[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

                     FANNIE MAE, FREDDIE MAC & FHA:



                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION


              HEARING HELD IN WASHINGTON, DC, JUNE 2, 2011


                            Serial No. 112-9


           Printed for the use of the Committee on the Budget

                       Available on the Internet:

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                        COMMITTEE ON THE BUDGET

                     PAUL RYAN, Wisconsin, Chairman
SCOTT GARRETT, New Jersey            CHRIS VAN HOLLEN, Maryland,
MICHAEL K. SIMPSON, Idaho              Ranking Minority Member
JOHN CAMPBELL, California            ALLYSON Y. SCHWARTZ, Pennsylvania
KEN CALVERT, California              MARCY KAPTUR, Ohio
W. TODD AKIN, Missouri               LLOYD DOGGETT, Texas
TOM COLE, Oklahoma                   EARL BLUMENAUER, Oregon
TOM PRICE, Georgia                   BETTY McCOLLUM, Minnesota
TOM McCLINTOCK, California           JOHN A. YARMUTH, Kentucky
JASON CHAFFETZ, Utah                 BILL PASCRELL, Jr., New Jersey
MARLIN A. STUTZMAN, Indiana          MICHAEL M. HONDA, California
JAMES LANKFORD, Oklahoma             TIM RYAN, Ohio
DIANE BLACK, Tennessee               DEBBIE WASSERMAN SCHULTZ, Florida
REID J. RIBBLE, Wisconsin            GWEN MOORE, Wisconsin
BILL FLORES, Texas                   KATHY CASTOR, Florida
MICK MULVANEY, South Carolina        HEATH SHULER, North Carolina
TIM HUELSKAMP, Kansas                PAUL TONKO, New York
TODD C. YOUNG, Indiana               KAREN BASS, California
FRANK C. GUINTA, New Hampshire

                           Professional Staff

                     Austin Smythe, Staff Director
                Thomas S. Kahn, Minority Staff Director

                            C O N T E N T S

Hearing held in Washington, DC, June 2, 2011.....................     1

    Hon. Paul Ryan, Chairman, Committee on the Budget............     1
        Prepared statement of....................................     2
        Questions submitted for the record.......................    62
    Hon. Chris Van Hollen, ranking minority member, House 
      Committee on the Budget....................................     3
        Additional submissions for the record:
            Statements from the National Association of Realtors 
              and the National Association of Home Builders......     3
            ``Table S-12.--Market Valuation and Balance Sheet of 
              Fannie Mae and Freddie Mac,'' (OMB)................    35
    Hon. John Campbell, a Representative in Congress from the 
      State of California, submission for the record:
        Letter, dated June 1, 2011, from the National Association 
          of Realtors............................................     6
    Hon. Scott Garrett, a Representative in Congress from the 
      State of New Jersey, submissions for the record:
        Letter, dated June 2, 2011, from Douglas M. Bibby and 
          Douglas S. Culkin......................................     7
        Prepared statement of Peter Evans, partner, Moran & Co., 
          on behalf of the National Multi Housing Council and the 
          National Apartment Association, dated May 25, 2011, 
          before the Insurance, Housing and Community Opportunity 
          Subcommittee, House Committee on Financial Services....     8
    Deborah J. Lucas, Assistant Director, Congressional Budget 
      Office.....................................................    15
        Prepared statement of....................................    17
        Response to questions submitted for the record...........    63
    Alex J. Pollock, resident fellow, American Enterprise 
      Institute..................................................    17
        Prepared statement of....................................    19
        Response to questions submitted for the record...........    64
    Sarah Rosen Wartell, executive vice president, Center for 
      American Progress Action Fund..............................    24
        Prepared statement of....................................    27
    Hon. Marcy Kaptur, a Representative in Congress from the 
      State of Ohio, submissions for the record:
        ``Banks Bundled Bad Debt, Bet Against It and Won''.......    65
        ``The Giant Revolving Door of Regulatory Hostage-Taking''    69
        ``Evanston's Magnetar Benefited From TALF''..............    72
        Article by Kenneth E. Scott and John B. Taylor, Wall 
          Street Journal.........................................    73
        ``Bill Shields Most Banks From Review''..................    74
        ``Erin Go Broke''........................................    76
        ``Report on Foreign Portfolio Holdings of U.S. Securities 
          as of June 30, 2008,'' Internet address to.............    77
        ``Firms Have Argued for Higher Investment Caps''.........    77
        ``Freddie Mac Says U.S. Investigation Dropped''..........    78
        ``Geithner, Member and Overseer of Finance Club''........    78
        ``The Help Fannie and Freddie Need''.....................    85
        ``Federal Reserve Bank of New York: Primary Dealers 
          List''.................................................    86
        ``Buffett Testifies That He Saw Early Signs of Freddie 
          Mac's Woes''...........................................    87
        ``The Real Size of the Bailout''.........................    88
        ``Too Big to Jail? Time to Fix Wall Street's 
          Accountability Deficit''...............................    90
        ``All Boarded Up''.......................................    91



                         THURSDAY, JUNE 2, 2011

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 10:30 a.m., in room 
210, Cannon House Office Building, Hon. Paul Ryan [Chairman of 
the Committee] presiding.
    Present: Representatives Ryan, Garrett, Campbell, Black, 
Mulvaney, Young, Rokita, Van Hollen, Kaptur, Doggett, McCollum, 
Pascrell, Honda, Wasserman Schultz, and Castor.
    Chairman Ryan. Good morning. Welcome all to this very 
important hearing. The purpose of today's hearing is to 
highlight the true cost and risk posed by the government's 
ongoing bailout of Fannie Mae and Freddie Mac. It also seeks to 
shed some light on the hidden cost of the mortgage insurance 
program run by Federal Housing Administration. This is 
obviously a very complex subject, but a critically important 
issue. The federal take-over of Fannie and Freddie is the most 
costly taxpayer bailout in the wake of the 2008 financial 
    For years, we were told Fannie and Freddie posed no 
liability to the Federal Government. Through their unique 
status cultivated through political influence, they pursued, 
what I would call ``crony capitalism.'' And the taxpayer is now 
being stuck with the bill. To date, the Treasury Department has 
provided about a $160 billion to Fannie and Freddie, and the 
CBO estimates that they are all end-cost for the decade will be 
about $370 billion. While the Treasury Department has put 
forward a framework for reform, the Obama administration still 
does not account for these estimated future costs in its 
budget, even though it has lifted the cap on Fannie and 
Freddie's line of credit. When it comes to this ongoing bail 
out of Fannie and Freddie, taxpayers have a right to know how 
much they are on the hook for. FHA is different than these two 
GSEs because it is included in federal budget totals. However, 
the current budgetary treatment of FHA under states the risks 
and costs of FHA guarantees, which now amount to nearly a fifth 
of all new single-family home loans. While CBO adjusts the cost 
of Fannie and Freddie loans for market risk under Federal 
Credit Reform Act, budget projections do not incorporate market 
risk into the cost of FHA guarantees. The housing market is 
still in a very fragile shape; all the recent news confirms 
this. There are no two ways about it.
    For the homeowners, for taxpayers and for working families 
across this country, we need to put an end to an ongoing 
bailout of Fannie and Freddie and advanced serious permanent 
solutions. That starts with a full accounting of their 
activities. We must advance plans to reform Fannie and Freddie 
to fully account for FHA loans and to stop the hemorrhage of 
taxpayer dollars and to limit the government's dominance and 
distortion of housing finance.
    I look forward to hearing from our witnesses today 
regarding these serious problems, and I look forward to a 
constructive debate on how we can save taxpayers from the 
consequences of misguided housing policy and crony capitalism, 
now and in the future.
    We have our own experts from our side of the aisle, Mr. 
Garrett and Mr. Campbell, who are senior members of the Banking 
and Financial Services Committee. But before I turn it over to 
the witnesses, I would like to recognize, Mr. Van Hollen for 
his opening statement.
    [The prepared statement of Chairman Paul Ryan follows:]

            Prepared Statement of Hon. Paul Ryan, Chairman,
                        Committee on the Budget

    Welcome all, to this important hearing. The purpose of today's 
hearing is to highlight the true costs and risks posed to taxpayers by 
the government's ongoing bailout of Fannie Mae and Freddie Mac.
    It also seeks to shed light on the hidden costs of the mortgage 
insurance program run by the Federal Housing Administration. This is a 
complex subject, but it is a critically important issue.
    The federal takeover of Fannie and Freddie is the most costly 
taxpayer bailout to result from the 2008 financial crisis.
    For years we were told Fannie and Freddie posed no liability to the 
Federal Government. Through their unique status, which they cultivated 
through political influence, they pursued what I call crony capitalism. 
And now, the taxpayer is stuck with the bill.
    To date, the Treasury Department has provided about $160 billion to 
Fannie and Freddie, and the Congressional Budget Office estimates their 
all-in cost for the decade will be about $370 billion.
    While the Treasury Department has put forward a menu of options for 
reform, the Obama administration still does not account for these 
estimated future costs in its budget, even though it has lifted the cap 
on Fannie and Freddie's line of credit.
    When it comes to this ongoing bailout of Fannie and Freddie, 
taxpayers have a right to know how much they are on the hook for.
    FHA is different from the two GSEs because it is included in 
federal budget totals. However, the current budgetary treatment of FHA 
understates the risk and cost of FHA guarantees, which now amount to 
nearly a fifth of all new single family home loans.
    The CBO adjusts the cost of Fannie and Freddie loans for market 
risk. But under the Federal Credit Reform Act, budget projections do 
not incorporate market risk into the cost of FHA guarantees.
    The housing market is still in very fragile shape--no two ways 
about it. For the homeowners, for taxpayers, and for working families 
across this country, we need to put an end to the ongoing bailout of 
Fannie and Freddie and advance serious solutions.
    That starts with a full accounting of their activities. We must 
advance plans to reform Fannie and Freddie; to fully account for FHA 
loans; to stop the hemorrhaging of taxpayer dollars; and to limit 
government's dominance and distortion of housing finance.
    I look forward to hearing from our witnesses today regarding these 
serious problems, and I look forward to a constructive debate on how we 
can save taxpayers from the consequences of misguided housing policy 
and crony capitalism, now and in the future.
    I'd like to welcome our panel of distinguished witnesses.
    Dr. Deborah Lucas, Assistant Director for Financial Analysis at the 
Congressional Budget Office--we are grateful to have her testimony 
before she returns to MIT's Sloan School of Management as a professor 
of finance.
    We also have Alex Pollock from the American Enterprise Institute--
who has years of housing and finance expertise, including serving as 
President of the Federal Home Loan Bank of Chicago.
    I'd like to finally welcome to the Committee Sarah Rosen Wartell, 
with us today from the Center for American Progress and Center for 
American Progress Action Fund.
    Thank you for testifying this morning, and with that, I yield to 
the Ranking Member, Mr. Van Hollen.

    Mr. Van Hollen. Well, thank you, Mr. Chairman. And let me 
also join you in welcoming our witnesses today. As the chairman 
said, this hearing focuses on a number of issues, including the 
technical issue of how to best account for the cost of federal 
support for the housing markets, both now and possibly into the 
future. That is a very important question. Whatever method we 
use should accurately and transparently provide the best 
estimate of what those costs are to the taxpayer.
    But the larger question, and the one that will have a much 
bigger impact on taxpayers and the economy are what housing 
policies decisions we make going forward, and how they will 
first influence the ultimate cost to taxpayers and homeowners 
of the book of business originated before the housing crisis 
and the financial melt-down; and two, whether our housing 
policies decision going forward will ensure that creditworthy 
borrowers will still have access to credit and be able to 
achieve the American Dream of homeownership.
    I do not know anyone who has proposed that we return to a 
system of what amounted to first an implicit and then an 
explicit government guarantee. The Treasury Department's 
February white paper on housing reform calls for reducing 
overall government support for the housing market and winding 
down Fannie Mae and Freddie Mac. The key question is what would 
a reformed housing market look like and what role, if any, 
should the Federal Government have in that. As the chairman 
mentioned, and we all know, the housing market is in a very 
fragile state right now.
    One proposal that has been advanced by Congressman 
Hensarling and six members of this committee, would very 
quickly end any federal role in the housing market. I am very 
concerned that those proposals, which would create fire sales 
of GSE portfolios, would only further depress home values and 
reduce the return to taxpayers of the current portfolio at 
Fannie Mae, regardless of what cost accounting method we use. 
Those concerns are shared by many others. And Mr. Chairman, I 
ask unanimous consents just to put in the records, statements 
from the home builders and the realtors, people who are, of 
course, intimately involved in the housing market.
    Chairman Ryan. Without objection.
    [The information follows:]

                          National Association of Realtors,
                                    Washington, DC, March 31, 2011.
Hon. Chris Van Hollen, Ranking Democrat,
House Committee on the Budget, Washington, DC 20515.
         realtors urge congress to approach gse reform slowly
    The National Association of REALTORS today urged Congress to move 
cautiously when reforming government-sponsored enterprises Fannie Mae 
and Freddie Mac.
    Reforming America's housing finance market can only be achieved 
through a forward looking, comprehensive approach that supports the 
housing and economic recoveries, said NAR President Ron Phipps in 
testimony before the House Subcommittee on Capital Markets today.
    ``As the leading advocate for home ownership, NAR strongly agrees 
that the existing system failed and that reforms are needed; however, 
redesigning a viable secondary mortgage model that will protect 
taxpayer dollars and serve the country's home owners today, and in the 
future, can only be achieved through a methodical, measured effort,'' 
said Phipps, broker-president of Phipps Realty in Warwick, R.I.
    NAR is concerned that without a comprehensive plan for reforming 
the secondary mortgage market, proposed legislation to quickly 
constrain Fannie Mae and Freddie Mac before an adequate replacement 
secondary mortgage market mechanism is established will further disrupt 
the still fragile housing market recovery.
    ``REALTORS agree that increasing private capital in the mortgage 
finance market is necessary for a healthy market and for reducing the 
government's involvement; however, proposed legislation that relies 
only on private capital to operate the secondary mortgage market will 
slow, if not stop, the housing and economic recovery,'' he said.
    Phipps testified that the pendulum on mortgage credit has already 
swung too far in the wrong direction and is hurting consumers and the 
economy. He added that quick decisions aimed at punishing certain 
market players will only punish the taxpayers by constraining their 
ability to access affordable mortgage financing, and that making it 
harder for those who can afford a safe mortgage does not further the 
goals of the recovery.
    ``Home ownership is a pillar of our economy. NAR research shows for 
every two homes sold, a job is created, providing needed revenue to 
both our state and local economies. This must be considered when 
debating the future of federal housing policies,'' said Phipps.
    He added that overreaching rules, like the qualified residential 
mortgage (QRM) exemption, could further curtail access to affordable 
credit and will only slow economic growth and hamper job creation.
    ``The QRM is likely to shape housing finance for the foreseeable 
future, and we believe that Congress intended to create a broad QRM 
exemption from the 5 percent risk retention requirement to include a 
wide variety of traditionally safe, well-underwritten products,'' said 
Phipps. ``Congress chose not to include a high down payment among the 
criteria it specified in the Dodd-Frank Act. A poor QRM policy that 
does not heed their intentions will only increase the cost and reduce 
the availability of mortgage credit.''
    The National Association of REALTORS, ``The Voice for Real 
Estate,'' is America's largest trade association, representing 1.1 
million members involved in all aspects of the residential and 
commercial real estate industries.

                                      Washington, DC, May 10, 2011.
                     housing finance market reform
            must ensure mortgage affordability, availability
    Reforms to America's housing finance market must ensure a reliable 
source of affordable mortgage lending for creditworthy consumers. 
That's according to Realtors and other industry insiders who examined 
the Federal Government's future role in the secondary mortgage market 
at the ``Fannie Mae & Freddie Mac: Obama Options and Beyond'' session 
during the National Association of Realtors, here through May 14.
    Panelist Steve Brown, 2011 NAR first vice-president nominee, opened 
the session by outlining NAR's position for reforming the government-
sponsored enterprises (GSEs), saying that reform is required, taxpayers 
must be protected from losses, and the Federal Government must continue 
to play a role in the secondary mortgage market to ensure a steady flow 
of mortgage liquidity in all markets under all economic conditions.
    ``As the leading advocate for home owners, NAR is concerned that 
eliminating the GSEs without a viable replacement is not a reasonable 
option and will severely restrict mortgage capital and result in higher 
fees and costs for qualified borrowers,'' said Brown. ``Reform of the 
secondary mortgage market needs to be comprehensive and undertaken 
    James Parrot, senior advisor for housing at the National Economic 
Council in Washington, D.C., overviewed the Obama administration's 
recommendations for reforming the GSEs in the wake of the financial 
crisis, which included varying levels of government backing. He noted 
the primary objective of the proposals was twofold--first, to lay out 
an immediate near-term path for reform, with steps that could be taken 
the next few years to reduce taxpayer risk and move the housing market 
to more stable footing, and second, to frame the discussion regarding 
the government's long-term role in housing finance.
    ``The government's large presence in the housing finance is 
unhealthy and needs to be scaled back; however, the steps we take over 
next few years to reduce the government's role and increase private 
capital will have a tremendous impact on the housing market and economy 
as well as the availability and affordability of mortgages,'' said 
Parrot. ``The objective isn't to turn away from housing, but to make 
the housing finance market stronger so that families and their most 
important asset are better protected,'' said Parrot.
    Panelist Susan Wachter, a professor at The Wharton School, 
University of Pennsylvania, agreed that private capital needs to return 
to the housing finance market, but that most likely won't happen until 
the market has stabilized.
    ``There needs to be more accountability and transparency in the 
secondary mortgage market so that private investors can best assess 
their risk and safely get back into the market,'' she said.
    Mark Calabria, director of Financial Regulation Studies at the Cato 
Institute, argued for a very limited government role in the secondary 
mortgage market; saying that the private capital market has the funds 
and capacity to absorb Fannie Mae and Freddie Mac's market share. He 
said that increased government support in the past few decades have 
only slightly increased America's home ownership rate and that rates in 
other countries are higher despite their government's limited 
involvement. Despite his opposing viewpoint to the level of 
involvement, Calabria did acknowledge that some government backstop was 
essential in the future, since the housing and finance markets are 
sensitive to booms and busts.
    David Katkov, executive vice president and chief business officer 
at The PMI Group, countered that it would be naive to move to a purely 
private market because it's been successful in other countries, adding 
that the U.S.'s housing finance system dwarfs that of other countries 
and is far more complex.
    Ann Grochala, vice president at the Independent Community Bankers 
of America also shared concerns for small lenders and community bankers 
in a purely private market, where competition from large lenders would 
be great.
    The National Association of Realtors, ``The Voice for Real 
Estate,'' is America's largest trade association, representing 1.1 
million members involved in all aspects of the residential and 
commercial real estate industries.

                                    Washington, DC, March 29, 2011.
             statement from nahb on proposals to eliminate
           the role of the gse's in the u.s. mortgage market
    Bob Nielsen, chairman of the National Association of Home Builders 
(NAHB) and a home builder from Reno, Nev., today issued the following 
statement on legislative proposals by Congressional leaders to 
effectively eliminate the role of the GSEs in the U.S. mortgage market:
    ``The National Association of Home Builders strongly supports 
efforts to modernize the nation's housing finance system, including 
reforms to the government sponsored enterprises Fannie Mae and Freddie 
    We can't go back to the system that existed before the Great 
Recession, but it is critical that any reforms be well-conceived, 
orderly and phased in over time.
    ``Proposals announced today by key Republicans in Congress 
represent a piecemeal approach to reform that would disrupt the housing 
market and could push the nation back into a deep recession. These 
proposals, along with similar plans announced by the Obama 
administration in February, show that many policy makers have clearly 
forgotten housing's importance to the economy.
    ``America's home builders urge the administration and Republicans 
in Congress to consider the potential consequences of their proposals. 
Congress needs to develop a workable housing finance system before it 
moves forward with policies that would further destabilize a housing 
market that is already struggling.
    Housing can be the engine of job growth this country needs, but it 
can't fill that vital role if Congress and the administration make 
damaging, ill-advised changes to the housing finance system at such a 
critical time.''

    Mr. Van Hollen. And there is also a bipartisan concern on 
that score. As you mentioned, there has been other legislation 
introduced that does not immediately wipe out any federal 
participation, but, in fact, allows federal participation to go 
forward in a much more responsible way. That has been 
introduced by Congressman Campbell, Gary Peters, and others 
that preserves a limited government role and one that is 
designed to protect the taxpayers but also allow for 
creditworthy borrowers to have access to the market.
    Others, like the Center for American Progress that put 
forward their own proposals and I commend them for putting 
something on the table. So Mr. Chairman, I thank you for 
holding this hearing. I think the question of how we account 
for these costs is, of course, an important one and I look 
forward to the testimony. But the real cost and the larger cost 
in the long run to taxpayers, homeowners and the economy will 
be determined by the housing policy decisions that we make here 
in the Congress. So with that, I thank you, and again, thank 
you for the witnesses.
    Chairman Ryan. Thank you. Today we are joined by Dr. 
Deborah Lucas.
    Mr. Campbell. Mr. Chairman?
    Chairman Ryan. Yeah.
    Mr. Campbell. Before we get to the witnesses, I would ask 
unanimous consent to submit for the record a letter from the 
National Association of Realtors.
    Chairman Ryan. Sure, and without objection.
    Mr. Campbell. Thank you.
    [The information follows:]

                                      Washington, DC, June 1, 2011.
    Dear Chairman Ryan and Ranking Member Van Hollen: Our nation's 
housing markets remain fragile and due to their dramatic impact on our 
nation's economy, our economic recovery has been slow at best. The 1.1 
million members of the National Association of REALTORS urge you to 
recognize the importance of both the Federal Housing Administration 
(FHA) and the secondary mortgage market to our nation's economic 
health. As the Budget Committee reviews ``Taxpayer Exposure in the 
Housing Markets,'' please consider the overall impacts of housing on 
our economy.
    Since its inception in 1934, FHA has successfully operated as a 
self-sufficient entity without expense to the American taxpayer. More 
recently, FHA has played a critical role in our nation's housing 
finance system and has outperformed all expectations in its ability to 
ensure the availability of safe, affordable mortgage financing to all 
markets during all economic conditions. Changing the way this program 
is evaluated doesn't change that.
    Today FHA is evaluated using standards set by the Federal Credit 
Reporting Act which is the same method that is used to evaluate ALL 
federal programs. In its recent report responding to the Chairman's 
request, the Congressional Budget Office (CBO) reaffirmed that using 
this traditional methodology FHA will generate a $4.4 billion surplus 
in FY12. Singling out and subjecting FHA to a different accounting 
standard such as fair value accounting does not permit a fair 
comparison of FHA's performance to all other federal programs. In 
addition, a fair value accounting method is an inappropriate way to 
analyze a public program like FHA unless the intent is to sell its 
assets at the time of analysis. Market conditions change and, 
therefore, a fair value accounting analysis is only as good as the day 
it is performed and only if the assets were to be sold at fire-sale 
prices. The FHA program should not be singled out for a less comparable 
and highly volatile measurement such as fair value accounting. Instead, 
an appropriate review of FHA's financial health--including cash 
reserves, loan performance and credit quality--indicate that FHA's 
performance is strong and its financial standing is solid.
    Freddie Mac and Fannie Mae, the government-sponsored enterprises 
(GSEs), have also played a very valuable role in housing markets. 
REALTORS agree that reforms are needed and an influx of private 
capital is necessary for the housing finance system to right itself. 
However, REALTORS are practical and understand that in extreme 
economic conditions like the one from which we are currently 
recovering, private capital will retreat from the market requiring the 
participation of entities that will remain in the marketplace 
regardless of economic conditions. The GSEs were created to support 
this specific mission within the secondary mortgage market and any 
replacements must meet this criterion as well. If government support of 
the GSEs was unavailable at the onset of the financial crisis, our 
nation's housing and overall economic recovery would be further 
    The National Association of REALTORS urges the Committee to 
consider the overall impact on housing programs on our national 
economy. Housing accounts for more than 15 percent of the national 
gross domestic product. For every additional 1,000 home sales, about 
500 jobs are added to the economy. Those are real jobs that give our 
families, friends and neighbors a chance to work. Our nation's recovery 
depends upon housing. What we need now is for the market to heal, to 
self-correct, and stabilize.
              Ron Phipps, ABR, CRS, GRI, GREEN, e-PRO, SFR,
                 2011 President, National Association of REALTORS.

    Chairman Ryan. Anybody else want to submit anything? Sure, 
we will have the clerk make photocopies and distribute it out.
    Mr. Garrett. As long as you do it, I was going to do it at 
the end, but since you are doing it. One for the National Multi 
Housing Council letter.
    Chairman Ryan. Okay, without objection.
    [The information follows:]
                                                      June 2, 2011.
Hon. Paul Ryan, Chairman,
Committee on the Budget, U.S. House of Representatives, Washington, DC 
    Dear Chairman Ryan: The National Multi Housing Council (NMHC) and 
National Apartment Association (NAA) applaud your leadership for 
holding a hearing: ``Fannie Mae, Freddie Mac & FHA: Taxpayer Exposure 
in the Housing Markets.'' As an industry, we share your concern that 
the bursting of the housing bubble has exposed serious flaws in our 
nation's housing finance system. As policymakers craft solutions to fix 
the single-family housing problems, it is critical they do not do so at 
the expense of the less understood, but vital multifamily sector.
    NMHC and NAA represent the nation's leading apartment firms. Our 
combined memberships are engaged in all aspects of the industry, 
including ownership, development, management and finance. NMHC 
represents the principal officers of the industry's largest and most 
prominent firms. NAA is the largest national federation of state and 
local apartment associations with 170 state and local affiliates 
comprised of more than 50,000 members. Together we represent 
approximately six million apartment homes.
    One-third of American households rent, and over 14 percent of 
households--16.7 million households--live in a rental apartment 
(buildings with five or more units). Our industry's ability to meet the 
nation's rental housing needs depends on reliable and sufficient 
sources of capital. To understand the role of Fannie Mae, Freddie Mac 
and FHA from a multifamily perspective, it is necessary first to have a 
broad understanding of the apartment industry's current capital 
sources--both before and during the crisis.
    For more than two years after the onset of the financial meltdown, 
virtually all private mortgage lenders abandoned the market, leaving 
the apartment industry to rely heavily on credit either insured or 
guaranteed by the Federal Government. An estimated 70 percent of 
apartment loans issued in 2010 had some form of government credit 
behind them, namely FHA, Fannie Mae or Freddie Mac. Even as the private 
debt markets improve, the FHA and Government Sponsored Enterprises 
(GSEs) are expected to account for half to two-thirds of the $60 
billion-$75 billion in credit provided to the apartment sector this 
year alone.
    Historically, however, the apartment industry has enjoyed access to 
mortgage credit from a variety of capital sources. In addition to the 
FHA and GSEs, banks and thrifts, life insurance companies, pension 
funds and the commercial mortgage-backed securities market have all 
provided significant amounts of mortgage capital to the apartment 
industry. Prior to the financial crisis, these capital sources provided 
our sector with $100-$150 billion annually, reaching as high as $225 
billion, to develop, refinance, purchase, renovate and preserve 
apartment properties.
    As policymakers consider the causes of, and solutions to, the 
single-family meltdown, it is important to distinguish between the 
finance systems supporting the single-family sector and the multifamily 
sector. The apartment industry did not overbuild in the housing boom. 
The discipline shown by the apartment industry has translated into 
stronger portfolio performance as well. Overall loan performance in the 
$853 billion multifamily sector remains healthy, with delinquencies and 
default rates only a fraction of those seen in single-family.
    Fannie Mae and Freddie Mac: The multifamily portfolio has earned 
net revenues of $2 billion for the taxpayers since conservatorship.
    The presence of a government-supported secondary multifamily 
mortgage market lowers the cost of capital, which enables the apartment 
industry to provide millions of units of unsubsidized workforce 
housing. Although Fannie Mae and Freddie Mac have rightfully been 
criticized for their role in the single family housing meltdown, they 
have performed admirably in the multifamily marketplace. Fully 90% of 
the apartment units financed by Fannie Mae and Freddie Mac over the 
past 15 years--more than 10 million units--were affordable to families 
at or below the median income for their community.
    Furthermore, the GSEs' multifamily programs were not part of the 
meltdown and are not broken. They have default rates of less than one 
percent--a tenth of those in the single-family sector--and even during 
conservatorship, they have earned net revenues of $2 billion.
  fha: an alternative debt capital source and private sector backstop
    Since its inception in 1934, FHA has insured over 47,000 
multifamily mortgages. It currently holds 13,000 multifamily mortgages 
in its portfolio (compared to 4.8 million single-family mortgages). 
While it accounts for just six percent of the total outstanding 
multifamily mortgage debt, it is a material and important source of 
capital for underserved segments of the rental market.
    In normal capital markets, FHA/Ginnie Mae play a limited, but 
important, role in the rental housing sector. During the economic 
crisis, however, FHA became virtually the only source of apartment 
construction capital. Demand for FHA financing surged, increasing more 
than five-fold. Applications have increased from $2 billion annually to 
$10 billion, and HUD anticipates that demand for FHA multifamily 
mortgage insurance will remain high for the next several years.
    Unfortunately, HUD's failure to keep pace with the volume of 
multifamily mortgage applications is exacerbating the nation's shortage 
of workforce housing, jeopardizing the thousands of jobs created by new 
apartment construction and reducing the new revenues the program could 
be generating for the Federal Government.
    The consequences of this backlog are magnified by the fact that 
private capital markets still have not recovered, leaving apartment 
firms with few alternatives. The result is a dramatic reduction in new 
apartment construction at a time when the nation's demand for 
affordable rental housing is growing faster than in recent decades.
    We greatly appreciate your efforts to review the housing needs of 
our nation. We respectfully request that this letter and the 
accompanying testimony presented to the House Financial Services 
Committee, Subcommittee on Housing regarding ``The Future Role of FHA 
and Ginnie Mae in the Single-Family and Multi-Family Mortgage'' be 
inserted in the record.
            Sincerely yours,
                               Douglas M. Bibby, President,
                                    National Multi Housing Council.
                         Douglas S. Culkin, CAE, President,
                                    National Apartment Association.

Attachment: NMHC/NAA testimony ``The Future Role of FHA and Ginnie Mae 
        in the Single-Family and Multi-Family Mortgage''
    testimony by peter evans, partner, moran & co., on behalf of the
 national multi housing council and the national apartment association
    Before the Insurance, Housing and Community Opportunity 
Subcommittee of the House Committee on Financial Services for the 
hearing on ``The Future Role of FHA and Ginnie Mae in the Singlefamily 
and Multifamily Mortgage Markets,'' held on May 25, 2011.

