOR-OIS spread--a key gauge of funding pressures and
perceived counterparty credit risk. Typically, 5-10 basis
points, on September 1, the one-month spread was 47 basis
points. By September 18th, when Treasury first went to
Congress, the spread had climbed 88 basis points to 135 basis
points. By the time the bill passed, just two week later on
October 3, the spread had climbed another 128 basis points to
263 basis points. By October 10, LIBOR-OIS spread rose another
75 basis points to 338 basis points. During this period, credit
markets effectively froze. The commercial paper market shut
down, 3-month Treasuries dipped below zero, and a money market
mutual fund ``broke the buck'' for only the second time in
history, precipitating a $200 billion net outflow of funds from
that market.
Given such market conditions, Secretary Paulson and
Chairman Bernanke recognized that Treasury needed to use the
authority and flexibility granted under the EESA as
aggressively as possible to help stabilize the financial
system. They determined the fastest, most direct way was to
increase capital in the system by buying equity in healthy
banks of all sizes. Illiquid asset purchases, in contrast,
require much longer to execute and would require a massive
commitment of funds.
Treasury immediately began designing a capital program to
complement the asset purchase programs under development. Since
launching the program on October 14, 2008, Treasury has
invested $192.3 billion of the $250 billion Capital Purchase
Program in 257 institutions in 42 states across the country, as
well as Puerto Rico.
Following that, as Treasury continued very serious
preparations and exploration of purchasing illiquid assets,
scale became a factor; for an asset purchase program to be
effective, it must be done on a very large scale. With $250
billion allocated for the CPP, Treasury considered whether
there was sufficient capacity in the TARP for an asset purchase
program to be effective. In addition, each dollar invested in
capital can have a bigger impact on the financial system than a
dollar of asset purchase; capital injections provide better
``bang for the buck.''
It also became clear that there was a need for additional
capital for non-bank financial institutions and support of the
non-bank financial market. A large contingency also arose that
threatened the financial system, as Treasury had to restructure
the Federal Reserve's loan to AIG, using $40 billion of TARP
funds. This action was taken to prevent the collapse of a
systemically significant financial institution and the impact
such a collapse would have on the system and economy. In
addition, Treasury was required to use TARP funds to support
Citigroup.
Treasury also realized that it would have to take actions
to support the non-banking market, a critical source of funds
for consumers and small and large businesses, by supporting the
securitization market. Such measures would help bring down
interest rates on auto loans, credit cards, student loans and
small business loans and could be achieved with a more modest
allocation from the TARP. Therefore, Treasury committed to
provide $20 billion of TARP resources in support of a $200
billion Federal Reserve facility--the Term Asset-Backed
Securities Loan Facility (TALF).
As such, Treasury's assessment at this time is that the
purchase of illiquid mortgages and mortgage-related securities
is not the most effective way to use TARP funds.
Q.6. The conservatorship of Fannie Mae and Freddie Mac has
resulted in the unintended consequence of increasing the
borrowing costs for the Federal Home Loan Banks (FHLBs) since
the markets apparently now view them as having a more distant
relationship to the government than the GSEs in
conservatorship. Additionally, the decision by the FDIC to
guarantee senior debt of financial institutions has raised
funding costs for Fannie Mae and Freddie Mac because the market
apparently does not view the $200 billion backstop provided to
the enterprises as an equivalent guarantee. Given the stated
purpose of putting the enterprises in conservatorship--to
ensure a stable housing market, to lower mortgage interest
rates, and to make sure the enterprises could actively purchase
agency MBS--what steps is the Treasury considering to address
these problems?
A.6. Treasury, working in concert with the Federal Reserve and
FHFA, has been closely monitoring financial markets,
particularly credit markets in terms of the impact and
consequences of our actions. While the GSEs and not the Federal
Home Loan Banks were placed into conservatorship with access to
$100 billion through the senior preferred purchase agreement,
all three entities have access to the GSE Credit Facility which
Treasury established at the time of conservatorship. As a
result, all three entities, including the FHLB, have access to
enormous liquidity limited only by the amount of collateral
which they have on their balance sheet. This credit facility
was established specifically to level the playing field for the
FHLBs. Furthermore, Treasury's purchases of MBS of FRE and FNM
since September, also set up after the conservatorship, have
instilled confidence in the overall mortgaged-backed securities
(MBS) markets. The recent actions by the Federal Reserve Bank
of New York to purchase the debt and MBS of the GSEs have also
added confidence, thus lowering borrowing costs across the
board, including those of FHLB. In fact, since the
conservatorship was announced, the spread on FHLB 2-year debt,
a benchmark issue, has declined from nearly 86 basis points
above the comparable two-year Treasury to less than 45 basis
points--in line with that of FNM and FRE--an enormous
difference in borrowing costs and a primary result of the joint
actions of Treasury and the Federal Reserve.
With regard to the FDIC guaranteed debt portfolio, while
these securities have an explicit FDIC guarantee, they still do
not possess the liquidity and depth of the GSE Agency or
Treasury markets. Hence, some large institutions cannot be as
actively involved in these markets since they need to purchase
in very large size. As an example, about $115 billion of FDIC
bank debt has been issued, while the agencies have over $3
trillion in debt outstanding. Partially as a result of this,
the GSEs are able to borrow at a lower spread to Treasuries
than FDIC backed debt. In fact, as mentioned above, 2-year
benchmark FDIC backed debt on average trades 60 basis points
above comparable 2-year Treasuries while GSE debt trades about
45 basis points above such Treasuries--i.e. the GSE borrowing
costs are cheaper. Moreover, the life of the senior preferred
agreement is in perpetuity for any debt issued between now and
December 31, 2009 and for any tenor, while the FDIC debt
program is limited to debt issued out three years and expires
June 30, 2009--a major difference.
Q.7. As you know, since it was rescued by the Federal Reserve,
AIG was engaged in lobbying activities at the state level.
Specifically, the company was lobbying against certain
requirements for mortgage brokers. The company subsequently
promised to stop these activities. What steps has the Treasury
Department taken to make sure that the entities receiving
federal assistance are not engaged in lobbying, particularly in
lobbying against important protections for borrowers? Did the
Treasury Department consider putting any lobbying restrictions
on the entities that it funds under the TARP?
A.7. As part of the agreement with AIG announced on November
10, 2008, AIG must be in compliance with the executive
compensation requirements of Section 111 of EESA. AIG must
comply with the most stringent limitations on executive
compensation for its top five senior executive officers, and
Treasury is requiring golden parachute limitations and a freeze
on the size of the annual bonus pool for the top 60 company
executives. Additionally, AIG must continue to maintain and
enforce newly adopted restrictions put in place by the new
management on corporate expenses and lobbying as well as
corporate governance requirements, including formation of a
risk management committee under the board of directors.
Q.8. I commend the Administration for following through with
Section 112 of EESA by convening an international summit on
November 15. In announcing the summit yesterday, the White
House explained that leaders of the G20 and key international
financial institutions will review progress on measures taken
to address the financial crisis and to discuss principles for
reform of regulatory and institutional regimes going forward.
Please describe what the Treasury and Federal Reserve intend to
accomplish through this summit and the subsequent working group
meetings that will follow the summit--specifically, what types
of principles for regulatory and institutional modernization
will the United States pursue in the international community?
Will these principles include protections for consumers and
households which form the foundation of economic prosperity in
our country as well as other countries?
A.8. The international summit was extraordinarily successful.
It resulted in a five-page statement by the participating
leaders as well as a 47-point action plan of quite specific
actions, both in the near term and in the longer term. There
were six key takeaways from the summit. First, there was broad
agreement on the importance of the countries of the G20 taking
and implementing pro-growth investment--pro-growth policies to
stimulate our economies. Second, the leaders pledged to improve
our regulatory regimes so to ensure that all financial markets,
all financial products, and all financial market participants
are subject to appropriate regulation or oversight. Related to
this was a pledge of enhancing international cooperation among
regulators and between regulators and international financial
institutions. Third, one of the significant reforms that was
agreed on was the need to reform international financial
institutions to give greater representation to emerging market
and developing economies. Fourth, there was an affirmation of
free market principles, and, also importantly, the leaders
expressly rejected protectionism. The final takeaway was a
recognition and commitment to address the needs of the poorest,
both by honoring our aid commitments, and by ensuring that the
World Bank and IMF are adequately resourced so that they can
help developing countries through this crisis. And here note
was taken of the new liquidity facilities of the IMF, as well
as the recent very large package announced by the World Bank,
to support needs for trade finance and promote infrastructure
development.
Q.9. The Treasury announced plans to invest $250 billion to
strengthen the balance sheet of banks and the rest of the TARP
money to provide relief to banks struggling with troubled
assets. How much money will Treasury devote to provide relief
for the millions of Americans struggling with troubled
mortgages?
A.9. The existing TARP programs have exhausted the $350 billion
in TARP funds that already have been authorized by Congress.
Not all of those funds have yet been disbursed, and given the
unpredictability and severity of the current financial crisis,
Treasury believes it is prudent to reserve some of our TARP
capacity to maintain not only our flexibility in responding to
unforeseen events, but also that of the next Administration.