    Chairwoman Biggert and Ranking Member Gutierrez, on behalf of this 
nation's 17 million households who call an apartment their home, the 
National Multi Housing Council (NMHC) and the National Apartment 
Association (NAA) would like to thank you for the opportunity to 
testify today on the future role of the Federal Housing Administration 
(FHA) and the Government National Mortgage Administration (GNMA) in 
multifamily mortgage markets.
    NMHC and NAA represent the nation's leading firms participating in 
the multifamily rental housing industry. Our combined memberships are 
engaged in all aspects of the apartment industry, including ownership, 
development, management and finance. The National Multi Housing Council 
represents the principal officers of the apartment industry's largest 
and most prominent firms. The National Apartment Association is the 
largest national federation of state and local apartment associations. 
NAA is a federation of 170 state and local affiliates comprised of more 
than 50,000 multifamily housing companies representing more than 5.9 
million apartment homes.
    We applaud your efforts to examine the role of FHA in America's 
housing market and ways to improve its ability to provide liquidity to 
key sectors of the rental housing market.
              growing demand for rental housing against a
                     backdrop of a supply shortfall
    Prior to addressing the role of FHA and GNMA multifamily finance 
programs now and in the future, it is worthwhile to take a moment and 
note the fundamental role multifamily housing plays in our nation's 
    The U.S. is on the cusp of a fundamental change in our housing 
dynamics. Changing demographics and new economic realities are driving 
more people away from the typical suburban house and causing a surge in 
rental demand. Tomorrow's households want something different. They 
want more choice. They are more interested in urban living and less 
interested in owning. They want smaller spaces and more amenities. And 
increasingly, they want to rent, not own. Unfortunately, our housing 
policy has yet to adjust to these new realities.
    Our society is changing in meaningful ways that are translating 
into new housing preferences. Married couples with children are now 
less than 22% of households and that number is falling. By 2030, nearly 
three-quarters of our households will be childless. Seventy-eight 
million Echo Boomers are beginning to enter the housing market, 
primarily as renters. Seventy-eight million Baby Boomers are beginning 
to downsize, and many will choose the convenience of renting.
    Beyond just changing demographics, there is also a much-needed 
change in consumer psychology underway that favors more long-term 
renters in the future. The housing crisis taught Americans that housing 
is shelter, not an investment. That awareness is freeing people up to 
choose the housing that best suits their lifestyle. For millions, that 
is an apartment.
    Renting has many advantages. Convenience, walkable neighborhoods 
and mobility to pursue job opportunities are some of the reasons why 
renting is no longer something you do until you can buy a house.
    Today, nearly 89 million Americans, almost one-third of all 
Americans, rent their home. There are 17.3 million apartments 
(properties with 5 or more units) in the U.S. that, taken together, 
provide a place to live for more than 14 percent of all households. In 
this decade, renters could make up half of all new households--more 
than seven million new renter households. Because of these changes, 
University of Utah Professor Arthur C. Nelson predicts that half of all 
new homes built between 2005 and 2030 should be rental units.
    Unfortunately, supply is beginning to fall short of demand. An 
estimated 300,000 units a year must be built to meet expected demand. 
Yet most forecasts suggest ground will be broken on fewer than half 
that many in 2011. In fact, new multifamily construction set an all-
time post-1963 low in 2010 at 97,000 new starts. That level of 
construction is not even enough to replace the units lost every year to 
demolition, obsolescence and other losses.
    While there may be an oversupply of single-family housing, the 
nation could actually see a shortage of multifamily housing as early as 
2012. The shortage is particularly acute in the area of workforce and 
affordable housing. The Harvard Joint Center for Housing Studies 
estimates a nationwide affordable housing shortfall of three million 
    This context is particularly important in understanding why it is 
vital that as Congress looks to reform housing finance, it do nothing 
that would jeopardize the construction, financing and availability of 
multifamily housing.
    The bursting of the housing bubble exposed serious flaws in our 
nation's housing finance system. As policymakers craft solutions to fix 
the single-family housing problems, they should be mindful not to do so 
at the expense of the much smaller and less understood, but vital, 
multifamily sector.
    The government sponsored enterprises' (GSEs) multifamily programs 
were not part of the meltdown and are not broken. They have default 
rates of less than one percent--a tenth of those in the single-family 
sector--and they actually produce net revenue (profits) for the U.S. 
government. They pose no risk to the taxpayer.
    Through careful underwriting, the GSEs' multifamily models have met 
the test. They have attracted enormous amounts of private capital; 
helped finance millions of units of market-rate workforce housing 
without federal appropriations; sustained liquidity in all economic 
climates; and ensured safety and soundness in their multifamily 
business. As a result of the liquidity provided by the GSEs, the United 
States has the best and most stable rental housing sector in the world.
    Apartments are not just shelter. They are also an economic 
powerhouse. The aggregate value of this apartment stock is $2.2 
trillion. Rental revenues from apartments total almost $120 billion 
annually, and management and operation of apartments are responsible 
for approximately 550,000 jobs.
            federal support of the multifamily credit market
Multifamily Capital Markets Overview
    Historically, the apartment industry has enjoyed access to mortgage 
credit from a variety of capital sources, each with its own focus, 
strengths and limitations. Private market sources include commercial 
banks, which offer short-term, floating rate financing for smaller, 
local borrowers. Life insurance companies target higher-quality 
properties in select markets. Their capital allocations change with 
market conditions, and their loan terms do not typically extend beyond 
10 years. The commercial mortgage-backed securities (CMBS) market 
became a material source of capital for the industry in the mid1990s 
but has been shut down since 2008, and it is unlikely to return to its 
pre-bubble levels of lending. Even in healthy economic times, these 
capital sources have been insufficient to meet the full needs of the 
apartment sector, most notably the affordable and workforce housing 
sectors and rental housing in smaller markets.
    To fill that gap, the Federal Government supports the multifamily 
housing finance market through three primary entities: the GSEs Fannie 
Mae and Freddie Mac; the Federal Housing Administration (FHA); and 
Ginnie Mae (GNMA). Each of these plays an important but different role 
in ensuring the availability of mortgage finance to the rental 
    The GSEs have served as the cornerstone of the multifamily housing 
finance system for decades, offering a broad range of mortgage 
products, including long-term debt for the entire range of apartment 
properties (market-rate workforce housing, subsidized, large 
properties, small properties, etc.) in all markets (primary, secondary 
and tertiary) at all times regardless of economic conditions.
    FHA was created in 1934 to insure multifamily loans originated by 
FHA-approved lenders to increase the capital availability to the 
industry. It offers high-leverage, long-term mortgages to many markets 
underserved by private capital. It primarily targets construction 
lending, although it is also available for substantial rehabilitation 
and acquisition and refinancing.
    GNMA was established in 1968 to help create a secondary market for 
both single-family and multifamily FHA-insured loans. GNMA guarantees 
investors the timely payment of principal and interest on mortgage-
backed securities (MBS) comprised of federally insured or guaranteed 
loans, including FHA loans. The GNMA guaranty allows mortgage lenders 
to obtain a more favorable price for their mortgage loans in the 
secondary market. Lenders can then use the proceeds to make new 
mortgage loans available. Notably, GNMA securities are the only MBS 
backed by the full faith and credit guaranty of the United States 
government, which means that even in troubled economic times, such as 
those that continue to confront the nation, investments in GNMA MBS are 
safe for investors.
FHA/GNMA: An Alternative Debt Capital Source and Private Sector 
    Since its inception in 1934, FHA has insured over 47,000 
multifamily mortgages. It currently holds 13,000 multifamily mortgages 
in its portfolio (compared to 4.8 million single-family mortgages). 
While it accounts for just six percent of the total outstanding 
multifamily mortgage debt, it is a material and important source of 
capital for underserved segments of the rental market.
    It is best known for offering construction loans to developers who 
lack access to bank and other private construction capital sources. It 
also serves borrowers with long-term investment goals as the only 
capital provider to offer 35-40-year loan terms. FHA lending is 
essential to borrowers in secondary markets, borrowers with smaller 
balance sheets, new development entities and non-profit firms, all of 
which are often overlooked by private capital providers.
    FHA-insured debt has also been widely used by sponsors of targeted 
affordable housing and properties that receive federal, state and local 
subsidies, project-based Section 8 and proceeds from Low-Income Housing 
Tax Credits (LIHTCs).
FHA serves the multifamily market through three key programs.
     Section 221(d)(3) and Section 221(d)(4) Mortgage Insurance 
Programs: These programs are of the most importance to the conventional 
apartment industry. They insure mortgages for new construction or 
substantial rehabilitation of multifamily rental or cooperative housing 
for moderate-income families, the elderly and the handicapped. Section 
221(d)(3) is used by nonprofit sponsors while Section 221(d)(4) is used 
by profit-motivated sponsors. Notably, the program enables GNMA to use 
mortgage-backed securities to provide liquidity support for long-term 
mortgages (up to 40 years), which leads to lower interest rates for 
     Section 207/223(f) Program: These mortgage insurance 
programs insure mortgage loans to facilitate the purchase or 
refinancing of existing multifamily rental housing that was originally 
financed with conventional or FHA-insured mortgages. Properties 
requiring substantial rehabilitation are ineligible for mortgage 
insurance under this program, though HUD permits the completion of non-
critical repairs after endorsement for mortgage insurance. The Section 
223(f) program enables GNMA to use mortgage-backed securities to 
provide liquidity support for long-term mortgages (up to 35 years), 
which leads to lower interest rates for borrowers.
    capacity and procedural obstacles create historic backlog at fha
    In normal capital markets, FHA/GNMA play a limited, but important, 
role in the rental housing sector. During the economic crisis, however, 
FHA became virtually the only source of apartment construction capital. 
Demand for FHA financing surged, increasing more than five-fold. 
Applications have increased from $2 billion annually to $10 billion, 
and HUD anticipates that demand for FHA multifamily mortgage insurance 
will remain high for the next several years.
    FHA's lack of resources and recently implemented new processing 
procedures have created an enormous backlog of pending applications for 
new construction financing (through the 221(d)(3) and 221(d)(4) 
programs and refinancing for maturing mortgages through the 207/223(f) 
programs. As a result, FHA is struggling to meet this increased demand. 
Further exacerbating its capacity issues are efforts implemented over 
the past year to create stricter credit requirements through more 
stringent loan terms and expanded underwriting review. Additionally, 
FHA has recently revised its mortgage closing documents for the first 
time in 30 years. These changes mean that borrowers are subject to 
processing times that can exceed 18 months, and there are increasing 
questions over whether applications will move forward at all.
    NMHC/NAA strongly support FHA's efforts to introduce sound credit 
and underwriting policies; however, these changes are disruptive to the 
critical housing needs of our nation's communities. Improvements cannot 
be undertaken at the cost of unnecessarily increasing government 
bureaucracy that results in a bottleneck of applications and the 
rejection of qualified development transactions. Multifamily rental 
developments financed through FHA create thousands of jobs and generate 
revenue for the Federal Government and communities; hence, delays at 
FHA miss an opportunity to contribute to the economic recovery. 
Moreover, the FHA multifamily program generates net revenues for the 
taxpayer--revenues that are forsaken when FHA is unable to process the 
applications in its pipeline.
    Before examining the specific problems facing FHA in greater depth, 
we must note that HUD Secretary Donovan and his team are working 
diligently to resolve some of the issues we are raising today. In fact, 
NMHC/NAA, along with the National Association of Home Builders and the 
Mortgage Bankers Association, meet with top HUD officials on a 
quarterly basis to drive continued progress. All that said, while some 
progress has been made, it remains incomplete. Congressional action and 
vigilance will be required to ensure all problems are swiftly and 
satisfactorily addressed.
Loan Processing Issues
    Increased demand for FHA financing has resulted in significantly 
longer loan processing times throughout the country. This is creating a 
significant hardship for apartment providers seeking to meet the 
nation's growing demand for rental housing.
    In recent months, HUD has attempted to reallocate resources to 
high-demand offices and increase the amount of information offered to 
borrowers so they will better know their place in the pipeline. HUD has 
also clarified its application fee refund policies to enable would-be 
borrowers to withdraw their applications without material financial 
penalty when alternate financing is available.
    Despite these efforts, applicants in many HUD field offices still 
have no idea how many projects are in the queue ahead of them or when 
HUD/FHA is likely to respond. We offer the following recommendations, 
which include some items HUD/FHA has already identified:
    1. Follow the Multifamily Accelerated Processing (MAP) Guide to 
ensure loans are processed efficiently.
    HUD insists that transactions can be expedited through its MAP 
program; however, field offices often deviate from the guide, creating 
confusion among borrowers and lenders over what is required to secure 
FHA-insured debt. A more consistent application of the MAP Guide will 
eliminate this confusion and help reduce FHA's review time.
    2. Seek a more efficient means to address credit concerns.
    As noted above, FHA has undertaken steps to strengthen the credit 
risk of its portfolio. However, some of these steps could be reworked 
in ways that would help expedite loan processing and still protect the 
agency. For instance, FHA has mandated that all loans over $15 million 
be processed by a National Loan Committee instead of being evaluated by 
the field office. This is an unnecessary complication. For years, FHA 
has relied on its lender partners to conduct due diligence, and the 
results have produced an FHA multifamily portfolio with acceptable 
credit performance. Instead of essentially abandoning this process, FHA 
should only require centralized review of loan requests that exceed the 
program's loan terms and requirements.
    3. Establish a special underwriting team for large, atypical loans.
    While we agree that loans that exceed the general parameters of 
loans typically insured by FHA should be carefully examined, creating a 
special team to process them would relieve the clogs in the pipeline 
and expedite the processing of more standard transactions.
    4. Provide greater oversight over market assessment information.
    HUD should use both appraisal data and the information provided by 
the Economic Market Analysis Division (EMAD) when reviewing 
applications instead of relying solely on EMAD data, which often is not 
an accurate assessment of local market conditions.
    While some of the processing backlogs are a result of procedural 
obstacles, the greatest source of the problem lies in the insufficient 
staffing and financial resources available to FHA to meet current and 
future demand.
    Although NMHC/NAA recognize that budget constraints confronting 
Congress and the nation make it unlikely that additional funding can be 
secured for administering the FHA multifamily mortgage insurance 
programs, we believe that existing resources can be reallocated to help 
alleviate bottlenecks.
    Most notably, HUD can establish field office monitoring teams to 
evaluate and improve the ability of each FHA office to process 
applications, relative to their market share and based on the timelines 
set forth in the MAP Guide. Appropriators in Congress should give HUD 
the discretion to reallocate capital and staffing resources to offices 
that are the most efficient. Until then, however, HUD should not stand 
on the lack of such flexibility as a reason for the backlog instead of 
finding alternative solutions within its authority. For example, high-
performing offices could be exempted from having the National Loan 
Committee review certain types of transactions that are unlikely to 
result in taxpayer losses. Finally, personnel in offices that are 
experiencing high volumes of applications could be supplemented by 
temporary duty assignments to help reduce backlogs.
              fha-rural regulatory improvement act of 2011
    The Committee has asked us to comment on its discussion draft, the 
FHA-Rural Regulatory Reform Act of 2011. While the bill predominantly 
addresses issues specific to the single-family and rural housing 
programs, there are several issues we want to raise regarding the FHA 
multifamily programs.
     Loan Limits: The current FHA multifamily loan limits are 
not high enough for properties that require elevator construction. 
Increases to the base loan limits and cost factors enacted over the 
past eight years have helped in many parts of the country, but they 
have not helped in urban areas where high-rise elevator construction is 
common As a result, there is a significant financing shortage in these 
areas, where demand for affordable and workforce housing is high.
    To meet the growing demand for affordable rental housing in urban 
areas, we propose a 50 percent increase in the FHA multifamily loan 
limits for elevator buildings. Elevator buildings are significantly 
more expensive to build, yet the loan limits for elevator buildings in 
FHA's most popular program, the 221(d)(4), are just 10 percent higher 
than garden apartment loan limits--$68,7000 for a two-bedroom in a 
high-rise versus $62,026 for a garden apartment. In a high cost market, 
the maximum elevator limit is $214,421 compared to a non-elevator limit 
of $195,382.
    Our proposal would increase the base loan limit for a two-bedroom 
unit in an elevator property from $68,070 to $93,039 (approximately a 
37% increase). Adding the high-cost area factors to this base limit 
would allow FHA to insure loans in elevator structures of up to 
$293,073 per unit. Such a change would make a material difference in 
the amount of rental housing constructed in urban markets.
    Last year, the House passed bipartisan legislation to increase the 
FHA multifamily loan limits in high-rise elevator properties. We urge 
this Congress to address the demand for construction financing in our 
nation's cities by including those provisions in your forthcoming bill.
     Capital Reserves. We appreciate the Committee's efforts to 
improve the long-term viability of the FHA multifamily programs by 
implementing a risk-based capital reserve. We strongly support 
adequately capitalizing the General Insurance and Special Risk 
Insurance Fund (GI/SRI funds). However, the mortgage insurance premium 
for lower-risk loan programs should not be increased to subsidize 
higher-risk FHA insurance activities. Such transfer of risk-based 
capital could have a chilling impact on the multifamily programs if 
premiums are raised to subsidize losses in other loan categories.
      fha is not the solution to the crisis confronting the gse's
    As this Committee and Congress examine ways to address the crisis 
confronting Fannie Mae and Freddie Mac, some have suggested that Fannie 
Mae and Freddie Mac's secondary mortgage programs be replaced by or 
merged with FHA. NMHC/NAA strongly oppose such efforts. Such a move 
would exacerbate liquidity issues facing the multifamily industry, 
which could reduce the availability of workforce housing and jeopardize 
the economic recovery.
    There are many reasons for our opposition. Lawmakers should 
recognize that FHA serves a very different market than Fannie Mae and 
Freddie Mac. It provides capital to help develop and preserve rental 
housing where bank financing and other forms of capital are unavailable 
or in short supply. It should continue to perform this important 
mission, and an important element of housing finance reform should be 
to identify areas where it is appropriate for private capital and FHA 
to partner. But even such risk-sharing programs would not come close to 
meeting the apartment industry's broad capital needs.
    Even if FHA served similar market segments to Fannie Mae and 
Freddie Mac, as our testimony suggests, FHA is woefully unprepared to 
assume greater responsibility. It is already failing to meet current 
multifamily program demand, and there is no expectation that the 
resources exist within the current budgetary framework to bring it to 
the level that it could replace the liquidity provided by Fannie Mae 
and Freddie Mac.
    Beyond its general capacity issues, FHA also has insufficient 
capacity to effectively respond to the multiplicity of unique and often 
complex issues presented by income property underwriting. This means 
that many viable deals that could lead to the construction of workforce 
housing might not be able to go forward simply because FHA would be 
incapable of structuring a deal.
    FHA's limited and inflexible mortgage products do not fit the 
variety of needs of the market and market conditions. Again, this means 
that profitable deals Fannie Mae and Freddie Mac might be able to 
underwrite today would not go forward under a regime where FHA was the 
only government-backed market participant.
    FHA also imposes arbitrary loan limits on its products that 
preclude credit in markets with significant land and development costs 
(i.e., high-cost markets). If FHA took over the activities of the GSEs, 
credit support could well be inadequate in urban markets nationwide, 
which would lead to reduced construction and very possibly a smaller 
number of units available to lower-and middle-income families.
    It is also critical to note that FHA's mortgage documents are 
outdated and not considered to meet many market conventions and 
standards. Imposing these on the entire sector would expose the entire 
industry to significantly slow processing times currently being 
experienced by the small segment of FHA borrowers. It would also force 
multifamily firms to devote resources to the bureaucratic exercise of 
filling out forms instead of doing what they do best, namely 
constructing multifamily housing.
    Finally, FHA has inadequate systems to oversee existing portfolios 
to manage credit risk and support prudent loan servicing. Whereas the 
GSE multifamily serious delinquency rates remain below one percent, 
moving operations to FHA could jeopardize this sterling record of 
success and unnecessarily leave American taxpayers open to billions of 
dollars in losses.
    Instead of joining Fannie Mae and Freddie Mac with FHA, housing 
finance reform should seek to encourage partnership between private and 
FHA multifamily mortgage credit sources where appropriate. Although 
such areas may be limited, they should focus on the development and 
preservation of multifamily housing where bank and other forms of 
capital are unavailable or in short supply.
    We believe there is a better solution than folding the GSEs' 
multifamily programs into FHA and that with more time and data from the 
Federal Housing Finance Agency (FHFA) we can develop a proposal to 
serve both the taxpayer and the millions of Americans who rely on 
rental housing for their shelter.
               reform must protect multifamily programs,
                do no harm and take fact-based approach
    While NMHC/NAA oppose merging GSE activities with FHA, we do 
strongly support housing finance reform and recognize the necessity of 
addressing the problems confronting Fannie Mae and Freddie Mac. That 
said, because of the multifamily sector's importance to the economy and 
prospects for recovery, proposals to address single-family housing 
problems must not be enacted at the expense of the very different, but 
vital, multifamily sector. Accordingly, we urge Congress to observe two 
principles before moving forward with any legislation:
    First, proposals should do no harm to a multifamily sector that was 
not responsible for the financial crisis and, at the same time, is 
critical to ensuring a robust supply of workforce housing that will 
help drive our nation's economic recovery. Over 20 percent of all 
American households now live in apartment homes. In addition, demand 
for apartments is forecast to grow rapidly: In this decade, renters 
could make up half of all new house-holds--more than seven million new 
renter households in total. Thus, public policy should take special 
care not to harm the planned production of workforce housing.
    Moreover, while many have called for the elimination of Fannie Mae 
and Freddie Mac, this could have devastating consequences to 
multifamily housing if not done in a thoughtful and deliberative 
manner. Nearly all of the multifamily funding provided by the existing 
GSEs helped create workforce housing. In fact, fully 90 percent of the 
apartment units financed by Fannie Mae and Freddie Mac over the past 15 
years--more than 10 million units--were affordable to families at or 
below the median income for their community.
    Looking forward, it is hard to imagine a scenario in which 
necessary levels of workforce housing could be constructed without some 
level of government credit support, particularly during times of 
economic difficulty. Without government credit support of multifamily 
mortgages or mortgage-backed securities to ensure a steady and 
sufficient source of capital going forward, the apartment industry will 
be unable to meet the nation's housing needs in all markets, and 
Americans will pay more for workforce housing. Finally, it is also 
critical for Congress to note that in stark contrast to the GSEs' 
single-family programs, the agencies' multifamily programs did not 
contribute to the housing meltdown. The risk models and underwriting 
standards Fannie Mae and Freddie Mac have used to produce millions of 
units of affordable housing work. In fact, Fannie Mae and Freddie Mac 
have actually earned net revenues exceeding $2 billion during 
    As a second principle, proposals to address Fannie Mae should only 
be enacted after the best available data has been made publicly 
available and analyzed. This will help Congress to avoid unintended 
consequences that could threaten the availability of workforce housing 
and ensure that future legislation reflects lessons that can be gleaned 
from Fannie Mae and Freddie Mac's activities prior to and following 
    We encourage House Financial Services Committee Chairman Bachus to 
request that the Government Accountability Office (GAO) conduct a study 
on the performance history of Fannie Mae and Freddie Mac's multifamily 
mortgage purchase activities since the enactment of the Housing and 
Community Development Act of 1992 (P.L. 102-550).
    NMHC/NAA believe that Congress should not move forward with 
comprehensive legislation addressing GSE multifamily mortgage 
activities until GAO obtains and analyzes data from the GSEs and FHFA 
that provides:
     An overview of the lending activities and multifamily 
housing mortgage products offered by the enterprises.
     Data regarding loan origination activities broken down by 
mortgage product, state and metropolitan area where the loans financed 
properties, the type of properties financed and the period of the loans 
(5-, 7-, 10-, 15-, 20-, 25-and 30-year mortgage terms) used for 
     An assessment of annual loan performance by product type 
based on debt coverage ratio and loan-to-value. This should also 
include an analysis of annual delinquency, default and foreclosure 
characteristics (in percentage and absolute numbers), and annual 
multifamily mortgage securitization activities.
     An examination of the credit standards and policy 
requirements the enterprises require for multifamily loans along with a 
comparison to other mortgage capital sources for both multifamily and 
single-family loans as available.
     Information about GSE multifamily loan loss reserves and 
their usage.
     An assessment of the enterprises' achievement of 
affordable housing goals, including multifamily contributions to 
corporate affordable housing goals and multifamily special affordable 
housing goals.
     An analysis of the enterprises' multifamily risk-sharing 
activities with the Department of Housing and Urban Development, the 
Federal Housing Administration, the Rural Housing Administration, and 
state and local housing finance agencies.
    In closing, NMHC/NAA look forward to working with this Committee 
and the Congress to reform the nation's housing finance markets while 
ensuring that a robust supply of capital is available to provide for a 
sufficient supply of workforce housing that is so necessary to driving 
a sustained economic recovery.
    Thank you again for the opportunity to testify this afternoon, and 
I stand ready to answer any questions you may have.

    Chairman Ryan. Anybody else want to submit something for 
the record? We will send copies of this one around as well.
    We are joined today by Deborah Lucas, the assistant 
director of the financial analysis division from the CBO. Also 
Alex Pollock, who is no stranger to this committee, a resident 
fellow at the American Enterprise Institute, former chair of 
the Chicago Federal Home Loan Bank, if I am not mistaken, and 
Sarah Rosen Wartell, executive vice president from the Center 
for American Progress Action Fund. Why do not we just start 
with Deborah and then move over?



    Dr. Lucas. Okay. Thank you. I appreciate the opportunity to 
testify about CBO's estimates of the budgetary cost of Fannie 
Mae and Freddie Mac, and the options for the future role of the 
Federal Government in the secondary mortgage market.
    In CBO's judgment, the federal conservatorship of Fannie 
Mae and Freddie Mac and their resulting ownership and control 
by the Treasury, make them effectively part of the government 
and imply that their operations should be reflected in the 
federal budget. Hence, in its baseline budget projections, CBO 
accounts for the cost of the GSE's operations as though they 
are being conducted by a federal agency.
    Now after consulting with the House and Senate Budget 
Committees, CBO concluded that using a so-called fair value 
approach to estimate those costs would give the Congress the 
most accurate and comprehensive information about the budgetary 
cost of supporting the GSEs. A fair value approach provides 
estimates of the value of the GSE's assets and liabilities that 
either corresponds to or approximates prices in a well-
functioning financial market.
    Using that method, back in August of 2009, CBO estimated 
that the net cost to the government of all of the GSE's 
outstanding mortgage commitments made through the end of 2009 
would total $291 billion. Now, since that time, CBO has not 
updated its estimate of the cost of the government of those 
past commitments. However, the GSE's financial report suggests 
that losses on those obligations may have increased somewhat 
since that time because of the continued weakening of the 
housing markets.
    So, looking forward, in its recent March 2011 baseline 
projections, CBO estimates that the new guarantees the GSEs 
will make over the next decade will cost the government $42 
    The subsidy rate for the GSE's new business has fallen 
since the peak of the financial crisis and it is projected to 
decline further as conditions in the housing market and the 
economy improve. However, under a fair value approach, the 
subsidy rate will remain positive as long as Fannie Mae and 
Freddie Mac provide guarantees at prices below what private 
financial institutions would offer.
    Now, unlike CBO, the administration's Office of Management 
and Budget treats Fannie Mae and Freddie Mac as non-
governmental entities for budgetary purposes. That implies that 
in the budget, OMB records only cash transfers between Treasury 
and the GSEs, such as for stock purchases and dividend 
payments. That approach can postpone the recognition of the 
costs of the GSE's new guarantee obligations for many years.
    The fair value approach that CBO is using for projections 
is also different than the procedures specified by the Federal 
Credit Reform Act of 1990, otherwise known as ``Credit 
Reform,'' which applies to most federal credit programs. Unlike 
Credit Reform estimates, which use Treasury rates for 
discounting, fair value estimates use discount rates that 
incorporate a risk premium. The inclusion of a risk premium 
recognizes that the financial risk to the government that it 
assumes when it issues mortgage guarantees, represents a cost 
to taxpayers.
    Now, those two approaches paint very different pictures of 
the cost of continuing to operate Fannie Mae and Freddie Mac 
under a current law over the next decade, whereas, on a fair 
value basis, their new obligations generate a budgetary cost 
under Credit Reform, the continuing operations would result in 
budgetary savings.
    Currently fair value accounting is used for the Troubled 
Asset Relief Program and by CBO for the GSEs, but the Credit 
Reform approach is used for most federal mortgage guarantee 
programs, including the Federal Housing Administration's Single 
Family Mortgage Insurance Program.
    CBO recently estimated the difference between the two 
methodologies as applied to that FHA program. Under Credit 
Reform, the FHA program would produce budgetary savings of $4.4 
billion in fiscal year 2012, but on a fair value basis, the 
program would cost $3.5 billion in the same year. That 
different budgetary treatment of the GSEs and the FHA means 
that a mortgage that generates a budgetary cost when it is 
guaranteed by Fannie Mae or Freddie Mac could show budgetary 
savings if FHA provide the coverage instead.
    Policymakers are contemplating a wide range of proposals 
for federal role in the secondary mortgage market, in general, 
for the future of Fannie Mae and Freddie Mac, in particular, 
and for the transition path to a new model. In a recent study, 
CBO analyzed those alternatives and the trade-offs among them. 
And my written statement summarizes that work. Any new approach 
would need to confront major design issues; if the approach 
includes federal guarantees, how to structure and price them, 
whether to support affordable housing, and if so, by what 
means, and how to structure and regulate the secondary market.
    Options will need to be evaluated using several criteria, 
including whether a given alternative would ensure a stable 
supply of financing for mortgages, how affordable housing goals 
would be met, how well taxpayers will be protected from risk, 
whether the federal guarantees would be priced fairly, and to 
what extent the approach would provide incentives to control 
    Whichever direction is ultimately chosen, the policy 
choices will have budgetary implications that could differ 
considerably depending on the budgetary treatment used. In 
CBO's judgment, continuing to use a fair value approach to 
estimate subsidy costs for Fannie Mae and Freddie Mac would 
provide the most accurate measure of the cost to taxpayers of 
any eventual transition to a new federal role in the secondary 
mortgage market. However, doing so would maintain the practice 
of accounting for similar federal credit programs and financial 
transactions in different ways. Thank you.
    [The prepared statement of Deborah Lucas may be accessed at 
the following Internet address:]


    Chairman Ryan. Mr. Pollock?

                  STATEMENT OF ALEX J. POLLOCK

    Mr. Pollock. Thank you, Mr. Chairman, Ranking Member Van 
Hollen, and members of the committee. Over the past four 
decades in this country, we have engaged in a truly remarkable 
financial experiment, or adventure of exploding agency debt, 
which is described in the graphs and the discussion in my 
written testimony. Now, this explosion in my view, calls into 
question old ways of thinking about accounting for, and 
managing, such debt. A vast debt of the non-budget agencies and 
government-sponsored enterprises, most of which is devoted to 
subsidizing housing finance, fully relies on the credit of the 
United States. This means by definition, it exposes taxpayers 
to losses, but, as we know, it is not officially accounted for 
as government debt. This debt puts federal budget at risk, or 
more precisely, subjects it to major uncertainties and 
potentially huge credit losses, as we have experienced. Indeed, 
it represents a kind of off-balance sheet financing and risk-
taking by the government. Fannie Mae and Freddie Mac in 
particular, can quite reasonably be thought of as government 
SIVs or S-I-Vs, and the analogy to say the SIVs used by 
Citibank to try to finance mortgages off off-balance sheet, is 
quite a tight analogy.
    In 1970, some 40 years or so ago, Treasury debt held by the 
public was $290 billion. Seems like a small number these days. 
And agency debt was $44 billion; so $290 versus $44.
    By 2006, at the height of the housing bubble Treasury debt 
was almost $5 trillion, but agency debt had inflated to $6.5 
trillion dollars. So over this time while Treasury debt 
increased 17 times, agency debt had multiplied 148 times. This 
created a, altogether, new and unprecedented situation in 
government finance.
    In 1970, agency debt represented only 15 percent of 
outstanding Treasury debt. By 2006, this had inflated to 133 
percent of Treasury debt. So, if you were managing the Treasury 
debt, you were managing less than half of the government's 
credit exposure. If we add these two types of debt together, we 
get what I call ``effective government debt'', that is debt 
dependent on the government's credit, which is held by the 
public, and this number is now nearly $17 trillion as shown in 
my written testimony.
    How was this agency debt explosion possible, we should ask. 
The financial reality is that bond salesmen peddling trillions 
of dollars of Fannie, Freddie, and other agency securities to 
investors all over the world, said to them something very much 
like this: You cannot go wrong buying these because they are 
really U.S. government credit. But they pay you a higher yield 
so you get more profit with no credit risk. And although this 
description was disputed by various official voices, in fact, 
what the bonds salesmen said was absolutely right, as 
experience has demonstrated, it was a good deal for the bond-
buyers but it was hardly a good deal for the taxpayers.
    How can we better think about the risk to the taxpayers 
represented by the explosion of agency debt? For entities 
subject to Federal Credit Reform Act, the expected, or that is 
really the best guess estimates of losses, must be reflected as 
costs in the federal budget. This requirement is useful, but it 
does not address the fact that we do not and cannot know what 
the losses will turn out to be. As the Congressional Budget 
Office points out, the FHA, for example, has often had to 
significantly increase its credit loss estimates which it 
worked so hard to make in the first place. The CBO correctly 
states, ``The expected cost of defaults does not account for 
the uncertainly about how costly such defaults ultimately will 
be.'' I concur with the recommendation that the budget cost 
analysis should reflect the reality of this uncertainty, which 
is imposed on the taxpayers.
    The explosion of agency debt means that managing the 
issuance of Treasury securities, as I said, has come to deal 
with only about half, and often less than half of the effective 
government debt. Now this brings me to two statutory 
    Congressman Van Hollen asked about the government role. In 
my view, a key government role is to manage its own credit, all 
of its own credit exposure. And this means that the Treasury 
Department should be firmly in control of the government's 
credit and its use by the off-balance sheet agencies. So I 
propose that we return to the logic, we remember the logic of 
the Government Corporation Control Act of 1945, an act still in 
force. This act spells out the responsibility of the Treasury 
Department to control the debt expansion of government 
corporations with notable rigor, and I cite the language of the 
act in my written testimony. There is no doubt whatsoever that 
Fannie and Freddie are now mixed ownership government 
corporations. So I recommend that Congress should amend the 
Government Corporation Control Act, explicitly to add Fannie 
Mae and Freddie Mac to the list of mixed ownership government 
corporations in that act, thus formally subjecting them to the 
appropriate financial discipline of the Treasury.
    A second useful reform was to find in the Revenue Act of 
1992, passed by the Congress but not enacted due to a veto for 
other reasons, this provision would have forced the Treasury 
Department to focus on how agency debt affects the cost of 
treasuries required in annual report to the Congress on that 
question. And in my view, there is no question that the 
explosion of agency debt increases the cost of treasuries. It 
raises the interest rate on treasuries by creating a giant 
competing supply of government-backed debt to compete with 
treasuries. How big this increased cost is subject to some 
debate. A recent fed study suggests that by taking $1.7 
trillion in government securities of which more than $1 
trillion were agencies securities out of the market, the rate 
on the 10-year Treasury was reduced by 30 to 100 basis points. 
This is a Federal Reserve brand new study. We put this logic 
and just apply it in reverse, adding $7 trillion of agency debt 
to the market, certainly, or at least, plausibly would have 
increased the cost of financing the Treasury by a like amount. 
So, by increasing the cost of the Treasury, the agency debt 
actually increases the explicit government deficit by 
increasing the cost of financing the government.
    So in this Revenue Act of 1992, the provision, which is 
quoted in my written testimony, would require an annual report 
of the Treasury analyzing the extent to which the behavior of 
agency debt has increased the cost of financing the Treasury 
itself. Now, I recommend that this provision should be 
reintroduced and enacted. In these ways, and I am sure there 
are others as well, we can help control for the future, the 
exposure of taxpayers created by the use of the government's 
credit card by agency debt. The consequent uncertainty of the 
true budget cost and the possibility of huge losses and the 
over-leveraging of the housing sector which uncontrolled agency 
debt promotes. Thank you very much for the opportunity to be 
    [The prepared statement of Alex Pollock follows:]

        Prepared Statement of Alex J. Pollock, Resident Fellow,
                     American Enterprise Institute

    taxpayer exposure through the dramatic expansion of agency debt
    Mr. Chairman, Ranking Member Van Hollen, and members of the 
Committee, thank you for the opportunity to be here today. I am Alex 
Pollock, a resident fellow at the American Enterprise Institute, and 
these are my personal views. Before joining AEI in 2004, I was the 
President and CEO of the Federal Home Loan Bank of Chicago from 1991 to 
2004. I have both professionally experienced and extensively studied 
the historical development of mortgage finance, including the 
remarkable role of agency debt.
    The huge debt of the non-budget agencies and government-sponsored 
enterprises (``agency debt'') fully relies on the credit of the United 
States, which means by definition exposure of the taxpayers to losses, 
but it is not accounted for as government debt. As the Federal Reserve 
carefully notes in its ``Flow of Funds'' report, non-budget agency and 
GSE debt is not ``considered officially to be part of the total debt of 
the Federal Government.''
    Not ``considered officially,'' but what is it really? It puts the 
federal budget at risk, or more precisely, subjects it to major 
uncertainties of credit losses. It represents a kind of off-balance 
sheet financing for the government. The vast majority of agency debt 
goes to finance housing though Fannie Mae, Freddie Mac, the Federal 
Home Loan Banks, and the FHA/Ginnie Mae combination. Fannie and Freddie 
in particular have not unreasonably been characterized as ``government 
SIVs,'' which failed.
                        agency vs. treasury debt
    Over the last several decades, we have engaged in a financial 
experiment, or adventure, of exploding agency debt relative to Treasury 
    In 1970, Treasury debt held by the public (``Treasury debt'') was 
$290 billion. Agency debt totaled only $44 billion. At the height of 
the housing bubble in 2006, Treasury debt was up to $4.9 trillion, but 
agency debt has inflated to $6.5 trillion. While Treasury debt had 
increased 17 times during these years, agency debt had multiplied 148 
    At the end of 2010, Treasury debt was $9.4 trillion, and agency 
debt was $7.5 trillion.
    Graph 1 shows the remarkable history of agency vs. Treasury debt.

    In 1970, agency debt represented only 15% of Treasuries. By the 
peak of the housing bubble in 2006, this had inflated to 133%. At the 
end of 2010, agencies were 81% of Treasuries, or about the level of 
1997-98, just before the housing bubble, still a notably high level.
    Graph 2 displays the trend of agency debt as a rapidly increasing 
percentage of Treasury debt. The percentage is falling at the end 
because of the big increases in Treasury debt we all know about.

    If we add these two types of debt together, we can get a total of 
``effective government debt'' (debt dependent on government credit) 
held by the public. Graph 3 compares this ``effective government debt'' 
with Treasuries--an instructive comparison.

                  increasing the cost of treasury debt
    The expansion of agency debt not only imposes risk and realized 
losses on taxpayers (we do not need to mention the $160 billion which 
the U.S. Treasury has been forced to put into Fannie and Freddie to 
prevent their financial collapse), it also increases the cost of 
Treasury's direct financing, by creating a huge pool of alternate 
government-backed securities to compete with Treasury securities, and 
thus increases the interest cost to taxpayers.
    So although agencies are not ``officially government debt,'' they 
undoubtedly increase the required interest rates on Treasury 
securities, in my judgment, and thus increase the federal deficit. The 
greater the amount of agency securities available as potential 
substitutes for Treasuries, the greater this effect must be. As a 
manager of a major institutional investor told me recently, ``We view 
Fannie and Freddie MBS as Treasuries with a higher yield--so now we own 
very few Treasuries.''
    It is difficult to put an exact number on the counterfactual 
question of how much this increased cost has been. However, a 
quantitative suggestion is implied by a recent Federal Reserve analysis 
(Joseph Gagnon et al., ``Large-Scale Asset Purchases by the Federal 
Reserve: Did They Work?''--FRBNY Economic Policy Review, May 2011). The 
authors conclude that by taking $1.7 trillion in securities out of the 
market by Federal Reserve purchases, of which more than $1 trillion 
were purchases of agency securities, the interest rates on ten-year 
Treasuries were reduced by ``somewhere between 30 and 100 basis 
    Suppose we run this logic in reverse: if the supply of effective 
government debt is increased by trillions of dollars of agency debt, 
perhaps that would increase the cost of long-term Treasuries by at 
least a like amount.
    This result depends on the idea that investors will substitute 
agency debt for Treasuries and thus reduce the demand for Treasuries 
from what it would have been. We can observe a striking example of this 
substitution in the aggregate balance sheet of the commercial banks.
    In 1970, commercial banks owned $63 billion in Treasuries and $14 
billion in agency securities. Their Treasury holdings were more than 
four times their agency holdings. By 2006, at the peak of the bubble, 
all commercial banks owned only $95 billion in Treasuries, which was 
dwarfed by their $1.14 trillion in agencies. They then had 12 times the 
investment in agencies as in Treasuries.
    At the end of 2010, the corresponding totals are $299 of Treasuries 
and $1.35 trillion in agencies. This long-term trend of agencies vs. 
Treasuries in banking investments is shown in Graph 4.

    Expressed as a percentage of banking assets, investment in 
Treasuries falls from 12% to less than 1%, then recovers to only 2% 
under current circumstances. Meanwhile investments in agencies inflates 
from less than 3% of banking assets to over 10%, then ended last year 
at 9.4%. This substitution is shown in Graph 5.

              why was the agency debt inflation possible?
    How was it possible for agency debt, and the corresponding taxpayer 
exposure, to grow so much for so long?
    Well, bond salesmen, peddling trillions of dollars of Fannie, 
Freddie and other agency securities to investors all over the world, 
told them something like this: ``You can't go wrong buying these, 
because they are really a U.S. government credit, but they pay you a 
higher yield! So you get more profit with no credit risk.''
    In contrast, a senior member of the Financial Services Committee 
memorably opined that Fannie and Freddie had ``no explicit guarantee * 
* * no implicit guarantee * * * no wink and nod guarantee.'' Official 
voices liked to point out that the offering memoranda for GSE debt said 
right there in bold face type that these securities were not guaranteed 
by the United States.
    Nonetheless, what the bond salesmen said was right, as events have 
conclusively demonstrated. A good sense of the resulting situation is 
described by then-Secretary of the Treasury Henry Paulson in his memoir 
of the financial crisis:
    ``Foreign investors held more than $1 trillion of the debt issued 
or guaranteed by the GSEs. * * * To them, if we let Fannie or Freddie 
fail and their investments got wiped out, that would be no different 
from expropriation. They had bought these securities in the belief that 
the GSEs were backed by the U.S. government. They wanted to know if the 
U.S. would stand behind this implicit guaranee--and what this would 
imply for other U.S. obligations, such as Treasury bonds.''
    Note how in this description, the belief that agency debt is simply 
government debt links to discussion of Treasury securities themselves.
                          risk vs. uncertainty
    Of course, using the credit of the United States to make, 
guarantee, insure or finance mortgage loans though any of the agencies 
which do so entails credit losses. This in itself is not a problem: if 
we knew what the losses would be, or knew what they would be within a 
narrow range, the losses could be easily priced and budgeted for.
    For entities subject to the Federal Credit Reform Act, the expected 
(best guess estimates) of losses must be reflected as costs in the 
federal budget. This requirement was without doubt a major improvement 
over previous practice, but it does not address the fact that we do not 
know what the losses will be. As the Congressional Budget Office points 
out, the FHA, for example, has often had to increase its estimates of 
credit losses. In fact, the expansion of leverage created by the very 
programs in question, may make the losses bigger.
    Huge increases in loss estimates characterized the failure of 
Fannie and Freddie. The limits of the most expert knowledge of the 
future extent of losses is highlighted by this statement of the then-
Director of the Office of Federal Housing Enterprise Oversight: ``Let 
me be clear--both [Fannie and Freddie] have prudent cushions above the 
OFHEO-directed capital requirements.'' This March, 2008 statement was 
indeed clear, but wrong; only six months later both agencies collapsed.
    Two months before the collapse, in July, 2008, the Chairman of the 
Senate Banking Committee pronounced: ``What's important are facts--and 
the facts are that Fannie and Freddie are in sound situation.''
    As the Congressional Budget Office correctly says: ``The expected 
cost of defaults * * * do not account for the uncertainty about how 
costly such defaults ultimately will be.'' [italics added] We need to 
consider both, but indeed, the uncertainty, as opposed to the estimated 
cost, is the hard issue.
    To help take the uncertainty into account, the CBO advocates using 
fair value cost estimates for Fannie, Freddie and the FHA, which draw 
from the market price for bearing credit loss uncertainty. I believe 
this is a reasonable thing to do, but even using such estimates, we 
would have greatly underestimated the losses imposed on the taxpayers 
by the use of the government's credit to back agency debt.
     make treasury responsible for managing the government's credit
    Managing the issuance of Treasury securities under the 
circumstances of the last decade, deals with only about half, and 
sometimes less than half, of the effective government debt.
    In contrast, in the 1970s, the Treasury Department was more 
actively involved with agency debt. That is probably one reason agency 
debt was proportially smaller. In those days, for example, it demanded 
its approval of every individual debt issuance by the Federal Home Loan 
Banks, as required by the Government Corporation Control Act of 1945.
    This Act, which grew out of the sensible worry that government 
corporations were too free in using the credit of the United States, 
considered that the Treasury Department should be in control of the 
government's own credit and its use by agencies.
    It defined among its terms ``a mixed ownership government 
corporation,'' reflecting government ownership of some of the capital 
of the entity, as one form of ``government corporation'' this category 
included and still does include the Federal Home Loan Banks.
    The responsibility of the Treasury Department for such corporations 
is spelled out by the Act with notable rigor--much more so than in the 
Fannie and Freddie charter acts. Thus:
    ``Before a Government corporation issues obligations and offers 
obligations to the public, the Secretary of the Treasury shall 
    (1) the form, denomination, maturity, interest rate, and conditions 
to which the obligations will be subject;
    (2) the way and time the obligations are issued; and
    (3) the price for which the obligations will be sold.''
    Pretty thorough.
    Since 2008, there is no doubt whatsoever that Fannie and Freddie 
have been and are substantively government corporations. The bulk of 
their equity capital is owned by the government, although there are 
small residual private interests in common and junior preferred stock. 
So Fannie and Freddie are clearly ``mixed-ownership government 
corporations,'' in the sense of the Government Corporation Control Act.
    I recommend that Congress should amend this Act explicitly to add 
Fannie Mae and Freddie Mac to its list of mixed-ownership government 
corporations, thus formally defining them as such.
    This would:
    --Reflect reality.
    --Clarify and emphasize the Treasury's responsibilty to manage the 
single biggest use by agencies of the credit of the United States.
make treasury responsible for overseeing the effects of agency debt on 
                     the cost of treasury financing
    In 1992, when agency debt was up to 56% of Treasuries, there was 
debate about the resulting effects on increasing the cost of Treasury 
debt ( I am reliably told). The Treasury Department of the time 
declined to estimate this effect, however, plausibly reflecting the 
political muscle and hardball political tactics of Fannie in those 
    In the text of the Revenue Act of 1992, passed by the Congress, but 
not enacted due to a veto, was this useful provision, intended to force 
the Treasury to focus on the issue:
    ``The Secretary of the Treasury shall annually prepare and submit 
to the Committee on Banking, Housing and Urban Affairs of the Senate 
and the Committee on Ways and Means of the House of Representatives a 
report setting forth the impact of the issuance or guarantee of 
securities by Government-related corporations on----
    (1) the rate of interest and amount of discount offered on 
obligations issued by the Secretary
    (2) the marketability of such obligations.'' [internal citations 
    To help address the obvious problems created by the inflation of 
agency debt, I recommend that this provision should be reintroduced and 
    In these ways, we could help control, for the future, the exposure 
of taxpayers created by the use of the government's credit card by 
agency debt, the consequent uncertainty of losses, and the 
overleveraging of the housing sector which resulted in this last cycle.
    Thank you again for the opportunity to share these views.