Separately from the TARP, Treasury has acted aggressively
to keep mortgage financing available and develop new tools to
help homeowners. Specifically, Treasury has achieved the
following three key accomplishments:
To support the housing and mortgage market,
Treasury acted earlier this year to prevent the failure of
Fannie Mae and Freddie Mac, the housing GSEs that affect over
70 percent of mortgage originations.
October 2007, Treasury helped establish the HOPE
NOW Alliance, a coalition of mortgage servicers, investors and
counselors, to help struggling homeowners avoid preventable
foreclosures.
Treasury worked with HOPE NOW, FHFA and the GSEs
to achieve a major industry breakthrough in November 2008 with
the announcement of a streamlined loan modification program
that builds on the mortgage modification protocol developed by
the FDIC for IndyMac.
Q.10. What is your position on the use of funds by financial
institutions under the CPP to acquire other institutions? Does
your position depend on whether the other institution is
healthy or failing?
A.10. The Treasury believes that banks and their management and
shareholders are in the best position to determine whether
acquisitions or mergers make sense. Acquisitions and mergers in
the banking industry are also reviewed by the appropriate
Federal banking agencies, which must consider the impact on the
relevant communities as well as financial and managerial
information. As noted above, the purpose and the focus of the
CPP is the stability of the financial system. The program is
not designed to, nor does it focus on, encourage or discourage
acquisitions or mergers.
More generally, Treasury believes that when failing bank is
acquired by a healthy bank, the community of the failing bank
is better off than if the bank had been allowed to fail.
Branches and financial services in that community are usually
preserved. Costs to the taxpayers via the FDIC deposit fund are
also lower than had the bank been allowed to fail. Prudent
mergers and acquisitions can strengthen our financial system
and our communities, while protecting taxpayers.
Q.11. We have received reports that insurance companies are in
talks with Treasury to allow access to the TARP program.
Q.11.a. Has any decision been made about whether insurance
companies may take part in the TARP program, and what is the
rationale for inclusion?
A.11.a. The Treasury Department is analyzing the inclusion of
insurance companies, including how to apply the CPP to bank
holding companies and thrift holding companies with insurance
company subsidiaries.
Q.11.b. Given that insurance companies are not federally
regulated (at least, not on their insurance business), what
exact oversight will be done to ensure safety and soundness of
the companies?
A.11.b. Regulation of insurance companies is undertaken at the
state level, not by the Treasury Department, and Treasury does
not interfere in these regulatory-supervisory matters. Treasury
also does not regulate the institutions which have chosen to
participate in the voluntary CPP program, as they are regulated
by their primary Federal regulators.
Separately, in March of 2008, Treasury published an
extensive Blueprint for a Modernized Regulatory Structure that
proposes a framework and many specific recommendations for
reforming our financial regulatory system, including in the
area of insurance. However, Treasury is using TARP to stabilize
the financial system today, while regulatory modernization will
likely take several years to complete.
Q.12. Each agency represented at the hearing has aggressively
used the tools at their disposal in dealing with the crisis.
However, sometimes the use of those tools has led to unintended
consequences. For instance, when the Treasury Department
guaranteed money market funds, it led to a concern on deposit
insurance and bank accounts. When the FDIC guaranteed bank
debt, it had an effect on GSE borrowing costs, which in turn
directly affects mortgage rates. Acknowledging that there is
often a need to act quickly in these circumstances, please
explain what steps and processes you have employed to inform
other agencies about significant actions you undertake to
ensure that there are not serious adverse unintended
consequences and that your actions are working in concert with
theirs.
A.12. Throughout the financial crisis, the Secretary has been
in very close contact with the other members of the President's
Working Group on Financial Markets (the Federal Reserve, the
SEC, and the CFTC) and the heads of the FDIC, OCC, and OTS. To
the maximum extent possible, programs have been developed
cooperatively among these different agencies.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM BRIAN D.
MONTGOMERY
Q.1. You are rightly proud to have been able to launch the HOPE
for Homeowners plan in so short a period of time, and I thank
you and the other agencies involved for your efforts. In the
end, of course, the goal is to help homeowners. Please provide
the Committee with information regarding your outreach efforts
to lenders, housing counselors, and borrowers. What steps have
you taken to sign up lenders? How many lenders are currently
participating? What steps have you taken to ensure borrowers
know about the program?
A.1. FHA conducted the first national training session for
lenders and counselors in Atlanta, Georgia, on November 13 and
14. Approximately 600 industry representatives attended the
session. FHA staff provided a comprehensive overview of the
program, explaining everything from borrower eligibility
criteria to servicing requirements to FHA's monitoring
practices on HOPE for Homeowners loans. The attendees were very
attentive, asking excellent questions and engaging in
substantive dialogue.
The next national FHA training session will be at the
Neighborworks Training Institute, to be held in Washington, DC,
from December 8th through December 12th. Additional counselor-
specific training will be conducted in an on-line course
offered by Neighborworks as well. Other lender and counselor
training sessions will be performed on a smaller scale, at the
local and regional level.
FHA has posted a calendar of training and outreach events
on the FHA.gov Web site, to provide consumers, counselors, and
lenders with a tool to look up events by date, location,
sponsor, and intended audience. The listing of events will be
updated on a regular basis, as the Board agencies continue to
work with industry partners to set up additional sessions. At
each of the events, staff from one or several of the HOPE for
Homeowners Board agencies will present information on the
program. The Web-based calendar of events can be found at
www.fha.gov. As of November 20, 56 sessions had been scheduled.
The national training schedule and a description of the events
held by headquarters staff are included as attachments.
Recognizing that timely outreach from the lender community
to struggling consumers is critically important, a form has
been added to the Web site for FHA-approved lenders to sign up
for the H4H program. There are currently more than 200 brokers
included on the list, which is available for consumers on
FHA.gov. Unfortunately, we have had very few originating
lenders sign up for the program to date. The lending community
not only needs time to understand the unique statutory
requirements of the H4H Program but also to modify their
protocols and practices, train their staff and update their
technology systems before they can responsibly offer it to
consumers. Consumers are strongly encouraged to contact their
servicing lender and any subordinate lien holders since their
participation is vital for a refinance into a HOPE for
Homeowners mortgage.
With regards to borrower outreach, FHA and our partner
agencies are executing an integrated consumer advertising
campaign across a variety of media including radio, print, and
the Internet. We are engaging HUD's target audiences through
various online channels, while maintaining the FHA.gov portal
in support piece in a variety of our marketing activities
communications channel. We have also leveraged HUD's field
network and industry partners to expand reach. Two online
applications are being developed by the Federal Reserve to post
on the FHA Web site. FHA also developed an online training
course for housing counselors with Neighborworks that will be
posted on the Web sites of both organizations.
Q.2. What impediments do you see to the use of the HOPE for
Homeowners program?
A.2. There are a number of specialized requirements that make
this program very different from, and more difficult than, any
other mortgage product the lending community has offered and/or
helped consumers to access.
FHA fully recognizes the challenging policy decisions that
the Congress and the Administration had to make to ensure that
any program designed to serve homeowners in need did not place
undue financial burden on American taxpayers. Nevertheless, the
lending community has consistently cited several key
shortcomings and expressed concern that the program was
unnecessarily complicated. The primary concerns raised
repeatedly are that the program:
1. imposes excessive costs on consumers
2. directs unfair payments to the Federal
government, at the expense of both lenders and
consumers
3. restricts eligibility so severely that few
homeowners in need can qualify
In line with these general concerns, FHA makes the
following specific recommendations for Congressional actions
needed to modify the program to increase uptake.
Eliminate SEM and SAM altogether
Permit subordinate liens to be placed behind HOPE
for Homeowners mortgages
Reduce 1.5% annual premium
Remove restrictive eligibility criteria,
including:
No intentional defaults
No false information on previous loan
No fraud over previous 10 years
No ownership of other residential real estate
March 1, 2008 DTI affordability measure
Remove 1st payment default provision
FHA looks forward to providing Congress with a full account
of the concerns we have been presented to begin the dialogue
about additional legislative changes that would improve program
participation.
Q.3. As you note in your testimony, FHA's loan volume has
skyrocketed over the past two years. Its market share has grown
from 2 percent to 17 percent. Please explain how FHA has
handled this huge increase in volume without compromising the
quality of the loans it has insured. Please provide the
Committee data on the types of loans insured (purchase money,
term refinance, cash out refinance, and others); the
characteristics of the loans (LTVs, sources of downpayments,
terms, and other relevant data); characteristics of the
borrowers (credit scores and other relevant data); and any
other information you think the Committee could use to evaluate
the new book of business.
A.3. The attached report provides statistics on FHA's increased
loan volume.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Q.4. Each agency represented at the hearing has aggressively
used the tools at their disposal in dealing with the crisis.
However, sometimes the use of those tools has led to unintended
consequences. For instance, when the Treasury Department
guaranteed money market funds, it led to a concern on deposit
insurance and bank accounts. When the FDIC guaranteed bank
debt, it had an effect on GSE borrowing costs, which in turn
directly affects mortgage rates.
Acknowledging that there is often a need to act quickly in
these circumstances, please explain what steps and processes
you have employed to inform other agencies about significant
actions you undertake to ensure that there are not serious
adverse unintended consequences and that your actions are
working in concert with theirs.