    Chairman Ryan. Thank you, Mr. Pollock. Ms. Wartell?


    Ms. Wartell. Good morning. And thank you, Chairman Ryan, 
Ranking Member Van Hollen and members of the committee. I am 
pleased to have the opportunity to testify today.
    Today's purpose is to examine how the budget reflects the 
taxpayers' cost to federal support for the housing market 
through Fannie Mae, Freddie Mac and FHA, but before I speak to 
that issue I want to put in a broader context. Right now the 
GSE's in conservatorship and FHA are essential to stabilizing 
the housing market. Their new business is both prudently 
underwritten and most likely profitable, allowing them to make 
dividend payments to the Treasury, offsetting losses incurred 
on earlier obligations during the housing bubble, and so 
reducing the net cost to the taxpayer.
    First quarter case Schiller Index shows that the housing 
market remains very weak. Had the GSEs and FHA not been able to 
pick up when the private market withdrew, the housing collapse 
would have been far more severe and the recovery even slower; 
something we should remember as we think about the future. No 
one wants to sustain the current situation. Government bears 
the credit risk on over 95 percent of mortgages today. Going 
forward, private capital at risk must be made to bear as much 
of the load as is possible. But we must ensure that the private 
market is ready to pick up the slack before we withdraw federal 
support or we risk deepening the vicious cycle of falling home 
values and a shrinking economy.
    The taxpayers' exposure to risk from the books of business 
originated before the housing collapse by the GSEs. It is 
fixed; there is nothing we can do about it; their exposure is 
fixed, but the ultimate cost of those obligations to the 
taxpayers is undetermined. The size of the losses that the 
taxpayers will pay will be determined in large part by the 
housing recovery, which in turn depends on the consistent 
availability of sustainable mortgage lending to the housing 
market. Limiting the GSE's role prematurely without a better 
design mechanism to ensure liquidity while protecting the 
taxpayers would weaken the housing recovery and have the effect 
of significantly increasing the GSEs and FHA's losses on past 
obligations, and thus the cost to the American taxpayer. With 
that in mind, let me address the budgetary treatment of the 
    First, the cost to the taxpayers of government support for 
Fannie and Freddie is already reflected in the federal budget. 
There is an important technical debate between budget analysts 
about what is the best methodology to use to report these costs 
and that debate in part hinges on whether the GSEs are now 
governmental entities or more like a bank that has been taken 
over by the FDIC, which is not treated as a governmental 
entity, and also it hinges on what discount rates to use. Those 
are important discussions. But please, we should not suggest 
that they are not reflected in the federal budget; the cost to 
the taxpayers of those obligations are.
    The payments in revenues and the effect on the deficit can 
be found in fact on Table S12 on Page 201 of the president's 
Fiscal Year 2012 Budget. Where OMB projects for 10 years the 
payments made under the preferred stock purchase agreements to 
bolsters the GSE's capital position and the dividend payments 
to the Treasury that are required under those agreements to be 
made and returned. It also shows the balance of those two 
numbers, which is the programs net effect on the deficit. What 
is more, additional information regarding the financial 
position of the enterprises is reported in many places, 
including by the Treasury Department's audited financial 
statements, the enterprises 10-K filings with the SEC, and 
quarterly reports from FHFA, their conservator.
    In my written testimony, I detail the consequences of the 
OMB and CBO approaches and my concerns with some of the 
inconsistencies created by the CBO approach, which is as Ms. 
Lucas noted in her testimony. I ask that that full statement be 
submitted for the record.
    A second concern is that we must recognize why the 
budgetary treatment of the GSEs is so complex. We are talking 
about how to reflect in the budget today when we have an 
effective guarantee of the GSEs. Obligations that were occurred 
at an earlier time when the securities were not explicitly 
backed by the full faith and credit. This situation is unique 
and it is temporary. There will be a transition to a new system 
and the GSEs as we know them, will be unwound. There is no 
debate among the administration, Congress or any party that 
that will be the case.
    So what is far more important than a debate about the 
budget treatment of past obligations is to ensure that any 
future system of government support includes explicit terms, 
fees charged for any federal support provided, and reserves 
held on the books of the taxpayers to protect themselves 
against future losses. Any explicit guarantee in the future 
should be accounted for in the budget using standard treatment 
for credit liabilities under Federal Credit Reform Act, and 
which establishes consistent ground rules for ensuring that the 
true cost of credit obligations are recognized when incurred.
    Personally, I support the availability of a government 
guarantee for liquidity targeted to support middle-class home 
buyers and renters. I am pleased to see that there is some 
emerging bipartisan support for this idea with Representative 
Campbell and Peters offering their own proposal which contains 
this core feature. But under any future plan, it is important 
that new guarantee obligations be treated under the same budget 
rules used for other federal credit programs, not that the 
entities are, but the guarantee costs are, so that the costs 
and benefits can be compared across programs under consistent 
    Finally, let me close by commending the Chairman and the 
committee for this hearing. This is technical stuff, but it 
implicates issues that matter to every American family, as 
Congressman Van Hollen mentioned. What is at stake in the 
housing finance reform debate is what kind of future is 
available to all Americans middle-class families. Can 
creditworthy borrowers get non-discriminatory access to a 30-
year fixed-rate mortgage? What that means for their family is 
that they can provide their families with the security of a 
home of their own on terms that they can afford. Will they see 
wild swings again in credit availability and the resulting 
depression of their home values and their savings? Will new 
quality rental housing be built to meet the burgeoning 
projected demand, or will we instead see skyrocketing rents and 
limited choices for renters?
    Congress and the administration have the responsibility to 
design a smart system of housing finance for the future that 
both protects the taxpayers and achieves these goals. I thank 
you, and would welcome a chance to answer any questions.
    [The prepared statement of Sarah Wartell follows:]

 Prepared Statement of Sarah Rosen Wartell, Executive Vice President, 
                Center for American Progress Action Fund

    Chairman Ryan, Ranking Member Van Hollen, and members of the 
Committee, thank you for the opportunity to testify today about the 
budgetary treatment of Fannie Mae, Freddie Mac, and the Federal Housing 
    As I understand it, the primary purpose of this hearing is to 
examine how the federal budget reflects the taxpayer's cost of federal 
support for the housing market through the government-sponsored 
enterprises, or GSEs, in conservatorship, Fannie Mae and Freddie Mac, 
as well as the Federal Housing Administration, or FHA.
    Let me begin by making three central points about the budget impact 
of the GSEs:
     First, the cost to the taxpayers of government support for 
Fannie and Freddie is already reflected in the federal budget. In 
addition, there is transparency about the financial position of the 
enterprises and the risks to the taxpayer provided by a number of other 
reports from the Treasury Department; the Office of Management and 
Budget, or OMB; and the Federal Housing Finance Agency, or FHFA. There 
is a technical debate between budget analysts about what is the best 
methodology to use to report these costs, but please do not let anyone 
tell you the costs are hidden or not reflected in the budget. I detail 
below how they are reported.
     The treatment of the GSEs is uniquely complex because we 
are talking about budget treatment of obligations incurred when the 
securities were not expressly backed by the full faith and credit of 
the Federal Government at a time when we now have an effective 
government guarantee and ongoing obligations as well. As the housing 
markets stabilize and a long-term housing finance reform policy is 
determined, new policy will be made that will involve unwinding the 
GSEs as we know them. Far more important than the debate about the 
current treatment of the historical obligations is to ensure any future 
system of government support includes express terms, fees charged for 
support provided, and reserves held to protect taxpayers against loss, 
and all these terms accounted for in the budget using standard budget 
treatment for credit liabilities under the Federal Credit Reform Act.
     Finally, the taxpayers' exposure to risk from the books of 
business originated before the collapse of the housing market cannot 
now be altered. It is fixed. But of course the ultimate cost of those 
obligations to the taxpayers is still undetermined. The cost depends 
heavily on the recovery of the housing market, which in turn depends 
upon the policy steps taken by Congress, the administration, and 
regulators. The GSEs in conservatorship and FHA are playing a central 
role in stabilizing the housing markets. This month's economic reports 
show that the housing market remains very weak. Had the GSEs and FHA 
not played their central role, the housing collapse would have been far 
more severe, the economic recovery slower to take hold and even more 
tepid, and the losses to the taxpayer far greater. What is more, 
precipitous actions now to limit their role prematurely and imprudently 
would weaken the housing recovery and have the effect of significantly 
increasing the GSEs' and FHA's losses on outstanding obligations. Thus, 
the cost to the taxpayers of these existing obligations depends upon 
the wise exercise of policy discretion in the months and years ahead.
                a note about the gses in conservatorship
    Before addressing the budget treatment of the GSEs in 
conservatorship, it's important to point out that the GSEs in 
conservatorship will be much different from those of the past. Since 
Fannie Mae and Freddie Mac were placed into conservatorship, the FHFA 
has monitored their business operations closely and mandated heightened 
underwriting standards. Both enterprises have also increased their 
guarantee fees and adjusted their pricing to attempt to price for 
    As a result, under most scenarios, the loans currently being 
guaranteed by the GSEs will not contribute to the losses Fannie Mae and 
Freddie Mac face going forward. Instead, the profits made from these 
new books of business will help to reduce losses from the outstanding 
obligations. In 2009 default rates for GSE-administered loans in their 
first 18 months were 1.2 percent and 1.1 percent, respectively. That's 
compared to 28.7 percent and 22.3 percent for GSE loans originated in 
2007.\2\ The losses GSEs are still reporting today are 
disproportionately the result of delinquencies and defaults on loans 
that were originated and guaranteed in 2006, 2007, and 2008.\3\
    Even as the financial situations of the GSEs improve, the Obama 
administration has repeatedly stated it has no interest in returning to 
the way things were before the crisis. The Treasury's white paper on 
housing reform released in February calls for reducing overall 
government support for the housing market (which currently relies on 
governmental support for more than 90 percent of loans) and winding 
down Fannie Mae and Freddie Mac. The phase-out plan includes continuing 
to increase guarantee fees, reducing conforming loan limits, and 
winding down their investment portfolios.\4\ So the GSEs in 
conservatorship represent a temporary situation whose ongoing 
operations are mitigating the costs of prior mistakes. The most 
important question is what a reformed housing finance system looks 
              how taxpayer support of the gses is reported
    In September 2008, upon the action of FHFA to place Fannie Mae and 
Freddie Mac in conservatorship, the Treasury Department launched 
temporary programs to provide capital to the GSEs to ensure each 
maintains a positive net worth. Specifically, Treasury agreed to make 
investments in senior preferred stock as required, but in exchange, 
Fannie Mae and Freddie Mac were required to pay quarterly dividends to 
Treasury at a rate of 10 percent.
    The president's first budget after the stock purchase programs 
began was released in February 2009 for FY 2010. It included a report 
of all projected payments to and receipts from the GSEs under those 
programs in the summary tables; in addition, those payments and 
expenses were reflected in the budget's projections of spending and 
revenues and resulting deficits. The table appeared again in the FY 
2011 and FY 2012 budgets. The most recent version can be found at Table 
S-12 on page 201 of the President's Budget for Fiscal Year 2012.
    Outlays to the GSEs to bolster their liquidity are reported as 
costs to the government. Dividends on preferred stock paid to the 
Treasury by the GSEs are reported as payments to the Treasury. The 
balance of those two numbers is the program's net effect on the federal 
    The Office of Management and Budget projects these numbers for the 
next 10 years. The FY 2012 budget estimates that the government will 
pay $236 billion to the GSEs between 2009 and 2021 in ``Senior 
Preferred Liquidity Payments'' and collect $163 billion in dividend 
payments. This means a net cost to government of $73 billion spread out 
over 13 years.\6\
    More detailed financial information on Fannie's and Freddie's 
financial position that underlies these budget cost estimates is 
provided in the budget's ``Appendix on Government Sponsored 
Enterprises.'' It includes a balance sheet for each enterprise, 
including the value of all assets, liabilities, and equity and status 
of outstanding mortgage-backed securities.\7\
    Similar financial information can be found in the Treasury 
Department's Performance and Accountability Report, which includes the 
audited financial statements of the Treasury. The ``Management's 
Discussion and Analysis'' section of the FY 2010 report (released 
November 15, 2010) contains the value of all current payments to and 
revenues from the GSEs, as well as long-term projections of future 
costs to the government. The Treasury estimated as of that date that it 
would eventually pay $508.1 billion in GSE outlays between 2009 and 
2031 and receive $472.2 in preferred stock dividends that were the 
obligations to be outstanding for that period. That would mean a net 
cost to the government of $35.9 billion over 22 years.\8\ (The 
difference with the OMB numbers above is timing and the duration of the 
projected period.)
    Fannie Mae and Freddie Mac also report themselves on what they 
receive from the Treasury and pay back in preferred stock dividends 
each year in their 10-k securities filings.
    Finally, the Federal Housing Finance Agency reports quarterly its 
Conservator's Report on the Enterprises Financial Performance. In 
October 2010 the oversight agency also published its own projection of 
Fannie and Freddie's financial performance through 2013. The 
Projections of the Enterprises' Financial Performance report estimated 
$221 billion in Treasury outlays and $80 billion in dividend revenues 
between 2009 through 2013, which is similar to the OMB and Treasury 
projections over that period.\9\ This report also included a stress 
test of the budgetary effect under difference scenarios for the 
economy. In its most recent quarterly report, FHFA noted that its 
October 2010 estimates of Treasury draws for the second half of 2010 
had ranged from $24 billion to $48 billion, but the actual combined 
Treasury draw for the second half of 2010 was only $6 billion, as the 
performance of loans was better than had been expected.
    In short, the federal budget reflects the current and projected 
costs of the Federal Government's support of the GSEs through the 
Preferred Stock Purchase Agreements. Additional information about the 
financial condition of the GSEs in conservatorship and the risk to the 
taxpayers from their obligations is also reported by an array of 
federal agencies and by the GSEs themselves.
                   cbo's alternative budget treatment
    CBO treats the GSEs differently than does OMB for budget purposes. 
As other witnesses will testify, CBO has concluded that Fannie Mae and 
Freddie Mac should be treated in the federal budget as government 
entities. As a result, CBO says, it ``considers transactions between 
them and the Treasury to be effectively intra-governmental payments, 
which do not affect net federal outlays.'' \10\
    OMB's treatment, on the other hand, is based on the conclusion that 
the GSEs remain separate private companies, under conservatorship. 
According to the 1967 Commission on Budget Concepts, inclusion of an 
entity's assets and liabilities in the federal budget depends on three 
basic factors: ownership, control, and permanence.\11\ Under the terms 
of the Housing and Economic Recovery Act of 2008, FHFA as conservator 
may take any action that is necessary to return Fannie Mae and Freddie 
Mac to sound and solvent condition and to preserve and conserve the 
assets of these firms. Treasury has made clear its intention to work 
with Congress to reduce the GSEs' role in the market and ultimately 
wind down both institutions at a pace that does not undermine economic 
recovery. Given these factors, it seems difficult to conclude that the 
current arrangement between Treasury and the GSEs is permanent.
    One consequence of treating the GSEs as on budget now will be that 
their treatment will inevitably change again as they are unwound. This 
may complicate further efforts to produce a consistent budget display 
and make effective comparisons over time. There is risk that, like Hall 
of Fame baseball players in the era of performance-enhancing drugs, 
budget records for this period will be marred by asterisks.
    CBO's preferred methodology estimates ``subsidy costs'' for each of 
the GSEs' existing businesses. It treats the GSEs' MBS business as if 
it were a government direct loan program. For estimating the subsidy of 
these credit obligations, CBO uses a method similar to the treatment of 
Federal Credit Reform Act of 1990, except that they diverge from the 
requirements of the FCRA by using an alternative discount rate. This 
alternative is an estimate of a private-sector discount rate, rather 
than the Treasury discount rate used under the Federal Credit Reform 
Act, where Treasury's discount rate is used to calculate a current 
value for the stream of revenues and expenses that will arise from a 
guarantee obligation.
    CBO argues that the Treasury discount rate underestimates the 
``tail risk'' to the taxpayers of costs proving to be far greater than 
thought most likely. They seek instead to determine the value that the 
private market would charge for the guarantee, arguing that is a more 
accurate measure of the cost to the taxpayers. Of course, no private 
actor, however, is in the position of the government with the ability 
to borrow at Treasury rates and the ability to spread risk across such 
a broad portfolio. So CBO must develop a measure of value through a 
series of assumptions. And the resulting estimate is really a measure 
of how the private market might value the guarantee rather than what it 
costs the Treasury to provide it.
    Finally, CBO's treatment of the GSEs as governmental requires them 
to explain why the GSE debt is nonetheless not included in estimates of 
the federal debt held by the public. CBO reports that budget documents 
prescribe a more narrow definition.\12\ In fact, no one is arguing that 
the $1.5 trillion in GSE debt outstanding should be added to the 
federal debt. Such a move would accomplish nothing other than upset 
investor expectations, prompt confusion, and potentially roil capital 
markets at great cost to the U.S. economy and housing markets in the 
form of reduced liquidity, higher interest rates, and downward pressure 
on home values.
    The dispute between CBO and OMB on the proper way to account in the 
budget for the GSEs is complex and technical. Both parties are acting 
in good faith to improve accuracy and provide clarity. But the choice 
of budget reporting parameters is not what is most important. CBO's 
treatment does nothing to reduce the taxpayers' exposure to loss or 
improve transparency about the taxpayer's actual exposure to loss or 
move us forward toward reform of the housing finance system.
    The fact of the matter is that budget analysts are trying to jerry 
rig a set of budget rules for these hybrid entities after the fact. We 
must acknowledge that the bulk of their costly obligations were 
originated under the policy that these entities did not carry a 
government guarantee, when events have subsequently revealed that they 
did. What is more, the guarantee was not priced or paid for. This 
experience teaches us important lessons about how we must treat any 
future government guarantee obligations in the future.
                  reform of the housing finance system
    My colleagues and I at the Center for American Progress have 
testified and written elsewhere about our views on long-term reform of 
the housing finance system. Our views are based on a proposal developed 
by the Mortgage Finance Working Group, convened by CAP, made up of 
secondary market and affordable housing experts. Our proposal can be 
found at: http://www.americanprogress.org/issues/2011/01/responsible--
    We believe that, in the future, we must establish a way to assess 
and budget for public risk while continuing to provide, where needed, a 
limited liquidity backstop. The added liquidity of a government 
guarantee will give millions of creditworthy borrowers access to the 
American Dream of homeownership and a chance to retain a foothold in 
the middle class. It will help families afford a long-term mortgage 
with a reliable fixed rate. It will help developers find capital to 
finance new apartments and other homes so households don't see their 
rents spike as growing demand and inadequate supply put decent rental 
options out of reach. And it will provide a mechanism to ensure that 
there does not develop a two-tier system of housing finance in which 
qualified borrowers who can sustain homeownership are nonetheless only 
given access to higher-priced credit because they live in underserved 
communities and communities of color.
    But never again, after housing finance reform, should we have 
implicit guarantees. Where a liquidity backstop is important, as I 
believe it will be for some targeted portion of the market, the 
guarantee should be explicit, available only for qualified obligations 
of a well-capitalized and regulated entity, a guarantee fee should be 
charged, and those fees should be collected in a catastrophic loss 
insurance fund to stand behind the guarantee, protecting the taxpayers 
against future loss.
    Any future government guarantees must be administered with strict 
discipline to protect taxpayers and promote ongoing market stability. 
This means that every obligation insured by the Federal Government must 
be for a specific public benefit and the value of its subsidy cost 
appropriated under the Federal Credit Reform Act.
                how fha costs and revenues are reported
    Before concluding, let me mention the budget treatment of FHA 
insurance programs. I was a deputy assistant secretary at FHA and I 
even got to know my husband, then the OMB FHA Budget examiner, by 
working together to develop a credit reform estimate for FHA reform 
legislation in the mid-1990s. So I fully understand the difficult task 
of accurately estimating the cost of federal credit programs.
    In contrast to the GSEs, FHA is a Federal Government entity. What 
is more, in exchange for federal insurance, a mortgage insurance 
premium is charged and a reserve fund is maintained with those fees to 
pay claims and to protect the taxpayers against loss. As a result, 
after experiencing significant losses on books of business incurred 
during the height of the housing bubble and in the immediate aftermath 
of the collapse, there remains more than $30 billion in the FHA Mutual 
Mortgage Insurance, or MMI, Fund. And the fund's capital reserve, while 
depleted, is still solvent. Premiums charged on current higher-quality 
books of business are replenishing the MMI fund. As a result, the most 
likely scenario is that FHA will continue unbroken its 77-year history 
of operations without requiring any infusion of taxpayer funds to 
remain solvent.\13\
    Since the passage of the Federal Credit Reform Act of 1990, or 
FCRA, as part of the Omnibus Budget Reconciliation Act of 1990, the 
cost of FHA's loan guarantees are accounted for in the federal budget 
under Credit Reform. According to a ``primer'' on credit reform by 
budget expert and fellow at the Johns Hopkins University Center for the 
Study of American Government Tom Stanton:
    Prior to credit reform, Federal credit program costs were budgeted 
and accounted for on a cash basis (the amount of cash flowing into or 
out of the Treasury), like other Federal programs. Cash accounting 
failed to portray accurately credit activities' long-term costs: direct 
loan costs were overstated, as annual loan disbursements appeared with 
a cost equivalent to grant outlays, and there was norecognition that 
borrower loan repayments would offset some or all of those outlays; 
guaranteed loan costs were understated, as they appeared as having no 
cost in the year the guarantee was made, with no recognition that 
future default outlays could result.
    Most loan programs were funded through revolving funds, in which 
repayments from prior loans offset outlays from new loans, and a 
program's net cash flows could appear to be reducing the deficit at the 
same time that billions of dollars in subsidized loans were being made. 
Policy makers, therefore, did not have the information with which to 
make informed budget allocation decisions, and credit program managers 
often were not fully aware of how their loan origination and servicing 
actions affected program costs.
    Credit reform recognizes that a loan's true cost is not captured by 
its cash flows in any one year; the true cost is the net value of its 
cash flows over the life of the loan.\14\
    Since enactment of credit reform, FHA has struggled to accurately 
predict revenues and costs in its single-family mortgage insurance 
program. In some years they assumed budgetary savings larger than 
ultimately proved to be the case. Beginning in 2002 they began 
estimating savings when the books insured proved to have a budgetary 
cost.\15\ These difficulties reflect weaknesses in the previous model 
that FHA and OMB used to predict future streams of premiums and 
expenses. The misestimates were most extreme during the housing bubble, 
when loans incurred under a down-payment assistance program proved to 
perform terribly but the model did not distinguish between these loans 
and more standard FHA lending.
    FHA responded in 2010 by revamping its independent actuarial 
review, including a more sophisticated forecasting model for home 
prices developed by Moody's (accurate price forecasting is a critical 
aspect of predicting defaults). For its first book of business using 
the new model, FHA slightly overestimated its subsidy costs for the 
first time in 18 years. This is a promising first step. And OMB and HUD 
continue to work to improve the estimates of house-price performance 
that are so central to predicting the performance of FHA insurance in 
    Yet some members of Congress contend that the better remedy is to 
shift from Credit Reform accounting to the use of ``Fair Value'' 
reporting. But in reality this change would in no way help FHA's 
ability to come up with accurate predictions of performance of insured 
loans. As described above, the key difference between these two methods 
is the choice of discount rates employed: Treasury discount rates are 
used for Credit Reform and an approximation of a ``private sector'' 
equivalent discount rate is used for the Fair Value reporting (see 
discussion on page 5 above regarding the choice of discount rate). 
Regardless of whether they're discounted by Treasury rates or a private 
market premium, the cost estimates will still be grounded on the same 
market forecasts. Biasing the estimates high will not change the 
economic reality in which FHA operates. It will, however, overstate the 
cost of operating the FHA program, so as to encourage misguided 
opposition and drive legislation to constrain its growth.
    But whatever the process, it is imperative that Congress apply the 
same budget rules to FHA loan guarantees as it does to all other 
federal credit programs. To responsibly manage government resources, we 
must measure the cost of all programs by the same standards. It would 
be irresponsible for Congress to cherry-pick individual credit programs 
to be subjected to special budget rules. This would make some programs 
appear more expensive than others, when really they are just calculated 
using entirely different measures of cost. It's like comparing two 
products priced in different currencies without considering the 
exchange rate.
    In closing, I would like to commend the chairman and the other 
members of this committee for holding this hearing. This is technical 
stuff, but it implicates larger issues before Congress. First, 
Congress's responsibility to carefully manage the housing market to 
protect against greater harm to American families and taxpayers; and 
second, Congress's role with the administration in designing a smart 
system of housing finance for the future. I would be happy to take any 
    \1\ Assistant Secretary for Financial Institutions Michael S. Barr, 
Testimony before the House Subcommittee on Capital Markets, Insurance, 
and Government Sponsored Enterprises, ``The Future of Housing Finance: 
A Progress Update on the GSEs,'' September 15, 2010, available at 
    \2\ Ibid.
    \3\ Ibid.
    \4\ Treasury Department, Reforming America's Housing Finance 
Market: A Report to Congress, February 2011, p12
    \5\ Office of Management and Budget, ``Analytical Perspectives of 
the Budget of the United States Government for Fiscal Year 2012'' 
(February 2011), p. 374.
    \6\ Office of Management and Budget, ``Budget of the United States 
Government for Fiscal Year 2012'' (February 2011), p. 201.
    \7\ Office of Management and Budget, ``Budget of the United States 
Government for Fiscal Year 2012'' (February 2011), Appendix on 
Government Sponsored Enterprises, p. 1319.
    \8\ U.S. Department of Treasury, ``2010 Performance and 
Accountability Report'' (December 2010), p. 21.
    \9\ Federal Housing Finance Agency, ``Projections of the 
Enterprises' Financial Performance Report'' (October 2010), p. 10 
(baseline scenario).
    \10\ Congressional Budget Office, ``CBO's Budgetary Treatment of 
Fannie Mae and Freddie Mac'' (January 2010).
    \11\ President's Commission on Budget Concepts, ``Final Report'' 
(1967). The final report has a section specifically on exclusion of 
GSEs from the federal budget, stating as a general rule that GSEs 
should be ``omitted from the budget when such enterprises are 
completely privately owned.'' The report also recommends that the 
``total volume of loans outstanding and borrowing of these enterprises 
at the end of each year be included at a prominent place in the budget 
document as a memorandum item'' (p30). This information is currently 
included as an appendix to the budget document.
    \12\ Congressional Budget Office, ``CBO's Budgetary Treatment of 
Fannie Mae and Freddie Mac'' (January 2010), p. 3.
    \13\ U.S. Department of Housing and Urban Development, ``Annual 
Report to Congress Regarding the Financial Status of the FHA Mutual 
Mortgage Insurance Fund Fiscal Year 2010'' (November 2010), p. 21.
    \14\ Thomas Stanton, ``Primer on Credit Reform'' (1998), p. 1, 
available at http://www.coffi.org/pubs/
    \15\ Congressional Budget Office, ``Accounting for FHA's Single-
Family Mortgage Insurance Program on a Fair-Value Basis'' (May 2011), 
p. 7.

    Mr. Garrett [presiding]. I thank you for your testimony. I 
appreciate the panel's testimony. And at this time, I will 
yield myself such time, I guess, as I consume in this 
committee. Unlike Financial Services where I am limited to five 
minutes, I am told by Paul before he left, I can just go on ad 
nauseam here, but I will try not to do that.
    Ms. Wartell, your comment at the end, you said, ``This is 
technical stuff.'' But that is not any reason why we should not 
have transparency with what we are talking about. And I will 
start with Ms. Lucas on this point.
    So we just had a hearing recently in Financial Services, 
and we brought up the letter up to Paul that CBO wrote with 
regard to this issue that the panels also addressed, and on the 
upside was the fact that there was agreement on everyone on the 
panel that, in fact, that there should be a reevaluation, if 
you will, of how the numbers are reported and to provide for 
more and greater transparency in regard to the budget and all. 
So that was the upside. The push-back, though, at least from 
one of the panelists was that well maybe the CBO just did not 
get it right. And looking back on the witness statement, it 
says, The CBO maybe been a little off, and it used Fannie and 
Freddie fees and private mortgage fees as to determinate to how 
the market risks to FHA should be calculated.
    Would you like just to spend a moment to expand upon your 
analysis and why that push-back is not correct but the CBO's 
analysis what for fair value is the correct analysis for 
determining on budget?
    Dr. Lucas. Yes, Congressman. Thank you. I guess where I 
would like to start is to say that, of course, any estimate of 
these costs is extremely difficult to get right. I am not sure 
any of us would even know what right was when we saw it because 
it involves so many uncertainties. Remember that we are 
projecting the cash flows over the life of 30-year mortgages in 
a world where we do not know what is going to happen to housing 
prices, default rates, and so forth. So there is a great deal 
of uncertainty in these estimates whether they are done under 
Credit Reform or on a fair-value basis.
    I think what is fundamentally important is that CBO is 
striving to give an unbiased estimate to the best of our 
ability. So when we are trying to go give these fair-value 
estimates, the idea is that you are trying to reflect what the 
price would be in a well-functioning financial market. Now, 
that was particularly challenging task for Fannie and Freddie, 
given how disrupted markets have been recently. But what we do 
is very much like the practice in private financial 
institutions that also have to struggle to do fair-value 
accounting because they are required to do so. And it does mean 
looking at market prices and trying to understand what is 
driving those market prices and how much risk is embodied in 
those prices.
    So when we look at the private guarantee fees, we look for 
mortgages that are comparable in their risk to the ones the 
GSEs are doing. We make adjustments for differences in the 
borrowers and the houses and the leverage and so forth, and so 
we try to come around to the best estimate that we can make of 
the cost of those guarantees, taking into account the cost of 
market risk as it is reflected in market prices. Now, I would 
be happy to provide you with a more technical answer to the 
question later on if you wanted more details.
    Mr. Garrett. That was pretty technical right there. But the 
bottom line is that there should be an evaluation or an 
appreciation of the fact that we are talking about mortgages 
here where there is market risk, and basically what CBO is 
trying to do is to put that into the calculation, that the 
valuation of those things are going to change overtime, and 
that the obligation of us, the taxpayer, the Federal Government 
is going to vary because of that over time, and you are trying 
to price that today, so we understand what that cost is going 
forward. Is that not, in a nutshell, what we you are trying to 
    Dr. Lucas. That is it.
    Mr. Garrett. Okay.
    Dr. Lucas. Exactly.
    Mr. Garrett. And absent doing that, you are really not 
giving a truly transparent answer to what the cost is to the 
taxpayers, and to the government today.
    Dr. Lucas. Well, you are certainly not giving as 
comprehensive a measure of the cost. I mean the view that this 
is important comes from viewing the taxpayer as the ultimate 
bearer of the risk that is coming from this. So, if everything 
goes well, the taxpayers will be fine. But if we have another 
dip in the housing market, another recession, that is when 
defaults are likely to really hit, that is when those defaults 
are most costly, and that is the source of this market risk 
that taxpayers would require compensation to bear if they were 
investors. And that is the philosophy behind including that 
cost in these cost estimates.
    Mr. Garrett. And Ms. Wartell, although you say that there 
is all this information out that is published in other reports, 
and what have you, elsewhere, there is also reports on 
everything else that Federal Government does elsewhere as well, 
but we still require the CBO and the OMB to actually put these 
things outside of here on budget so it is actually properly 
reflected as far as the obligations of the government. So why 
is it with just this one unique area that is satisfactorily 
that just because it is reported someplace else it is not 
prudent to actually list it as on-budget and what the cost is 
today? Why do you make this exception?
    Ms. Wartell. Well, I do not think it is exception. What I 
was arguing, in fact, is that the cost to the Treasury of those 
obligations, what they will pay in future support under the 
contract that they have with the GSEs, which is the preferred 
stock purchase agreement, those costs are projected and they 
are on the budget, as well as the revenues that they anticipate 
receiving from the dividend payer.
    Mr. Garrett. But the market risk is not on the budget?
    Ms. Wartell. Well, the market risk is embedded in the 
estimate of what those costs will be because those costs will 
    Mr. Garrett. When you say that it is in CBO's estimate, it 
is not in OMB's estimate that is embedded.
    Ms. Wartell. OMB's estimate has a measure of risk. The 
difference between CBO and OMB's estimate is whether or not 
they use a discount rate that is the rate that is charged to 
the Treasury, what Treasury obligations essentially can be 
purchased at, versus what a private actor would be charged 
because there is no private actor with this capacity; it is an 
estimate of what that would be. We do know what the Treasury 
rates are.
    But the other problem is that the Federal Government is not 
a private actor; we know it is fixed costs, which are borrowing 
at Treasury costs; no one else has the capacity to borrow, and 
no one else has the capacity to spread risk. So what the use of 
that discount rate does is it is an attempt to estimate what 
the value of that risk is, but not necessarily the cost. That 
is the technical debate between analysts is to whether this is 
a more precise estimate of the cost to tax payers.
    Mr. Garrett. I put my time in. Mr. Pollock, I will let you 
verbally have the closing word on this comment.
    Mr. Pollock. Thank you, Mr. Chairman. The economist, Frank 
Knight, almost 100 years ago, famously and correctly 
distinguished between risk, which are odds that you know and 
uncertainty which means you do not know what is going to 
happen. As I interpret this discussion, it is about the 
uncertainty, which inevitably comes into the picture when you 
are extending credit and when you are financing things. So if 
you knew what the losses would be by a best-guess estimate, or 
estimated loss, and you knew that is what the losses were, then 
it would be very easy. You have the Credit Reform Act 
procedure. The problem is, not only do you not know it, you 
cannot know it. And I think, as I interpret, the CBO's 
recommendation is trying to correctly to take into account the 
inherent uncertainty that these losses may be much greater than 
anybody's previous best guess, we have experienced that many, 
many times. And there is one final point, which is the very 
fact that you think you know what the losses are going to be, 
as we just saw in the housing bubble, induces you to extend 
more credit, to run up the risk further and to make the losses 
bigger. And all of that, while hard to do in a precise way, is 
directionally what the CBO is trying to do, and I think that is 
    Mr. Garrett. Mr. Van Hollen?
    Mr. Van Hollen. Thank you, Mr. Chairman. Again, I want to 
thank all the witnesses for their testimony. I want to stay on 
the technical point for a minute and then get to the larger 
question of where do we go from here. And, Mr. Chairman, I do 
want to submit from the record the portions of the OMB budget, 
page 201; it talks about the market valuation, a balance sheet 
of Fannie Mae and Freddie Mac.
    [The information referred to follows:]

    Mr. Van Hollen. And I understand Ms. Wartell's testimony to 
be those risks are embedded in their analysis and their 
projections. [inaudible] Ms. Wartell in your testimony, you 
talk about the fact that you are going to apply this other 
approach to measuring the risk and cost and that we need to do 
it uniformly across all credit programs. And just a quote from 
your written testimony: it says, ``It would be irresponsible 
for Congress to cherry-pick individual credit programs to be 
subject to special budget rules. This would make some programs 
appear more expensive than others, when really they are 
calculated using entirely different measures of costs. It is 
like comparing two products priced in different currencies 
without considering the exchange rate.'' Could you elaborate a 
little bit on that?
    Ms. Wartell. Yes, that reference was to the discussion 
about FHA and whether or not FHA, which is a Federal Government 
program, there is no controversy there, should be evaluated 
using the fair value method versus the methodology that is used 
under Federal Credit Reform Act. And I think they are two 
points there.
    The first is it that consistency is enormously important 
because the ability to weigh the difference priorities of 
Congress requires you be able to treat like-items alike.
    The second point is that it is perfectly appropriate for us 
to have supplemental information about FHA or other credit 
programs that get to this question of variability of risk 
because housing markets are different than energy markets that 
we also guarantee. But we should be looking at the cost to the 
taxpayers of those programs using similar methodologies.
    Mr. Van Hollen. Thank you. Ms. Lucas would you agree with 
    Dr. Lucas. I certainly would agree with that. In fact, one 
of the stated purposes of the Credit Reform Act was to put 
credit on a level playing field with other commitments that the 
government makes. And I think one of those problematic things 
going on right now is the different treatments are being used 
in different places. Just to mention that Ms. Wartell said that 
what OMB is doing right now is it under Credit Reform, but for 
the GSEs it is actually using a cash basis of accounting in the 
budget. So right now, we have an inconsistency between cash and 
even Credit Reform for the GSEs. So the GSEs, as they are being 
accounted for now, are not comparable with the FHA either in 
the way the administration is accounting for them. But 
certainly being consistent is extremely important.
    The GSE accounting is consistent with the way TARP was 
accounted for, and those obligations sort of arose in 
connection with the same problems that led to the TARP. So 
there was a consistency there, but there are inconsistencies in 
other places.
    Mr. Van Hollen. Ms. Wartell, if you want to briefly respond 
to that.
    Ms. Wartell. You are right about the reference to Fannie 
and Freddie. The question of consistency then determines 
whether or not you believe that Fannie and Freddie are like FHA 
in their current situation. Are we treating them consistently? 
They were private entities with private shareholders. They are 
now mixed ownership because the government owns a portion of 
them. But they are entities that are being wound down in their 
status. And we do not treat other entities being wound down 
like the banks that are on resolve by the FDIC that way. And so 
we have, in our striving for consistency, there are multiple 
facets in which we are striving to be consistent. And on that 
regard, the treatment of the GSEs, like FHA, makes them 
inconsistent with other things that are also not temporary in 
    Mr. Van Hollen. Mr. Chairman, I think members of this 
committee are getting a good sense of just how technical this 
issue is. That does not mean it is not important, it is. I 
think we would all agree we want the most transparent and 
accurate assessment of the cost to the taxpayers. And we 
obviously will continue to pursue that. But the larger costs in 
the long run has been said by some of our witnesses, and I 
mention in my opening statement is how we respond to the 
current situation because there are certain actions we could 
take that I believe would dramatically cost the taxpayer more 
both in terms of the obligations that we have already signed up 
to, but also would hurt the availability of credit for 
creditworthy borrowers going forward.
    And so, Ms. Wartell, if you could just briefly explain what 
you think the consequences would be of three proposals. One, 
proposal is that introduced by Mr. Hensarling and a number of 
members of this committee. And the second, and I know Mr. 
Campbell has an interest in this, the one that he introduced 
that has bipartisanship co-sponsorship, and then the proposal 
that you have advanced at the Center For American Progress.
    Ms. Wartell. Well I think the nut of the Hensarling 
proposal is an effort to unwind the GSEs but not to replace 
them with any form of targeted government liquidity backstop in 
the future and to do it quickly. And the speed is of particular 
concern because of the current fragile state of the housing 
market. If you were to disrupt the expectations of investors, 
people would worry now that a house that they buy today, no one 
will be able to buy or be able to get a mortgage on similar 
terms if there is no GSEs in the future. So they will be 
worried that they will not be able to sell it for what they 
purchased it for. That will deter purchases in the housing 
market and that will deflate values. So, my fear is that if 
Congress were to give serious consideration to that 
legislation, the market today would begin to price in some of 
those risks. And the effect of that would be to make our 
current economic fragility even more extreme.
    The Campbell Peters Bill and others represent this notion 
that there should be a limited targeted liquidity back stop 
standing behind private capital that is fully at risk, meaning 
that the private investors have to lose all of their money 
before any government insurance and it also embodies the notion 
that there would be a charge paid for the government standing 
behind it. It would be built into the cost of the mortgage and 
the government would collect that money and hold it as a 
reserve fund, but would leave liquidity available, not for 
jumbo mortgages and high-end mortgages, but for the mainstream 
middle part of the market. So there is consistent availability 
that will allow house prices to resume their normal 
appreciation based on underlying economics. That approach, it 
seems to me goes a long way towards moving forward in the 
housing market.
    The cap proposal that was developed by our Mortgage Finance 
Working Group, takes the nut of the Peters Campbell proposal, 
but also includes with it some obligations to ensure that all 
of our communities have access to credit. One of the 
consequences of this unfortunate foreclosure crisis is that 
particular communities that were targeted by some primary 
lenders are seen equity stripped and where there are high 
concentrations of foreclosures; it is going to take a long time 
for housing values there to recover. And so we create an 
obligation to ensure that the private market would serve all of 
our communities with access to credit, and to the extent they 
cannot do it profitably, there would be a shared risk with the 
taxpayers on budget priced under federal Credit Reform that we 
hope think will ensure that we recover most quickly but, at the 
same time, limit the taxpayer's exposure from the future.
    Mr. Garrett. And then I guess it is appropriate to follow 
that line of questioning with the gentleman from California.
    Mr. Campbell. Thank you, Mr. Chairman, and thank you all 
for being here.
    It has been said many times there is no debate or 
discussion that Fannie and Freddie as they exist should be 
wound down. And that we want to account for them accurately and 
transparently, and that we want to reduce that cost to the 
taxpayer. Nobody disagrees with that. So I would like to focus 
on, obviously, the future and what we are going to replace 
Fannie and Freddie with and what consequences that may have. So 
Dr. Lucas, starting with you. If we have, as Ms. Wartell 
described, something that is an explicit permitted federal 
guarantee behind a lot of private capital, and for that 
guarantee there is a market charge, not dissimilar from FDIC 
insurance, the way that works, CBO, in that sort of instance, 
something like that could score at zero or little or low cost; 
is that correct? I am not asking to score the proposal at this 
time, but just in concept that kind of thing.
    Dr. Lucas. It is certainly true that the more private 
protection there is in front of the government and the less 
likely it is that the government will see losses, the lower the 
estimated score would be.
    Mr. Campbell. And you mentioned in your testimony about one 
of the problems that Fannie and Freddie is that there was no 
charge for what was implicit and became explicit. In this case, 
there would be a market charge.
    Dr. Lucas. That is right. Unfortunately, the term ``market 
charge'' brings us squarely back to the ugly technical 
discussion we were having earlier because one person's view of 
what covers the cost to the government is different than the 
others. If, in my mind, a market charge would include a cost 
for the risk-bearing, and as you said, it would not be 
particularly large if the government was protected by a lot of 
private capital and by the value of the houses and so forth, 
and good under writing.
    Mr. Campbell. Okay. Let me go on to one other. If we were 
to withdraw any government support and wind down Fannie and 
Freddie and withdraw any government support, and that resulted 
in a drop in housing prices, that would put further taxpayer 
money at risk in the Fannie and Freddie portfolios that exist, 
    Dr. Lucas. Yes, it would.
    Mr. Campbell. And that could potentially cost the 
taxpayer's money?
    Dr. Lucas. Yes, it could.
    Mr. Campbell. Ms. Wartell, I think you testified kind of to 
this degree that if we were to wind down Fannie and Freddie and 
replace them with nothing, no government support and the 30 
year fixed rate mortgage as we know it vanished, which means 
that people would pay more money per month for the same house, 
and the only way that can happen is if there is a significant 
and matching decline in housing prices. And so, if that then 
occurs, it could cost the taxpayer a lot of money. So by 
replacing it with a system, as Mr. Peters and I have 
introduced, we could actually be saving a lot of taxpayer 
money, both with the Fannie and Freddie portfolio, and in terms 
of what that kind of drop in housing, which is one-seventh of 
the economy, would do to the overall, very fragile recovery. 
Your comments?
    Ms. Wartell. I would agree with that. I think that there is 
a real concern that our housing prices today assume the lesson 
we learned after the 1930s, which is that there will be 
consistent availability of mortgage credit that was built into 
the prior system with all its flaws. It did, in fact, until we 
had the explosion of the private label securities market 
outside of that system, we did, in fact, avoid bubble bust 
cycles. If we go back to a world out that consistent 
availability and the potential for bubble-bust, it will make 
people much more reluctant to invest. I would also add another 
point. I think that one consequence of that system, without any 
government liquidity backstop to an otherwise private market, 
is that a great deal more of the market would land in FHA. FHA 
is 100 percent government guarantee. That means that we charge 
premiums for it, but we stand behind the whole mortgage loss. 
There is no credit risk on the part of the lender. So it seems 
to me that that privatization scheme actually will shift a 
significant portion of the market to government with no private 
credit ahead of us. And that seems to me exposing us loss more 
loss, not less.
    Mr. Campbell. Thank you, Mr. Pollock, and I have very 
little time, but you seem to stand out in believing that if we 
withdrew federal guarantee and had no replacement, that somehow 
that is not going to cause problems for the economy, for 
taxpayers and for housing, and that somehow the elimination of 
the 30-year mortgage, as we know it, or a 40 percent down 
payment, as you have suggested in some of your work, is somehow 
not going to have a very negative impact on housing, very 
negative impact on the economy, very negative impact on 
revenue, and therefore on taxpayers with their Fannie and Fred 
portfolio, come on.
    Mr. Pollock. Let me back up a minute, if I may, Congressman 
and look at the result of the GSEs and the explosion of the 
agency debt, which was to create hyper-leverage in housing 
markets and housing finance markets, hyper-leverage in 
    Mr. Campbell. Mr. Pollock?
    Mr. Pollock. Wait a minute.
    Mr. Campbell. And my time is over so, I do not know how the 
Chairman wants to handle it, but we are not proposing to 
replace the GSEs with the GSEs. No one in this room proposing 
that, so do not go to a failed model to describe what a future, 
different, entirely different model might look like.
    Mr. Garrett. Let him answer your question.
    Mr. Pollock. Congressman, with respect, I agree. We do not 
want to go to the failed model and we certainly do not want to 
repeat the failed model, neither the 30s model which created 
tremendous housing busts in the 1960s and '70s nor the GSE 
model. Remember that this theory of having private capital in 
front of government risk was exactly a theory of Fannie Mae and 
Freddie Mac and in the 1990s when their risk-based capital was 
set up, the theory was that this risk based capital would allow 
them to survive a new depression, obviously, it was all wrong. 
The government never prices risk right. It does not price in 
right in the FDIC. That has why the FDIC's net worth was vastly 
negative. It does not private it right in pension guarantees. 
It does not price it right in housing. It does not price it 
right in flood insurance. It never prices it right. What we 
need to move to, and where I think we would agree is we need to 
move in a coordinated transition, which we have suggested would 
be a five-year transition to solve the problems that you point 
to, problems largely created by the past mistakes of this 
design. We need to go through a five-year transition; the end 
point of which is, we move to a largely private mortgage market 
where the prices are market prices. I have no doubt there will 
be a robust 30 year mortgage in that market.
    Mr. Campbell. That, no doubt, is not shared by anybody in 
the marketplace who might actually fund those 30 year fixed 
rate mortgages, by the way.
    Mr. Pollock. With respect, we could discuss that more 
later. And the final point would be we would bring the 
government, or we need to bring the government, as I said in my 
testimony, into control of its own credit, not hand it over to 
uncontrolled agencies which run around with the government's 
credit card.
    Mr. Garrett. Thank you. I recognize the gentle lady.
    Ms. McCollum. Thank you, Mr. Chair. In my district and 
throughout the United States, communities are still struggling. 
The repercussions of the housing crisis are still being felt by 
too many homeowners. And this is great reading, the financial 
crisis inquiry report. And so I am just going to kind of 
refresh the housing bubble here from page 422.
    The housing bubble had two components: the actual homes and 
the mortgages that financed them. And they looked briefly at 
the components and it is possible causes. It goes on to say 
conventional wisdom is that a bubble is hard to spot when you 
are in one, and it is obviously painful later after it is 
burst. Even after the U.S. housing bubble burst, there is no 
consensus of what caused it, but they go on to list a couple of 
things that they went into detail: population growth, land use 
restrictions, over optimism, easy financing, and they go on to 
explain that.
    Now, just recently, Standard & Poors found the single 
family homes dropped to their lowest level since 2009. Even 
more troubling to me is in the 20 metropolitan areas that they 
looked at, housing prices in the Twin Cities had the biggest 
drop, which is very unusual for the Twin Cities. Compared to 
March of last year, prices fell 10 percent in my community, 
making it the only area to see a double-digit drop. Well, it is 
important that we understand the causes of the 2008 housing 
finance market collapse. It is equally important that we enact 
smart reforms to ensure it does not happen again. There seems 
to be a consensus on part of the solution of restructuring 
Fannie and Freddie that in a way that protects housing 
opportunities for middle class families, but also limits 
taxpayer risk, as Mr. Campbell was describing.
    The second equally important part is ensuring that Wall 
Street reforms passed last year are fully enacted. So the 
second part is where I want to focus on my question because I 
think we have heard a lot of talk about repealing the financial 
regulatory overhaul pass last year as well as weakening the 
consumer protection. In fact, Republicans who want to protect 
taxpayers from bail-outs, yet their budget intends to take the 
cops off the Wall Street watch here by cutting the SEC, the 
CTFC and completely eliminating the Consumer Finance Protection 
Bureau. So the very agencies charged with making sure that big 
banks that play by the rules when it comes to issuing mortgages 
and other credit products, there is no one watching the fox in 
the hen house. So I have a question, and my question is 
directed to you, Ms. Wartell. I am interesting in hearing what 
steps are needed in addition to reforming the GSEs to ensure 
that similar crises are avoided in the future, particularly 
what would happen to the housing market if Fannie and Freddie 
are completely privatized in the Dodd-Frank Act is not 
implemented. And after you are done answering that question, if 
there is any time remaining, I would yield it to the gentleman 
from California, if he has any further rebuttal to make.
    Ms. Wartell. Yes, thank you. Representative McCollum. I 
would make two points. I think first of all as we were talking 
about earlier, if we simply unwound the GSEs with no 
replacement, I think we face a real risk of returning to the 
period of time of real wild swings in housing prices. Not 
simply regionally, as we have had in the pass, but nationwide. 
And that was the experience in the 1930s. The United States 
housing market enjoyed between the 1930s and the 1990s, 
certainly had ups and downs. But there was never time in which 
mortgage capital was not available. FHA was there as a backstop 
during the oil patch crisis. And that availability of crises 
helped to ensure that these swings were not as extreme. That 
allows people to invest in homeownership, have the community 
benefits that we get from homeownership and also the 
opportunity to participate in the well savings that 
homeownership has provided for American families, the fourth 
savings, if you will, that homeownership provides.
    To your question about implementation of Dodd-Frank, I 
would just note that specifically as to the housing market, the 
Dodd-Frank legislation has a number of important regulatory 
actions that are currently pending. Members of this committee 
who feel strongly that we need to get the private market to be 
back bearing more of the risk in the housing market, have a 
strong interest in having those regulations completed. The 
qualified residential mortgage definition and the QM 
definition, the Qualified Mortgage definition, both of those 
are, right now, the private market does not know what the 
ground rules are going to be. When those regulations are in 
place, we will have clarity about the ground rules. And I think 
you will then see the beginning of private label securities 
market serving the top end of the market and have the capacity 
as we withdraw the GSEs from the upper end of the market, to 
take over more of that. If we do not complete those rule 
makings, the ability to shift some of this risk from the public 
sector to the private sector will be limited. So I would argue 
implementation of Dodd-Frank is extremely important to getting 
the private sector to serve more of our housing market today.
    Mr. Garrett. Thank you. The gentleman from South Carolina.
    Mr. Mulvaney. Thank you, Mr. Chairman.
    Very briefly a couple of comments. I want to get beyond the 
technical aspects of it and come back to what is actually 
happening here. Mr. Pollock, let me walk through these 
scenarios and tell me if I have got this correct.
    If a private lender issues a non-conforming loan, say a 
jumbo loan, that has no government backing at all, and the 
homeowner defaults, just does not pay their mortgage, it is the 
lender who bears the brunt of that, correct?
    Mr. Pollock. Correct.
    Mr. Mulvaney. But the lender ends up losing their money in 
that particular transaction. However, if we are in a FHA back 
situation, the lender lends the money to the homeowner, the 
homeowner is unable to pay, tell me then, Mr. Pollock, who 
bears the brunt of that?
    Mr. Pollock. The FHA.
    Mr. Mulvaney. Which is ultimately the taxpayer of the 
United States of America, correct? And I think that is what is 
in a lot of this discussion, is that that is essentially what 
we are doing is that we are asking the taxpayers to help 
subsidize people who do not pay their mortgages. And I think 
that gets lost in a lot of the detail about this discussion.
    What you have brought to my attention today, Mr. Pollock, 
was something I had not considered before, which was the 
indirect impact of the agency debt on the overall interest rate 
environment. Was it your testimony, I think that your estimate 
was some place between 30 and 100 basis points that we are 
paying higher on our public debt because of this huge agency 
debt. Did I get that right?
    Mr. Pollock. That is correct, Congressman.
    Mr. Mulvaney. And I think this committee has heard 
testimony several times from the CBO and other folks that an 
additional 100 basis points on what we pay for our debt when 
the debt is $14 trillion is roughly $1.4 trillion over the 
decade. So the taxpayer is paying there. And I think what we 
lose track of here is that we all talk about propping up the 
housing industry, and listen, I am a home builder, so I 
understand the importance of this particular industry to the 
nation. There is no question about it. But what we are doing is 
essentially shifting a tremendous burden on to the taxpayer.
    I want to address Mr. Campbell point very quickly and then 
I want to ask one question about the 30-year mortgage. Mr. 
Chairman, I would suggest that what my colleague from 
California is suggesting, along with folks on the other side of 
the aisle, is that this time we will get it right. We know we 
screwed it up before. We know we have done a really, really 
lousy job in doing this in the past and it is cost literally 
trillions of dollars. But this time, we are going to be much 
smarter in doing this than everybody else who has been here 
before. And that is all that I hear again. Is well, we know we 
screwed this up, but boy, if we do it right this time, it is 
really, really going to work, and Mr. Pollock, I think you hit 
the nail on the head when you said that government cannot do 
that because it does not know how to price risk. And that is 
because we do not price risk on a market-based assessment. We 
price risk on a political-based assessment. We make political 
decisions about what things cost as opposed to free market 
decisions about what things cost.
    That is a lot of talking for me. I do have a legitimate 
question for everybody on the Board, which is I have heard a 
great deal of discussion about the possible existence or non-
existence of the 30 year mortgage that so many of us are 
familiar with. I have heard arguments that it will go away if 
we get rid of the GSEs and do not replace it, and then I have 
heard arguments that it will not go away. I was always under 
the impression when I was in the industry that the reason for 
the 30-year mortgage was, in large part, because of the 30-year 
Treasury bill or Treasury note. And my understanding is that is 
not going away any time soon. You all have a minute and a half 
each or a minute left each I would love Ms. Wartell to tell me 
why you think the 30 year is going away, and then, Mr. Pollock 
to tell me why you think it is not.
    Ms. Wartell. The 30 year fixed rate mortgage requires a 
lender if there is not access to a secondary market investor or 
the ultimate investor to hold out their money for 30 years. And 
on terms, if it is fixed rate, that are set at the beginning of 
that 30 year period. That is a great deal of uncertainty about 
how interest rates will shift. And the most market investors 
are unwilling to leave their obligations out for that long 
without knowing where interest rates will go. They will at a 
price. And I think that Alex is right when he says that the 30 
year fixed rate mortgage will be available, but it will not be 
available, in my view, at a price that most middle class 
American families will be able to afford. Those mortgages that 
Alex will cite that are available at that price tend to be for 
very, very high quality borrowers with very high down payments. 
Most Americans do not have those terms and conditions.
    Mr. Pollock. Congressman, there are private fixed rate 
mortgages that have 30 year terms. There has not been in this 
country a middle class private 30 year mortgage securitization 
market for prime mortgages. Now, this is a puzzle, which we 
will solve readily, but the puzzle is, it is the most logical 
market that should have developed as a secondary market prime 
30 year middle class mortgages. Why do we not have it? Because 
the government, in the form of Fannie Mae and Freddie Mac, 
crowded out the private market. And there are big pools of 
money in this country and all over the world who are long-term 
investors who are looking for what we call long duration 
securities, duration and they buy long term corporates, they 
buy long term governments, they buy long term infrastructure 
bonds, they buy long term municipal bonds, and they will buy 
the long term mortgages as well.
    Mr. Garrett. Thank you. The gentleman from New Jersey.
    Mr. Pascrell. I want to thank the gentleman from New 
Jersey, chair?
    Mr. Campbell, unfortunately, we, many of us on this side, 
not all of us, agree with your analysis, so I hope it does not 
doom whatever you are going to work at. We get the idea. We 
    Ms. Rosen Wartell, you said on Page 8 of your testimony the 
Treasury discount rates are used for Credit Reform and an 
approximation of a private sector equivalent discount rate is 
used for the fair value reporting, and you discuss that on page 
5 in your remarks. Regardless of whether they are discounted by 
Treasury rates or a private market premium, the cost estimates 
will still be grounded on the same market forecast. Biasing the 
estimates high will not change the economic reality in which 
FHA has to operate. It will, however, overstate the cost of 
operating the FHA program, so as to encourage misguided 
opposition and drive legislation to constrain its growth. But 
whatever the process, you say, it is imperative that Congress 
apply the same budget rules that FHA loan guarantees as it does 
to all other federal credit programs. Am I stating your 
position correctly? So I do believe in what Mr. Campbell has 
stated as an analysis of the program. I think your analysis is 
    I would like to know, Ms. Rosen Wartell, what would this 
piecemeal approach, which I am reluctant to embrace, and 
apparently, you are too. We have heard what it would do to the 
30-year mortgage; you have been pretty specific about that. 
What would it do to the following three things: consumer 
protection, first-time home buyers, and multi-family units. 
Give me one or two sentences on each.
    Ms. Wartell. And to be clear, this is not about scoring, 
this is about unwinding the GSEs in a piecemeal fashion.
    First of all, I think one of the things the GSEs have done 
is they have provide standard terms and decisions for most of 
the market until we had the private markets take their place. 
Those standardizations help make it far easier for consumers to 
shop and compare. They could not do that during the private 
label subprime boom because everything was so confusing. That 
has hurts consumers, to first-time homeownership.
    Down payment is the single greatest barrier to first-time 
home buyers. It is very hard for people to save, particularly 
with stagnant wages over the last decade, and the availability 
of low down payment lending to well-qualified borrowers will be 
made more difficult in the world that has been described.
    Mr. Pascrell. Excuse me, what exactly would be made more 
    Ms. Wartell. If we have only private investor loans at a 
price affordable to home buyers, low down payment lending, 
lending that requires five percent down payment for borrowers 
who are otherwise well qualified, who have good credit, will be 
far more difficult to get, its prices would be higher. I think 
the availability would be diminished.
    For multifamily, it is very important to remember that the 
GSEs during the crisis also provided an enormous amount of 
liquidity for the rental market. For demographic reasons, we 
are going to see a huge increase in demand for rental housing 
over the next 20 years, and we have had a complete shut down in 
the supply for a significant period of time. One of the reasons 
families with three kids bought homes was because there was not 
decent rental housing that they would afford and so they 
stretched themselves to become homeowners. Without a mechanism 
for liquidity for long-term finance for rental housing, we will 
also see increasing pressure on rents and difficulty in 
    Mr. Pascrell. Okay, thank you, so much. Mr. Pollock, how 
would you expand consumer protection in your protocol?
    Mr. Pollock. Thanks Congressman. First of all, let me say, 
I believe the greatest obstacle to first-time home buyers is 
inflated house prices. And inflated house prices reflected 
among other things, all the government subsidies flowing into 
housing so we are doing a disfavor to first-time home buyers by 
subsidizing house prices; so one way to protect them would be 
to not do that.
    Secondly, I have discussed for years a theme, which the 
nascent Consumer Financial Protection Bureau has picked up, 
which is simplified, clear, straight-forward mortgage 
disclosure, which I do think would be a major improvement. You 
certainly do not need a new government agency, which is free of 
the discipline of appropriations to get that, but to get that 
simplified disclosure; I think is something that we could all 
agree on. It turns out to be hard to do to make things clear 
and simple, but it can be done.
    Mr. Pascrell. Thank you for your contribution. Thank you, 
Mr. Chairman.
    Mr. Garrett. And I thank the gentleman from New Jersey. 
Gentleman from Indiana.
    Mr. Young. Dr. Lucas, I believe it was Ms. Wartell who 
spoke earlier of the incongruity of using one sort of 
accounting analysis for one particular government program and 
then a different sort of accounting analysis for a different 
government programs. Why in your mind is it appropriate to use 
a fair value analysis for the housing market and using a unique 
accounting method just for this sector in terms of how 
government keeps its books?
    Dr. Lucas. Okay. I did not mean to imply that it is 
appropriate to use a unique accounting treatment for any 
sector, and I believe that we want to move towards an 
accounting treatment for all credit obligations that give 
Congress the best picture of what their true cost is. The way 
that we got to fair value where the GSEs really started, I 
think with the treatment of TARP, where our fair value was 
required, because it was possible that TARP would have appeared 
to make money for the government, which did not seem like, 
perhaps the best way to account for it.
    So for the GSEs, there was a number of considerations, many 
of which are legal, many of which I do not want to go into 
detail on because I do not think I am the best qualified to 
describe it. But basically, the GSEs were difficult. They did 
not fit into any natural bucket. The budget has two choices, 
basically, cash and credit reform. Cash did not seem 
appropriate for the reasons I discussed in my testimony. It 
does not give a sense of the obligations going forward and so 
forth. The Credit Reform Act was also problematic. There were 
some contradictions between the GSE's charter acts and the 
Credit Reform Act that did not quite reconcile. But beyond all 
that, I think that fair value treatment does give the most 
comprehensive picture of what the costs are, and that 
ultimately was why we settled on that for the GSEs.
    Mr. Pollock. Chairman, could I just add a footnote there? 
It is my view that there is a big difference between the 
housing finance activities of the government and these other 
things, in that the housing finance activities are so much 
bigger. So in a day when the total agency debt was 15 percent 
of the Treasury market, you probably did not care that much. 
But when it is as big as or bigger than the whole outstanding 
stock of direct government debt, you care a lot. And I think it 
gives us good reason to focus on them independently as opposed 
to a lot of many smaller things.
    Mr. Young. It would seem logical and consistent that, 
frankly, in other sectors, in other areas of government-backed 
finance, we would also try and incorporate market risk, right? 
I mean, that is a counter to the argument that I frequently 
hear, which is that we have an inconsistency here. Perhaps we 
do. Maybe all the more reason for its embracing a fairer value 
sort of method of accounting for other areas. But I know that 
broadens the conversation here.
    Mr. Pollock, under the current cash accounting method, the 
FHA uses, government makes a profit. That is correct, sir, 
right, according to our books?
    Mr. Pollock. Well, actually, what FHA does under Credit 
Reform is to estimate its future losses, which is a kind of an 
accrual, and have to book those. Whether you call it a profit 
or not is a little tricky because we do not charge the FHA in 
the accounting for their operating expenses. Those are 
separately appropriated and separately budgeted. So all these 
numbers we have been talking about, unlike with a normal 
company, or a normal insurance company, we do not count the 
cost of actually operating the programs, as the CBO correctly 
points out. So one of the things I would like to see as a 
supplementary FHA account would be a set of GAP books that 
actually measures the profit and loss of the insurance business 
of the FHA the same way we would measure any other insurance 
    Mr. Young. It seems curious to me, could not the government 
actually improve its balance sheet if we mandated that the 
United States government had to insure every loan in the 
mortgage marketplace, right?
    Mr. Pollock. Well, that is the reductio ad absurdum, if I 
could use the reduction to absurdity of the argument that, of 
course, we make profits and the more we guarantee, the more 
profits we make. And of course, the more we do that, the less 
market discipline, the less efficient is our resource 
allocation, and the bigger the ultimate collapses tend to be.
    Mr. Young. Thank you. And for the record, I was not 
suggesting that we do that.
    Mr. Garrett. The gentleman from California.
    Mr. Honda. Thank you, Mr. Chairman. I want to thank the 
chair and ranking member for convening this panel and for the 
panelist being here. It is my hope that our community can use 
hearings like this to engage in a serious discussion about the 
housing market. We have seen too many debates on serious issues 
hijacked by the special interest agendas.
    For example, in this committee, a budget was reported to 
claim to tackle the deficit and did, but really represents an 
agenda to privatize Medicare and block Medicaid in order to pay 
for more spending tax on charity for the top two percent of our 
earners. This is unacceptable.
    We are facing serious economic issues in this country that 
Congress must address. The eyes of the nation, and indeed of 
the world, are upon us. Today we have two critical questions to 
address: First, Republicans have a single mantra regardless of 
the issues, deregulate, deregulate, deregulate, the market will 
police itself. Will completely deregulating the housing market 
prevent future crisis? I think everyone, Democrats, 
Republicans, understands that certainty is a key ingredient for 
a high-growth economy. So my colleagues across the table would 
like to wind down Fannie Mae and Freddie Mac. However, given 
the increasing income inequality in our country, and I will say 
that again, given the increasing income inequality in our 
country, when the median income for 90 percent of families is 
around $30,000, given these factors, under the Republican 
proposal, how will the bottom 90 percent buy homes in the 
absence of Fannie Mae and Freddie Mac, and will they be able to 
obtain a 30-year mortgage at reasonable rates? I may like to 
start with Ms. Lucas and then Mr. Pollock and then end with 
    Dr. Lucas. Okay.
    Mr. Honda. You have a minute each.
    Dr. Lucas. Okay. Well CBO really has not done an analysis 
of what the affect would be of reducing the subsidies to Fannie 
Mae and Freddie Mac. It is clear that if they were less 
subsidized, the cost of borrowing would go up to some extent. 
There has been some estimates that range from just a few basis 
points to over a percent. Whether that is a good or a bad 
thing, I think depends on the perspectives, and I am going to 
let my colleagues on the panel give those perspectives.
    Mr. Pollock. Congressman, in my judgment, these median 
income families will be able to buy houses and with mortgages 
in a market system with market prices. You mentioned 
regulation. I would like to point out that one of the reasons 
why house prices are falling right now and why the housing 
market is so soggy is the natural regulatory overreaction in 
the wake of the bust, which has had the effect of making 
mortgage credit much more difficult to get because the lenders 
are terrified with their increased legal and regulatory risks 
of even making a loan. So I am sure we have all heard endless 
anecdotes about people with good credit who are put through the 
most outrageous process even to get a loan. And when the credit 
is tied up in this way, it makes it harder for anybody to buy a 
house. We see this cycle after cycle, that in the wake of the 
bust comes a regulatory overreaction of clamping down 
excessively which makes recovery from the bust more difficult.
    A second reason that I would like to point out why we have 
continuing serious problems is exactly the 30-year fixed rate 
mortgage. The 30-year fixed rate mortgage is an instrument, 
which if housing prices are inflating, works very well. If 
housing prices are deflating, it is a terrible instrument. It 
locks people into high mortgage payments which they cannot get 
out of. And when they do not have the equity to refinance, they 
are trapped in the mortgage, so we have endless programs of 
trying to modify and change the rates on the mortgages to 
reflect the current market, which do not work very well. So we 
do need to understand these underlying causes of our current 
problems. Thank you, Congressman.
    Mr. Honda. Okay, Mr. Chair I would like to have Ms. 
    Ms. Wartell. For the medium income family that you 
describe, the availability of long-term finance allows them to 
set their housing prices. If they were subject to only 
affordable adjustable rate mortgages, they would recognize that 
as interest rates fluctuate, their housing costs could suddenly 
grow dramatically. The transaction cost for a family to move 
their home because their housing just got more expensive is far 
more difficult than it is for investors to adjust their 
portfolios in different interest rate environments. So it is 
the availability of the long-term finance that I think is so 
important to the median income family.
    Under Mr. Campbell's bill and my own proposal, the cost of 
the subsidy the GSEs got would be priced in the future, which 
means housing costs will go up a little bit. And everybody 
thinks that is appropriate. We should not have a hidden cost to 
the taxpayers. But what is important is the consistent 
availability of credit to allow people to make investments in 
    Mr. Honda. Thank you.
    Mr. Garrett. Gentleman, yield back. Gentleman from Indiana.
    Mr. Rokia. Yes. Thank you, Mr. Chairman. I appreciate the 
witnesses coming today. I have enjoyed listening and have one, 
maybe two questions, if I can get them in.
    First, to Mr. Pollock. Earlier this year, Dr. Carmen 
Reinhart, you may be familiar with her work, testified in front 
of this committee. She has done extensive work on debt burden, 
specifically in countries or models that have 90 percent debt 
to GDP ratios, and what the negative impact on economic growth 
is. One thing she talked about was that not only does public 
borrowing rise precipitously ahead of a sovereign debt crisis, 
but that the governments involved when this happens, are often 
found to have, quote-unquote hidden debts. Mr. Pollock, from 
your testimony, you would say that the U.S. has hidden debts, 
    Mr. Pollock. That is correct Congressman.
    Mr. Rokia. Okay. What is the impact of GSE and other agency 
debt, so not just GSE, on our fiscal solvency? All right, I am 
getting a little way from Fannie and Freddie here, as our debt 
held by the public approaches the high levels that Reinhart 
discusses in her analysis?
    Mr. Pollock. I should say that Carmen and her husband are 
good friends of mine and we share many approaches to 
understanding financial cycles. When any borrower is running up 
his debt, it is very tempting to try to put the debt in an off-
balance sheet way, that we observed again and again in private 
markets, and it is also observed in government markets exactly 
as you suggest. So the curious thing about the explosion of 
agency debt over the last four decades is precisely this 
creation of a debt that really was not hidden, I mean, we knew 
it was there, but it was hidden in terms of the official way we 
talk about the debt. Among the results, being much more risk to 
the taxpayers, a higher cost to financing the Treasury. And I 
reiterate my recommendation that we ought to require the 
Treasury to provide an annual report to the Congress on the 
extent to which agency debt has made Treasury debt more 
expensive or has affected Treasury debt, and on the overall 
credit worthiness of the government. And I reiterate my 
recommendation that we ought, in statute, explicitly to make 
the Treasury responsible for managing the overall credit 
worthiness of the United States, and that means they have to 
manage the debt of these mixed ownership government 
corporations, like, Fannie Mae and Freddie Mac. Or, we just 
have to recognize the reality.
    Mr. Rokia. Thank you, Mr. Pollock. And I said this was a 
question to Mr. Pollock, but I was wondering now if CBO wants 
to comment on the same set of questions?
    Dr. Lucas. CBO has published various reports that talk 
about different measures of the debt, and certainly the public 
debt is the public debt. But these other obligations affect the 
fiscal situation of the United States.
    I think it is important to think about the sum of the two, 
as Dr. Pollock has. I think it is also important, though, to 
recognize that not all debt is the same. So the debt of the 
GSEs is backed by the mortgages that are making payments on 
that debt. So it is not quite the same thing as debt which is 
just backed by tax revenues from the citizens. So it certainly 
matters, but it has to be a little bit careful.
    Mr. Pollock. Just like the SIVs of Citibank.
    Mr. Rokia. Say that again, please?
    Mr. Pollock. Just like this term SIV, SIV stands for 
Structured Investment Vehicle.
    Mr. Rokia. Oh, thank you.
    Mr. Pollock. Just like the SIVs of Citibank, I said.
    Mr. Rokia. Right, thank you.
    Mr. Pollock. I was having some fun with my good friend and 
    Mr. Rokia. I was going to ask you if you had a reply to 
that. A serious one.
    Mr. Pollock. Well, no, I agree we have to look at the whole 
picture just as any entity looking at its finances has 
liabilities of different kinds. But you have to tote up the 
total liabilities and figure out and control their effect on 
your credit worthiness.
    Mr. Rokia. Okay. Thank you, very much, Mr. Pollock. And 
then, Ms. Wartell, not to leave you out. And if you want to 
quickly comment on that you can. But I have interest in this 
rent versus buying.
    Mr. Garrett. Would the gentleman yield?
    Mr. Rokia. Sure.
    Mr. Garrett. Ms. Lucas, you said it is all the debt is 
backed by mortgages?
    Dr. Lucas. Well, I was just noting that the debts that the 
GSEs have issued was issued in order to purchase mortgages.
    Mr. Garrett. But not their entire book of all their debt is 
backed by mortgages, correct?
    Dr. Lucas. At the time when they issued the debt, they are 
issuing it to purchase a mortgage. Some of the mortgages have 
since fallen in value. And so there is a gap between the value 
of those mortgage assets and the liabilities of their debt. And 
that gap is what is reflected in those costs of the business 
that they already have. I did not mean to say those were not 
real costs, only that when you have an asset as well as a 
liability, the existence of the asset can change your view of 
the liability and what it does to the stability of the 
financial situation of the country.
    Mr. Garrett. Yield back.
    Mr. Rokia. Thank you, Mr. Chairman. Just real quick with 
Ms. Wartell. I am intrigued by the concept that we are starting 
to realize now that maybe not everyone should be, or has to be, 
a homeowner in order to realize an American dream. Maybe the 
American dream evolves and changes. Do you think the history of 
pushing people to buy homes has distorted markets and that 
perhaps not everyone should own a home?
    Ms. Wartell. I think there is widespread consensus that 
federal housing policy has been imbalanced, that we need to get 
the balance right, that we need to make sure that there are 
appropriate housing choices for everyone at their stage of life 
and with their family conditions. That means we need to ensure 
there is credit availability to finance rental housing and that 
that are good rental housing choices.
    Mr. Rokia. Thank you.
    Ms. Wartell. Absolutely.
    Mr. Rokia. Okay. Thank you, ma'am.
    Mr. Garrett. And I thank you. And the lady is recognized as 
soon as the light comes on.
    Ms. Kaptur. Thank you, Mr. Chairman. I want to thank our 
witnesses very much, and our committee for at least providing 
us the opportunity to talk with one another across party lines.
    My two main questions are, and I am going to make a 
statement after the question so you can think about the 
questions, six banks in our nation now control two-thirds of 
our banking system. How do we restore real competition for 
mortgage credit? And number two, how do we restore prudent 
mortgage lending and origination that recapitalizes local and 
regional community financial institutions, not distant 
speculative lenders? Some, as you have heard this morning want 
to blame Fannie Mae and Freddie Mac for the financial meltdown. 
And I would like to put their role in perspective as I see it. 
They were doing fine until deregulation of private financial 
markets occurred during the 1990s and what we have experienced 
now in this past decade is the government has become the 
dumpster for the mistakes of the private sector and the cost 
are enormous.
    High-risk behavior in America's housing market began during 
the early 1990s when financial deregulation pushed by some here 
in Congress, allowed the private financial sector to turn 
formally prudent mortgage loans into bonds and then securitize 
them into the international market in a manner that bore no 
relationship to true value nor the local real estate market. I 
would like to place in the record an article from this week's 
New York Times, the ``Good Banker,'' by Joe Lucera. There are 
many good bankers left out there. They need to come before our 
committee and help us figure out a better future for this 
    I remember in the early 1990s when the largest commercial 
banks, and later Wall Street's speculative investment houses 
came up here and applauded the demise of the staid thrift 
industry and its conservative mortgage lending practices as the 
big Wall Street banks hungrily sought after a globalized 
market, and after the housing market, that they had not been 
into as a new national profit center. I recall when the sign 
outside the door of the former Banking and Housing and Urban 
Affairs Committee was taken down and that committee renamed the 
financial services committee. That signaled a new era of 
abandonment of strict practices in mortgage loan origination 
and standards of prudent lending that had regulated private 
sector mortgage behavior for most of the 20th Century, 
following The Great Depression.
    In fact, during the 1990s, the securities jurisdiction of 
the energy and commerce committee was merged under that 
Financial Services Committee as Congress passed, without my 
support, the Leach-Bliley Act. And when the Glass-Steagall Act 
that it separated banking and speculations since 1933 was wiped 
off the books in 1990 under that Leach-Bliley Act, the 
speculators were unleashed full bore. I have a bill, H.R. 1489 
that would restore important Glass-Steagall provisions.
    Fannie Mae and Freddie Mac were not the quarterbacks in 
this game of market manipulation, Wall Street was. But Fannie 
and Freddie were very important wide receivers in this high-
stakes big bank hyperventilation of the mortgage market. The 
private sector big banks and speculative houses soon discovered 
that home mortgages were pretty sleepily instruments with a 30 
year pay-back time horizon that did not yield the quick seven-
year pay back of commercial loans or speculative prospects. So 
the big banks and their minions and the origination servicing 
and rating industries figured out how to inflate their returns. 
I would like to place on the record a few pages from the book 
published in 1996 by former chairman and CEO of Fannie Mae, 
James Johnson, entitled ``Showing America a New Way Home.'' In 
it, he clearly described what the private sector was up too: 
transforming the way America financed home buying, the mortgage 
system, from an industry that is almost exclusively dependent 
on depositors to one that is investor-based. He lauds the fact 
that capital to finance homeownership will be virtually 
unlimited, I am quoting, unlike the former savings and loans, 
and that international capital markets will now assume the 
risk, and our superbly well-equipped to evaluate performance as 
they invest in securities backed by mortgages. Fannie Mae and 
Freddie Mac were wide receivers in this transformation, but the 
quarterbacks sat on Wall Street and on the Board of the Federal 
    Looking back, it is hard to understand how he could have 
such unguarded faith in an untested system of the deregulated 
global private financial marketplace for housing finance. But 
that is what happened. And Fannie Mae and Freddie Mac then 
adopted high-risk practices too, becoming key agents to move 
this mortgage paper into international tranches.
    For our nation to dig itself out of the worst housing 
depression since the Great Depression, we must go back and 
unwind what happened and restore prudent lending standards 
again. I have a bill, the Fannie Mae and Freddie Mac 
Investigative Commission Act. It is a straight-forward piece of 
legislation that creates an independent commission to 
investigate and analyze what policies practices and board 
decisions on risk management that were made at Fannie Mae and 
Freddie Mac that led to the enterprises financial instability 
and the subsequent conservatorship of the two entities. This 
commission would build on the work of the Financial Crisis 
Inquiry Commission as a basis for, again, disciplining the 
financial practices that led our nation to such a precipice.
    I have many, many documents to enter into the record and 
Mr. Chairman, I will wait for the second round for them to 
address the two questions I have asked about restoring 
competition in our banking system. Again, and recapitalizing 
local markets that are capital-starved at this moment.
    Mr. Garrett. And the gentle lady yields back and as the 
gentle lady indicates as long as our panel's available, we are 
going to do, at the request of some of the members, a second 
round. And we should probably put the caveat to members that 
are here too, since these members have been sitting here 
through all this.
    I will yield at first to the gentleman from California.
    Mr. Campbell. Thank you, Mr. Chairman. Mr. Pollock, well, 
we have to have a little discussion about some of the things 
that obviously, that you and I disagree about.
    In your comments and responses to the gentleman from 
Indiana, I believe I heard you advocate for lower housing 
prices, correct?
    Mr. Pollock. Congressman, first of all, let me say I really 
look forward to a discussion when we get a chance in person to 
go over some of these things. I know you are very knowledgeable 
on these topics and I would look forward to that a lot.
    Lower housing prices are obviously good for some people, 
mainly the people who are buying houses, especially the first 
time home buyers. They are bad for people who bought the house 
previously at a higher price. They are like the price of 
anything. When it goes up it is good for the people who are 
long, and when it goes down, it is good for the people who are 
    Mr. Campbell. Yes, but I believe I heard you say that you 
thought they were too high and that they were artificially 
propped up and that this was hurting new home buyers and that 
we out to let them fall.
    Mr. Pollock. What I was trying to point out was that in the 
housing bubble, we, without question, artificially inflated 
house prices to a great extent.
    Mr. Campbell. Okay, how about now?
    Mr. Pollock. And I think they are probably now in my own 
forecast, they are coming across a long and rocky bottom, where 
house prices will be falling in real terms but moving in an 
irregular flat line in nominal terms.
    Mr. Campbell. Okay, that is what you forecast. But you 
think it would be good if they dropped some more?
    Mr. Pollock. The specific point I make is that the 
gentleman asked about what is an obstacle to homeownership for 
first-time home buyers, and I said high house prices, inflated 
house prices are such an obstacle. There are other obstacles, 
of course.
    Mr. Campbell. You know, we out to switch places because 
your very good at not answering the question that supposed to 
be our job. But I heard what you said before to the gentleman 
from Indiana. Now I think maybe I get it. Because if you 
believe that a fallen home prices is okay, then having no 
government support for the system, which will trigger that, and 
that is okay. But the recession, or near depression, that we 
had in 2008 was triggered by 28 percent drop in home prices. I 
do not want to do that again. I do not want to see that again. 
The home market is one-seventh of the U.S. economy and it is 
already holding back this recovery and we are not going to get 
any kind of recovery if we do not have a robust housing market, 
and removing that support and triggering another significant 
drop is just going to move us into recession, which in terms of 
the Budget Committee that we are talking means less revenue and 
it means that all these Fannie and Freddie debts, which none of 
us are happy about but we got them, I mean the taxpayer has 
them, and further declines in home prices, I think there is no 
dispute about that is going to cost taxpayers a lot more lost 
money on Fannie and Freddie portfolios that we already have. 
You like to comment on that?
    Mr. Pollock. Yes, sir, I would love to Congressman. Thank 
you very much.
    First of all the trigger, of course, for the fallen house 
prices was the 90 percent inflation in house prices, which made 
the subsequent fall absolutely inevitable. The fall was about 
30 percent of the peak, which is about 60 percent of the base.
    Mr. Campbell. Okay, Mr. Pollock, you always want to go back 
and talk about that. I want to talk about where we are now and 
where we might go now.
    Mr. Campbell. And if I am wrong on this, say I am wrong, 
but your concept of what you want to do going forward will 
result in a drop in housing prices, and you are okay with that. 
Is that correct?
    Mr. Pollock. I think that is not correct. My view is I 
think it would be correct if our proposal were to happen in 
five minutes. But since it is a five year transition, I think 
it is not correct.
    Mr. Campbell. What if the five year transition is not 
    Mr. Pollock. The very point of a five year transition is to 
leave the financing, which is now in place, with the support of 
the government and the taxpayers to get us through the 
transition out of the bust, which is unfortunately necessary 
because of the bubble.
    Mr. Campbell. Okay, well, Mr. Pollock, I just in my final 
22 seconds, you know, my conversations with the people who 
would lend the money, I know you seem to think that there be 30 
year fixed rate mortgages without government support. But, you 
know, we do not have to speculate. That exists. There is the 
non-conforming market, the jumbo market out there right now, 
and as Ms. Wartell indicated, you can get a jumbo loan at a 30-
rate fix with, like, 50 percent down. And if that is the place 
we are going and that is what it looks like and that is where 
your proposals would lead us, that is going to make the last 
housing drop look small. And that is why we cannot afford to 
have that happen. I yield back. Thank you, Mr. Chairman.
    Mr. Garrett. Ms. Kaptur.
    Ms. Kaptur. Thank you, Mr. Chairman. I am very interested 
in your comments on my statement. That has how I view the 
world. Two questions: six banks in our country now control two-
thirds of the system. What do we do to restore real competition 
for mortgage credit, just taking that piece of the credit 
system? And secondly, how do we restore prudent mortgage 
lending and origination that recapitalizes local and regional 
community financial institutions, not just in speculative 
lenders? Yes, Ms. Wartell?
    Ms. Wartell. If I may, thank you, Ms. Kaptur. I think that 
having a system of housing finance in the future that ensures 
access to the secondary market for community-based financial 
institutions is one of the goals of the kind of proposal that 
cap has and could well be achieved under Representative 
Campbell and Peters legislation with some minor adjustments.
    It is a great concern to me that we have such concentration 
and a very small number of lenders. For origination of so much 
of our mortgage market these days.
    Ms. Kaptur. Will the gentle lady yield just for one 
statement? And also a group of individuals and institutions 
that have no respect for the local real estate market. When 
they end up owning these homes and holding these homes, they do 
not take care of them. Plumbing is ripped out. What is going on 
across this country is a disaster.
    Ms. Wartell. In a fully privatized world, where access to 
the secondary market where the lender's ability to sell, the 
larger financial institutions will have a far greater ability 
to access the secondary market as many of them develop their 
own private label security origination schemes during the last 
    My concern is that there is a mechanism to ensure that 
small banks and community-based institutions like CDFIs and 
others have access to the secondary market. Our proposal 
includes a requirement that those who insure mortgages and 
package them for securitization should not be originators of 
those mortgages except to the extent that it is in the form of 
a co-op of originators, so that we can ensure that a wide array 
of financial institutions have that access. That will, I think, 
in part address some of your concerns that community-based 
lenders cannot effectively compete against these large 
    Ms. Kaptur. May I ask, you assume securitization is 
fundamental to the housing system of the future?
    Ms. Wartell. Yes, I do. I think if you were to take the 
size of the housing market today and imagine putting that on 
balance sheet of our current financial institutions, it would 
dwarf their capacity to lend and it would collapse access to 
capital for other parts of our community.
    Ms. Kaptur. But how do we strength local institutions as 
opposed to these very irresponsible distant institutions in 
that scheme? I am not sure I support securitization as the only 
option for the future.
    Ms. Wartell. I do not support it as the only option. I 
think we need to go back to a world in which we have 
securitization and balance sheet lending as we did in the past. 
Some of that securitization needs to be like FHA lending for 
targeted borrowers and some can be private with private capital 
risk, but access to the secondary market through liquidity 
backstop and some of it needs to be fully private. But what we 
need to do is have appropriate regulation to ensure that 
lenders throughout our economy, large and small, can access 
those markets.
    Ms. Kaptur. Thank you. Mr. Pollock, you have been waiting 
to say something.
    Mr. Pollock. Congresswoman, I have to say, I enjoyed your 
comments so much because it makes me think of one of the great 
proofs that economics is not a science, and that is that 
whatever happens, we can have mutual inconsistent 
interpretations of the events and neither side can prove its 
story. And by the way, Congressman Campbell, I really look 
forward to some further discussions. I know we will find 
something we agree on.
    Mr. Campbell. And I do too. I failed to mention that, but I 
look forward to further discussions as well.
    Mr. Pollock. I have in the course of my career worked for 
big banks.
    Ms. Kaptur. I noticed that.
    Mr. Pollock. And I ran a thrift. So I have some experience 
with that.
    Ms. Kaptur. Yes, you were on Federal Home Loan Bank Board.
    Mr. Pollock. And a federal home loan bank. The thrifts, of 
course, were extremely heavily regulated and, nonetheless, 
collapsed. When I was with the Federal Home Loan Bank of 
Chicago, we made the observation that you could find a 
regularity in the mortgage market, and that was that the 
mortgages originated by small banks and thrifts had 
consistently higher credit quality than those originated by all 
other originators. And we set out to give them a better way to 
finance these mortgages because we used so say to them, and 
what do you think the credit quality of your mortgages is? And 
they would say, Excellent. And we would say what do you think 
your charge-off on your customers, your local mortgages? And 
they would say, one basis point a year, or something. So we 
said, well, in that case, why did you want to pay 25 basis 
points to Fannie Mae and Freddie Mac to divest the credit of 
your own customer? That does not make sense. And they would 
say, Yeah, I never thought about it, but you are right. They 
were basically being overcharged for the transfer of the credit 
risk consistently for decades by Fannie and Freddie.
    So what I would like to see is a way for small banks to be 
more robust competitors in the credit sector of the market 
where they are demonstrably extremely competent actors, where 
they could retain the credit risk, be paid for retaining the 
credit risk, but have a way to finance the interest rate risk. 
We actually have designed a program like that, which I think 
much more could be made of if we set about it rightly because 
we have a set of actors in our 6,000 or 7,000 smaller banks 
that make mortgage loans and whose local credit talent, we need 
to take much more advantage of.
    Ms. Kaptur. I am so glad you came today. We probably do not 
agree on many things but I want to thank the Chairman because I 
think this is very valuable. You know, members of Congress do 
not talk about this very much. The whole housing sector and it 
is terrible role in bringing our economy down after the rising 
gas prices triggered the whole mess and the rising oil per 
barrel back in 2008. But it is really sad that this institution 
has not met its obligation to the American people when you look 
at what has happened over the last three or four years and the 
hemorrhage that is going on across this country. So I would 
just encourage the Chairman to bring them back with a brown bag 
lunch and let's talk about their experience. Because somehow 
these discussions are not occurring in the Senate, they are not 
happening in the Financial Services Committee, maybe this 
Budget Committee could do the country a favor. We need to take 
the best talent we have, take the bills that are being proposed 
and actually try to do something on a bipartisan basis to move 
forward. Now, I am very concerned about the future and about 
our credit system, certainly for mortgages and about the 
hemorrhage in this housing market that is devaluing these 
assets and destroying these assets as we sit here today. So I 
would just ask the Chairman to think forward and, you know, I 
would be willing to work with you and our chairman, Mr. Van 
Hollen in that effort.
    Mr. Garrett. And I thank you. And I know you have been very 
interested in a leader on this issue and just one differ is 
that, yes, we have actually been taking up these issues in the 
Financial Services, at least in the Capital Markets Committee, 
as some of these members have been here on that. But I look 
forward to the idea of coming again and exploring them. 
Gentleman from Indiana.
    Mr. Rokia. Thank you, Mr. Chairman. Just picking up a 
little bit on the question I asked Ms. Wartell about the 
American dream, and this came out in of the exchange you had 
with Representative Campbell, Mr. Pollock, the idea that our 
economy somehow revolves or orbits around the idea of housing 
starts and homeownership, and we can discuss the definition of 
the American dream and if it should stay the same or if it 
should evolve or if politicians of both parties have forced the 
American dream by distorting the free market system instead of 
allowing Americans to earn the American dream. But can each of 
you point to any economic and empirical data, not cultural or 
political rhetoric, again, economic or empirical evidence of 
why the economy should be based on homeownership or home starts 
or home building, or anything like that, I receive a good deal 
of support from the Home Builder Associations, so I am sure I 
am going to be in trouble for this, but we have to be honest as 
Ms. Kaptur says, and if we are going to ask these questions, 
figure out why it is that it has to be this way to the economy 
to center itself around home building and homeownership. Ms. 
    Dr. Lucas. Okay. Well, from an economist perspective, it 
does not have to be centered around it, it is an important part 
of the economy.
    Mr. Rokia. Why?
    Dr. Lucas. Because people want and need good places to 
live. So I am a little perplexed by the question. There needs 
to be homes.
    Mr. Rokia. I am talking about homeownership.
    Dr. Lucas. There is a role for rental housing and there is 
a role for homeownership, and there are other countries where 
rental housing plays a significantly larger role and people 
seem to get good housing services through the rental markets 
there. So it is true that your economy has sort of moved in the 
direction of heavily favoring homeownership and we could be 
organized in different way, but where we are right now, is that 
it is a large faction.
    Mr. Rokia. Okay, thank you. Same question.
    Mr. Pollock. Congressman, if you look around the world and 
homeownership rates vary a lot among countries, among developed 
countries. The U.S. is sort of in the middle of the pack in 
terms of the percent of households who are homeowners who are 
neither the highest nor the lowest. An interesting country is 
Switzerland, a very rich, pleasant country, which has very low 
homeownership, perhaps in consistent with your hypothesis here. 
It also has a central bank whose shares are publicly traded or 
the citizens can buy shares in the central bank, an interesting 
concept by the way. My view would be that obviously shelter is 
a very big and very important sector and that people ought to 
exercise their preferences to own or rent as they like and as 
they are able, and many people will like to own and will be 
able to own. Others will like to rent and that that should be a 
market outcome left to the voluntary exchange of the citizens.
    Mr. Rokia. I note your term voluntary.
    Ms. Wartell. I largely agree with Alex and since that does 
not happen that often it is worth noting. But I would note that 
in our society, we have created a system that uses housing as a 
principal form of savings for American families. And people 
essentially pay down their mortgages over time and they receive 
significant tax advantages for doing so. So we are, in a sense, 
encouraging that savings and that wealth accumulation and that 
wealth accumulation allows families to both invest in small 
businesses and educations of their children, as well as provide 
for their own secure retirement when they are no longer 
earning. We could make a policy decision not to encourage 
savings in that form and to do that differently, but those are 
very fundamental changes in the way our tax code operates and 
our housing system has been built.
    Unfortunately, we have created that set of incentives but 
we have only allowed some to participate in this. And so we 
have enormous disparities in wealth in our society, especially 
on our racial grounds but on a wide array of grounds, including 
geography, and so that some people are getting the benefits of 
those subsidies and that encouragement of homeownership and 
others are not. Unless and until we are prepared to say that we 
do not want to encourage homeownership, then it seems to be 
important that we ensure access to homeownership as a means of 
accumulating wealth and to give access to the opportunities to 
grow businesses, to educate children, and to have a secure 
    Mr. Rokia. Thank you, Mr. Chairman. Very educational. Yield 
back. Thank you witnesses.
    Mr. Garrett. Gentleman yields back. Gentle lady from 
    Ms. Wasserman Schultz. Thank you, Mr. Chairman. My question 
is for Ms. Wartell. Would you agree that one way the Federal 
Government can assist in stabilizing the housing market is by 
helping to prevent avoidable foreclosures?
    Ms. Wartell. Absolutely.
    Ms. Wasserman Schultz. I am from the state of Florida and, 
you know, right now we have many homeowners who are locked into 
high interest rate loans and they do not have the ability to 
refinance, they lost too much equity, many of them are upside 
down. Four and a half million borrowers with outstanding 
mortgage loans in Florida are in that situation; 2.1 million 
owe more than the value of their home; that is 47 percent of 
the population in Florida. Nearly 20 percent of underwater 
mortgages in the United States involve Florida properties. So 
allowing homeowners to refinance and lock in historically low 
rates would help a lot of people be able to stay in their 
homes. Our colleague, Dennis Cardoza from California, has 
introduced legislation, and I do not know if Mr. Chairman, that 
has been spoken about already. But, he has introduced 
legislation called ``The Home Act,'' the Housing Opportunity 
and Mortgage Equity Act: And that would require Fannie Mae and 
Freddie to allow homeowners to refinance those mortgages. So 
rather than pull the rug out from under the housing market, is 
there not a better solution, like this one, for stabilizing 
home prices?
    Ms. Wartell. I think finding ways to avoid avoidable 
foreclosures has got to be an enormous priority in efforts to 
stabilize the market. I am not familiar with that legislation, 
so I would rather not comment on it now without looking. But I 
would say that there are a couple of different strategies that 
are useful in that. One thing we have written about in the past 
is mediation, which requires lenders before they foreclose to 
sit down with the borrowers and consider seriously, with an 
advocate on their side before they foreclose. Nothing forces 
them to do a modification but gives them another bite at the 
apple. There have been models in a number of states that have 
been very successful in showing that lenders actually get 
higher recoveries through those programs. I think taking a look 
at what has happened to credit scores because of the 
foreclosure crisis, to help people become eligible for 
refinances, of the kind you have mentioned, is another piece. 
And I think I have been encouraging the administration and 
others to bring together the credit rating agencies and the 
lenders to work on that. I think in the servicing standards, we 
have to establish national servicing standards and lenders have 
to be encouraged to give a loan loss mitigation a more serious 
try before they move to foreclosure, and, essentially, they 
become worried about time.
    And I think that there are tricky issues with Fannie and 
Freddie in mandating them to refinance because it is not always 
the case that a refinance in that case will result in higher 
recoveries. And the government in the current period has an 
obligation to mitigate their losses. But I think it is possible 
if you do that in the right circumstances, to encourage Fannie 
and Freddie to do refinancings or principal write-downs. It 
might actually increase recoveries.
    Ms. Wasserman Schultz. And you would agree that it is 
certainly better than what the Republicans have proposed which 
is to just get rid of all the foreclosure mitigation programs 
and do nothing else and leave people twisting in the wind?
    Ms. Wartell. I understand the frustration because many of 
these programs have not worked as nearly as well as we would 
have liked. And I think we do not understand something about 
the behavioral models of the financial institutions as to why 
what seems to be economically rational have not been steps that 
they have chosen to take, but I think that approach, which is 
to throw the baby out with the bath water, if you will, is only 
to, sort of, finding the bottom faster in very painful ways.
    Ms. Wasserman Schultz. But what disturbs me is that the 
only thing that our Republican colleagues under their 
leadership has proposed is, what are colleague, Mr. Henserling 
has said, that is that best foreclosure mitigation program is a 
job. And that is certainly a let them eat-cake approach and one 
that is not going to help solve the problem over the long term, 
would you agree?
    Ms. Wartell. I would. I think that avoiding avoidable 
foreclosures is not only in the best interest of maintaining 
the larger economy, it is also in the lender's best interest 
and we have to find a way to see where those interests align.
    Ms. Wasserman Schultz. Thank you, very much. I yield back.
    Mr. Garrett. The gentle lady yields back. Yield to the 
gentle lady for introduction.
    Ms. Kaptur. I thank the gentlemen. I just want to encourage 
the Chairman and the Ranking Member to keep focus on deep 
probes about the future of the U.S. housing finance system is 
essential to our system of capital formation. And I just wanted 
to put on the record the book, the ``Mystery of Capital,'' by 
Hernando Desoto, where he talks about the importance of our 
property valuation system. And housing is so tied to that now, 
as essential to our form of capital accumulation and savings in 
this country; we need to be talking at that level in this 
Congress about where we are headed with this market. And so I 
thank the Chairman for this hearing today and look forward to 
working with him and Mr. Van Hollen in the future to do a 
better job for the American people.
    Mr. Garrett. And I thank the lady for that. And I will 
yield myself the remaining five minutes of this hearing to just 
run down a couple of questions. So we heard from at the very 
outset from Ms. Lucas with regard to the necessity or the 
encouragement for it to go into consistency and a more 
transparent and a fair value rating as far as accounting. We 
heard from Ms. Wartell to say that as far as for all the debts 
has already incurred we should not go back and change it for 
what is on the books already and use that system, correct? And 
basically going forward, though, I also thought I heard you say 
that you would not suggest that we go and adopt what the CBO is 
recommending with regard to changing the evaluation or the 
accounting methodology for the entities; is that correct?
    Ms. Wartell. As to the GOCs I think, in their current form 
in conservatorship, that is correct.
    Mr. Garrett. And with the FHA?
    Ms. Wartell. With the FHA, I believe that they should be 
accounted for under Credit Reform, they need to improve their 
models, which I think they are working on, but I think the fair 
value accounting should certainly not be done only for FHA, and 
I think probably needs to be refined significantly before we 
are adopted government wide.
    Mr. Garrett. My understanding, though, is you would not, 
then, take into the risk factor that which CBO would be placing 
in their accounting, is that correct?
    Ms. Wartell. This method of pricing that risk factor is not 
one that I think is appropriate at this time.
    Mr. Garrett. Right. And that is where we disagree because I 
think most people would understand that you have various risk 
factors, both in the pricing of housing going forward over the 
next 30 years, you are nodding your head that that is a risk. 
And also, there certainly is interest rate risk, and the first, 
of course, is credit risk. Somehow or other that has to be 
taken and accounted for because system rehab right now, correct 
me, if not, shows actually that there is a profit over FHA, 
    Ms. Wartell. For FHA.
    Mr. Garrett. And I think the gentleman from Indiana made 
somewhat of a flippant sort of comment saying, well, if that is 
making a profit, then I guess we should insure the entire 
marketplace. Is there any reason why his flippant comment is 
not correct that we should not insure the entire market if we 
are making a profit there or expand it significantly?
    Ms. Wartell. Yes. And I think the reason is because of the 
wisdom of the policy makers in this committee and in this 
Congress who will not simply because it is a revenue source to 
make decisions that are bad for the housing market.
    Mr. Garrett. Okay. At the very beginning of our hearing 
today, Mr. Van Hollen started off by saying, ``Well, no one 
wants to go back to a system that guarantees either explicitly 
or implicitly,'' and then he continued on. But after the last 
hour, I realized yes, there are. The gentleman to the right 
wants to do that, and the gentleman over to the left also want 
to do that. They do want to go back to a system that has, at 
least at some level, in their proposals, at least some level 
where the government will explicitly guarantee it. Well, Mr. 
Pollock, you said something that sparked an idea in my head. 
You said we have already tried that to the extent to say that 
with the GSEs to say that, well, there was private equity in 
there and it got wiped out. Is that not really just on a 
different variation of what these various proposals are here 
today: it will wipe these things all out, but you still, at the 
end of the day, the Federal Government, that means you and 
everybody in this room, backs it up?
    Mr. Pollock. Yes, I agree with that, Mr. Chairman.
    Mr. Garrett. Okay. So there is any version that comes out 
either side of the aisle, as well-intentioned as they mean, 
where at the end of the day, that Federal Government has to 
step in to provide the liquidity into the marketplace, means 
that there is a guarantee by Federal Government. Ms. Lucas, is 
that too simple of an understanding of that if there is a 
guarantee at the end of the day?
    Dr. Lucas. No. I think it is absolutely right. And I think 
the challenge in the design of moving to a new system is to 
make the need for that as unlikely as possible.
    Mr. Garrett. And was that not also partly the design for 
the GSEs that we have right now, the design was to make it 
unlikely and not possible because that was the system we 
already just went through, correct?
    Dr. Lucas. That is right.
    Mr. Garrett. All right.
    Dr. Lucas. It was a system where they tried to put private 
capital there, but the requirements for the capital were quite 
    Mr. Garrett. Right. And another point, the gentleman from 
South Carolina made an interesting point with regard to what 
this is costing us, and he came up with a number of $140 
billion a year in a sense that there is a cost to the fact that 
we have so much GSE debt out there, agency debt out there, this 
is impacting upon the price of treasuries. Mr. Pollock, you 
said that, correct?
    Mr. Pollock. That is right, Mr. Chairman.
    Mr. Garrett. Does anyone disagree with that assessment that 
the fact that we have so much agency debt out there that that 
effects in some way shape or form price of treasuries? No one 
    Ms. Wartell. I have not had a chance to look at the study 
Alex refers to so I would be happy to comment for the record.
    Mr. Garrett. If that is true, though, and the gentleman 
says that that is costing even $100 billion, should not that be 
reflected somewhere in our accounting for Federal Government 
besides the price risking Ms. Lucas is talking about, should 
that not be reflected some place in our budget?
    Ms. Wartell. If that is the case, it is, because that is 
the price the Treasury is paying for the debt. So I think it is 
reflected in our budget.
    Mr. Garrett. So it is priced in the fact that it was 
costing us more money to borrow all the money that we are stuck 
having to borrower all the time, is what you are saying?
    Mr. Pollock. But we do not understand it was an effect of 
what we are doing with agency debt.
    Mr. Garrett. But you said it is built into the higher cost 
of borrowing.
    Ms. Wartell. I am not prepared at this point to comment on 
the study because I have not seen it. But Treasury pays the 
price the Treasury pays for a debt. It fluctuates based on a 
variety of factors consistently, and to what extent the size of 
the agency debt is a part of that, I cannot comment today.
    Mr. Garrett. And last point on this, and not to open up a 
whole thing, but as the gentle lady from California made the 
accusations that we do not care on the Republican side of the 
aisle, and that sort of thing about people twisting in the wind 
and I do not think anyone on our side wants that to occur.
    Ms. Wartell. Of course.
    Mr. Garrett. But is it not possible that we can try to get 
to the same end game? To try to make sure that there is 
sufficient housing in the country, to try to deal with the 
situation that the gentle lady is trying to deal with here, 
people in difficult situations that, instead of financing debt, 
which is what our system does right now, correct, we could 
finance equity and we could finance equity through a whole host 
of other programs and would still get to the same end game of 
trying to deal with the housing situation. Is that not an 
alternative to this situation?
    Ms. Wartell. I am not sure what you mean by financing 
equity. If you mean provide direct grants in the form of down 
payment assistance, you can, although the leverage there means 
that the additional amount of assistance is significantly more 
expensive for the taxpayers.
    Mr. Garrett. And it is all on the books as well.
    Ms. Wartell. I would argue that the goal of Credit Reform 
and all of our policies here is to put it on the books. And if 
I might, sir, the one difference between the past in any of the 
proposals in the future, is that the guarantee for the GSEs in 
the past was implicit, not explicit and they never paid for it. 
And what we are all proposing for any system in the future is 
that it be paid for so that that would be on the books.
    Mr. Garrett. And I think we will close to understand that 
someone is going to pay for it no matter what. You are right. 
But I do thank you very much, to the panel, and the gentle 
lady's comment with regard to further hearings on this or other 
discussions, formal or otherwise, I think would be a great 
thing because they are to technical and it is so very 
important. So, thank you for that. We will look forward to 
doing that. Thanks to the panel.
    The record, it will be open for the next 30 days and if 
there are additional questions, they can submit it to the 
panel. And to that end, I will take the profit of the chair and 
to submit one question to Ms. Wartell right now to elicit your 
comments on that last question with regard to the studies. That 
would be fantastic. Thank you again to the panel and to all the 
members who stayed with us. Thanks. The meeting is adjourned.
    [Questions submitted for the record and their responses 