A.4. Developing a risk-oriented business plan early in the H4H
Program's implementation was an essential element designed to
assist the Oversight Board to ensure that the processes,
procedures, and communication requirements are put in place to
do what Congress has directed it to do. The H4H team has
developed a business plan that builds on the considerable work
already completed by the agencies to develop the Program. It is
a living document with a key purpose to assist the Oversight
Board and its member agencies to sufficiently: (1) identify and
prioritize Program risks, and to (2) develop action plans and
strategies to sufficiently mitigate the highest Program risks.
In developing this business plan the agencies operated
under the key assumptions: (1) HUD is operating the program,
(2) there is a strong preference to leverage HUD's existing
processes, and (3) to appropriately assess risk and provide
risk mitigation strategies, it is critically important to focus
on elements that are unique to the H4H program as these areas
may pose the highest risks to the Program and agencies
administering the Program. This includes identifying the new or
adapted business processes that will be required. The risk
identification also includes externalities that may be outside
of the agencies' control.
As the HOPE for Homeowners Program moves from its Startup
Phase (July 30-October 1) into its Implementation Phase
(October 1-December 31), the staffs of the Treasury Department,
FDIC, and Federal Reserve have less need for active involvement
in the day-to-day matters of the Program. Other than resources
contributed to unfinished implementation of the Program's
implementing regulations and mortgagee letters, these staff
efforts will shift to a monitoring role over this transitional
period. By the end of this Implementation Phase, FHA management
and staff will be expected to operate the program, and the
Oversight Board and its member agencies will together monitor
program performance, make recommendations for refinements or
enhancements based on feedback from the Program's results and
(if relevant) changes in the economic and housing market
environment, and their own analyses. Staffs from the agencies
will continue to communicate regularly and coordinate Oversight
Board meetings and affairs, including required monthly reports
to Congress. The Treasury Department, FDIC, and Federal Reserve
will of course be responsive to requests for resources and
assistance if needed, including but not limited to possible
exigent circumstances in the economy and/or housing market.
To facilitate this transition and to put in motion the
changed roles, the four agencies will initiate a more formal
set of staff structures and processes aimed at fulfilling these
responsibilities and maintaining attendant controls and
information flows. The chart below summarizes these structures
and processes.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
----------------------------------------------------------------------------------------------------------------
Number of
Date Event Description Audience attendees
----------------------------------------------------------------------------------------------------------------
10/1............................ FHA Conference Introductory Industry; 600+
Call. conference call Consumers.
to announce
program roll out.
10/1............................ Inside Mortgage Conference call on Industry.......... 300+
Finance. FHA modernization
included
questions on H4H.
10/2............................ Federal Reserve... H4H briefing...... Consumer affairs 12 regional banks.
office and
outreach staff.
10/6............................ National Council H4H briefing...... State Finance 30 states.
of State Housing Agencies.
Finance Agencies.
10/7............................ FHA Conference H4H briefing...... Counselors........ 200+
Call.
10/8............................ Housing summit.... 2 sessions on H4H; Government 600+
general overview officials;
and more in-depth. lenders;
counselors.
10/14........................... American Bankers H4H briefing...... ABA members....... 250+
Association (ABA).
10/15........................... FHA Conference H4H briefing Industry; 500+
Call. targeted to top government
30 FHA lenders officials.
and FHA liaisons.
10/15........................... FHA Conference H4H briefing and Counselors........ 100+
Call. discussion of
outreach efforts.
10/16........................... National Council H4H briefing...... State Finance 20 states.
of State Housing Agencies.
Finance Agencies.
10/27........................... FHA Field Briefing Field briefing for Government 100+
FHA and HUD staff officials.
who perform
outreach
activities.
10/30........................... Inside Mortgage H4H briefing...... Industry.......... 200+
Finance.
11/5............................ FHA Conference H4H briefing...... Industry.......... 200+
Call.
11/6............................ Federal Housing H4H briefing...... Government 100+
Finance Agency. officials.
11/13-14........................ National H4H National 2-day Industry; 600+
Training extensive Counselors.
Conference. training program
on H4H.
11/19........................... National Press Sec. Preston Media............. 100+
Club Event. announces
programmatic
changes to H4H
product.
11/20........................... Mortgage Bankers Issues with Industry.......... 100+
Association. implementing H4H.
12/4............................ Independent H4H briefing...... Industry.......... 300+
Community Bankers
of America.
12/5............................ Neighborworks..... Taped three hour Counselors........ n/a
online training
course.
12/8-9.......................... Neighborworks..... Two day training Counselors........ tbd
event.
----------------------------------------------------------------------------------------------------------------
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM JAMES B.
LOCKHART, III
Q.1. There has been significant confusion in the marketplace
regarding the status of debt offered by Fannie Mae and Freddie
Mac. Specifically, there is confusion as to whether or not that
debt is guaranteed by the federal government. Your revised
testimony makes it clear that the federal government is not
directly guaranteeing the debt. Rather, the government has
provided a $100 billion capital backstop to each enterprise
with which it can pay all its debts.
However, the failure to extend this guarantee has had a
number of unintended consequences in light of the government's
decision to explicitly guarantee senior debt for other
financial institutions. For example, the press reports that the
cost of raising debt for both Fannie Mae and Freddie Mac has
gone up significantly since the latter decision. In addition,
the two enterprises have apparently been unable to raise
anything but short-term funding. This leads to a number of
questions:
Q.1.a. Was FHFA consulted in the deliberations regarding
guarantee of bank debt? If so, was any consideration given to
the possibility that such a guarantee might undermine the
ability of the enterprises to fund themselves effectively?
Q.1.b. Is any thought being given, or are any discussions
underway regarding providing the enterprises with the same
guarantee as has been given to other financial institutions?
Q.1.c. One outcome of these increased funding costs is an
increase in mortgage interest rates. According to the Wall
Street Journal (October 30, 2008; ``Mortgage Plan Isn't Cutting
Rates''), rates for 30-year fixed rate mortgages have climbed
to 6.64%, up from the prior week's 6.24%. Given the fact that
one of FHFA's stated purposes for putting the enterprises into
conservatorship was to support the housing market, including
with increased purchases of agency MBS, what can be done about
these higher funding costs? Is this funding problem undermining
the ability of the enterprises to meet its mission of
maintaining a stable and orderly housing market?
Q.1.d. Please provide the Committee with data showing the
change in funding costs for the enterprises from just prior to
the conservatorship to the announcement of the guarantee for
senior debt of financial institutions to the present. Please
provide data on the associated mortgage rates over the same
period of time.
A.1.a-d Getting mortgage rates down more in line with declines
in Treasury yields has the potential to provide significant
benefit to troubled housing markets. As the attached chart and
tables show, the establishment of the conservatorships was
accompanied by a quick drop in mortgage rates of more than 40
basis points, and spreads of Enterprise yields above Treasury
yields fell comparably. Those gains appeared to erode over the
next few weeks, with continued bad news about financial
institutions and the economy. The announcement of FDIC
insurance for senior debt of insured depository institutions
coincided with further widening of yield spreads and higher
mortgage interest rates. However, it is important to note that
yields on GNMA mortgage-backed securities (MBS), which are
guaranteed with the full faith and credit of the U.S.
Government performed comparably with yields on MBS guaranteed
by the Enterprises. FHFA received a pre-announcement
notification of the senior debt guarantees. We are unaware of
any plans to extend those guarantees to the Enterprises,
something that might require legislation. Subsequently, the
Fed's announcement of $500 billion of MBS purchases and $100
billion of GSE debt purchases caused a significant decline in
Enterprise yields spreads and in mortgage rates, bringing
interest rates on 30-year fixed-rate loans to their lowest
level in the nearly 38 years' history of Freddie Mac's survey.
Q.1.e. In addition, the funding for the Federal Home Loan Banks
(FHLB) has also been rising. In fact, it is our understanding
that FHLB debt is even more expensive than debt issued by the
enterprises. What is being done to address this problem?
Q.1.f. All the housing GSEs are increasingly dependent on short
term financing. What challenges will it pose if the GSEs are
increasingly forced to depend on short-term financing to carry
on their operations?
A.1.e-f: Debt of the Federal Home Loan Banks initially
benefitted similarly to that of the Enterprises following the
establishment of the Enterprise conservatorships. Shortly
thereafter, however, Bank yields rose relative to Enterprise
yields. While debt yields of all GSEs had been very close,
differentials of as much as 60 basis points opened up at 2, 3,
and 5-year maturities. While HERA gave Treasury authority to
buy unlimited quantities of debt from any of the housing GSEs,
the preferred stock agreements were only made with Fannie Mae
and Freddie Mac because the Banks did not need that kind of
support. Nonetheless, the market seemed to view them as less
protected. Since the Fed's debt purchase plans were announced
in late November, though, yields spreads among the different
GSEs have tightened and returned to near normal amounts. All of
the housing GSEs, and especially the Enterprises depend to some
extent on their ability to issue intermediate-term debt. That
was nearly impossible in the fall, but recently increased
investor interest has permitted GSE issues of debt with
maturities of as long as five years. Conditions are still far
from satisfactory, but improving. In the meantime, purchases by
the Treasury under its GSE MBS Purchase Facility have augmented
those of the Enterprises and the Fed.
Q.1.g. In a recent story, Business Week reported that FHFA was
requiring enterprises to buy troubled mortgage assets. Is this
true? If so, what is the policy rationale for doing this?
A.1.g The story was unfounded. We did not require the
Enterprises to buy troubled assets. We believe they can best
serve the housing and mortgage markets primarily by using their
resources to maintain a liquid secondary mortgage through
purchasing and guaranteeing new loans. In addition, we have
been encouraging them to reduce foreclosures and mitigate
losses by aggressively modifying their own troubled loans and
setting a standard for others.
Q.2 Section 110 of the Emergency Economic Stabilization Act of
2008 (ESA) requires FHFA to ``Implement a plan that seeks to
maximize assistance for homeowners'' in order to avoid
preventable foreclosures. Please describe in detail your
agency's plan in this regard, and any steps that have already
been taken to implement this plan.
A.2.
a. FHFA Expertise: FHFA employs examiners and executives
who have expertise and/or experience in default management,
non-performing loans, loss mitigation and REO management. These
individuals provide supervision and oversight of both
enterprises in these areas.
b. Enterprise Internal Controls. For the last 18-months,
FHFA has focused on the loss mitigation and REO management
areas. FHFA has reviewed the enterprises' internal policies and
procedures, seller/servicer guides, bulletins and
announcements, as well as the internet sites and published
materials to support servicers' loss mitigation efforts,
activities and reporting.
c. Enterprise Reporting. FHFA consistently receives
internal monthly and quarterly management reports for non-
performing loans that include loss mitigation efforts. To
compliment these internal reports, starting in 2008, FHFA
required the enterprises to submit a monthly report on loss
mitigation activities. Data from those reports are aggregated
with results posted to FHFA's website. FHFA's Foreclosure
Prevention Report (formerly, Mortgage Metrics Reports) provides
the most comprehensive data on loss mitigation efforts (in
comparison to HOPE NOW and the OCC/OTC reports), and
continuously reports on the loss mitigation performance ratio.
This ratio has clearly brought transparency to and focus on the
enterprises' efforts in assisting borrowers.
For 2009 reporting, FHFA has enhanced reporting
requirements effective with data for January loss mitigation
actions. The additional data elements relate to expanded
modification types ( as required by EESA), the reason/s for
default, default status (e.g., bankruptcy, military indulgence,
government seizures, probate), property condition, and
occupancy status.
d. FDIC Loan Modification Program. FHFA worked with the
FDIC and the enterprises to pilot the FDIC/IndyMac loan
modification program, announced August 20, 2008. FHFA initiated
work on this effort in August 2008. Both enterprises initiated
the pilot in October.
e. Streamlined Modification Program (SMP). FHFA became
actively involved with HOPE NOW Alliance members and the
enterprises in October with the goal of rolling out a
streamlined modification program. The program was announced
November 11th and rolled out December 15th. To enhance the
success of this program, both enterprises suspended the
scheduling of and scheduled foreclosure sales on occupied
properties for the period November 26th to January 31st. The
suspension allows borrowers in foreclosure the opportunity to
cure the serious delinquency with a loan modification.
f. Loss Mitigation Programs. The enterprises, offer other
loss mitigation programs to assist borrowers in saving their
homes--forbearance plans, payment plans, a standard loan
modification and a delinquency advance program (e.g., Fannie
Mae's HomeSaver Advance program.) For borrowers who are unable
to make a payment at the most liberal modified terms, both
enterprises offer short sales, deeds-in-lieu and charge-offs in
lieu of foreclosure.
g. Loan Modification Issues. FHFA has worked with both
enterprises in reviewing accounting, trust and capital issues
that may disincent the enterprises from being aggressive with
modifications. Those issues have been addressed. The
enterprises have a solid understanding of FHFA's desired
objective of keeping borrowers in their homes. In particular,
Fannie Mae announced major changes to its trust that allow for
more flexibility with loan modifications.
h. Interagency Efforts. FHFA has continued to work with
HOPE NOW Alliance members, the OCC, OTS, HUD, FDIC and Treasury
to discuss industry issues and concerns, and the enterprises'
in particular. Results of this communication have allowed FHFA
to obtain third party views on how well the enterprises are
doing, and what they could be doing better or differently.
i. Non-Agency Investments. FHFA has taken an active role in
communicating with PLS servicers, trustees and investors to
encourage them to adopt the SMP program, or a comparable
program acceptable to all PLS investors and in compliance with
PLS pooling and servicing agreements. FHFA has supplemented
these conversations with meetings with American Securitization
Forum (ASF) officers. Doing so has not only helped borrowers
whose loan are in PLS securities, but also the enterprises who
own 20% of PLS securities.
Q.3. Discussions with a number of entities, from major lenders
and servicers to housing counselors, reveal that Fannie Mae and
Freddie Mac are resisting efforts to do loan modifications.
Please describe the efforts being undertaken by the two
enterprises, and the FHLBs, to engage in loss mitigation.
Specifically, what are the loss mitigation policies of the
GSEs? What barriers do you see in these policies to moving
toward a more systematic approach to loan modifications?
A.3.
a. Loan Modification Efforts. FHFA's oversight and
supervision of the enterprises doesn't confirm the view that
the enterprises are resisting efforts to do loan modifications.
In fact, since the early 1990s, both enterprises have been
leaders in the loss mitigation area, and set the standards for
what is best practice for the industry.
In discussing this observation with both enterprises, two
points were made. First, many servicers were unaware of the
authority the enterprises had delegated to them to review and
approve loan modifications in their behalf. Second, the
enterprises strongly believed the proper way to assist a
borrower and modify the loan is through the standard rather
than the streamlined process. The standard process requires a
customized approach to working with the borrower and his/her
circumstances based on a cash-flow budget. The streamlined
process requires an approach that is less borrower-specific,
and makes assumptions about the borrower's ability to pay at
modified terms based on a ratio analysis.
Initially, the enterprises resisted efforts to adopt a
streamlined modification program, because it wouldn't
necessarily address the individual borrower's unique situation.
Because of rising delinquencies, the increase in properties in
the foreclosure process, and servicers' capacity limitations,
the enterprises worked actively with HOPE NOW Alliance members,
and agreed to SMP program guidelines.
b. Communication from External Parties. When an external
party has contacted FHFA regarding the enterprises' actions, we
follow up with the enterprise on the specific concern. As a
result, either FHFA and/or the enterprise contacts the external
party. In addition, FHFA will discuss the situation and
circumstances, and determine if there is a more general or
broader issue that requires attention. Recently, a housing
counseling agency contacted FHFA regarding concerns around
Fannie Mae's decisions on loan modification requests. FHFA met
with the counseling agency, and asked it to provide specific
examples (cases) where borrowers had requested modifications
that were not approved by Fannie Mae. Fannie Mae was very open
to this and agreed to do so. Generally, FHFA has found it to be
more beneficial and productive to work with specific examples
and instances, than to address broad generalizations.
c. Loss Mitigation Performance. As reported in FHFA's
monthly and quarterly Foreclosure Prevention Reports through
September 2008:
1. Loss Mitigation Performance Ratio. The enterprises'
loss mitigation ratio has fluctuated from 46.9 percent to 64.8
percent from January to September, and averaged 54.6 percent.
That ratio measures the number of borrowers who were helped
versus those who needed help (were destined for foreclosure.)
FHFA's 2009 performance goals target a 25 percent increase in
loan modifications over 2008 actuals.
2. Loss Mitigation--Borrower Retained Property. Loss
mitigation actions that allowed the borrower to retain his or
her property represented 93 percent of all loss mitigation
actions--139,381 in total. Of that number, 49,128 were
completed payment plans, 45,179 were delinquency advances, and
44,458 were loan modifications.
3. Completed Foreclosures. Completed foreclosures as a
percent of new foreclosures initiated averaged 32.7 percent for
the enterprises, but 41.5 percent for OCC/OTS servicers and
42.8 percent for HOPE NOW servicers.
d. Loss Mitigation Policies, Procedures and Processes. Both
enterprises have internal policies and procedures, seller/
servicer guides, and bulletins and announcements, as well as
internet sites and materials to support servicers' loss
mitigation efforts and activities. To compliment those, the
enterprises provide training materials and training (on-line
and classes) in loss mitigation.
e. Barriers. Reported barriers to effective loan
modifications are not an outgrowth of enterprise policies. They
are:
1. Subordinate liens. There are a high number of loans
with subordinate second liens. A successful workout often
requires the cooperation of the second lien holder, who may/may
not be represented by the first mortgage servicer.
2. Unable to Contact/Locate. Servicers are often unable to
assess the borrower's financial position and/or get him or her
to commit to a loan modification because the borrower can' be
contacted, is evading the servicer's calls or letters, and/or
has abandoned the property. In many cases, the properties were
purchased as investment properties. The borrowers never
intended to live in them. If the property looses value and/or
the borrower has trouble renting the property, the borrower is
inclined to walk away from a bad investment.
3. Bankruptcy. Borrowers in bankruptcy cannot be contacted
directly by the servicer for a workout--even though they may
take this action in an effort to save their homes. Therefore,
the population of borrowers who can be solicited for a loan
modification is reduced.