         Questions Submitted for the Record From Chairman Ryan

                            for mr. pollock
    1. Collective risk of government guarantee in housing markets.
    a. This question pertains to the risks associated with providing a 
government guarantee for housing. Spreading the government guarantee 
among smaller financial institutions may have the benefits of risk 
diversification, but it also creates different types of risk, do you 
agree? The Savings and Loan crisis, for example, caused a systemic 
shock to markets, despite it originating among many smaller 
institutions. Would you say that systemic risk to the taxpayer exists 
regardless of the size of a financial institution, or group of 
institutions, carrying the implicit or explicit government guarantee?
    2. Government support of housing values.
    a. Is there risk associated with government trying to maintain 
housing values at artificial levels? Didn't such policies contribute to 
the bubble in housing markets--and isn't the U.S. economy now 
continuing to suffer the consequences? If government keeps in place its 
policy of artificially holding up housing values, couldn't that lead to 
another bubble and bailout?
                             for dr. lucas
    1. Discrepancies in Fannie & Freddie vs. FHA accounting.
    a. If fair value treatment were applied to FHA--the same accounting 
method that is currently used to estimate the cost of Fannie and 
Freddie--how would FHA appear in the budget? Would the cost go up or 
down? Can you explain why?
    b. Does the current accounting treatment, credit reform, understate 
the risk exposure of FHA loans? In other words, are premiums collected 
for FHA loans currently sufficient to cover the risks of insuring the 
    c. If a policy were to, for example, lower the conforming loan 
limit for FHA-insured loans, how would the scoring differ under 
straight, credit reform versus fair value?

          Questions Submitted for the Record From Mr. Calvert

    The GSEs today have more than $5 trillion in mortgage assets. The 
GSEs provide the vast majority of liquidity for the residential housing 
market, guaranteeing 70 percent of single-family mortgage-backed 
securities issued.
    We should know the facts and base our actions on the causes of the 
crisis. We need to understand what needs to be fixed without making 
drastic changes that are not based on the complexity of the system.
    Reform of the housing finance system should be comprehensive and 
should not be done in haste.
    There is no question that we need to bring private capital back 
into the housing market. When this happens, the role of the GSEs will 
be reduced. But, we need to be realistic. Private capital is not here 
in the near term. What would happen in the mortgage market right now if 
there were no Fannie and Freddie today? In order to support recovery, 
we need to be sure there is liquidity in the system.
     For all witnesses--FHA's performance is stronger than 
ever--with credit scores topping 700 and a foreclosure rate that is 
lower even than prime conventional loans. FHA's total capital resources 
are more than $33 billion, and FHA is outpacing expectations for 
rebuilding the required excess reserves. Do you believe this program is 
at risk?
     For Director Deborah Lucas of CBO--Does CBO disagree with 
the findings of the independent actuarial report of FHA, which shows 
that the program is strong and will rebuild their excess reserves 
within the next several years?
     For Alex Pollock of AEI--In 2008, Peter Wallison of AEI 
published a critique on fair value accounting. In this paper, he states 
that ``fair value accounting has been the principal cause of an 
unprecedented decline in asset values and an unprecedented rise in 
instability among financial institutions.'' If this is true, don't you 
agree that fair value accounting is then a dangerous way to try and 
evaluate FHA?
     For Alex Pollock of AEI--If FHA and the GSEs had not 
worked as their designers had planned--to remain in the marketplace 
during times like we are experiencing today--our housing and economic 
recovery would probably be a lot slower. Do you believe that private 
capital is ready to return to the market, and do you believe that it 
won't flee again during tough economic times?

         Responses to Budget Committee Questions From Ms. Lucas

                       representative ken calvert
    Question 1: For all witnesses--FHA's performance is stronger than 
ever--with credit scores topping 700 and a foreclosure rate that is 
lower even than prime conventional loans. FHA's total capital resources 
are more than $33 billion, and FHA is outpacing expectations for 
rebuilding the required excess reserves. Do you believe this program is 
at risk?

    CBO Answer: CBO does not believe that the FHA MMI program is at 
risk of exceeding its budgetary resources. Even if performance turns 
out to be poorer than projected, Congress will not have to provide 
funding for any future credit reestimates because the MMI program is 
subject to the Federal Credit Reform Act (FCRA), which provides 
Treasury with permanent indefinite authority to cover any shortfalls 
associated with this program.
    The FHA estimates that the 2011 subsidy rate for the MMI forward is 
negative (over -3%), meaning that the value of fee collections are 
estimated to exceed the cost of net payments for defaults as estimated 
under FCRA. (To date, FHA has never requested an appropriation for the 
program.) In contrast, CBO estimates that under FCRA, insuring more 
than $250 billion of new mortgages in 2011 would result in fewer 
savings to the government because CBO's estimated subsidy rate for 2011 
is close to -1 percent.
    The MMI Fund that tracks FHA's capital resources is an accounting 
mechanism that can provide some useful information regarding the 
financial position of the MMI program in terms of its long-term cash 
inflows and outflows. However, the actuarial report does not measure 
budgetary resources, and the results from that report do not affect the 
government's ability or commitment to pay eligible claims.
    From a broader economic perspective, the FHA program continues to 
pose a risk to taxpayers despite higher credit scores on new mortgages 
guaranteed in recent years and relatively low default rates. The 
program has grown significantly, increasing taxpayer exposure to 
potential future losses. The mortgages guaranteed by FHA have very high 
loan-to-value ratios which could lead to large future losses in the 
event of a national drop in home prices or a future recession.

    Question 2: For Director Deborah Lucas of CBO--Does CBO disagree 
with the findings of the independent actuarial report of FHA, which 
shows that the program is strong and will rebuild their excess reserves 
within the next several years?

    CBO Answer: CBO agrees that if the most likely path for future 
default losses and revenues materialize, the FHA's reserves would 
increase over the next several years. However, there is significant 
downside risk associated with those estimates. A borrower's equity 
position in the mortgaged home is one of the most important drivers of 
default behavior. Over 65 percent of new loans guaranteed by the FHA in 
the past few years had loan-to-value ratios in excess of 95 percent, 
leaving those borrowers particularly vulnerable to negative equity with 
even moderate drops in the value of their homes. A further nationwide 
fall in housing values or a slower than expected reduction in 
unemployment rates could result in significantly higher default losses 
and lower reserve levels.
                           chairman paul ryan
    Question 1: If fair value treatment were applied to FHA--the same 
accounting method that is currently used to estimate the cost of Fannie 
and Freddie--how would FHA appear in the budget? Would the cost go up 
or down? Can you explain why?

    CBO Answer: Using a fair value treatment rather than the Federal 
Credit Reform Act (FCRA) methodology to estimate the budgetary cost of 
FHA would result in a cost increase. For example, under the FCRA 
methodology, CBO estimates that the program would produce budgetary 
savings of $4.4 billion in fiscal year 2012. That result stems from an 
estimated subsidy rate of -1.9 percent applied to an estimated loan 
volume of $233 billion. On a fair-value basis, in contrast, the program 
would have a cost of $3.5 billion in 2012, CBO estimates--reflecting an 
estimated positive subsidy rate of 1.5 percent applied to the same 
projected loan volume.
    The cost of FHA is higher on a fair value basis primarily because, 
by incorporating a market-based risk premium, fair-value estimates 
recognize that the financial risk that the government assumes when 
issuing credit guarantees is more costly to taxpayers than FCRA-based 
estimates suggest. By using Treasury rates for discounting, FCRA 
accounting implicitly treats market risk--a type of risk that is 
reflected in market prices because investors require compensation to 
bear it--as having no cost to the government. However, when the 
government guarantees risky mortgages, it is effectively passing market 
risk through to members of the public. If the mortgages pay off as 
expected, the premiums paid cover the average loss rate from defaults; 
but if default losses turn out to be higher than expected, the losses 
must be paid for through higher future taxes or lower future government 

    (See CBO's Letter to Honorable Paul Ryan, ``Accounting for FHA's 
Single-Family Mortgage Insurance Program on a Fair-Value Basis,'' May 
18, 2011, for additional information.)

    Question 2: Does the current accounting treatment, credit reform, 
understate the risk exposure of FHA loans? In other words, are premiums 
collected for FHA loans currently sufficient to cover the risks of 
insuring the loans?

    CBO Answer: The current accounting treatment does not reflect the 
full cost to taxpayers of the risk exposure from FHA mortgage 
guarantees, as discussed in my previous answer. When the cost is 
measured on a more comprehensive fair value basis, projected premium 
income is not sufficient to offset that cost--there is a positive fair 
value subsidy.

    Question 3: If a policy were to, for example, lower the conforming 
loan limit for FHA-insured loans, how would the scoring differ under 
straight, credit reform versus fair value?