4. Fraud/Misrepresentation. Given that some loans were
originated under low or no documentation programs, a review of
the defaulted borrower's situation may reveal that the borrower
never made the income to support the mortgage in the first
place. Efforts to modify the loan may be unsuccessful as the
borrower may have no ability to pay at even the most favorable
terms.
Q.4. Each agency represented at the hearing has aggressively
used the tools at their disposal in dealing with the crisis.
However, sometimes the use of those tools has led to unintended
consequences. For instance, when the Treasury Department
guaranteed money market funds, it led to a concern on deposit
insurance and bank accounts. When the FDIC guaranteed bank
debt, it had an effect on GSE borrowing costs, which in turn
directly affects mortgage rates.
Acknowledging that there is often a need to act quickly in
these circumstances, please explain what steps and processes
you have employed to inform other agencies about significant
actions you undertake to ensure that there are not serious
adverse unintended consequences and that your actions are
working in concert with theirs.
A.4. We meet frequently with other agencies to discuss policy
issues and planned significant actions. HERA specifically
provided for consultation with the Federal Reserve on
implementation of new powers and sharing of information about
the condition of our regulated entities. It also created the
Federal Housing Finance Oversight Board, which meets at least
quarterly and includes the Secretaries of Treasury and HUD, as
well as the Chairman of the SEC. The Senior Preferred Stock
Purchase Agreements signed between the Enterprises and Treasury
ensure consultation or agreement with the Treasury on many
aspects of the Enterprises activities. The EESA created the
Financial Stability Oversight Board, which includes the same
members as the FHFA Oversight Board plus the Federal Reserve
Chairman. It has met seven times, and staff have met
frequently. In addition, we have met informally with these
agencies and others numerous times in the past few months to
discuss issues, policies, and planned actions. We worked
closely, for example, with the Treasury and HUD, and consulted
with the FDIC, in developing the Streamlined Modification
Program adopted by the Enterprises and a majority of the
portfolio lenders participating in the private sector alliance
HOPE NOW to reduce foreclosures.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD
FROM ELIZABETH A. DUKE
AIG
Q.1. Former AIG CEO Hank Greenberg recently wrote a letter that
was reported in the Washington Post as saying, ``Unless there
is immediate change to the structure of the Federal loan [to
AIG], the American taxpayer will likely suffer a significant
financial loss.'' (Washington Post, November 3, 2008). However,
in the Federal Reserve Board's report to the Senate Banking
Committee about the Fed's actions with respect to AIG under
Section 13(3) of the Federal Reserve Act, the Board told the
Committee that it does not expect the loans to result in any
losses to the Federal Reserve System or the taxpayer. Can you
please explain why Mr. Greenberg is incorrect?
A.1. Outstanding advances to AIG under the credit facility
initially provided to AIG on September 16, 2008 (the Revolving
Credit Facility) are secured by the pledge of assets of AIG and
its primary non-regulated subsidiaries, including AIG's
ownership interest in its regulated U.S. and foreign
subsidiaries. AIG has announced a comprehensive and global
divestiture program to raise funds to repay the Revolving
Credit Facility. These dispositions will include subsidiaries
that rank among the largest and most prominent businesses in
the industry.
As part of our oversight activities arising from our role
as a lender to AIG, Federal Reserve staff, assisted by expert
advisers that we have retained, reviews this divestiture
program and closely monitors the company's progress in
implementing the divestiture program's objectives on an ongoing
basis, as well as cash flows and financial condition. The
Federal Government's restructuring of its financial
relationship with AIG announced on November 10, 2008, which
includes the acquisition of $40 billion in newly issued Senior
Preferred Stock of AIG by the U.S. Treasury, and the
modification of some of the initial terms of the Revolving
Credit Facility, should enhance AIG's ability to repay the
Facility by, among other things, providing additional time to
execute its asset disposition plan. Given the substantial
assets of AIG and the senior and secured position of the
Revolving Credit Facility, the Board expects that the Revolving
Credit Facility will not result in any net loss to the Federal
Reserve or taxpayers.
Advances to Maiden Lane II LLC (ML II) and to Maiden Lane
III LLC (ML III) under the credit facilities established to
partially fund the acquisition of certain AIG-related assets by
these special purpose vehicles are secured by a lien on all of
the assets held by ML II and ML III respectively. Given the
expected amounts to be realized from the cash flows produced by
these assets as well as the proceeds from disposition of these
assets over time, and the subordinated positions of AIG in ML
II and ML III, the Board does not expect any net cost to the
taxpayers as a result of the failure to repay the credit
extended by the Federal Reserve to ML II and ML III.
Q.2. What is the total sum of money the Federal Reserve System
has lent to AIG through any and all actions undertaken by the
Federal Reserve, including the Commercial Paper Funding
Facility (CPFF)? What process was used to determine AIG's
eligibility to participate in the CPFF? Did the Federal Reserve
consider the fact that AIG was already subject to special Fed
lending when deciding AIG's eligibility to participate in the
CPFF?
A.2. As initially structured in September 2008, the Revolving
Credit Facility allowed AIG to borrow up to $85 billion. From
inception of this Facility to November 5, 2008, the total
aggregate amount of borrowings were approximately $77.0
billion, of which approximately $16.0 billion was repaid on or
before that date. In connection with the U.S. Treasury's
announcement that it would acquire $40 billion in AIG Senior
Preferred Stock in November, the proceeds of which were used to
repay amounts outstanding under the Facility, the total amount
of credit permitted to be outstanding under the Facility was
reduced to $60 billion. As of December 31, 2008, AIG had
approximately $38.9 billion in advances outstanding under the
Facility.
Four AIG affiliates, AIG Funding, Inc., International Lease
Finance Corporation, Curzon Funding LLC, and Nightingale
Finance LLC, have borrowed from the CPFF. Under the terms of
the CPFF, these four affiliates may borrow an aggregate amount
of up to approximately $20.9 billion from that Facility. As of
November 5, 2008, these four affiliates had borrowed an
aggregate amount of approximately $15.2 billion under the CPFF.
By its terms, the CPFF is available to any U.S. issuer of
commercial paper that meets the eligibility requirements of the
Facility. Among other requirements, the commercial paper
financed through the CPFF special purpose vehicle must be rated
A-1/P-1/F-1 by a major nationally recognized statistical rating
organization. The fact that a particular issuer may be eligible
to borrow under; or be affiliated with an eligible borrower
under, other credit facilities established under section 13(3)
of the Federal Reserve Act does not disqualify the issuer under
the terms of the CPFF. For example, affiliates of primary
dealers that have access to the Primary Dealer Credit Facility
are not ineligible to borrow under the CPFF. The four AIG
affiliates that are borrowers from the CPFF meet the
eligibility criteria of that Facility.
The Federal Reserve Bank of New York (FRBNY) is authorized
to provide up to $22.5 billion in senior secured credit to ML
II to partially fund its acquisition of approximately $40
billion (par value) in residential mortgage-backed securities
from AIG. As of December 31, 2008, the FRBNY had lent $19.5
billion to ML II. As a result of the ML II credit facility, on
December 12, 2008, the Securities Borrowing Facility for AIG,
through which the FRBNY could lend up to $37.8 billion in cash
to AIG in exchange for collateral in the form of investment
grade securities that were being returned by AIG's securities
lending counterparties, was terminated. On November 5, 2008,
before the Securities Borrowing Facility was terminated, AIG
had borrowed approximately $19.9 billion under that Facility.
All borrowings under the Securities Borrowing Facility were
repaid in full when the facility was terminated on December 12,
2008.
The FRBNY is authorized to provide up to $30 billion in
senior secured credit to ML III to partially fund its
acquisition of approximately $69 billion (par value) of multi-
sector collateralized debt obligations (CDOs) protected by
credit default swaps (CDS) and similar contracts written by
AIG. As of December 31, 2008, FRBNY had lent $24.3 billion to
ML III.
Q.3. What is AIG's market capitalization? Is the present value
of AIG's equity and assets (using mark-to-market accounting)
greater than AIG's liability to the Federal Reserve?
A.3. As explained in response to Question 1, advances under the
Revolving Credit Facility are to be repaid with the proceeds of
asset sales by AIG, including the disposition of many of its
major U.S. and foreign insurance subsidiaries. The shares of
the insurance subsidiaries of AIG are not themselves publicly
traded or valued on a mark-to-market basis. Based on its recent
common stock price, as of year-end 2008, AIG's market
capitalization was approximately $4.2 billion. However, current
market capitalization is not necessarily a reliable indicator
of the value that the purchasers of AIG's businesses, which
rank among some of the most prominent in the industry, will pay
for these assets and thus the amount of proceeds that will be
received from the disposition of these businesses. As stated
above, in light of the substantial assets of AIG and the senior
and secured position of the Revolving Credit Facility, the
Board expects that the Revolving Credit Facility will not
result in any net loss to the Federal Reserve or taxpayers.
Q.4. How has AIG used the funding the System has provided, and
what analysis have you done to conclude that the loans will be
repaid?