    CBO Answer: Such a policy would alter the expected future volume of 
FHA-insured loans and possibly affect the composition and risk 
characteristics of borrowers. The effects on the predicted path of 
future cash flows would be the same under either accounting treatment. 
The difference between FCRA and fair value estimates is in the 
effective discount rates; the same projected cash flows generally 
result in higher costs on a fair value basis, all else equal, because 
losses tend to occur during periods of economic stress when they are 
most costly to society.
    Under FCRA, FHA's subsidy rate generally has been negative. A 
policy that reduced the size of a program with a negative subsidy rate 
would tend to show a budgetary cost because profitable activity would 
be curtailed. By contrast, the subsidy rate for FHA on a fair value 
would generally be positive. Hence shrinking the program would be 
expected to reduce its budgetary cost, assuming no other offsetting 

        Responses to Budget Committee Questions From Mr. Pollock

    Thanks for these interesting follow-up questions. My responses are 
as follows:
                       chairman ryan's questions
    1. Yes: many small institutions can create systemic risk and 
experience systemic failure when they all do the same thing, thereby 
making themselves subject to the same macro risk factors. As the 
question suggests, the savings and loan collapse of the 1980s is a good 
example of this. The common risks were in the first place interest rate 
risk (a risk they were required to take by regulation), and then later 
commercial real estate risk (a risk they were encouraged by the 
government to take, in an attempt to correct the first problem). The 
1970s, 1980s, 1990s and 2000s each experienced a widespread real estate 
credit collapse. The government, i.e. taxpayer, guarantees of various 
kinds--FSLIC, FDIC, GSEs, FHA--promote the expansion of credit into the 
inflating sectors, thereby putting the federal budget also at risk.
    2. Yes: House prices in the 2000s inflated to (in retrospect) 
irrational levels. The government's promotion of mortgage credit and 
guarantees, including the so-called ``implicit'' but very real GSE 
guarantees, were an important element in this bubble behavior. Having 
reached irrational levels, house prices needed to fall. We should not 
expect house prices to be different in this respect from any other 
price. National average house prices, having fallen more than 30%, have 
approximately reached their longer-term trend, which suggests to me 
that we are probably in the process of a lengthy, rocky bottoming 
process in nominal house prices. Real house prices will, I believe, 
continue to fall as part of the adjustment out of the bubble.
                    congressman calvert's questions
    1. On the FHA: I believe all lending programs are always at risk, 
because lending is a risky business, subject to recurring bouts of 
losses much greater than expected. Having losses much greater than 
expected has certainly characterized the FHA's experience. If we were 
to take the FHA's capital resources as the $33 million stated in the 
question, that would mean a capital ratio of about 3%, a low capital 
ratio. However, their capital ratio as officially calculated is only 
about 1/2%, obviously extremely low. I must confess to finding the 
financial statements of the FHA rather opaque: I would like to see it 
produce a set of GAAP statements as additional information so it could 
be compared to the rest of the credit risk-taking world. Such 
statements, like those of all private insurance companies, would cause 
the FHA to pay for its own operating expenses out of its operating 
income and/or capital. As we know, FHA's operating expenses are now 
excluded from its reported results.
    2. On fair value accounting: this is an interesting and subtle 
question. When it comes to banks' financial statements, I believe all 
financial institutions should publish both a GAAP balance sheet and a 
fully marked-to-market (fair value) balance sheet. They are each 
informative one aspect of the financial reality. I would similarly be 
happy to publish both calculations about the FHA. No single perspective 
can capture the whole truth. As I interpret the CBO's recommendation, 
it is properly trying to estimate the economic cost of uncertainty, 
which is unavoidably imposed on the taxpayers when they guarantee 
credit risk. The best guess or ``expected'' net future credit losses do 
not capture this uncertainty, which is an additional cost, well 
recognized in the accepted theory of risk.
    3. On GSEs: if the GSEs had not been escalating leverage in the 
housing finance sector, in accordance with the way their designers had 
planned, the housing bubble would have been less extreme, and the 
resulting bust would have been less severe. The GSEs have been 
systematically displacing private capital for a generation, which 
resulted in hyper-leverage of mortgage credit risk and consequent great 
risk (now come home to roost) to the federal budget; I recommend a 
five-year transition in which this dynamic is reversed.

    [Additional submissions of Ms. Kaptur follow:]

          [December 23, 2009; House Advantage: Product Design]

             Banks Bundled Bad Debt, Bet Against It and Won

                 By Gretchen Morgenson and Louise Story

    In late October 2007, as the financial markets were starting to 
come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very 
good news. At 37, he was named a managing director at the firm.
    Mr. Egol, a Princeton graduate, had risen to prominence inside the 
bank by creating mortgage-related securities, named Abacus, that were 
at first intended to protect Goldman from investment losses if the 
housing market collapsed. As the market soured, Goldman created even 
more of these securities, enabling it to pocket huge profits.
    Goldman's own clients who bought them, however, were less 
    Pension funds and insurance companies lost billions of dollars on 
securities that they believed were solid investments, according to 
former Goldman employees with direct knowledge of the deals who asked 
not to be identified because they have confidentiality agreements with 
the firm.
    Goldman was not the only firm that peddled these complex 
securities--known as synthetic collateralized debt obligations, or 
C.D.O.'s--and then made financial bets against them, called selling 
short in Wall Street parlance. Others that created similar securities 
and then bet they would fail, according to Wall Street traders, include 
Deutsche Bank and Morgan Stanley, as well as smaller firms like 
Tricadia Inc., an investment company whose parent firm was overseen by 
Lewis A. Sachs, who this year became a special counselor to Treasury 
Secretary Timothy F. Geithner.
    How these disastrously performing securities were devised is now 
the subject of scrutiny by investigators in Congress, at the Securities 
and Exchange Commission and at the Financial Industry Regulatory 
Authority, Wall Street's self-regulatory organization, according to 
people briefed on the investigations. Those involved with the inquiries 
declined to comment.
    While the investigations are in the early phases, authorities 
appear to be looking at whether securities laws or rules of fair 
dealing were violated by firms that created and sold these mortgage-
linked debt instruments and then bet against the clients who purchased 
them, people briefed on the matter say.
    One focus of the inquiry is whether the firms creating the 
securities purposely helped to select especially risky mortgage-linked 
assets that would be most likely to crater, setting their clients up to 
lose billions of dollars if the housing market imploded.
    Some securities packaged by Goldman and Tricadia ended up being so 
vulnerable that they soured within months of being created.
    Goldman and other Wall Street firms maintain there is nothing 
improper about synthetic C.D.O.'s, saying that they typically employ 
many trading techniques to hedge investments and protect against 
losses. They add that many prudent investors often do the same. Goldman 
used these securities initially to offset any potential losses stemming 
from its positive bets on mortgage securities.
    But Goldman and other firms eventually used the C.D.O.'s to place 
unusually large negative bets that were not mainly for hedging 
purposes, and investors and industry experts say that put the firms at 
odds with their own clients' interests.
    ``The simultaneous selling of securities to customers and shorting 
them because they believed they were going to default is the most 
cynical use of credit information that I have ever seen,'' said Sylvain 
R. Raynes, an expert in structured finance at R & R Consulting in New 
York. ``When you buy protection against an event that you have a hand 
in causing, you are buying fire insurance on someone else's house and 
then committing arson.''
    Investment banks were not alone in reaping rich rewards by placing 
trades against synthetic C.D.O.'s. Some hedge funds also benefited, 
including Paulson & Company, according to former Goldman workers and 
people at other banks familiar with that firm's trading.
    Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. 
Egol available for comment. But Mr. DuVally said many of the C.D.O.'s 
created by Wall Street were made to satisfy client demand for such 
products, which the clients thought would produce profits because they 
had an optimistic view of the housing market. In addition, he said that 
clients knew Goldman might be betting against mortgages linked to the 
securities, and that the buyers of synthetic mortgage C.D.O.'s were 
large, sophisticated investors, he said.
    The creation and sale of synthetic C.D.O.'s helped make the 
financial crisis worse than it might otherwise have been, effectively 
multiplying losses by providing more securities to bet against. Some $8 
billion in these securities remain on the books at American 
International Group, the giant insurer rescued by the government in 
September 2008.
    From 2005 through 2007, at least $108 billion in these securities 
was issued, according to Dealogic, a financial data firm. And the 
actual volume was much higher because synthetic C.D.O.'s and other 
customized trades are unregulated and often not reported to any 
financial exchange or market.
                         goldman saw it coming
    Before the financial crisis, many investors--large American and 
European banks, pension funds, insurance companies and even some hedge 
funds--failed to recognize that overextended borrowers would default on 
their mortgages, and they kept increasing their investments in 
mortgage-related securities. As the mortgage market collapsed, they 
suffered steep losses.
    A handful of investors and Wall Street traders, however, 
anticipated the crisis. In 2006, Wall Street had introduced a new 
index, called the ABX, that became a way to invest in the direction of 
mortgage securities. The index allowed traders to bet on or against 
pools of mortgages with different risk characteristics, just as stock 
indexes enable traders to bet on whether the overall stock market, or 
technology stocks or bank stocks, will go up or down.
    Goldman, among others on Wall Street, has said since the collapse 
that it made big money by using the ABX to bet against the housing 
market. Worried about a housing bubble, top Goldman executives decided 
in December 2006 to change the firm's overall stance on the mortgage 
market, from positive to negative, though it did not disclose that 
    Even before then, however, pockets of the investment bank had also 
started using C.D.O.'s to place bets against mortgage securities, in 
some cases to hedge the firm's mortgage investments, as protection 
against a fall in housing prices and an increase in defaults.
    Mr. Egol was a prime mover behind these securities. Beginning in 
2004, with housing prices soaring and the mortgage mania in full swing, 
Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, 
Goldman issued 25 Abacus deals, according to Bloomberg, with a total 
value of $10.9 billion.
    Abacus allowed investors to bet for or against the mortgage 
securities that were linked to the deal. The C.D.O.'s didn't contain 
actual mortgages. Instead, they consisted of credit-default swaps, a 
type of insurance that pays out when a borrower defaults. These swaps 
made it much easier to place large bets on mortgage failures.
    Rather than persuading his customers to make negative bets on 
Abacus, Mr. Egol kept most of these wagers for his firm, said five 
former Goldman employees who spoke on the condition of anonymity. On 
occasion, he allowed some hedge funds to take some of the short trades.
    Mr. Egol and Fabrice Tourre, a French trader at Goldman, were 
aggressive from the start in trying to make the assets in Abacus deals 
look better than they were, according to notes taken by a Wall Street 
investor during a phone call with Mr. Tourre and another Goldman 
employee in May 2005.
    On the call, the two traders noted that they were trying to 
persuade analysts at Moody's Investors Service, a credit rating agency, 
to assign a higher rating to one part of an Abacus C.D.O. but were 
having trouble, according to the investor's notes, which were provided 
by a colleague who asked for anonymity because he was not authorized to 
release them. Goldman declined to discuss the selection of the assets 
in the C.D.O.'s, but a spokesman said investors could have rejected the 
C.D.O. if they did not like the assets.
    Goldman's bets against the performances of the Abacus C.D.O.'s were 
not worth much in 2005 and 2006, but they soared in value in 2007 and 
2008 when the mortgage market collapsed. The trades gave Mr. Egol a 
higher profile at the bank, and he was among a group promoted to 
managing director on Oct. 24, 2007.
    ``Egol and Fabrice were way ahead of their time,'' said one of the 
former Goldman workers. ``They saw the writing on the wall in this 
market as early as 2005.'' By creating the Abacus C.D.O.'s, they helped 
protect Goldman against losses that others would suffer.
    As early as the summer of 2006, Goldman's sales desk began 
marketing short bets using the ABX index to hedge funds like Paulson & 
Company, Magnetar and Soros Fund Management, which invests for the 
billionaire George Soros. John Paulson, the founder of Paulson & 
Company, also would later take some of the shorts from the Abacus 
deals, helping him profit when mortgage bonds collapsed. He declined to 
                       a deal gone bad, for some
    The woeful performance of some C.D.O.'s issued by Goldman made them 
ideal for betting against. As of September 2007, for example, just five 
months after Goldman had sold a new Abacus C.D.O., the ratings on 84 
percent of the mortgages underlying it had been downgraded, indicating 
growing concerns about borrowers' ability to repay the loans, according 
to research from UBS, the big Swiss bank. Of more than 500 C.D.O.'s 
analyzed by UBS, only two were worse than the Abacus deal.
    Goldman created other mortgage-linked C.D.O.'s that performed 
poorly, too. One, in October 2006, was a $800 million C.D.O. known as 
Hudson Mezzanine. It included credit insurance on mortgage and subprime 
mortgage bonds that were in the ABX index; Hudson buyers would make 
money if the housing market stayed healthy--but lose money if it 
collapsed. Goldman kept a significant amount of the financial bets 
against securities in Hudson, so it would profit if they failed, 
according to three of the former Goldman employees.
    A Goldman salesman involved in Hudson said the deal was one of the 
earliest in which outside investors raised questions about Goldman's 
incentives. ``Here we are selling this, but we think the market is 
going the other way,'' he said.
    A hedge fund investor in Hudson, who spoke on the condition of 
anonymity, said that because Goldman was betting against the deal, he 
wondered whether the bank built Hudson with ``bonds they really think 
are going to get into trouble.''
    Indeed, Hudson investors suffered large losses. In March 2008, just 
18 months after Goldman created that C.D.O., so many borrowers had 
defaulted that holders of the security paid out about $310 million to 
Goldman and others who had bet against it, according to correspondence 
sent to Hudson investors.
    The Goldman salesman said that C.D.O. buyers were not misled 
because they were advised that Goldman was placing large bets against 
the securities. ``We were very open with all the risks that we thought 
we sold. When you're facing a tidal wave of people who want to invest, 
it's hard to stop them,'' he said. The salesman added that investors 
could have placed bets against Abacus and similar C.D.O.'s if they had 
wanted to.
    A Goldman spokesman said the firm's negative bets didn't keep it 
from suffering losses on its mortgage assets, taking $1.7 billion in 
write-downs on them in 2008; but he would not say how much the bank had 
since earned on its short positions, which former Goldman workers say 
will be far more lucrative over time. For instance, Goldman profited to 
the tune of $1.5 billion from one series of mortgage-related trades by 
Mr. Egol with Wall Street rival Morgan Stanley, which had to book a 
steep loss, according to people at both firms.
    Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, 
left Goldman and later published a novel, ``How I Caused the Credit 
Crunch.'' In it, he wrote that bankers deserted their clients who had 
bought mortgage bonds when that market collapsed: ``We had moved on to 
hurting others in our quest for self-preservation.'' Mr. Ishikawa, who 
now works for another financial firm in London, declined to comment on 
his work at Goldman.
                        profits from a collapse
    Just as synthetic C.D.O.'s began growing rapidly, some Wall Street 
banks pushed for technical modifications governing how they worked in 
ways that made it possible for C.D.O.'s to expand even faster, and also 
tilted the playing field in favor of banks and hedge funds that bet 
against C.D.O.'s, according to investors.
    In early 2005, a group of prominent traders met at Deutsche Bank's 
office in New York and drew up a new system, called Pay as You Go. This 
meant the insurance for those betting against mortgages would pay out 
more quickly. The traders then went to the International Swaps and 
Derivatives Association, the group that governs trading in derivatives 
like C.D.O.'s. The new system was presented as a fait accompli, and 
    Other changes also increased the likelihood that investors would 
suffer losses if the mortgage market tanked. Previously, investors took 
losses only in certain dire ``credit events,'' as when the mortgages 
associated with the C.D.O. defaulted or their issuers went bankrupt.
    But the new rules meant that C.D.O. holders would have to make 
payments to short sellers under less onerous outcomes, or ``triggers,'' 
like a ratings downgrade on a bond. This meant that anyone who bet 
against a C.D.O. could collect on the bet more easily.
    ``In the early deals you see none of these triggers,'' said one 
investor who asked for anonymity to preserve relationships. ``These 
things were built in to provide the dealers with a big payoff when 
something bad happened.''
    Banks also set up ever more complex deals that favored those 
betting against C.D.O.'s. Morgan Stanley established a series of 
C.D.O.'s named after United States presidents (Buchanan and Jackson) 
with an unusual feature: short-sellers could lock in very cheap bets 
against mortgages, even beyond the life of the mortgage bonds. It was 
akin to allowing someone paying a low insurance premium for coverage on 
one automobile to pay the same on another one even if premiums over all 
had increased because of high accident rates.
    At Goldman, Mr. Egol structured some Abacus deals in a way that 
enabled those betting on a mortgage-market collapse to multiply the 
value of their bets, to as much as six or seven times the face value of 
those C.D.O.'s. When the mortgage market tumbled, this meant bigger 
profits for Goldman and other short sellers--and bigger losses for 
other investors.
                            selling bad debt
    Other Wall Street firms also created risky mortgage-related 
securities that they bet against.
    At Deutsche Bank, the point man on betting against the mortgage 
market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to 
select hedge fund clients, arguing they should short the mortgage 
market. He sometimes distributed a T-shirt that read ``I'm Short Your 
House!!!'' in black and red letters.
    Deutsche, which declined to comment, at the same time was selling 
synthetic C.D.O.'s to its clients, and those deals created more short-
selling opportunities for traders like Mr. Lippmann.
    Among the most aggressive C.D.O. creators was Tricadia, a 
management company that was a unit of Mariner Investment Group. Until 
he became a senior adviser to the Treasury secretary early this year, 
Lewis Sachs was Mariner's vice chairman. Mr. Sachs oversaw about 20 
portfolios there, including Tricadia, and its documents also show that 
Mr. Sachs sat atop the firm's C.D.O. management committee.
    From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.'s, 
which it called TABS. Even when the market was starting to implode, 
Tricadia continued to create TABS deals in early 2007 to sell to 
investors. The deal documents referring to conflicts of interest stated 
that affiliates and clients of Tricadia might place bets against the 
types of securities in the TABS deal.
    Even so, the sales material also boasted that the mortgages linked 
to C.D.O.'s had historically low default rates, citing a ``recently 
completed'' study by Standard & Poor's ratings agency--though fine 
print indicated that the date of the study was September 2002, almost 
five years earlier.
    At a financial symposium in New York in September 2006, Michael 
Barnes, the co-head of Tricadia, described how a hedge fund could put 
on a negative mortgage bet by shorting assets to C.D.O. investors, 
according to his presentation, which was reviewed by The New York 
    Mr. Barnes declined to comment. James E. McKee, general counsel at 
Tricadia, said, ``Tricadia has never shorted assets into the TABS 
deals, and Tricadia has always acted in the best interests of its 
clients and investors.''
    Mr. Sachs, through a spokesman at the Treasury Department, declined 
to comment.
    Like investors in some of Goldman's Abacus deals, buyers of some 
TABS experienced heavy losses. By the end of 2007, UBS research showed 
that two TABS deals were the eighth- and ninth-worst performing 
C.D.O.'s. Both had been downgraded on at least 75 percent of their 
associated assets within a year of being issued.
    Tricadia's hedge fund did far better, earning roughly a 50 percent 
return in 2007 and similar profits in 2008, in part from the short 

                            [June 17, 2010]

         The Giant Revolving Door of Regulatory Hostage-Taking

                  By Ilan Moscovitz and Morgan Housel

    The late economist George Stigler wouldn't be surprised at today's 
    Stigler, you see, won a Nobel Prize for the concept of ``regulator 
capture,'' or the idea that ``regulation may be actively sought * * * 
by the industry and is designed and operated primarily for its 
    Sound familiar? If you've noticed a pattern of government favoring 
Wall Street, you've cracked an important code. One of the great 
confusions of the past two years is how the financial industry managed 
to fully wreck shop while remaining mostly untouched from the hands of 
regulators. After 9/11, airline security was immediately revamped from 
head to toe. Three years after the financial collapse began, here we 
are; almost nothing has changed.
             friends don't let friends turn down plutocracy
    If you're trying to make sense of this, look no further than what's 
often called Wall Street's revolving door to Washington. In short, 
those whose duty it is to regulate Wall Street have a curious tendency 
to be elite members of * * * Wall Street.
    We've compiled a brief list of examples:

         Person                      Was (or still is)                    Then became (or now serves as)
Donald Regan              CEO, Merrill Lynch                      Treasury Secretary (under Reagan)
Nicholas Brady            Chairman, Dillon Read                   Treasury Secretary (Reagan)
Robert Rubin              Co-Chairman, Goldman Sachs (NYSE: GS)   Treasury Secretary (Clinton)
Roger Altman              Partner, Lehman Brothers                Deputy Secretary of Treasury (Clinton)
Frank Newman              Chief Financial Officer, Bank of        Undersecretary of Domestic Finance (Clinton)
                           America (NYSE: BAC)
Robert Steel              Vice Chairman, Goldman Sachs            Undersecretary of Domestic Finance (G.W. Bush)
Hank Paulson              CEO, Goldman Sachs                      Treasury Secretary (G.W. Bush)
Josh Bolten               Executive Director, Goldman Sachs       White House Chief of Staff (G.W. Bush)
Neel Kashkari             Vice President, Goldman Sachs           U.S. Treasury, Head of TARP (G.W. Bush)
Bill Donaldson            Chairman, Donaldson Lufkin Jenrette     Chairman, SEC (G.W. Bush)
Edward Forst              Every imaginable senior position,       TARP Advisor (G.W. Bush)
                           Goldman Sachs
John Snow                 Chairman, Business Roundtable           Treasury Secretary (G.W. Bush)
Kendrick Wilson III       Managing Director, Goldman Sachs        Advisor, Department of Treasury (G.W. Bush)
Barbara Shycoff           Vice President, American Express        Managing Director, Office of Thrift
                           (NYSE: AXP)                             Supervision (G.W. Bush)
John Dugan                Banking industry lobbyist               Comptroller of the Currency (G.W. Bush)
Michael Froman            Managing Director, Citigroup (NYSE: C)  White House Liaison to G7, G8, G20 (Obama)
Herb Allison              Chief Operating Officer, Merrill Lynch  Assistant Secretary for Financial Stability,
                                                                   Department of Treasury (Obama)
Lewis Sachs               Director, Bear Stearns                  Treasury top aide (Obama)
Richard Fisher            Investment banker, Brown Brothers       President, Federal Reserve Bank of Dallas
Dennis Lockhart           Senior Corporate Officer, Citigroup     CEO, Federal Reserve Bank of Atlanta
William Dudley            Managing director, Goldman Sachs        President, Federal Reserve Bank of New York
Jon Corzine               Senior partner, Goldman Sachs           Governor, New Jersey
Stephen Friedman          Chief Operating Officer, Chairman of    Chairman, New York Fed
                           Goldman Sachs
Edward Murphy             Chief Financial Officer, JPMorgan       Executive Vice President, New York Fed
Peter Peterson            Co-Founder, Blackstone                  Board of Directors, New York Fed
Walter Shipley            Chairman, Chase Manhattan               Board of Directors, New York Fed
Sanford Weill             Chairman, Citigroup                     Board of Directors, New York Fed
Richard Fuld              Chairman, CEO, Lehman Brothers          Board of Directors, New York Fed
Jeffrey Immelt            Chairman, CEO, General Electric (NYSE:  Board of Directors, New York Fed
Jamie Dimon               Chairman, CEO, JPMorgan                 Board of Directors, New York Fed
Kevin Warsh               Executive Director, Morgan Stanley      Governor, Federal Reserve Board
Elizabeth Duke            Chairman, American Bankers Association  Governor, Federal Reserve Board
Robert Kimmitt            Managing Director, Lehman Brothers      Deputy Secretary of Treasury (G.W. Bush)
Gary Gensler              Partner, Goldman Sachs                  Undersecretary of Treasury (Clinton), Head of
                                                                   Commodity Futures Trading Commission (Obama)

    We found hundreds of examples, but we'll stop there. You get the 
                      first-class financial incest
    Now, just because someone has worked in the financial industry 
doesn't necessarily mean they can't take on Wall Street when it's their 
job to do so. In spite of his former career as an investment banker, 
Dallas Fed president Richard Fisher argued earlier this month that 
``banks that are `too big to fail' are simply `too big.' We must cap 
their size or break them up.'' He's an independent voice who doesn't 
robotically hew to the interests of the financial lobby.
    But he's also a rare gem. Consider John Dugan, a former bank 
lobbyist who now serves as comptroller of the currency. His office (the 
OCC) regulates and supervises the big national banks.
    You probably know where this is going. Instead of policing banks, 
Dugan's OCC has played the role of mama bear protector.
     The New York Times reports that of the hundreds of 
thousands of consumer complaints fielded over the past decade, fewer 
than 200 enforcement orders were issued.
     When West Virginia tried to sue Capital One (NYSE: COF) 
for credit card abuses, the company applied for a charter under the 
OCC, ostensibly seeking its infamously gentle embrace. Now a national 
bank under Dugan's sole purview, Capital One escaped West Virginia's 
jurisdiction, and the state was politely told to pipe down and move 
along. The head of the Financial Crisis Inquiry Commission told Dugan, 
``You tied the hands of the states and then sat on your hands.'' And it 
worked magnificently.
     Under the OCC's light watch, commercial banks took on 
insane derivatives exposure. Untold commercial banks were backstopped 
by taxpayers when things turned explosive. Dugan seems content with 
this result: ``In the end, the fact that they got the [bailout] money 
but took steps to fix themselves * * * to pay the government back 
quickly, will be viewed as a successful way to deal with a very 
difficult situation.'' Forget moral hazard. His friends lived.
                  the customer is always right (ahem)
    This kind of behavior isn't restricted to Wall Street. After the BP 
(NYSE: BP) oil spill, the world has * * * been appalled after learning 
how the Minerals Management Service (MMS) was literally in bed and 
snuggling with the oil companies it oversaw.
    Appalling, yes. But MMS' relationship with Big Oil was juvenile 
compared with banks and their regulators.
    OCC derives its operating budget not from Congress, not from 
states, but from the banks it regulates. Big deal, you say? The problem 
is that banks can shop around for friendlier regulators if OCC's 
restrictions rain on their master plan. Banks are literally regulators' 
paying customers, which must be kept happy for a regulator to justify 
its existence. Consider this profile of former Countrywide CEO Angelo 
Mozilo (courtesy of The New Yorker):
    Mozilo called some of the regulators' concerns ``much ado about 
nothing.'' He decided that Countrywide should try to switch regulators, 
leaving the Fed and the O.C.C. for the weaker Office of Thrift 
Supervision (O.T.S.) * * * the O.T.S. had lobbied Countrywide to make 
the switch.
    That's impressively stupid.
                           get us out of here
    What's the solution? Consolidating regulators and giving them their 
own operating budgets so they don't have to compete against one another 
for business seems like a no-brainer. But we're admittedly stumped on 
the issue of regulatory capture and won't pretend to have all the 
answers. When regulators are hiring, they can't just reject every Wall 
Street veteran. We want regulators who know what they're doing. We just 
don't want the police to coincidentally be the criminal's frat brother.
    That said, here are two things we can do that would help us turn 
this ship around.
    (1) Find ways to have less money in politics.
    The financial industry spends more than $1 million a day on 
lobbying. All too often that means industry sellouts are appointed as 
    Fixing this problem is easier said than done. Voting for 
politicians with backbones is probably a good start, as is demanding 
some kind of campaign finance reform or improved transparency of who's 
paying for those annoying ads.
    (2)When a simple law will work, don't tinker with regulatory 
    Firm laws can be far superior to discretion. We shouldn't always 
give regulators discretion to exempt and make random subjective calls 
as they please.
    Consider this: Currently, the Federal Reserve subsidizes Dugan's 
too-big-to-fail banks by allowing them to use our FDIC-insured deposits 
for gambling with risky derivatives--the same ones that contributed to 
the 2008 financial meltdown. That's a recipe for disaster. Because 
there's no good reason for taxpayers to subsidize derivatives casinos, 
why not just end the practice and be done with it?
    This is actually something that's being voted on over the next 

                   [Posted Dec. 2, 2010 at 5:57 a.m.]

                Evanston's Magnetar Benefited From TALF

               By Dow Jones Newswires-Wall Street Journal

    Hedge funds and investors whose bearish trades on housing helped 
them profit amid the credit crisis were among those that benefited from 
a U.S. government emergency rescue program to kick-start lending, 
according to Federal Reserve data released Wednesday.
    That program, known as the Term Asset-Backed Securities Lending 
Facility, or TALF, and established during the financial crisis, 
provided low-cost loans from the Federal Reserve to investors buying 
bonds backed by student, auto and commercial-property loans and other 
assets. The program, which lasted from March 2009 until June 2010, was 
aimed at helping banks move loans off their books by repackaging them 
into bonds and selling them.
    Funds managed or backed by Evanston-based Magnetar Capital, 
Tricadia Capital and FrontPoint Partners, which made large profits 
betting on a downturn in the U.S. housing market before the crisis, 
were among those who obtained low-cost loans from the Fed to buy 
securities, according to the Fed data.
    The Fed on Wednesday released the names of 177 borrowers that 
obtained a total of $71 billion in low-cost loans from the TALF program 
to buy newly issued asset-backed securities with a market value of 
about $79 billion. In effect, buyers were able put up a small amount of 
their own money and borrow about 82 percent to 95 percent of the 
securities' value.
    The program generated big returns for investors--as high as 48 
percent in some cases at the height of the crisis, though more commonly 
in the range of 20 percent to 40 percent, analysts say. Toward the end 
of the TALF program, as yields on many securities fell, returns for 
borrowers were closer to 10 percent.
    The fact that some investors who profited amid the financial 
downturn benefited from TALF could elicit questions about why a U.S. 
bailout using taxpayer money helped finance new investments for them.
    A spokesman for the Federal Reserve Bank of New York, which 
administered the TALF program, said it was meant to increase the flow 
of credit to consumers and businesses and achieved that purpose. ``The 
program was designed to encourage very broad participation, as long as 
borrowers met specific eligibility criteria,'' he added.
    TALF borrowers also included New York distressed debt investors 
such as Angelo, Gordon & Co. and Siguler Guff & Co. Pension funds such 
as the California Public Employees' Retirement System and the municipal 
pension plan of Milford, Conn., took part, as did scores of large 
mutual funds and little-known funds set up specifically to invest in 
securities using money from TALF.
    John Paulson, whose hedge fund Paulson & Co. made large profits 
betting against subprime mortgages, also was an indirect beneficiary of 
the government's rescue progra OneWest Bank, a Pasadena, Calif., bank 
previously known as IndyMac, which now counts Paulson and his fund 
among its private-equity backers, borrowed $34.4 million from TALF in 
July 2009 to buy securities backed by mortgage-servicing advances, the 
Fed data show. It repaid the money a few months later.
    Representatives for the hedge funds and other borrowers either 
declined to comment or weren't available for comment.
    When TALF was set up, funds hoping to establish new investment 
vehicles had to move quickly before prices on asset-backed securities 
rebounded from super-distressed levels, said Sreeniwas Prabhu, managing 
partner of Atlanta money manager Angel Oak Capital Advisors LLC, which 
invests in mortgage securities but didn't participate in TALF.
    ``A lot of the guys in our business had already figured out that 
the valuations had gotten way out of whack,'' Prabhu said.
    Ernie Patrikis, a partner at New York law firm White & Case who 
previously served as general counsel for the Federal Reserve Bank of 
New York, said the Fed likely will learn lessons about who benefited 
from the rescue progra But Patrikis said that the investor money in the 
TALF program did help stabilize markets.
    ``They got that money, and what did they do with it?'' Patrikis 
said. ``They recycled it, presumably, and that's a good thing.''
    Like other Fed lending programs, the TALF program wasn't designed 
to exclude any particular firms; as long as they met the program's 
eligibility criteria, they could obtain loans to buy securities. The 
program did impose restrictions on borrowers' ability to hedge or make 
bearish bets on the securities they purchased using Fed money.
    Most of the Fed loans carried interest rates of between 1 percent 
and 2 percent and were used to purchase securities with higher yields. 
The borrowed money juiced some of those returns to double-digit levels 
at relatively little risk to the buyers

                [Wall Street Journal article, page A13]

                 By Kenneth E. Scott and John B. Taylor

    Despite trillions of dollars of new government programs, one of the 
original causes of the financial crisis--the toxic assets on bank 
balance sheets--still persists and remains a serious impediment to 
economic recovery. Why are these toxic assets so difficult to deal 
with? We believe their sheer complexity is the core problem and that 
only increased transparency will unleash the market mechanisms needed 
to clean them up.
    The bulk of toxic assets are based on residential mortgage-backed 
securities (RMBS), in which thousands of mortgages were gathered into 
mortgage pools. The returns on these pools were then sliced into a 
hierarchy of ``tranches'' that were sold to investors as separate 
classes of securities. The most senior tranches, rated AAA, received 
the lowest returns, and then they went down the line to lower ratings 
and finally to the unrated ``equity'' tranches at the bottom.
    But the process didn't stop there. Some of the tranches from one 
mortgage pool were combined with tranches from other mortgage pools, 
resulting in Collateralized Mortgage Obligations (CMO). Other tranches 
were combined with tranches from completely different types of pools, 
based on commercial mortgages, auto loans, student loans, credit card 
receivables, small business loans, and even corporate loans that had 
been combined into Collateralized Loan Obligations (CLO). The result 
was a highly heterogeneous mixture of debt securities called 
Collateralized Debt Obligations (CDO). The tranches of the CDOs could 
then be combined with other CDOs, resulting in CDO2.
    Each time these tranches were mixed together with other tranches in 
a new pool, the securities became more complex. Assume a hypothetical 
CDO2 held 100 CLOs, each holding 250 corporate loans--then we would 
need information on 25,000 underlying loans to determine the value of 
the security. But assume the CDO2 held 100 CDOs each holding 100 RMBS 
comprising a mere 2,000 mortgages--the number now rises to 20 million!
    Complexity is not the only problem. Many of the underlying 
mortgages were highly risky, involving little or no down payments and 
initial rates so low they could never amortize the loan. About 80% of 
the $2.5 trillion subprime mortgages made since 2000 went into 
securitization pools. When the housing bubble burst and house prices 
started declining, borrowers began to default, the lower tranches were 
hit with losses, and higher tranches became more risky and declined in 
    To better understand the magnitude of the problem and to find 
solutions, we examined the details of several CDOs using data obtained 
from SecondMarket, a firm specializing in illiquid assets. One example 
is a $1 billion CDO2 created by a large bank in 2005. It had 173 
investments in tranches issued by other pools: 130 CDOs, and also 43 
CLOs each composed of hundreds of corporate loans. It issued $975 
million of four AAA tranches, and three subordinate tranches of $55 
million. The AAA tranches were bought by banks and the subordinate 
tranches mostly by hedge funds.
    Two of the 173 investments held by this CDO2 were in tranches from 
another billion-dollar CDO--created by another bank earlier in 2005--
which was composed mainly of 155 MBS tranches and 40 CDOs. Two of these 
155 MBS tranches were from a $1 billion RMBS pool created in 2004 by a 
large investment bank, composed of almost 7,000 mortgage loans (90% 
subprime). That RMBS issued $865 million of AAA notes, about half of 
which were purchased by Fannie Mae and Freddie Mac and the rest by a 
variety of banks, insurance companies, pension funds and money 
managers. About 1,800 of the 7,000 mortgages still remain in the pool, 
with a current delinquency rate of about 20%.
    With so much complexity, and uncertainty about future performance, 
it is not surprising that the securities are difficult to price and 
that trading dried up. Without market prices, valuation on the books of 
banks is suspect and counterparties are reluctant to deal with each 
    The policy response to this problem has been circuitous. The 
Federal Reserve originally saw the problem as a lack of liquidity in 
the banking system, and beginning in late 2007 flooded the market with 
liquidity through new lending facilities. It had very limited success, 
as banks were still disinclined to buy or trade such securities or take 
them as collateral. Credit spreads remained higher than normal. In 
September 2008 credit spreads skyrocketed and credit markets froze. By 
then it was clear that the problem was not liquidity, but rather the 
insolvency risks of counterparties with large holdings of toxic assets 
on their books.
    The Federal Government then decided to buy the toxic assets. The 
Troubled Asset Relief Program (TARP) was enacted in October 2008 with 
$700 billion in funding. But that was not how the TARP funds were used. 
The Treasury concluded that the valuation problem seemed 
insurmountable, so it attacked the risk issue by bolstering bank 
capital, buying preferred stock.
    But those toxic assets are still there. The latest disposal scheme 
is the Public-Private Investment Program (PPIP). The concept is that 
private asset managers would create investment funds of half private 
and half Treasury (TARP) capital, which would bid on packages of toxic 
assets that banks offered for sale. The responsibility for valuation is 
thus shifted to the private sector. But the pricing difficulty remains 
and this program too may amount to little.
    The fundamental problem has remained untouched: insufficient 
information to permit estimated prices that both buyers and sellers 
find credible. Why is the information so hard to obtain? While the 
original MBS pools were often Securities and Exchange Commission (SEC) 
registered public offerings with considerable detail, CDOs were sold in 
private placements with confidentiality agreements. Moreover, the 
nature of the securitization process has made it extremely difficult to 
determine and follow losses and increasing risk from one tranche and 
pool to another, and to reach the information about the original 
borrowers that is needed to estimate future cash flows and price.
    This account makes it clear why transparency is so important. To 
deal with the problem, issuers of asset-backed securities should 
provide extensive detail in a uniform format about the composition of 
the original pools and their subsequent structure and performance, 
whether they were sold as SEC-registered offerings or private 
placements. By creating a centralized database with this information, 
the pricing process for the toxic assets becomes possible. Making such 
a database a reality will restart private securitization markets and 
will do more for the recovery of the economy than yet another redesign 
of administrative agency structures. If issuers are not forthcoming, 
then they should be required to file the information publicly with the 

    Mr. Scott is a professor of securities and corporate law at 
Stanford University and a research fellow at the Hoover Institution. 
Mr. Taylor, an economics professor at Stanford and senior fellow at the 
Hoover Institution, is the author of ``Getting Off Track: How 
Government Actions and Interventions Caused, Prolonged and Worsened the 
Financial Crisis'' (Hoover Press, 2009).

                   [New York Times, October 16, 2009]

                  Bill Shields Most Banks From Review

                           By Stephen Labaton

    Washington--Bowing to political pressure from community bankers, 
the House Financial Services Committee approved an exemption on 
Thursday for more than 98 percent of the nation's banks from oversight 
by a new agency created to protect consumers from abusive or deceptive 
credit cards, mortgages and other loans.
    The carve-out in legislation overhauling the regulatory system 
would prevent the new consumer financial protection agency from 
conducting annual examinations of the lending practices at more than 
8,000 of the nation's 8,200 banks, leaving only the largest banks and 
other lenders subject to the agency's examiners.
    Earlier in the day, the committee completed its work on a different 
contentious provision of the legislation when, on a nearly straight 
party-line vote of 43 to 26, it approved tougher regulations over the 
derivatives market. That provision, too, contained exemptions for many 
    The exemption for the banks was endorsed by the chairman, 
Representative Barney Frank of Massachusetts, who saw it as necessary 
to win support for the overall bill from the committee's moderate and 
conservative Democrats. Their support is particularly important because 
the Republicans are unified against the legislation.
    The committee approved the exemption for all but the largest banks 
in an amendment offered by two of those Democrats, Representative Brad 
Miller of North Carolina and Representative Dennis Moore of Kansas.
    ``Community banks and credit unions were perhaps not without sin in 
the last couple of years but they were certainly not engaged in the 
worst abuses,'' Mr. Miller said. ``They make the argument that for 
bigger banks, examiners are camping out. But for them, examiners come 
and it is very disruptive and adds compliance costs. The consumer 
financial protection agency will be able to do the job but it will not 
create a further burden on small banks and credit unions.''
    The measure creating the new agency has already been significantly 
pared back from the Obama administration's proposal. While the 
exemption approved on Thursday would cover a vast sector of the banking 
industry, those institutions control only about 20 percent of the 
roughly $14 trillion in assets held by commercial banks. The 150 
largest banks, which would face more regulatory scrutiny, hold the 
remaining four-fifths of the assets.
    Under the Miller-Moore amendment, the new agency would have the 
authority to write rules for all banks and other lenders, including 
lenders that have never faced significant regulation. But the banks 
with assets of less than $10 billion and credit unions smaller than 
$1.5 billion would not face regular exams by the agency.
    Instead, the consumer regulations would continue to be enforced in 
most cases by the agencies that monitor the financial condition of the 
banks. Mr. Frank said that under the amendment, the new agency would 
still have the authority to investigate complaints raised at any bank.
    Mr. Frank and senior administration officials have accused the bank 
agencies of failing to aggressively enforce rules protecting consumers 
from predatory loans. Mr. Frank said the change would not in any way 
diminish the oversight of the smaller banks, which would continue to 
face regular examinations by bank regulators for consumer problems. He 
also noted that the largest banks, which would face examinations by the 
new agency, had engaged in the worst abuses.
    The amendment was warmly greeted by lobbyists for the smaller 
    ``The Miller-Moore amendment addresses some of our key concerns,'' 
said Camden R. Fine, president of the Independent Community Bankers of 
America, which represents about 5,000 financial institutions.
    But the American Bankers Association said it was not enough.
    ``We continue to have our fundamental concern that the bill will 
create a new agency with incredibly broad powers that will be in 
constant conflict'' with other regulators, said Edward L. Yingling, 
president of the association.
    In a briefing by telephone with reporters, the assistant Treasury 
secretary, Michael S. Barr, deflected questions about whether the 
administration had a view about the Miller-Moore amendment.
    The legislation's chapter on derivatives would impose new 
regulations and capital requirements on dealers, and would force more 
trades onto exchanges or electronic platforms. But in a major 
concession to businesses, many trades intended to hedge risks by 
companies like airlines, manufacturers and energy interests would be 
exempt from trading through exchanges or clearinghouses.
    While the administration quickly embraced the derivatives 
legislation, a top regulator appointed by President Obama indicated 
that compromises made to win the support of moderate Democrats led to 
problematic loopholes. The regulator, Gary G. Gensler, chairman of the 
Commodity Futures Trading Commission, vowed to try to strengthen the 
measure when it is considered by a second House committee next week.
    ``The committee's bill is a significant step toward lowering risk 
and promoting transparency,'' Mr. Gensler said. ``Substantive 
challenges remain.'' He added that he hoped a final bill ``covers the 
entire marketplace without exception.''
    Mr. Gensler did not spell out the specific problems with the 
legislation on Thursday, but last week he listed a host of exemptions 
and loopholes, a few of which have since been addressed.
    The derivatives legislation was criticized by consumer groups as 
being too weak and by Wall Street interests as being too onerous.
    Kenneth E. Bentsen Jr., an executive vice president at the 
Securities Industry and Financial Markets Association, said provisions 
requiring some types of now-private transactions to trade through 
clearinghouses or exchanges ``could raise transaction costs while not 
necessarily reducing risk in a commensurate amount.''
    Robert G. Pickel, the chief executive of the International Swaps 
and Derivatives Association, a trade group, said the legislation would 
``force people to trade a certain way, which ultimately means parties 
would have less flexibility to effectively manage their risks.''
    But Ed Mierzwinski, consumer program director at the United States 
Public Interest Research Group, said the legislation had ``broad 
exceptions that swallow any rule it creates.''

           [New York Times, April 20, 2009, op-ed columnist]

                             Erin Go Broke

                            By Paul Krugman

    ``What,'' asked my interlocutor, ``is the worst-case outlook for 
the world economy?'' It wasn't until the next day that I came up with 
the right answer: America could turn Irish.
    What's so bad about that? Well, the Irish government now predicts 
that this year G.D.P. will fall more than 10 percent from its peak, 
crossing the line that is sometimes used to distinguish between a 
recession and a depression.
    But there's more to it than that: to satisfy nervous lenders, 
Ireland is being forced to raise taxes and slash government spending in 
the face of an economic slump--policies that will further deepen the 
    And it's that closing off of policy options that I'm afraid might 
happen to the rest of us. The slogan ``Erin go bragh,'' usually 
translated as ``Ireland forever,'' is traditionally used as a 
declaration of Irish identity. But it could also, I fear, be read as a 
prediction for the world economy.
    How did Ireland get into its current bind? By being just like us, 
only more so. Like its near-namesake Iceland, Ireland jumped with both 
feet into the brave new world of unsupervised global markets. Last year 
the Heritage Foundation declared Ireland the third freest economy in 
the world, behind only Hong Kong and Singapore.
    One part of the Irish economy that became especially free was the 
banking sector, which used its freedom to finance a monstrous housing 
bubble. Ireland became in effect a cool, snake-free version of coastal 
    Then the bubble burst. The collapse of construction sent the 
economy into a tailspin, while plunging home prices left many people 
owing more than their houses were worth. The result, as in the United 
States, has been a rising tide of defaults and heavy losses for the 
    And the troubles of the banks are largely responsible for putting 
the Irish government in a policy straitjacket.
    On the eve of the crisis Ireland seemed to be in good shape, 
fiscally speaking, with a balanced budget and a low level of public 
debt. But the government's revenue--which had become strongly dependent 
on the housing boom--collapsed along with the bubble.
    Even more important, the Irish government found itself having to 
take responsibility for the mistakes of private bankers. Last September 
Ireland moved to shore up confidence in its banks by offering a 
government guarantee on their liabilities--thereby putting taxpayers on 
the hook for potential losses of more than twice the country's G.D.P., 
equivalent to $30 trillion for the United States.
    The combination of deficits and exposure to bank losses raised 
doubts about Ireland's long-run solvency, reflected in a rising risk 
premium on Irish debt and warnings about possible downgrades from 
ratings agencies.
    Hence the harsh new policies. Earlier this month the Irish 
government simultaneously announced a plan to purchase many of the 
banks' bad assets--putting taxpayers even further on the hook--while 
raising taxes and cutting spending, to reassure lenders.Is Ireland's 
government doing the right thing? As I read the debate among Irish 
experts, there's widespread criticism of the bank plan, with many of 
the country's leading economists calling for temporary nationalization 
instead. (Ireland has already nationalized one major bank.) The 
arguments of these Irish economists are very similar to those of a 
number of American economists, myself included, about how to deal with 
our own banking mess.
    But there isn't much disagreement about the need for fiscal 
austerity. As far as responding to the recession goes, Ireland appears 
to be really, truly without options, other than to hope for an export-
led recovery if and when the rest of the world bounces back.
    So what does all this say about those of us who aren't Irish?
    For now, the United States isn't confined by an Irish-type fiscal 
straitjacket: the financial markets still consider U.S. government debt 
safer than anything else. But we can't assume that this will always be 
true. Unfortunately, we didn't save for a rainy day: thanks to tax cuts 
and the war in Iraq, America came out of the ``Bush boom'' with a 
higher ratio of government debt to G.D.P. than it had going in. And if 
we push that ratio another 30 or 40 points higher--not out of the 
question if economic policy is mishandled over the next few years--we 
might start facing our own problems with the bond market.
    Not to put too fine a point on it, that's one reason I'm so 
concerned about the Obama administration's bank plan. If, as some of us 
fear, taxpayer funds end up providing windfalls to financial operators 
instead of fixing what needs to be fixed, we might not have the money 
to go back and do it right.
    And the lesson of Ireland is that you really, really don't want to 
put yourself in a position where you have to punish your economy in 
order to save your banks.
    [The report, ``Report on Foreign Portfolio Holdings of U.S. 
Securities as of June 30, 2008,'' may be accessed at the following 
Internet address:]



                      [Saturday, October 27, 2007]

                   Fannie, Freddie Portfolios Shrink

              Firms Have Argued for Higher Investment Caps

          By David S. Hilzenrath, Washington Post Staff Writer

    Though Fannie Mae and Freddie Mac have been arguing that they 
should be granted authority to buy more mortgages to help ease a credit 
crunch, data released by the companies this week show that they haven't 
been using the authority they already possess.
    Both companies reduced their mortgage-related investments in 
September, widening the gap between their holdings and the limits on 
those holdings.
    Freddie Mac sold more mortgage-related assets last month than 
during any other month in the almost four years for which it has posted 
data on the Web.
    In addition, Freddie Mac reduced its commitments for future 
purchases, indicating that it was slackening activities that might give 
the mortgage markets a lift.
    The federally chartered companies buy mortgages from lenders and 
package them into securities for sale to investors, making money 
available for banks and other lenders to issue new loans.
    In response to accounting scandals at the two companies, the 
government capped the amount of mortgages and mortgage-backed 
securities they can hold in their portfolios.
    The companies and their allies in Congress have argued that they 
could provide relief to borrowers facing foreclosure if their 
regulator, the Office of Federal Housing Enterprise Oversight, loosens 
their shackles.
    Historically, the investment portfolios have been major profit 
centers for the two companies. Limiting the growth of the portfolios 
has the potential to constrain the companies' future profits, but OFHEO 
has argued that the caps are necessary to prevent the companies from 
putting themselves and the financial system at risk.
    Fannie Mae, of the District, said its portfolio of mortgage-related 
investments shrank by $5.1 billion last month. The company declined 
yesterday to explain.
    Freddie Mac, of McLean, whose portfolio shrank by $19.1 billion, 
said the reduction in its holdings was partly an effort to ensure that 
it has the required capital to absorb potential losses.
    ``A lot of it is reflective of the value of the assets in the 
portfolio,'' said Michael Cosgrove, a Freddie Mac spokesman.
    Noting that other investment firms have been reporting big losses 
on mortgage-backed securities, Karen Shaw Petrou, an analyst with 
Federal Financial Analytics, said it appeared that Freddie Mac was 
selling assets to prepare for write-downs in the value of mortgage 
    Petrou, whose clients include adversaries of Fannie Mae and Freddie 
Mac, said Freddie Mac was more vulnerable to problems with subprime 
loans than Fannie Mae.
    In addition to imposing caps on the companies' portfolios, OFHEO 
increased the level of capital the companies must maintain as a cushion 
against losses. Freddie's disclosure this week was a reminder that if 
the portfolio caps are loosened, the capital requirement could remain a 
constraint on the companies.
    For the quarter ended Sept. 30, Fannie Mae and Freddie Mac were 
each allowed to hold $735 billion of mortgages and securities backed by 
mortgages. As of that date, Fannie Mae's holdings totaled $723.8 
billion and Freddie Mac's totaled $713.2 billion.
    Freddie Mac's commitments for future purchases declined to $11.5 
billion in September from $20.4 billion in August. Fannie Mae's net 
commitments rose $13.6 billion in September over August.
    The monthly snapshot does not reflect actions the companies might 
have taken since OFHEO adjusted the caps on Sept. 19, allowing the 
companies to expand their portfolios slightly.

           [From MarketWatch, Sept. 12, 2006, 4:28 p.m. EDT]

              Freddie Mac Says U.S. Investigation Dropped

                    By Robert Schroeder, MarketWatch

    Washington (MarketWatch)--A U.S. criminal probe into accounting 
missteps at Freddie Mac appears to be over, the mortgage finance 
company said Tuesday.
    ``The U.S. Attorney's office has not initiated contact with us in 
well over two years and it is our understanding that the matter is 
inactive,'' said Doug Duvall, Freddie's senior director of public 
    ``We expect no further action in this matter,'' Duvall said.
    Duvall added Freddie understands the U.S. Attorney's office for the 
Eastern District of Virginia doesn't issue notices about concluding 
    A spokesman for the U.S. Attorney's office said he couldn't comment 
on the matter.
    Freddie Mac has been under scrutiny since admitting in 2003 that it 
understated earnings for 2000, 2001 and 2002 by $5 billion. The scandal 
led to the ouster of former CEO Leland Brendsel, former company 
president David Glenn and chief financial officer Vaughn Clarke. The 
company has paid fines including a $125 million penalty to federal 
regulators to settle the accounting matter.
    The apparent discontinuation of the case follows similar action by 
the Justice Department in its case against Fannie Mae , another 
government-sponsored housing enterprise. See full story.
    Congress has been attempting to create a new, more powerful 
regulator to oversee both housing finance companies, which were created 
by lawmakers but whose stock and debt are publicly traded. However, 
with elections looming and few legislative days left on the calendar, 
analysts are skeptical Congress will be able to fashion new rules for 
the companies soon.
    Freddie is still trying to get back to regular financial reporting. 
Last Friday, CEO Richard Syron said the company is aiming to get its 
books current by 2007, after it announces its full-year 2006 results. 
See full story.
    Shares of the McLean, Va.-based company gained 38 cents to finish 
trading at $63.90 on Tuesday.

               [From the New York Times, April 27, 2009]

             Geithner, Member and Overseer of Finance Club

                  By Jo Becker and Gretchen Morgenson

    Last June, with a financial hurricane gathering force, Treasury 
Secretary Henry M. Paulson Jr. convened the nation's economic stewards 
for a brainstorming session. What emergency powers might the government 
want at its disposal to confront the crisis? he asked.
    Timothy F. Geithner, who as president of the New York Federal 
Reserve Bank oversaw many of the nation's most powerful financial 
institutions, stunned the group with the audacity of his answer. He 
proposed asking Congress to give the president broad power to guarantee 
all the debt in the banking system, according to two participants, 
including Michele Davis, then an assistant Treasury secretary.
    The proposal quickly died amid protests that it was politically 
untenable because it could put taxpayers on the hook for trillions of 
    ``People thought, `Wow, that's kind of out there,' '' said John C. 
Dugan, the comptroller of the currency, who heard about the idea 
afterward. Mr. Geithner says, ``I don't remember a serious discussion 
on that proposal then.''
    But in the 10 months since then, the government has in many ways 
embraced his blue-sky prescription. Step by step, through an array of 
new programs, the Federal Reserve and Treasury have assumed an 
unprecedented role in the banking system, using unprecedented amounts 
of taxpayer money, to try to save the nation's financiers from their 
own mistakes.
    And more often than not, Mr. Geithner has been a leading architect 
of those bailouts, the activist at the head of the pack. He was the 
federal regulator most willing to ``push the envelope,'' said H. Rodgin 
Cohen, a prominent Wall Street lawyer who spoke frequently with Mr. 
    Today, Mr. Geithner is Treasury secretary, and as he seeks to 
rebuild the nation's fractured financial system with more taxpayer 
assistance and a regulatory overhaul, he finds himself a locus of 
    Even as banks complain that the government has attached too many 
intrusive strings to its financial assistance, a range of critics--
lawmakers, economists and even former Federal Reserve colleagues--say 
that the bailout Mr. Geithner has played such a central role in 
fashioning is overly generous to the financial industry at taxpayer 
    An examination of Mr. Geithner's five years as president of the New 
York Fed, an era of unbridled and ultimately disastrous risk-taking by 
the financial industry, shows that he forged unusually close 
relationships with executives of Wall Street's giant financial 
    His actions, as a regulator and later a bailout king, often aligned 
with the industry's interests and desires, according to interviews with 
financiers, regulators and analysts and a review of Federal Reserve 
    In a pair of recent interviews and an exchange of e-mail messages, 
Mr. Geithner defended his record, saying that from very early on, he 
was ``a consistently dark voice about the potential risks ahead, and a 
principal source of initiatives designed to make the system stronger'' 
before the markets started to collapse.
    Mr. Geithner said his actions in the bailout were motivated solely 
by a desire to help businesses and consumers. But in a financial 
crisis, he added, ``the government has to take risk, and we are going 
to be doing things which ultimately--in order to get the credit flowing 
again--are going to benefit the institutions that are at the core of 
the problem.''
    The New York Fed is, by custom and design, clubby and opaque. It is 
charged with curbing banks' risky impulses, yet its president is 
selected by and reports to a board dominated by the chief executives of 
some of those same banks. Traditionally, the New York Fed president's 
intelligence-gathering role has involved routine consultation with 
financiers, though Mr. Geithner's recent predecessors generally did not 
meet with them unless senior aides were also present, according to the 
bank's former general counsel.
    By those standards, Mr. Geithner's reliance on bankers, hedge fund 
managers and others to assess the market's health--and provide guidance 
once it faltered--stood out.
    His calendars from 2007 and 2008 show that those interactions were 
a mix of the professional and the private.
    He ate lunch with senior executives from Citigroup, Goldman Sachs 
and Morgan Stanley at the Four Seasons restaurant or in their corporate 
dining rooms. He attended casual dinners at the homes of executives 
like Jamie Dimon, a member of the New York Fed board and the chief of 
JPMorgan Chase.
    Mr. Geithner was particularly close to executives of Citigroup, the 
largest bank under his supervision. Robert E. Rubin, a senior Citi 
executive and a former Treasury secretary, was Mr. Geithner's mentor 
from his years in the Clinton administration, and the two kept in close 
touch in New York.
    Mr. Geithner met frequently with Sanford I. Weill, one of Citi's 
largest individual shareholders and its former chairman, serving on the 
board of a charity Mr. Weill led. As the bank was entering a financial 
tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi's 
chief executive.
    But for all his ties to Citi, Mr. Geithner repeatedly missed or 
overlooked signs that the bank--along with the rest of the financial 
system--was falling apart. When he did spot trouble, analysts say, his 
responses were too measured, or too late.
    In 2005, for instance, Mr. Geithner raised questions about how well 
Wall Street was tracking its trading of complex financial products 
known as derivatives, yet he pressed reforms only at the margins. 
Problems with the risky and opaque derivatives market later amplified 
the economic crisis.
    As late as 2007, Mr. Geithner advocated measures that government 
studies said would have allowed banks to lower their reserves. When the 
crisis hit, banks were vulnerable because their financial cushion was 
too thin to protect against large losses.
    In fashioning the bailout, his drive to use taxpayer money to 
backstop faltering firms overrode concerns that such a strategy would 
encourage more risk-taking in the future. In one bailout instance, Mr. 
Geithner fought a proposal to levy fees on banks that would help 
protect taxpayers against losses.
    The bailout has left the Fed holding a vast portfolio of troubled 
securities. To manage them, Mr. Geithner gave three no-bid contracts to 
BlackRock, an asset-management firm with deep ties to the New York Fed.
    To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a 
critic of the bailout, Mr. Geithner's actions suggest that he came to 
share Wall Street's regulatory philosophy and world view.
    ``I don't think that Tim Geithner was motivated by anything other 
than concern to get the financial system working again,'' Mr. Stiglitz 
said. ``But I think that mindsets can be shaped by people you associate 
with, and you come to think that what's good for Wall Street is good 
for America.''
    In this case, he added, that ``led to a bailout that was designed 
to try to get a lot of money to Wall Street, to share the largesse with 
other market participants, but that had deeply obvious flaws in that it 
put at risk the American taxpayer unnecessarily.''
    But Ben S. Bernanke, the chairman of the Federal Reserve, said in 
an interview that Mr. Geithner's Wall Street relationships made him 
``invaluable'' as they worked together to steer the country through 
    ``He spoke frequently to many, many different players and kept his 
finger on the pulse of the situation,'' Mr. Bernanke said. ``He was the 
point person for me in many cases and with many individual firms so 
that we were prepared for any kind of emergency.''
                           an alternate path
    A revolving door has long connected Wall Street and the New York 
Fed. Mr. Geithner's predecessors, E. Gerald Corrigan and William J. 
McDonough, wound up as investment-bank executives. The current 
president, William C. Dudley, came from Goldman Sachs.
    Mr. Geithner followed a different route. An expert in international 
finance, he served under both Clinton-era Treasury secretaries, Mr. 
Rubin and Lawrence H. Summers. He impressed them with his handling of 
foreign financial crises in the late 1990s before landing a top job at 
the International Monetary Fund.
    When the New York Fed was looking for a new president, both former 
secretaries were advisers to the bank's search committee and supported 
Mr. Geithner's candidacy. Mr. Rubin's seal of approval carried 
particular weight because he was by then a senior official at 
    Mr. Weill, Citigroup's architect, was a member of the New York Fed 
board when Mr. Geithner arrived. ``He had a baby face,'' Mr. Weill 
recalled. ``He didn't have a lot of experience in dealing with the 
    But, he added, ``He quickly earned the respect of just about 
everyone I know. His knowledge, his willingness to listen to people.''
    At the age of 42, Mr. Geithner took charge of a bank with enormous 
influence over the American economy.
    Sitting like a fortress in the heart of Manhattan's financial 
district, the New York Fed is, by dint of the city's position as a 
world financial center, the most powerful of the 12 regional banks that 
make up the Federal Reserve system.
    The Federal Reserve was created after a banking crisis nearly a 
century ago to manage the money supply through interest-rate policy, 
oversee the safety and soundness of the banking system and act as 
lender of last resort in times of trouble. The Fed relies on its 
regional banks, like the New York Fed, to carry out its policies and 
monitor certain banks in their areas.
    The regional reserve banks are unusual entities. They are private 
and their shares are owned by financial institutions the bank oversees. 
Their net income is paid to the Treasury.
    At the New York Fed, top executives of global financial giants fill 
many seats on the board. In recent years, board members have included 
the chief executives of Citigroup and JPMorgan Chase, as well as top 
officials of Lehman Brothers and industrial companies like General 
    In theory, having financiers on the New York Fed's board should 
help the president be Washington's eyes and ears on Wall Street. But 
critics, including some current and former Federal Reserve officials, 
say the New York Fed is often more of a Wall Street mouthpiece than a 
    Willem H. Buiter, a professor at the London School of Economics and 
Political Science who caused a stir at a Fed retreat last year with a 
paper concluding that the Federal Reserve had been co-opted by the 
financial industry, said the structure ensured that ``Wall Street gets 
what it wants'' in its New York president: ``A safe pair of hands, 
someone who is bright, intelligent, hard-working, but not someone who 
intends to reform the system root and branch.''
    Mr. Geithner took office during one of the headiest bull markets 
ever. Yet his most important task, he said in an interview, was to 
prepare banks for ``the storm that we thought was going to come.''
    In his first speech as president in March 2004, he advised bankers 
to ``build a sufficient cushion against adversity.'' Early on, he also 
spoke frequently about the risk posed by the explosion of derivatives, 
unregulated insurancelike products that many companies use to hedge 
their bets.
    But Mr. Geithner acknowledges that ``even with all the things that 
we took the initiative to do, I didn't think we achieved enough.''
    Derivatives were not an altogether new issue for him, since the 
Clinton Treasury Department had battled efforts to regulate the 
multitrillion-dollar market. As Mr. Geithner shaped his own approach, 
records and interviews show, he consulted veterans of that fight at 
Treasury, including Lewis A. Sachs, a close friend and tennis partner 
who managed a hedge fund.
    Mr. Geithner pushed the industry to keep better records of 
derivative deals, a measure that experts credit with mitigating the 
chaos once firms began to topple. But he stopped short of pressing for 
comprehensive regulation and disclosure of derivatives trading and even 
publicly endorsed their potential to damp risk.
    Nouriel Roubini, a professor of economics at the Stern School of 
Business at New York University, who made early predictions of the 
crisis, said Mr. Geithner deserved credit for trying, especially given 
that the Fed chairman at the time, Alan Greenspan, was singing the 
praises of derivatives.
    Even as Mr. Geithner was counseling banks to take precautions 
against adversity, some economists were arguing that easy credit was 
feeding a more obvious problem: a housing bubble.
    Despite those warnings, a report released by the New York Fed in 
2004 called predictions of gloom ``flawed'' and ``unpersuasive.'' And 
as lending standards evaporated and the housing boom reached full 
throttle, banks plunged ever deeper into risky mortgage-backed 
securities and derivatives.
    The nitty-gritty task of monitoring such risk-taking is done by 25 
examiners at each large bank. Mr. Geithner reviewed his examiners' 
reports, but since they are not public, it is hard to fully assess the 
New York Fed's actions during that period.
    Mr. Geithner said many of the New York Fed's supervisory actions 
could not be disclosed because of confidentiality issues. As a result, 
he added, ``I realize I am vulnerable to a different narrative in that 
    The ultimate tool at Mr. Geithner's disposal for reining in unsafe 
practices was to recommend that the Board of Governors of the Fed 
publicly rebuke a bank with penalties or cease and desist orders. Under 
his watch, only three such actions were taken against big domestic 
banks; none came after 2006, when banks' lending practices were at 
their worst.
                        the citigroup challenge
    Perhaps the central regulatory challenge for Mr. Geithner was 
    Cobbled together by Mr. Weill through a series of pell-mell 
acquisitions into the world's largest bank, Citigroup reached into 
every corner of the financial world: credit cards, auto loans, trading, 
investment banking, as well as mortgage securities and derivatives. But 
it was plagued by mismanagement and wayward banking practices.
    In 2004, the New York Fed levied a $70 million penalty against 
Citigroup over the bank's lending practices. The next year, the New 
York Fed barred Citigroup from further acquisitions after the bank was 
involved in trading irregularities and questions about its operations. 
The New York Fed lifted that restriction in 2006, citing the company's 
``significant progress'' in carrying out risk-control measures.
    In fact, risk was rising to dangerous levels at Citigroup as the 
bank dove deeper into mortgage-backed securities.
    Throughout the spring and summer of 2007, as subprime lenders began 
to fail and government officials reassured the public that the problems 
were contained, Mr. Geithner met repeatedly with members of Citigroup's 
management, records show.
    From mid-May to mid-June alone, he met over breakfast with Charles 
O. Prince, the company's chief executive at the time, traveled to 
Citigroup headquarters in Midtown Manhattan to meet with Lewis B. 
Kaden, the company's vice chairman, and had coffee with Thomas G. 
Maheras, who ran some of the bank's biggest trading operations.
    (Mr. Maheras's unit would later be roundly criticized for taking 
many of the risks that led Citigroup aground.)
    His calendar shows that during that period he also had breakfast 
with Mr. Rubin. But in his conversations with Mr. Rubin, Mr. Geithner 
said, he did not discuss bank matters. ``I did not do supervision with 
Bob Rubin,'' he said.
    Any intelligence Mr. Geithner gathered in his meetings does not 
appear to have prepared him for the severity of the problems at 
Citigroup and beyond.
    In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, 
Mr. Geithner praised the strength of the nation's top financial 
institutions, saying that innovations like derivatives had ``improved 
the capacity to measure and manage risk'' and declaring that ``the 
larger global financial institutions are generally stronger in terms of 
capital relative to risk.''
    Two days later, interviews and records show, he lobbied behind the 
scenes for a plan that a government study said could lead banks to 
reduce the amount of capital they kept on hand.
    While waiting for a breakfast meeting with Mr. Weill at the Four 
Seasons Hotel in Manhattan, Mr. Geithner phoned Mr. Dugan, the 
comptroller of the currency, according to both men's calendars. Both 
Citigroup and JPMorgan Chase were pushing for the new standards, which 
they said would make them more competitive. Records show that earlier 
that week, Mr. Geithner had discussed the issue with JPMorgan's chief, 
Mr. Dimon.
    At the Federal Deposit Insurance Corporation, which insures bank 
deposits, the chairwoman, Sheila C. Bair, argued that the new standards 
were tantamount to letting the banks set their own capital levels. 
Taxpayers, she warned, could be left ``holding the bag'' in a downturn. 
But Mr. Geithner believed that the standards would make the banks more 
sensitive to risk, Mr. Dugan recalled. The standards were adopted but 
have yet to go into effect.
    Callum McCarthy, a former top British financial regulator, said 
regulators worldwide should have focused instead on how 
undercapitalized banks already were. ``The problem is that people in 
banks overestimated their ability to manage risk, and we believed 
    By the fall of 2007, that was becoming clear. Citigroup alone would 
eventually require $45 billion in direct taxpayer assistance to stay 
    On Nov. 5, 2007, Mr. Prince stepped down as Citigroup's chief in 
the wake of multibillion-dollar mortgage write-downs. Mr. Rubin was 
named chairman, and the search for a new chief executive began. Mr. 
Weill had a perfect candidate: Mr. Geithner.
    The two men had remained close. That past January, Mr. Geithner had 
joined the board of the National Academy Foundation, a nonprofit 
organization founded by Mr. Weill to help inner-city high school 
students prepare for the work force.
    ``I was a little worried about the implications,'' Mr. Geithner 
said, but added that he had accepted the unpaid post only after Mr. 
Weill had stepped down as Citigroup's chairman, and because it was a 
good cause that the Fed already supported.
    Although Mr. Geithner was a headliner with Mr. Prince at a 2004 
fundraiser that generated $1.1 million for the foundation, he said he 
did not raise money for the group once on the board. He attended 
regular foundation meetings at Mr. Weill's Midtown Manhattan office.
    In addition to charity business, Mr. Weill said, the two men often 
spoke about what was happening at Citigroup. ``It would be logical,'' 
he said.
    On Nov. 6 and 7, 2007, as Mr. Geithner's bank examiners scrambled 
to assess Citigroup's problems, the two men spoke twice, records show, 
once for a half-hour on the phone and once for an hourlong meeting in 
Mr. Weill's office, followed by a National Academy Foundation cocktail 
    Mr. Geithner also went to Citigroup headquarters for a lunch with 
Mr. Rubin on Nov. 16 and met with Mr. Prince on Dec. 4, records show.
    Mr. Geithner acknowledged in an interview that Mr. Weill had spoken 
with him about the Citigroup job. But he immediately rejected the idea, 
he said, because he did not think he was right for the job.
    ``I told him I was not the right choice,'' Mr. Geithner said, 
adding that he then spoke to ``one other board member to confirm after 
the fact that it did not make sense.''
    According to New York Fed officials, Mr. Geithner informed the 
reserve bank's lawyers about the exchange with Mr. Weill, and they told 
him to recuse himself from Citigroup business until the matter was 
    Mr. Geithner said he ``would never put myself in a position where 
my actions were influenced by a personal relationship.''
    Other chief financial regulators at the Federal Deposit Insurance 
Company and the Securities and Exchange Commission say they keep 
officials from institutions they supervise at arm's length, to avoid 
even the appearance of a conflict. While the New York Fed's rules do 
not prevent its president from holding such one-on-one meetings, that 
was not the general practice of Mr. Geithner's recent predecessors, 
said Ernest T. Patrikis, a former general counsel and chief operating 
officer at the New York Fed.
    ``Typically, there would be senior staff there to protect against 
disputes in the future as to the nature of the conversations,'' he 
                           coping with crisis
    As Mr. Geithner sees it, most of the institutions hit hardest by 
the crisis were not under his jurisdiction--some foreign banks, 
mortgage companies and brokerage firms. But he acknowledges that ``the 
thing I feel somewhat burdened by is that I didn't attempt to try to 
change the rules of the game on capital requirements early on,'' which 
could have left banks in better shape to weather the storm.
    By last fall, it was too late. The government, with Mr. Geithner 
playing a lead role alongside Mr. Bernanke and Mr. Paulson, scurried to 
rescue the financial system from collapse. As the Fed became the 
biggest vehicle for the bailout, its balance sheet more than doubled, 
from $900 billion in October 2007 to more than $2 trillion today.
    ``I couldn't have cared less about Wall Street, but we faced a 
crisis that was going to cause enormous damage to the economy,'' Mr. 
Geithner said.
    The first to fall was Bear Stearns, which had bet heavily on 
mortgages and by mid-March was tottering. Mr. Geithner and Mr. Paulson 
persuaded JPMorgan Chase to take over Bear. But to complete the deal, 
JPMorgan insisted that the government buy $29 billion in risky 
securities owned by Bear.
    Some officials at the Federal Reserve feared encouraging risky 
behavior by bailing out an investment house that did not even fall 
under its umbrella. To Mr. Geithner's supporters, that he prevailed in 
the case of Bear and other bailout decisions is testament to his 
    ``He was a leader in trying to come up with an aggressive set of 
policies so that it wouldn't get completely out of control,'' said 
Philipp Hildebrand, a top official at the Swiss National Bank who has 
worked with Mr. Geithner to coordinate an international response to the 
worldwide financial crisis.
    But others are less enthusiastic. William Poole, president of the 
Federal Reserve Bank of St. Louis until March 2008, said that the Fed, 
by effectively creating money out of thin air, not only runs the risk 
of ``massive inflation'' but has also done an end-run around 
Congressional power to control spending.
    Many of the programs ``ought to be legislated and shouldn't be in 
the Federal Reserve at all,'' he contended.
    In making the Bear deal, the New York Fed agreed to accept Bear's 
own calculation of the value of assets acquired with taxpayer money, 
even though those values were almost certain to decline as the economy 
deteriorated. Although Fed officials argue that they can hold onto 
those assets until they increase in value, to date taxpayers have lost 
$3.4 billion. Even these losses are probably understated, given how the 
Federal Reserve priced the holdings, said Janet Tavakoli, president of 
Tavakoli Structured Finance, a consulting firm in Chicago. ``You can 
assume that it has used magical thinking in valuing these assets,'' she 
    Mr. Geithner played a pivotal role in the next bailout, which was 
even bigger--that of the American International Group, the insurance 
giant whose derivatives business had brought it to the brink of 
collapse in September. He also went to bat for Goldman Sachs, one of 
the insurer's biggest trading partners.
    As A.I.G. bordered on bankruptcy, Mr. Geithner pressed first for a 
private sector solution. A.I.G. needed $60 billion to meet payments on 
insurance contracts it had written to protect customers against debt 
    A.I.G.'s chief executive at the time, Robert B. Willumstad, said he 
had hired bankers at JPMorgan to help it raise capital. Goldman Sachs 
had jockeyed for the job as well, but because the investment bank was 
one of A.I.G.'s biggest trading partners, Mr. Willumstad rejected the 
idea. The potential conflicts of interest, he believed, were too great.
    Nevertheless, on Monday, Sept. 15, Mr. Geithner pushed A.I.G. to 
bring Goldman onto its team to raise capital, Mr. Willumstad said.
    Mr. Geithner and Mr. Corrigan, a Goldman managing director, were 
close, speaking frequently and sometimes lunching together at Goldman 
headquarters. On that day, the company's chief executive, Lloyd C. 
Blankfein, was at the New York Fed.
    A Goldman spokesman said, ``We don't believe anyone at Goldman 
Sachs asked Mr. Geithner to include the firm in the assignment.'' Mr. 
Geithner said he had suggested Goldman get involved because the 
situation was chaotic and ``time was running out.''
    But A.I.G.'s search for capital was fruitless. By late Tuesday 
afternoon, the government would step in with an $85 billion loan, the 
first installment of a bailout that now stands at $182 billion. As part 
of the bailout, A.I.G.'s trading partners, including Goldman, were 
compensated fully for money owed to them by A.I.G.
    Analysts say the New York Fed should have pressed A.I.G.'s trading 
partners to take a deep discount on what they were owed. But Mr. 
Geithner said he had no bargaining power because he was unwilling to 
threaten A.I.G.'s trading partners with a bankruptcy by the insurer for 
fear of further destabilizing the system.
    A recent report on the A.I.G. bailout by the Government 
Accountability Office found that taxpayers may never get their money 
                           the debt guarantee
    Over Columbus Day weekend last fall, with the market gripped by 
fear and banks refusing to lend to one another, a somber group gathered 
in an ornate conference room across from Mr. Paulson's office at the 
    Mr. Paulson, Mr. Bernanke, Ms. Bair and others listened as Mr. 
Geithner made his pitch, according to four participants. Mr. Geithner, 
in the words of one participant, was ``hell bent'' on a plan to use the 
Federal Deposit Insurance Corporation to guarantee debt issued by bank 
holding companies.
    It was a variation on Mr. Geithner's once-unthinkable plan to have 
the government guarantee all bank debt.
    The idea of putting the government behind debt issued by banking 
and investment companies was a momentous shift, an assistant Treasury 
secretary, David G. Nason, argued. Mr. Geithner wanted to give the 
banks the guarantee free, saying in a recent interview that he felt 
that charging them would be ``counterproductive.'' But Ms. Bair worried 
that her agency--and ultimately taxpayers--would be left vulnerable in 
the event of a default.
    Mr. Geithner's program was enacted and to date has guaranteed $340 
billion in loans to banks. But Ms. Bair prevailed on taking fees for 
the guarantees, and the government so far has collected $7 billion.
    Mr. Geithner has also faced scrutiny over how well taxpayers were 
served by his handling of another aspect of the bailout: three no-bid 
contracts the New York Fed awarded to BlackRock, a money management 
firm, to oversee troubled assets acquired by the bank.
    BlackRock was well known to the Fed. Mr. Geithner socialized with 
Ralph L. Schlosstein, who founded the company and remains a large 
shareholder, and has dined at his Manhattan home. Peter R. Fisher, who 
was a senior official at the New York Fed until 2001, is a managing 
director at BlackRock.
    Mr. Schlosstein said that while he and Mr. Geithner spoke 
frequently, BlackRock's work for the Fed never came up.
    ``Conversations with Tim were appropriately a one-way street. He'd 
call you and pepper you with a bunch of questions and say thank you 
very much and hang up,'' he said. ``My experience with Tim is that he 
makes those kinds of decisions 100 percent based on capability and zero 
about relationships.''
    For months, New York Fed officials declined to make public details 
of the contract, which has become a flash point with some lawmakers who 
say the Fed's handling of the bailout is too secretive. New York Fed 
officials initially said in interviews that they could not disclose the 
fees because they had agreed with BlackRock to keep them confidential 
in exchange for a discount.
    The contract terms they subsequently disclosed to The New York 
Times show that the contract is worth at least $71.3 million over three 
years. While that rate is largely in keeping with comparable fees for 
such services, analysts say it is hardly discounted.
    Mr. Geithner said he hired BlackRock because he needed its 
expertise during the Bear Stearns-JPMorgan negotiations. He said most 
of the other likely candidates had conflicts, and he had little time to 
shop around. Indeed, the deal was cut so quickly that they worked out 
the fees only after the firm was hired.
    But since then, the New York Fed has given two more no-bid 
contracts to BlackRock related to the A.I.G. bailout, angering a number 
of BlackRock's competitors. The fees on those contracts remain 
    Vincent Reinhart, a former senior Federal Reserve official, said a 
more open process might have yielded a better deal for the taxpayers.
    ``They may have been able to convince themselves that this was the 
only way to go, but it sounds to me like nobody stepped back and said, 
`What's this going to look like to the outside world,' '' he said.
                           rescues revisited
    As Mr. Geithner runs the Treasury and administration officials 
signal more bailout money may be needed, the specter of bailouts past 
haunts his efforts.
    He recently weathered a firestorm over retention payments to A.I.G. 
executives made possible in part by language inserted in the 
administration's stimulus package at the Treasury Department's 
insistence. And his new efforts to restart the financial industry 
suggest the same philosophy that guided Mr. Geithner's Fed years.
    According to a recent report by the inspector general monitoring 
the bailout, Neil M. Barofsky, Mr. Geithner's plan to underwrite 
investors willing to buy the risky mortgage-backed securities still 
weighing down banks' books is a boon for private equity and hedge funds 
but exposes taxpayers to ``potential unfairness'' by shifting the 
burden to them.
    The top echelon of the Treasury Department is a common destination 
for financiers, and Mr. Geithner has also recruited aides from Wall 
Street, some from firms that were at the heart of the crisis. For 
instance, his chief of staff, Mark A. Patterson, is a former lobbyist 
for Goldman Sachs, and one of his top counselors is Lewis S. Alexander, 
a former chief economist at Citigroup.
    A bill sent recently by the Treasury to Capitol Hill would give the 
Obama administration extensive new powers to inject money into or seize 
systemically important firms in danger of failure. It was drafted in 
large measure by Davis Polk & Wardwell, a law firm that represents many 
banks and the financial industry's lobbying group. Mr. Geithner also 
hired Davis Polk to represent the New York Fed during the A.I.G. 
    Treasury officials say they inadvertently used a copy of Davis 
Polk's draft sent to them by the Federal Reserve as a template for 
their own bill, with the result that the proposed legislation Treasury 
sent to Capitol Hill bore the law firm's computer footprints. And they 
point to several significant changes to that draft that ``better 
protect the taxpayer,'' in the words of Andrew Williams, a Treasury 
    But others say important provisions in the original industry bill 
remain. Most significant, the bill does not require that any government 
rescue of a troubled firm be done at the lowest possible cost, as is 
required by the F.D.I.C. when it takes over a failed bank. Treasury 
officials said that is because they would use the rescue powers only in 
rare and extreme cases that might require flexibility. Karen Shaw 
Petrou, managing director of the Washington research firm Federal 
Financial Analytics, said it essentially gives Treasury ``a blank 
    One year and two administrations into the bailout, Mr. Geithner is 
perhaps the single person most identified with the enormous checks the 
government has written. At every turn, he is being second-guessed about 
the rescues' costs and results. But he remains firm in his belief that 
failure to act would have been much more costly.
    ``All financial crises are a fight over how much losses the 
government ultimately takes on,'' he said. And every decision 
``requires we balance how to achieve the most benefits in terms of 
improving confidence and the flow of credit at the least risk to 

    This article has been revised to reflect the following correction:
                       correction: april 28, 2009
    An article on Monday about Treasury Secretary Timothy F. Geithner 
misstated, in some editions, the surname of a former Treasury official 
who gave an account of a meeting last June about the approaching 
financial crisis. She is Michele Davis, not Smith.