A.4. Consistent with the terms of the Revolving Credit
Facility, AIG has used the proceeds of advances under the
Revolving Credit Facility for general corporate purposes,
including as a source of liquidity to pay obligations as and
when they become due. Since the establishment of the Facility,
a significant portion of the Facility proceeds has been used to
meet continued cash requirements associated with AIG's
securities lending program and for collateral calls related to
its portfolio of CDS and similar contracts AIG had written on
multi-sector CDOs. In the future, draws on the Revolving Credit
Facility are not expected to be used for these purposes to a
significant extent because the credit facilities provided to ML
II and ML III are designed to address the liquidity pressures
on AIG related to these factors. Draws on the Facility going
forward may continue to be used for other general corporate
purposes, such as to repay maturing debt obligations and
provide operating funds, loans or capital to the company's
subsidiaries.
See the answer to Question 1 for a description of the steps
Federal Reserve staff is taking with regard to assessing
whether outstanding advances under the Revolving Credit
Facility will be repaid.
Q.5. Has the Federal Reserve put any restrictions on the
lobbying activities of AIG?
Have any other restrictions been placed on AIG's
business or other activities?
A.5. As is usual in commercial lending transactions involving
distressed borrowers, the Federal Reserve has certain rights as
a creditor under the loan documentation relating to the
Revolving Credit Facility, such as the right to require that
overall corporate governance be acceptable to the Federal
Reserve. Other provisions in the loan documentation include a
prohibition, while the Federal Reserve Facility is outstanding,
on making certain types of shareholder distributions, such as
payment of dividends on common stock, and a requirement to
submit to the Federal Reserve as lender a significant number of
financial statements and reports that address a broad range of
topics relating to the financial condition and future prospects
of AIG. Regarding restrictions on its business, AIG may not
make material changes to its business activities without the
consent of the Federal Reserve, and may not enter into new swap
transactions except under policies approved by the Federal
Reserve or to hedge or mitigate risks.
Although the Federal Reserve loan documentation does not
specifically address AIG's lobbying activities, as a condition
of the Treasury's acquisition of $40 billion in Senior
Preferred Stock under the Troubled Assets Relief Program
(TARP), AIG must maintain and implement a written policy on
lobbying, governmental ethics, and political activities that,
among other things, applies to AIG and all of its subsidiaries
and affiliated foundations. This policy may not be materially
amended without the prior written consent of the Treasury.
Q.6. While financial problems in AIG Financial Products have
been detailed by the Federal Reserve and the press,
specifically regarding credit default swaps, Board staff has
indicated that the life insurance company held by AIG may also
have financial problems. Please detail these financial
problems. Please indicate whether any of the loans, and if so,
what amount, has been spent in the life insurance, and other
insurance companies.
A.6. During the first three quarters of 2008, AIG reported
significant losses arising primarily from other-than-temporary-
impairment charges on its investment portfolio, which was the
result to a significant extent of declines in the market values
of mortgage-backed securities AIG held in connection with the
securities lending program operated by AIG's regulated
insurance subsidiaries. To address the losses from this
activity during the period from inception of the Federal
Reserve's Revolving Credit Facility to November 5, 2008, AIG
had used about $19 billion of advances from the Facility to
make capital contributions to its insurance companies or to
repay obligations to the securities lending program. The ML II
credit facility was designed to help AIG address these
positions. ML II acquired from AIG's insurance subsidiaries, in
return for cash, the residential mortgage-backed securities
that these subsidiaries held as part of the securities lending
program. These actions allow ML II to manage and realize the
underlying value of these securities over the longer term, and
relieve AIG and its insurance subsidiaries from the short-term
volatility in the mark-to-market value of these assets in the
current economic environment. These actions also were designed
to enhance the safety and soundness and overall financial
condition of the insurance companies.
Q.7. In return for the Federal Reserve loan, the federal
government now controls almost 80 percent of AIG.
What federal entity is/will control this large
share of AIG?
What decisions have been made about how this
control will be exercised?
How many Federal Reserve or other federal staff
are currently on-site at AIG? Please detail the roles of these
staff.
A.7. Under the terms of the Revolving Credit Facility as
amended, AIG will issue shares of perpetual, non-redeemable
convertible preferred stock to a trust that will hold the stock
for the benefit of the U.S. Treasury. The preferred stock is
convertible into 77.9 percent of AIG's outstanding common
stock. Decisions regarding the exercise of any voting rights
associated with this preferred stock and regarding any
disposition of the stock to third parties will be made by the
independent trustees of the trust. In addition to this equity
interest, the Treasury Department, in connection with its
acquisition of $40 billion of senior preferred stock of AIG
under the TARP, also received warrants to purchase 2 percent of
the common stock of AIG. Control over these instruments is
exercised by the Treasury Department in compliance with the
rules and conditions applicable to the TARP.
A team of approximately 10 Federal Reserve staff, led by a
Senior Vice President of the FRBNY, has primary responsibility
for managing and implementing the oversight of AIG provided for
in the loan documentation relating to the Revolving Credit
Facility. Federal Reserve staff are on-site at AIG to monitor
the company's funding, cash flows, use of proceeds, and
progress in pursuing its divestiture plan. Federal Reserve
representatives are also in regular contact with AIG senior
management and attend all AIG board meetings and board
committee meetings.
Q.8. Board staff has indicated that the Federal Reserve has not
taken a close look at the solvency of the insurance companies
held by AIG because those activities are regulated at the state
level. Is this correct? Has the Federal Reserve done a thorough
analysis of AIG's insurance companies, including their
solvency?
A.8. Under the existing statutory framework, the relevant state
insurance regulatory authorities have the primary
responsibility for determining the financial condition of AIG's
insurance company subsidiaries. This includes the authority to
take action to resolve regulated insurance companies that fail
to meet the state regulator's capital, solvency, and other
regulatory requirements. As a lender to MG, the Federal Reserve
closely monitors the cash flow, earnings, and general financial
condition of the company on a consolidated basis, which
includes reviewing financial information on all of the
company's major subsidiaries, including the insurance
subsidiaries. In carrying out this oversight responsibility,
the Federal Reserve coordinates on an ongoing basis with the
appropriate state insurance authorities.
EESA
Q.9. What actions has the Board taken to implement a plan under
Section 110 of the Emergency Economic and Stabilization Act of
2008 with respect to foreclosure mitigation for mortgages or
mortgage-backed securities held, owned, or controlled by or on
behalf of a Federal Reserve Bank?
A.9. Section 110 of the Emergency Economic Stabilization Act
directs Federal property managers, to the extent that they
hold, own, or control mortgages, mortgage-backed securities,
and other assets secured by residential real estate
(residential mortgage assets), to ``implement a plan that seeks
to maximize assistance for homeowners and use its authority to
encourage the servicers of the underlying mortgages, and
considering net present value to the taxpayer, to take
advantage of the HOPE for Homeowners Program under section 257
of the National Housing Act or other available programs to
minimize foreclosures.'' Section 110 generally provides that
the Federal Reserve Board (Board) is a Federal property manager
with respect to any mortgage, mortgage-backed securities, or
pool of such securities (residential mortgage assets) held,
owned, or controlled by or on behalf of a Federal Reserve Bank
other than residential mortgage assets that are held, owned, or
controlled by or on behalf of a Federal Reserve Bank ``in
connection with open market operations under section 14 of the
Federal Reserve Act (12 U.S.C. 353), or as collateral for an
advance or discount that is not in default.''
The Board is currently not a Federal property manager for
any residential mortgage assets within the scope of section
110. To the extent that residential mortgage assets are held,
owned or controlled by the Federal Reserve Banks, these assets
are held, owned or controlled in connection with open market
operations or as collateral for advances or discounts that are
not in default, such as the credit extended to Maiden Lane
LLC.\1\
---------------------------------------------------------------------------
\1\ Maiden Lane LLC is the limited liability company to which a
portfolio of assets was transferred in connection with a loan by the
Federal Reserve Bank of New York, which facilitated the acquisition of
The Bear Stearns Companies Inc. by JPMorgan Chase & Co.
---------------------------------------------------------------------------
Nonetheless, the Board is in the final stages of developing
a foreclosure mitigation policy for use by the Federal Reserve
Banks. In addition to applying this policy in situations
required by section 110, the Board will consider whether there
are situations in which it is appropriate and feasible for the
Board to apply the policy voluntarily.
In developing this policy, the Board has consulted with the
Federal Deposit Insurance Corporation, the Federal Housing
Finance Agency, and other governmental and industry
representatives, and has carefully considered recent
developments and changes to industry protocols relating to
foreclosure mitigation. The Board expects to finalize and vote
on this policy soon and will promptly submit a copy of its
policy once approved to Congress. The goal of the policy will
be fully consistent with the requirements and goals of section
110 to offer distressed homeowners a sustainable loan
modification when such action would result in a higher expected
net present value (NPV) than would be expected through
foreclosure.
Specifically, what goals has the Board
established for the number or percentage of mortgages that
should be modified to comply with the Act?
Any portfolio that becomes subject to the Board's
foreclosure mitigation policy will contain unique
characteristics, such as the number of whole residential
mortgage loans versus residential mortgage-backed securities,
the percentage of senior mortgage loans versus subordinate
mortgage loans, and the number of performing loans versus non-
performing loans. To account for these variables, the Board
does not expect to establish a pre-set number or percentage of
loans that must be modified under its policy.
However, as noted above, the Board's over-arching goal
under the policy will be to try to keep consumers in their
homes by offering sustainable loan modifications when the
expectedNPV of a loan modification would be greater than the
expected NPV of the net proceeds to be received through foreclosure.
What process has the Board established to
communicate the plan, including modification goals, to Maiden
Lane or the regional Federal Reserve Bank that would serve as
the agent for the Board in carrying out its duty under the law?
As noted above, the Board is in the final stages of
developing a foreclosure mitigation policy to guide the Federal
Reserve Banks in the event that the Board becomes a Federal
property manager. The Board will transmit that policy to the
Reserve Banks and require that the Reserve Banks, and any
agents they may hire to assist in the management or servicing
of the mortgage portfolios subject to section 110, abide by the
policy.
How many Bear Stearns loans have been modified to
date and what were the terms?
Wells Fargo & Company (Wells Fargo) and EMC Mortgage
Corporation currently act as the servicers of the whole
residential mortgages that serve as collateral for the loan to
Maiden Lane LLC. Both Wells Fargo and EMC Mortgage are members
of the HOPE NOW Alliance and utilize industry standard
protocols for loan modifications that are consistent with the
standards and guidelines established by the HOPE NOW Alliance.
Loan modifications for mortgages that serve as collateral for
the loan to Maiden Lane LLC have been offered to delinquent
borrowers who are facing other-than-temporary economic
hardships, but who may have the capacity to perform on the loan
following a modification of terms that provides an expected NPV
greater than what would be expected through foreclosure.
Workout plans, which are not formal loan modifications, are
offered to borrowers with temporary problems and need
assistance bringing their account current through short-term
modifications to their payments.
The ability to offer loan modifications and workout plans
for loans that serve as collateral for the extension of credit
to Maiden Lane LLC is contingent on whether the subject assets
are whole mortgage loans rather than mortgage-backed
securities. Because mortgage-backed securities are pools of
mortgages in which the Federal Reserve Bank only holds a
fractional interest along with other investors, the Reserve
Bank does not have direct control over the servicing of those
residential mortgage assets. The majority of residential
mortgage assets that serve as collateral for the loan to Maiden
Lane LLC are in the form of residential mortgage-backed
securities. Moreover, all of the residential whole loans in the
portfolio were performing as of March 14, 2008, when Maiden
Lane LLC acquired the portfolio.
As of November 30, 2008, slightly more than 11 percent of
the residential mortgage whole loans that serve as collateral
for the loan to Maiden Lane LLC and that were both
nonperforming and more than 60 days past due had been
permanently modified through a reduction in interest rate, an
extension of term, a deferral or reduction in the principal
balance, or a combination of such actions. Typically, permanent
loan modifications initially are considered when borrowers
become 60 days or more past due.
The number of permanent loan modifications is expected to
increase in the coming months. A significant portion of the
loans currently 60 days or more past due only reached this
stage recently and, as you know, the loan modification process,
even under the best of circumstances, can take time, as the
borrower must be contacted and appropriate analysis conducted
to confirm that a modification is both appropriate and
sustainable. Moreover, the loan modifications currently offered
to borrowers for the loans backing the credit extension to
Maiden Lane LLC become permanent only after a borrower makes
three timely payments under the modified terms. Therefore, the
number of permanently modified loans is expected to increase as
more delinquent borrowers are contacted and finish the
negotiation process and as borrowers that are in their three-
month verification period fulfill their obligations and receive
permanent loan modifications.
In addition, many delinquent borrowers are receiving
flexible terms and assistance that may lead to loan workouts in
forms other than formal loan modifications--for example, short
sales or in the case of borrowers facing temporary financial
hardships, a repayment plan. These workouts are not included in
the stated percentage of loan modifications.
Q.10. I commend the Administration for following through with
Section 112 of EESA by convening an international summit on
November 15th. In announcing the summit, the White House
explained that leaders of the G20 and key international
financial institutions will review progress on measures taken
to address the financial crisis and to discuss principles for
reform of regulatory and institutional regimes going forward.
Please describe what the Federal Reserve and Treasury
Department intend to accomplish through this summit and the
subsequent working group meetings that will follow the summit--
specifically, what types of principles for regulatory and
institutional modernization will the United States pursue in
the international community? Will these principles include
protections for consumers and households which form the
foundation of economic prosperity in our country as well as
other countries?
A.10. In a statement released following their November 15
meeting, the G-20 Heads of State articulated five key
principles that will govern efforts by the official sector to
reform the global financial system. These principles include
strengthening transparency and accountability of financial
markets and financial institutions, enhancing sound regulation,
promoting integrity in financial markets, reinforcing
international cooperation, and reforming international
financial institutions. These efforts are constructive and
should help to make the global financial system more robust and
resilient. The Federal Reserve is working with its counterparts
in the G-20 to identify and implement specific measures that
will contribute to achieving these five principles. Initiatives
to protect consumers and households are central to these
efforts. The statement from the G-20 Heads of States emphasized
that bolstering consumer protection is an essential step toward
protecting the integrity of global financial markets. Consumers
and households benefit both directly and indirectly as the
financial system becomes stronger, better regulated, and more
transparent.
Commercial Paper Funding Facility
Q.11. What real assets are securing loans made under the CPFF
to special purpose vehicles?
A.11. The loans made under the CPFF to the special purpose
vehicle (SPV) are collateralized by the highly rated commercial
paper purchased by, and the fees collected by, the SPV.
Q.12. What has the Federal Reserve done to clarify the effect
of the CPFF on the daily rates reported in the Board's H-15
data release?
What has the Board done to make clear that the
support provided by the CPFF has altered the overall commercial
paper rate?
Does the H-15 data still represent an actual
market rate, without credit enhancement by the CPFF or any
other recent government action?
A.12. On November 5, 2008 we added the following footnote to
the H-15 release:
Financial paper that is insured by the FDIC's Temporary
Liquidity Guarantee Program is not excluded from relevant
indexes, nor is anyfinancial, nonfinancial, or asset-backed
commercial paper that may be directly or indirectly affected by
one or more of the Federal Reserve's liquidity facilities. Thus
the rates published after September 19, 2008, likely reflect
the direct or indirect effects of the new temporary programs
and, accordingly, likely are not comparable for some purposes
to rates published prior to that period.
The commercial paper rates published on the H-15 release
have and continue to be a reflection of actual transactions
that take place in the U.S. commercial paper market. We have
never screened out transactions with third-party credit
enhancements.
Q.13. What analysis has the Federal Reserve undertaken to
determine which markets usually use the 90-day commercial paper
rate in conducting their business?
Which of the markets, if any, did the Fed
determine use this rate regularly in their business operation?
What steps, if any, has the Federal Reserve taken
to assure that the actions to lower the costs of issuing
commercial paper are not having an adverse impact on other
markets which are pegged to the 90-day financial commercial
paper?
Was a similar analysis conducted with respect to
possible implications for markets that use other short term
(under 365-day) commercial paper as a result of the
establishment of the CPFF?
What steps, if any, has the Federal Reserve taken
to assure that the actions to lower the costs of issuing
commercial paper is not having an adverse impact on those other
markets?
A.13. By law, the reimbursement rates on student loans are tied
to the 90-day financial CP rate. In addition, dealers report
that some financial contracts (e.g., derivatives) settle on
certain CP rates published by the Federal Reserve.
The link of the reimbursement rate on student loans to the
90-day financial CP rate has become problematic for student
lenders, because their cost of funds tends to be tied to Libor,
and the spread between Libor and the fmancial CP rate has moved
against them. Importantly, the wider spread likely reflects
pressures on the Libor rate as well as the CP rate. In
addition, this spread first widened a few weeks before the CPFF
began operation.
To ensure that market participants fully understand our
methodology for calculating CP rates, we published the
following announcement on the Federal Reserve's commercial
paper website on November 5, the first paragraph of which was
also added (as already mentioned in our response to Question
11) as a footnote to the Federal Reserve's H-15 release:
CLARIFICATION OF CRITERIA CONSIDERED FOR COMMERCIAL PAPER RATES
Financial paper that is insured by the FDIC's Temporary
Liquidity Guarantee Program is not excluded from relevant
indexes, nor is any financial, nonfinancial, or asset-backed
commercial paper that may be directly or indirectly affected by
one or more of the Federal Reserve's liquidity facilities. Thus
the rates published after September 19, 2008, likely reflect
the direct or indirect effects of the new temporary programs
and, accordingly, likely are not comparable for some purposes
to rates published prior to that period.
Through November 4, the documentation on the ``About'' page
of this release indicated that paper issued under ``credit-
enhanced programs'' was excluded from the samples of issues
used to calculate reported rates. This wording was intended to
convey that asset-backed commercial paper was excluded from the
calculation of financial rates. Indeed, consistent with that
intent, the Federal Reserve has, since 2006, published a
separate rate series for asset-backed commercial paper. To
avoid confusion, the reference to ``credit-enhanced programs''
will be dropped.
Too Big to Fail
Q.14. When Chairman Bernanke testified before this Committee in
support of emergency legislation to stabilize the economy, he
acknowledged that we have a ``serious `too big to fail' problem
in this country,'' and that ``it is much worse than we thought
it was coming into this crisis.'' Ironically, as Gary Stern,
President of the Federal Reserve Bank of Minneapolis points
out, ``The too-big-to-fail problem . . . has been exacerbated
by actions taken over the past year to bolster financial
stability.'' In surveying the financial landscape, one is
struck by the fact that we are seeing increased consolidation
of financial institutions--not just of commercial banks, but
including enormous combinations of commercial and investment
banks. In fact, news-reports indicate that a number of the
institutions that received capital injections are using them to
do additional acquisitions.
Are such consolidations increasing our ``too big
to fail'' problem, thereby increasing the problem of moral
hazard? If so, what do we do about it?
A.14. Working with the Treasury, the FDIC, and other agencies,
the Federal Reserve believes that we must take all steps
necessary to minimize systemic risk. We are also concerned
about actions that increase moral hazard. As the Federal
Reserve has previously noted, the acquisition of a troubled
financial institution by a healthy firm can significantly
mitigate risks to the financial system as a whole, preserve
banking services in affected communities, and reduce the costs
to taxpayers. Although preserving market discipline and
avoiding moral hazard are extremely important, in exceptional
circumstances it may be necessary for the government to
intervene to protect financial and economic stability by taking
steps to avoid the threat that could result from the failure of
a major financial institution when financial markets are
already quite fragile. The problems that result from moral
hazard and the existence of institutions that are ``too big to
fail'' must be addressed through prudent decisionmaking by
government agencies, regulatory changes, improvements in the
financial infrastructure, and other measures designed to
prevent reoccurrence of threats to overall financial stability.
Reforming the system to address these problems should be a top
priority for lawmakers and regulators.
Q.15. Each agency represented at the hearing has aggressive!),
used the tools at their disposal in dealing with the crisis.
However, sometimes the use of those tools has led to unintended
consequences. For instance, when the Treasury Department
guaranteed money market funds, it led to a concern on deposit
insurance and bank accounts. When the FDIC guaranteed bank
debt, it had an effect on GSE borrowing costs, which in turn
directly affects mortgage rates.
Acknowledging that there is often a need to act quickly in
these circumstances, please explain what steps and processes
you have employed to inform other agencies about significant
actions you undertake to ensure that there are not serious
adverse unintended consequences and that your actions are
working in concert with theirs.
A.15. For many years, the Federal Reserve has worked with other
government agencies--including the Treasury Department, the
Securities and Exchange Commission, the Commodity Futures
Trading Commission, and the other banking agencies--through the
President's Working Group on Financial Markets and in other
forums, to foster the safety and soundness of financial
institutions and the stability of financial markets. During the
financial crisis, this collaboration has increased greatly, and
includes regular conference calls at the principals' level as
well as formal and informal staff contacts with a range of
other agencies to exchange information on financial
developments and to discuss possible policy responses.
Such interactions have contributed importantly to the
policy response to the crisis. Indeed, in some cases joint
decisions by multiple agencies are required to take particular
policy steps. For example, in order for the FDIC to invoke the
systemic risk exception to the general requirement for least-
cost resolution of a troubled insured depository institution,
both the FDIC and Federal Reserve Boards must recommend such a
step by two-thirds majorities and the Secretary of the
Treasury, in consultation with the President, must determine
that a least-cost resolution would have serious adverse effects
on economic conditions or financial stability, and that a non-
least-cost resolution would avoid or mitigate such adverse
effects. This process, which involves considerable interaction
between the three agencies at both the staff level and the
principals' level, has been undertaken three times this fall,
in connection with the difficulties of Wachovia and Citibank
and with the establishment of the FDIC's Temporary Liquidity
Guarantee Program. Similarly, some other policy actions have
involved more than one agency, and so by necessity have
required extensive inter-agency consultation. An example is the
Term Asset-Backed Securities Loan Facility, which calls for an
equity investment by the Treasury Department and credit
provided by the Federal Reserve. Even when joint action not
been formally required to adopt a particular policy, the
Federal Reserve has found it useful to exchange views regarding
the possible policy in order to benefit from the assessments of
other agencies. In many cases such consultations have been
organized by Treasury Department and have included a wide range
of government agencies.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR ENZI FROM ELIZABETH A.
DUKE
Q.1. As someone with extensive background in the banking
industry, what is your opinion of the recent action taken by
the SEC and FASB to clarify mark-to-market accounting
regulations? Do you feel such clarification was beneficial for
our banking industry? What about the financial market as a
whole?
A.1. As the question indicates, the SEC and FASB issued a press
release on September 30, 2008 containing certain clarifications
related to the fair value accounting guidance contained in FASB
Statement No. 157, Fair Value Measurements, for the benefit of
auditors and preparers of financial statements. Subsequently,
the FASB issued FASB Staff Position No. FAS 157-3, Determining
the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active. Those formal actions were supplemented by
a number of roundtable sessions and other meetings and
presentations during which SEC and FASB staff discussed
practical challenges involved in performing fair value
measurements in markets that have become significantly less
active.
Generally, guidance was helpful to banks and financial
markets because it addressed some of the challenges of
measuring fair values in inactive markets. However, this
guidance did not significantly reduce the uncertainties around
the quality of fair value measurements that users and investors
are experiencing. This may indicate that additional information
and guidance may be necessary to address these uncertainties.
The Federal Reserve is supportive of further efforts by the SEC
and the FASB to clarify existing fair value accounting
guidance.
In addition, as the SEC completes its study of ``mark-to-
market'' accounting by January 2, 2009 as required by the
Emergency Economic Stabilization Act of 2008, we will review
the report and consult with the SEC regarding additional steps
that may be deemed necessary in light of recent market events.
If necessary, such steps could range from modifications of
accounting requirements to additional clarification of existing
guidance. Combined with steps that have already been completed
to provide clarifying guidance, we trust that actions taken in
response to the SEC study will benefit both the banking
industry and the financial market as a whole.
Q.2. It is possible this committee will be revisiting the
regulation of credit default swaps (CDS) and other previously
unregulated derivative contracts in the near future. Do you
believe the proper entity to regulate such financial products
is the Federal Reserve? If not, which regulator is best suited
to oversee these financial products in your opinion?
A.2. On November 14 the President's Working Group on Financial
Markets (PWG) announced a broad set of policy objectives to
guide efforts to address the full range of challenges
associated with CDS and other OTC derivatives, including
improving the transparency and integrity of the CDS market,
enhancing risk management of OTC derivatives, further
strengthening the OTC derivatives market infrastructure, and
strengthening cooperation among regulatory authorities. The
Federal Reserve believes that this cooperative approach to
these issues, which draws on the strengths and broad existing
authority of the various federal agencies, is likely to be more
effective at addressing these concerns than assigning authority
to oversee CDS to the Federal Reserve or any other single
agency.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM
ELIZABETH A. DUKE
Q.1. I am gravely concerned, about a situation whereby banks
are taking advantage of AIG's low credit rating to make a
windfall off of transactions they have with our nation's mass
transit agencies. Is the Treasury willing to appoint a senior
official to work with the Fed, the IRS, and these public
transit agencies to make sure taxpayer money is protected?
Given the urgent nature of this situation I would like an
answer to this question by Tuesday October 28. (Please contact
my staffer Hal Connolly at 202-224-4744 if you have any further
questions)
Q.2. Our nation's public transit agencies are potentially
liable for payments in the hundreds of millions of dollars to
banks due to the downgrading of AIG through LILO/SILO leveraged
leases. Does the Treasury and the Fed think it appropriate that
these banks are in a position to make a windfall at the expense
of these public agencies? Without action by the Treasury banks
stand to gain all of the benefits the IRS has declared to be
inappropriate. Has the IRS backed away from its previous
position on these leases?
A.1.-A.2. As you indicate, a number of transit authorities have
issued obligations that were guaranteed in whole or in part by
American International Group, Inc. (MG) as part of complex,
tax-driven lease transactions.
It was precisely for the purpose of limiting the potential
adverse effects on the economy of the failure of AIG that the
Federal Reserve, on September 16, 2008, extended a line of
credit to AIG in the amount of $85 billion. The Federal Reserve
was concerned that the disorderly failure of MG during the
current period of economic turmoil and fragile markets would
have wide-ranging systemic effects and exacerbate the already
troubled economic situation.
Since that time, the Federal Reserve, working with the
Department of the Treasury, has taken additional actions to
help restore confidence in AIG to allow it to maintain its
credit ratings and conduct its business while it engaged in an
orderly restructuring. On November 10, 2008, the Federal
Reserve restructured its credit facility and agreed to provide
two additional liquidity support facilities to AIG. At the same
time, the Department of the Treasury provided an emergency
injection of capital to the company.
While the Federal Reserve has used its authority to provide
liquidity to AIG, the Federal Reserve does not have authority
to cure the potential technical defaults on the transit
authority bonds, which are based on the credit ratings of MG.
The credit ratings for AIG are not established by the Federal
Reserve, though the actions of the Federal Reserve and the
Treasury in providing funding to MG have helped to stabilize
those ratings. We understand that the transit authorities are
in discussions with lenders to find mutually agreeable ways to
cure the potential defaults.
We recognize the importance of mass transit to communities,
both as a matter of the economic contribution that mass transit
makes to urban communities in particular and in the effects it
has on the lives of users of mass transit. This is an important
issue that we are monitoring carefully.