          [From the Washington Post, Wednesday, July 16, 2008]

                    The Help Fannie and Freddie Need

                         By Franklin D. Raines

    Don't bail out Fannie Mae and Freddie Mac. They don't need it. The 
losses they face are not surprising, given what's happened to housing 
prices. They have more than enough capital to meet their cash 
obligations when those become due, which is the most basic definition 
of solvency. They also have hundreds of billions of dollars' worth of 
unencumbered assets that can be used as collateral for secured 
borrowing, were that to become necessary. The recent Treasury proposals 
do not change these facts.
    What the companies need from Washington is policy clarity. I say 
this not just on the basis of my experience as an executive at Fannie 
Mae but also because of my experience as director of the Office of 
Management and Budget and my time as an investment banker in the 1980s, 
when I helped solve the problems of cities and states in financial 
    The Treasury proposals, curiously, substitute government capital 
for private capital. Fannie and Freddie have served their housing 
mission for decades by marshalling private equity from around the 
world. Federal capital funds are inherently limited, while private 
capital is essentially unlimited. The goal of any rescue plan should be 
to restore unfettered access to the private markets.
    The administration and Congress need to recodify the basic 
understanding between the two companies and the capital markets that 
has worked so well for so long. While recent efforts have quelled 
short-term concerns about an imminent collapse, we should be focused on 
what's needed for the longer term.
    Here are a few sentences for policymakers to start with:
    Fannie Mae and Freddie Mac remain and will continue to be integral 
parts of the U.S. housing finance system. Their central role in housing 
policy, not a federal guarantee, is what has attracted trillions of 
dollars of debt capital.
    This would not be an easy statement for the White House or the Fed 
to make. It would require them to abandon their multiyear effort to 
eliminate the companies by talking them down to the financial markets. 
Buyers of long-term debt are not interested in investing in entities 
that are opposed by their national government or are slated for 
extinction. Treasury Secretary Henry Paulson appears to be trying to 
make such a declaration, but the silence from the Fed and the White 
House on whether the companies have a future is deafening.
    Fannie and Freddie will be permitted to operate as for-profit 
companies able to earn a competitive return on invested equity capital.
    It has been confusing, at best, for equity investors to hear 
officials call for Freddie and Fannie to raise more capital while 
simultaneously restricting their ability to earn a profit on that 
capital. The government needs to remove impediments to the companies' 
investing in on-balance-sheet assets, creating new products within the 
secondary mortgage market and managing risks in the most cost-effective 
manner. Also, Congress needs to make clear that the companies are not 
going to be a cookie jar to be raided whenever housing funds are needed 
elsewhere. If Fannie and Freddie can earn a competitive return on 
capital invested, there will be no limit to the amount of equity 
capital they can raise.
    Congress should make clear that the requirements imposed on Fannie 
and Freddie regarding the capital they must have on hand will be based 
solely on the amount needed to support the risks they take. Many in the 
market fear that a new regulator, as contemplated in pending 
legislation, would use capital requirements as a way to restrain the 
companies' growth or limit the scope of their activities in the 
secondary market. Injecting the Fed into the capital regulatory process 
does nothing to assuage this fear.
    Fannie and Freddie can borrow from the Federal Reserve on a fully 
collateralized basis in the same manner as any bank in America.
    The Fed has acknowledged the need for such access on a temporary 
basis. Congress needs to make that access permanent.
    It is ironic that the administration is straining to convince the 
financial markets that the U.S. government stands behind the two 
companies. That was the market view seven years ago. However, 
ideologues in the Bush administration and commercial competitors of 
Fannie and Freddie have skillfully manipulated the markets to undermine 
Fannie and Freddie for more than six years. The result has been a 
weakening of the two linchpins of the housing finance system just when 
they are needed most.
    Just yesterday, Fed Chairman Ben Bernanke outlined the problems 
facing our economy. It is time to make a choice: Continue the policy 
approach of trying to kill off the companies and reap the economic 
carnage that will inevitably produce, or make a forthright statement 
that these companies are necessary instruments of national policy. 
Paulson has tried to move the administration and the Fed back from the 
brink. But too much ambiguity remains.
    President Bush should stand with Secretary Paulson, Chairman 
Bernanke, Fannie and Freddie's regulator, and with the chairmen of the 
relevant House and Senate committees, and together they should declare 
Fannie and Freddie's clear roles in our markets. They should codify 
this role in legislation that will bind future administrations. The 
sooner this happens, the better.
    The writer was chairman and chief executive of Fannie Mae from 1999 
to 2004 and served as director of the Office of Management and Budget 
in the Clinton administration. He receives a pension and deferred 
compensation from Fannie Mae and owns stock in the company.

[Government Securities Dealers Statistics Unit, Federal Reserve Bank of 
                        New York, June 5, 2008]

                   Federal Reserve Bank of New York:
                          Primary Dealers List

        Memorandum to all Primary Dealers and Recipients of the
       Weekly Press Release on Dealer Positions and Transactions

    The latest list reflects the following changes:
     Effective September 18, 2006, Dresdner Kleinwort 
Wasserstein Securities LLC changed its name to Dresdner Kleinwort 
Securities LLC.*
    *Revised July 15, 2008 to reflect correct effective date Dresdner 
Kleinwort Wasserstein Securities LLC changed its name to Dresdner 
Kleinwort Securities LLC.

  List of the Primary Government Securities Dealers Reporting to the 
 Securities Dealers Statistics Unit of the Federal Reserve Bank of New 

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Bear, Stearns & Co., Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Countrywide Securities Corporation
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Dresdner Kleinwort Securities LLC
Goldman, Sachs & Co.
Greenwich Capital Markets, Inc.
HSBC Securities (USA) Inc.
J. P. Morgan Securities Inc.
Lehman Brothers Inc.
Merrill Lynch Government Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
UBS Securities LLC.

    Note: This list has been compiled and made available for 
statistical purposes only and has no significance with respect to other 
relationships between dealers and the Federal Reserve Bank of New York. 
Qualification for the reporting list is based on the achievement and 
maintenance of the standards outlined in the Federal Reserve Bank of 
New York's memorandum of January 22, 1992.

        [From the Washington Post, Wednesday, October 31, 2007]

    Buffett Testifies That He Saw Early Signs of Freddie Mac's Woes

          By David S. Hilzenrath, Washington Post Staff Writer

    Billionaire investor Warren E. Buffett sat in front of a video 
camera in Omaha, spelled his name for the record and minced no words as 
he testified for the government yesterday in its case against former 
Freddie Mac chief executive Leland C. Brendsel.
    Brendsel is accused of presiding over accounting manipulations and 
running Freddie Mac in a reckless manner. Buffett, one of the most 
successful and revered investors, sold a huge stake in the mortgage 
funding company before the manipulations came to light, and the 
government wanted him to explain why.
    Buffett said he was troubled in part by a Freddie Mac investment 
that had nothing to do with its business.
    ``I follow the old dictum: There's never just one cockroach in the 
kitchen,'' Buffett said.
    The government is trying to show that Brendsel's promises of 
double-digit earnings growth set Freddie Mac on a dangerous path, and 
Buffett said they were another key reason he sold.
    Sometimes, when executives offer earnings projections and cannot 
make the numbers, ``they start making up the numbers,'' he said.
    Trying to deliver smoothly increasing earnings ``can lead to a lot 
of trouble in any company,'' and it is ``unachievable'' at a company 
like Freddie Mac, whose business is inherently unpredictable, Buffett 
    Under cross-examination by an attorney for Brendsel, Buffett 
acknowledged that many companies offered earnings projections, 
including two big companies where he has been a director, Coca-Cola and 
    He agreed that his antipathy for the practice was a minority view 
among professional investors. Asked to read aloud from Freddie Mac 
annual reports, he showed that the McLean company had been predicting 
``mid-teens'' earnings growth years before he began liquidating his 
    Three weeks into Brendsel's trial on administrative charges, 
Buffett's testimony by video link was the most vivid, yet. The 
Berkshire Hathaway chairman, who is a member of the board of The 
Washington Post Co., sat at a table against a wrinkled gray backdrop, a 
Coke bottle in easy reach and looked into the lens. Brendsel and other 
participants in the proceeding watched Buffett on big-screen 
televisions in a richly paneled Washington courtroom.
    Because the case involves regulatory rather than criminal charges, 
Brendsel is not at risk of going to prison. He is trying to avoid 
liabilities and penalties that could exceed $1 billion.
    With a fortune estimated at $52 billion, Buffett, known by admirers 
as the Sage of Omaha, ranked second on Forbes magazine's latest list of 
the richest Americans. Buffett has pledged the vast majority of his 
wealth to the philanthropic foundation run by Microsoft Chairman Bill 
Gates, who topped the list with $59 billion, and Gates's wife Melinda, 
also a member of the Post Co. board.
    Buffett said he bought stock in Freddie Mac in the 1980s because 
``it looked ridiculously cheap.'' He said his company became one of 
Freddie Mac's largest shareholders before it began liquidating its 
stake in the late 1990s at an eventual profit of about $2.75 billion.
    Buffett said he met with Brendsel and former Freddie Mac president 
David W. Glenn five or six times over the years at Brendsel's request, 
initially at a summer house Buffett had in Laguna Beach, Calif. 
Brendsel requested and followed some of his recommendations on whom 
Freddie Mac should appoint to its board, Buffett said.
    Buffet said he became troubled when Freddie Mac made an investment 
unrelated to its mission. He wasn't clear on the specifics but said he 
``didn't think that made any sense at all'' and ``was concerned about 
what they might be doing * * * that I didn't know about.''
    Achieving ``mid-teens'' earnings growth ``seemed to become more and 
more a mantra of the organization,'' giving him greater cause for 
concern, Buffett said.
    Buffett said he reviewed Freddie Mac's annual reports every year he 
held stock in the company. Presented with excerpts from reports for as 
early as 1992, he agreed with Brendsel's lead attorney, Kevin M. 
Downey, that he held onto his shares while Freddie Mac repeatedly 
affirmed its earnings goals.
    Buffett said he thought he expressed his concern to Brendsel in 
several conversations but added that he didn't keep notes or a diary 
and couldn't recall details.
    Downey said the specific wording about mid-teens earnings growth 
did not appear in a disclosure Freddie Mac filed in 2001, but Buffett 
rejected the implicit suggestion that Brendsel was responding 
appropriately to his concern.
    ``He may have seen the writing on the wall,'' Buffett said.
    Downey suggested that Freddie Mac properly tempered its 
projections, pointing to warnings in an annual report that its earnings 
could be affected by various adverse developments. Buffett said the 
cautionary words were merely legal boilerplate.
    ``I would not be particularly impressed by them,'' he said.
    Asked by the judge, William B. Moran, whether he felt his concerns 
were vindicated, Buffett said, ``I think they were fully vindicated.''

              [Mother Jones, January/February 2010 Issue]

                      The Real Size of the Bailout

                             By Nomi Prins

    The price tag for the Wall Street bailout is often put at $700 
billion [3]--the size of the Troubled Assets Relief Program. But TARP 
is just the tip of the iceberg of money paid out or set aside by the 
Treasury Department and Federal Reserve. In her book, It Takes a 
Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from 
Washington to Wall Street [4], Nomi Prins [5]uncovers the hush-hush 
programs and crunches the hidden numbers to calculate the shocking 
actual size of the bailout: $14.4 trillion and counting.
    (Figures current as of October 31, 2009. Click here [6] for an 
explanation of the abbreviations and programs below.)
    This chart is part of Mother Jones' coverage [7] of the financial 
crisis, one year later.

              [Mother Jones, January/February 2010 Issue]

                            Too Big to Jail?
            Time to Fix Wall Street's Accountability Deficit

                 By Monika Bauerlein and Clara Jeffery

    MAYBE WALL STREET should open a casino right there on the corner of 
Broad, because these guys simply cannot lose. After kneecapping the 
global economy, costing millions their homes and livelihoods, and 
saddling our grandchildren with massive debt--after all that, they're 
cashing in their bonuses from 2008. That's right, 2008--when amid the 
gnashing of teeth and rending of garments over the $700 billion TARP 
[1] legislation (a mere 5 percent of a $14 trillion [2] bailout; see 
``The Real Size of the Bailout [3]''), humiliated banks rolled back 
executive bonuses. Or so we thought: In fact, those bonuses were simply 
reconfigured to have a higher proportion of company stock. Those shares 
weren't worth so much at the time, as the execs made a point of telling 
Congress, but that meant they could only go up, and by the time they 
did, the public (suckers!) would have forgotten the whole exercise. It 
worked out beautifully: The value of JPMorgan Chase [4]'s 2008 bonuses 
has increased 20 percent to $10.5 billion, an average of nearly $6 
million for the top 200 execs. Goldman [5]'s 2008 bonuses are worth 
$7.8 billion.
    And why are bank stocks worth more now? Because of the bailout, of 
course. Bankers aren't being rewarded for pulling the economy out of 
the doldrums. Nope, they're simply skimming from the trillions we've 
shoveled at them. The house always wins. Indeed, 2009 bonuses are 
expected to be 30 to 40 percent higher than 2008's. And don't forget 
AIG [6], which paid the same division that helped cook up collateral 
debt obligations and credit default swaps ``retention bonuses'' worth 
$475 million, in some execs' cases 36 times their base salaries.
    As anyone who watches Dog Whisperer [7]knows, rewarding bad 
behavior produces more of the same--so it's no surprise that Wall 
Street is back to business as usual. Derivatives are still unregulated 
(thanks, Congress!), exotic sliced-and-diced securities are being 
resliced and rediced, and the biggest offenders in peddling subprime 
mortgages? They are raking in millions in federal grants to--wait for 
it--fix subprime mortgages.
    And the worst part? These fat-cat recidivists don't even have the 
decency to fake contrition. The New York Times' Andrew Ross Sorkin [8] 
says that whenever he asked Wall Street CEOs ``Do you have any remorse? 
Are you sorry? The answer, almost unequivocally, was no.'' When asked 
by MoJo's Stephanie Mencimer if he regretted helping to bring down the 
economy, former AIG CEO Hank Greenberg [9] said flatly, ``No. I think 
we had a very good record.'' Lloyd Blankfein [10], Goldman Sachs' CEO 
(his haul between 2006-2008: $157 million) went so far as to tell the 
Times of London, ``We help companies to grow by helping them to raise 
capital. It's a virtuous cycle. We have a social purpose.'' Bankers 
like him are ``doing God's work.''
    This is blasphemy worthy--along with usury--of the 7th circle of 
hell. And while Goldman's PR minions, visions of pitchforks dancing in 
their heads, coaxed Blankfein into coughing up a lame apology, the 
comment perfectly distilled the Kool-Aid Wall Street has forced down 
our throats. MoJo's Kevin Drum sums it up in his investigation [11] of 
Wall Street's outsize influence in Washington: Political payola--$475 
million in campaign contributions just in the 2008 cycle--is only part 
of it. Something more insidious is at work. ``Unlike most industries, 
which everyone recognizes are merely lobbying in their own self-
interest, the finance industry successfully convinced everyone that 
deregulating finance was not only safe, but self-evidently good for the 
entire economy, Wall Street and Main Street alike,'' he writes. Some 
call this phenomenon ``intellectual capture,'' he adds, but 
``considering what's happened over the past couple of years, we might 
better call it Stockholm syndrome.''
    Sure enough, as our Washington bureau chief David Corn reports 
[12], pollsters have been surprised to find that while Americans are 
angry about the economy, they often blame not the bankers, but 
politicians--and even themselves. We spent too much, the logic goes, 
and now we're reaping the rewards. There's some validity to that--we 
all played along as if the good times would never end. But who sold us 
this crock? Wall Street and its troubadours, from faux regulators like 
Alan Greenspan [13] to so-called financial journalists like Jim ``Mad 
Dog'' Cramer [14].
    And actually, when it comes to restraint and humility, consumers 
seem to be the only ones learning their lesson. Personal savings are up 
for the first time in decades; spending is down. Why? Because we, the 
little people, actually felt the pain of the crash. New incentives, new 
behavior. Not so on Wall Street; not so in Washington [15].
    It's not too late. If nothing else, last summer's tea parties 
showed that politicians will listen to popular outrage--when it seems 
to threaten their jobs. What if, as Nobel-winning economist Joe 
Stiglitz suggests [16], we foreclosed on bankers and politicians who 
are morally bankrupt? What if people started showing up at town halls 
demanding accountability from those who gambled away their jobs and 
homes? There is plenty of blame to go around. Let's start putting some 
of it back where it belongs.
    Source URL: http://motherjones.com/politics/2010/01/too-big-jail
    [1] http://motherjones.com/politics/2008/09/700-billion-bailout-
    [2] http://motherjones.com/politics/2010/01/what-else-could-14-
    [3] http://motherjones.com/politics/2010/01/real-size-bailout-
    [4] http://motherjones.com/kevin-drum/2009/06/un-bailout
    [5] http://motherjones.com/politics/2009/07/how-you-finance-
    [6] http://motherjones.com/mojo/2009/03/obama-looking-revealing-
    [7] http://channel.nationalgeographic.com/series/dog-whisperer
    [8] http://www.nytimes.com/2009/10/19/business/media/
    [9] http://motherjones.com/mojo/2009/11/greenberg-still-unrepentant
    [10] http://www.timesonline.co.uk/tol/news/world/us--and--americas/
    [11] http://motherjones.com/politics/2010/01/wall-street-big-
    [12] http://motherjones.com/politics/2010/01/financial-crisis-wall-
    [13] http://motherjones.com/politics/2008/10/alan-shrugged
    [14] http://www.cnbc.com/id/15838187
    [15] http://motherjones.com/politics/2010/01/henhouse-meet-fox-
    [16] http://motherjones.com/politics/2010/01/joseph-stiglitz-wall-

                  [The New York Times, March 8, 2009]

                             All Boarded Up

                           By Alex Kotlowitz

    TONY BRANCATELLI, a Cleveland city councilman, yearns for signs 
that something like normal life still exists in his ward. Early one 
morning last fall, he called me from his cellphone. He sounded 
unusually excited. He had just visited two forlorn-looking vacant 
houses that had been foreclosed more than a year ago. They sat on the 
same lot, one in front of the other. Both had been frequented by 
squatters, and Brancatelli had passed by to see if they had been 
finally boarded up. They hadn't. But while there he noticed with alarm 
what looked like a prone body in the yard next door. As he moved 
closer, he realized he was looking at an elderly woman who had just one 
leg, lying on the ground. She was leaning on one arm and, with the 
other, was whacking at weeds with a hatchet and stuffing the clippings 
into a cardboard box for garbage pickup. ``Talk about fortitude,'' he 
told me. In a place like Cleveland, hope comes in small morsels.
    The next day, I went with Brancatelli to visit Ada Flores, the 
woman who was whacking at the weeds. She is 81, and mostly gets around 
in a wheelchair. Flores is a native Spanish speaker, and her English 
was difficult to understand, especially above the incessant barking of 
her caged dog, Tuffy. But the story she told Brancatelli was familiar 
to him. Teenagers had been in and out of the two vacant houses next 
door, she said, and her son, who visits her regularly, at one point 
boarded up the windows himself. ``Are they going to tear them down?'' 
she asked. Brancatelli crossed himself. ``I hope so,'' he mumbled.
    Prayer and sheer persistence are pretty much all Brancatelli has to 
go on these days. Cleveland is reeling from the foreclosure crisis. 
There have been roughly 10,000 foreclosures in two years. For all of 
2007, before it was overtaken by sky-high foreclosure rates in parts of 
California, Nevada and Florida, Cleveland's rate was among the highest 
in the country. (It's now 24th among metropolitan areas.) Vacant houses 
are not a new phenomenon to the city. Ravaged by the closing of 
American steel mills, Cleveland has long been in decline. With fewer 
manufacturing jobs to attract workers, it has lost half its population 
since 1960. Its poverty rate is one of the highest in the nation. But 
in all those years, nothing has approached the current scale of ruin.
    And in December, just when local officials thought things couldn't 
get worse, Cuyahoga County, which includes Cleveland, posted a record 
number of foreclosure filings. The number of empty houses is so 
staggeringly high that no one has an accurate count. The city estimates 
that 10,000 houses, or 1 in 13, are vacant. The county treasurer says 
it's more likely 15,000. Most of the vacant houses are owned by lenders 
who foreclosed on the properties and by the wholesalers who are now 
sweeping in to pick up houses in bulk, as if they were trading in 
baseball cards.
    Brancatelli and others--judges, the police, city officials, 
residents--are grappling with the wreckage left behind, although to 
call this the aftermath would be premature. Even with President Barack 
Obama's plan to help prevent foreclosures, the city is bracing for 
more, especially as more people lose their jobs. The city's 
unemployment rate is now 8.8 percent. Moreover, on some streets so many 
houses are already vacant that those residents left behind are not 
necessarily inclined to stay. ``It just happens so fast, the sad part 
is you really have little control,'' Brancatelli told me. ``It 
snowballs on the street, and you try to prevent that avalanche.'' 
Walking away from a house even makes a kind of economic sense when the 
mortgage far exceeds the home's value; Obama's foreclosure-prevention 
plan does little to address that situation. Now outside investors have 
descended on Cleveland; they pick up properties for the price of a 
large flat-screen TV and then try to sell them for a profit.
    So much here defies reasonableness. It's what Brancatelli keeps 
telling me. A few months ago, he met with Luis Jimenez, a train 
conductor from Long Beach, Calif. Jimenez had purchased a house in 
Brancatelli's ward on eBay and had come to Cleveland to resolve some 
issues with the property. The two-story house has a long rap sheet of 
bad deals. Since 2001, it has been foreclosed twice and sold four 
times, for prices ranging from $87,000 to $1,500. Jimenez bought it for 
$4,000. When Jimenez arrived in Cleveland, he learned that the house 
had been vacant for two years; scavengers had torn apart the walls to 
get the copper piping, ripped the sinks from the walls and removed the 
boiler from the basement. He also learned that the city had condemned 
the house and would now charge him to demolish it. Brancatelli asked 
Jimenez, What were you thinking, buying a house unseen, from 2,000 
miles away? ``It was cheap,'' Jimenez shrugged. He didn't want to walk 
away from the house, but he didn't have the money to renovate. The 
property remains an eyesore. ``Generally, I'm an optimist, but none of 
this makes sense,'' Brancatelli told me. ``Trying to give order to all 
this chaos is the big challenge.''
    Like others who have stayed in Cleveland, Brancatelli, who has 
lived in his two-story American Foursquare for 15 years, is trying to 
hold the wall against the flood. Of his ward, known as Slavic Village, 
he says: ``It's one of the most resilient communities in the country. 
People are rolling up their sleeves and working. We can't wait for 
others to step in.'' This was a tone--the swagger of the underdog--that 
I heard from other Cleveland stalwarts during the weeks I spent in the 
city this winter. ``Cleveland's a blue-collar community,'' Mayor Frank 
Jackson told me. ``They're surviving-cultures. And we will fight 
    The task is achingly slow; each house its own battle. On one street 
I visited, in a ward near Brancatelli's, a third of the houses were 
abandoned. One resident, Anita Gardner, told me about the young family 
who moved in down the street a few years before. They spruced up the 
house with new windows, a fireplace, wood kitchen cabinets, track 
lighting and a Jacuzzi. When they lost the house to foreclosure, they 
left nothing for the scavengers. They stripped their own dwelling, 
piling toilets, metal screen doors, kitchen cabinets, the furnace and 
copper pipes into a moving van. ``They said, `Why should someone else 
get it?' '' Gardner told me. ``So they took it themselves.'' In 
December, Gardner's neighbor watched a man strain to push a cart filled 
with thin slabs of concrete down the street. It explained why so many 
of the abandoned homes in the city are without front steps, as if their 
legs had been knocked out from under them. Perhaps such pillage is part 
of the natural momentum of a city being torn apart. If you can't hold 
onto something of real value, at least get your hands on something.
    Foreclosures are a problem all over the country now, but Cleveland 
got to this place a while ago. Cities, old and new, are looking at 
what's occurring in Cleveland with some trepidation--and also looking 
for guidance. Already places as diverse as Atlanta, Chicago, Denver, 
Las Vegas and Minneapolis have neighborhoods where at least one of 
every five homes stands vacant. In states like California, Florida and 
Nevada, where many of the foreclosures have been newer housing, there 
is fear that with mounting unemployment and more people walking away 
from their property, houses will remain empty longer, with a greater 
likelihood that they will deteriorate or be vandalized. ``There are 
neighborhoods around the country as bad as anything in Cleveland,'' 
says Dan Immergluck, a visiting scholar at the Federal Reserve Bank of 
Atlanta and an associate professor in the city and regional planning 
program at Georgia Tech. Local officials from other industrial cities 
have visited Cleveland to learn how it's dealing with the devastation. 
``Cleveland is a bellwether,'' Immergluck says. ``It's where other 
cities are heading because of the economic downturn.''
    TONY BRANCATELLI, WHO IS 51, is a man of a birdlike build and 
intensity, but he also possesses a Midwestern folksiness, closing most 
conversations with a cheerful ``alrighty.'' Over the past couple of 
years, he has become a minor media star. Journalists from Sweden, 
Japan, China, Germany, Britain and France have visited him, drawn to 
his ward because of the high rate of foreclosures, at present two a 
day. Brancatelli's world is defined by the borders of Slavic Village. 
It's where he grew up and where he has lived for all but three years of 
his life. His license plate reads Slavic 1. (He tried to convince his 
wife to get plates that read Slavic 2, but she declined.) The 
neighborhood took root roughly a hundred years ago: diminutive, narrow 
homes--some no more than 900 square feet--built within walking distance 
of the steel mills now shuttered. The demographics have been changing 
over the past decade: African-Americans moving in, whites moving out. A 
common story. Unintentionally, it's one of the few racially mixed 
communities in Cleveland.
    Brancatelli's mother worked as a waitress at a local diner, then as 
a clerk at a neighborhood Army-Navy store. His father was an auto 
mechanic. They divorced when Brancatelli was 12, yet Brancatelli 
describes his childhood in Slavic Village in nostalgic hues. ``You 
always knew somebody,'' he says. ``You didn't need formal day care. 
There was always somewhere to stay.''
    He began working for the Slavic Village Development Corporation, a 
local nonprofit group, in 1988 and a year later became its director. 
The organization built and renovated storefronts and homes, bringing 
new people to the area. In fact, he met his wife when she bought a 
rehabbed house in the neighborhood. He stayed at the development group 
for 17 years until moving on to the City Council.
    Cleveland has long been known for its unusually large number of 
nonprofit housing groups, and in the 1990s their impact on the city was 
noticeable. Under Brancatelli's watch, Slavic Village Development 
constructed more than 500 new homes and rehabbed more than 1,000. 
Brancatelli measured success by the number of homes the group sold for 
more than $50,000. ``We started to see this incredible 
transformation,'' he recalls. A local thrift, Third Federal Savings and 
Loan, built its new corporate headquarters in Slavic Village. Marc A. 
Stefanski, chairman and chief executive of Third Federal, told me, 
``There was a good feeling that, hey, this neighborhood's coming 
back.'' Throughout the city, there was a renaissance of sorts: new 
housing construction in the neighborhoods and, downtown, three sports 
stadiums and the Rock and Roll Hall of Fame. Cleveland adopted the 
moniker ``The Comeback City.''
    But then Cleveland was hit hard--and early--by the foreclosure 
crisis. In 1999, Brancatelli noticed something peculiar: homes, many of 
which were in squalid condition, were selling for inflated prices. One 
entrepreneur in particular caught Brancatelli's attention: 27-year-old 
Raymond Delacruz. He would buy a distressed property and, at best, make 
nominal repairs before quickly selling it for three or four times what 
he paid for it. The flips needed the cooperation of appraisers and the 
gullibility of home buyers. But the proliferation of mortgage 
companies--mostly based out of state and willing to provide loans with 
little documentation--also facilitated flippers. And the flippers 
justified the high prices to both home buyers and mortgage companies by 
pointing to the high prices nonprofit housing groups, like 
Brancatelli's, were getting for their new construction.
    There was something else going on in the city that was even more 
destructive. Unlike fast-growing communities in Florida and California, 
Cleveland didn't see housing prices rise through the stratosphere. But 
even moderately rising property values created the conditions for 
subprime lenders to exploit strapped homeowners. Cold-calling mortgage 
brokers offered refinancing deals that would let homeowners use the 
equity in their houses to pay off other debts. A neighbor of 
Brancatelli's had medical problems and fell behind in her bills. She 
refinanced, then did it two more times, draining the equity in her 
house. ``She used her house as an A.T.M.,'' Brancatelli says. ``In the 
end, they just walked away. The debt exceeded the value of the house.'' 
In other instances, mortgage brokers would cruise neighborhoods, 
looking for houses with old windows or a leaning porch, something that 
needed fixing. They would then offer to arrange financing to pay for 
repairs. Many of those deals were too good to be true, and interest 
rates ballooned after a short period of low payments. Suddenly burdened 
with debt, people began to lose homes they had owned free and clear.
    As early as 2000, a handful of public officials led by the county 
treasurer, Jim Rokakis, went to the Federal Reserve Bank of Cleveland 
and pleaded with it to take some action. In 2002, the city passed an 
ordinance meant to discourage predatory lending by, among other things, 
requiring prospective borrowers to get premortgage counseling. In 
response, the banking industry threatened to stop making loans in the 
city and then lobbied state legislators to prohibit cities in Ohio from 
imposing local antipredatory lending laws.
    In the ensuing years, the city's real estate was transformed into 
an Alice-in-Wonderland-like landscape. Local officials began keeping 
track of foreclosed homes by placing red dots on large wall maps. Some 
corners of the map, like Slavic Village, are now so packed with red 
dots they look like puddles of blood. The first question outsiders now 
ask is, Where has everyone gone? The homeless numbers have not 
increased much over the past couple of years, and it appears that most 
of the people who lost their homes have moved in with relatives, found 
a rental or moved out of the city altogether. The county has lost 
nearly 100,000 people over the past seven years, the largest exodus in 
recent memory outside of New Orleans.
    Banks are now selling properties at such low prices--many below 
what they sold for in the 1920s--you have to wonder why they bother to 
foreclose at all. (The F.D.I.C. estimates that each foreclosure costs a 
bank on average $50,000, more than if they were to do a loan 
modification.) All of this leaves Brancatelli in a constant state of 
exasperation. When asked how he's doing, he often takes a breath and 
replies, ``Another day in paradise.''
    O.V.V. IS A TERM OF ART that stands for Open, Vacant and 
Vandalized. Houses fitting this description have popped up like prairie 
dogs. They are boarded, unboarded, then boarded again, and the city 
can't keep up with the savvy squatters. They will prop the plywood over 
the front entrance to make it look as if it's nailed shut. One woman 
told me that she called the police last summer when she saw smoke 
coming out of a vacant home across the street; it turned out that some 
young men were cooking on a grill inside.
    On a dreary wintry day, Brancatelli took me to Hosmer Street, on 
which a fourth of the homes were foreclosed. As we strolled down the 
block, Brancatelli noticed something odd. Through a side window of one 
slender house, we could make out a waist-high pile of tree limbs and 
branches. The front door was off the hinges and propped against the 
entrance. We entered through the rear, where the door was gone 
altogether. ``Hello,'' Brancatelli hollered, ``City!''--an effort to 
both warn squatters and frighten animals. Earlier that day we entered 
another O.V.V. and heard footsteps upstairs. ``They don't have a gun,'' 
he had assured me. He explained that scavengers know enough not to 
carry weapons because it would mean more prison time should they be 
caught. Even in O.V.V.'s, there are rules.
    Inside, we found firewood and brush piled in the kitchen and front 
room. ``The crap we deal with,'' Brancatelli muttered to himself. He 
snapped a photo with his cellphone and sent an e-mail message to the 
city's Building and Housing Department, urging the department to send 
someone to secure the house. He often does this two or three times a 
day. But finding a collection of timber like this is of particular 
concern; over the past year there have been more than 60 fires in his 
ward, all in vacant houses. The fire department tried stakeouts but has 
not caught anyone. The general belief is that the fires are set either 
by squatters trying to stay warm or by mischievous kids. Brancatelli, 
though, wonders aloud if it might be vigilantes who don't like the 
blight on their block. ``Maybe I'm overthinking it,'' he says. More 
likely, he's projecting. He would like to see many of these houses just 
    This is Brancatelli's conundrum: many of the abandoned homes should 
be razed. They're either so old or so impractically tiny that they have 
little resale value, or they have been stripped of their innards and 
are in utter disrepair. There are an estimated one million lender-owned 
properties nationwide, and on average each house sits empty for eight 
months, a length of time that is only growing. Demolition, though, is 
costly: roughly $8,000 a house. Two years ago, Litton Loan Servicing, a 
mortgage servicer, discussed giving the city a number of foreclosed 
homes. Free. The city told them that would be fine, but only if the 
company came up with money to pay for the necessary demolitions. The 
transaction never occurred.
    Last summer, Congress appropriated $3.9 billion in emergency funds 
for cities to acquire and rehab foreclosed properties. (An additional 
$2 billion will be available under the recently enacted economic-
stimulus package.) The legislation was labeled the Neighborhood 
Stabilization Program, but Cleveland and a handful of other cities had 
to lobby hard to convince Congress that ``stabilization'' in their 
cities meant tearing down houses--not renovating them. Last month, 
Cleveland said it planned to use more than half of its $25.5 million 
allotment to raze 1,700 houses. This presents an opportunity to 
reimagine the city, to erase the obsolete and provide a space for the 
new. (There's little money now to build, so imagine is the operative 
word.) Cuyahoga County is also establishing a land bank, a public 
entity that can acquire distressed properties and hold on to the land 
until improved economic times allow for redevelopment. The county hopes 
to persuade banks to unload their distressed properties, which the land 
bank would then raze, as well as give up some foreclosed properties in 
the suburbs, which the county could eventually renovate and sell.
    Other cities--including Minneapolis, Youngstown, Detroit and 
Cincinnati--have put aside at least a third of their neighborhood-
stabilization funds for demolition. ``As properties stay vacant for 
longer periods of time,'' says Joe Schilling, a founder of the National 
Vacant Properties Campaign, ``it's inevitable that even in some of the 
fast-growing communities, they'll have to look at demolition.'' 
Phoenix, for instance, has set aside a quarter of its grant money to 
tear down abandoned homes.
    Cleveland may use some of those demolition dollars on houses now 
owned by the Federal Government. Between the Department of Housing and 
Urban Development and entities like Fannie Mae and Freddie Mac, the 
Federal Government has control of roughly a thousand abandoned 
properties in Cleveland. Across the street from the house with the 
timber inside sits a one-and-a-half story vacant property owned by HUD, 
which had guaranteed the last mortgage. On the front porch, a large 
picture window was wide open, but Brancatelli chose to enter through 
the front door. Going on a hunch, he punched the numbers in the address 
into the lockbox. The toilet was gone, as was the copper piping. HUD 
recently sold this house--for $1,500--but didn't inform the new owner 
that the house had been condemned. ``They dumped the house,'' 
Brancatelli grumbled. ``It's this kind of stuff that drives me nuts.''
    A few weeks ago Brancatelli persuaded HUD to let the owner out of 
his purchase. Then HUD offered to sell the city its distressed 
properties, including this one, for $100 each. You might think this was 
something to celebrate. Brancatelli, though, is irked. As he sees it, 
the city will now have to use some of its emergency HUD financing to 
demolish houses that HUD was responsible for.
    THE LIFE OF A CLEVELAND CITY COUNCILMAN has become one of answering 
complaints derived in one way or another from the foreclosure crisis. 
In November, Zachary Reed, who represents the ward near Slavic Village, 
received a pleading phone call from Cecilia Cooper-Hardy, a constituent 
and school-bus driver who lives next to a vacant house. Cooper-Hardy 
told Reed that as she was leaving for work at 5 one morning, she peered 
out her living-room window and noticed a pair of eyes staring back at 
her from behind a slit cut in a window shade next door. Reed had the 
house secured, but within days the boards were pulled off. Cooper-Hardy 
then purchased a pistol that she now keeps under her pillow. The local 
police commander calls her regularly, just to make sure everything's 
O.K., a routine he has adopted with others as well. Last summer, while 
Cooper-Hardy was doing yardwork, someone slipped in her back door. She 
hollered to a neighbor across the street who was drinking in the yard 
with friends. They rushed to her aid as the burglar fled. That neighbor 
is gone now. Another foreclosure. So every morning she offers up a 
prayer, and then she peeks out her living room blinds to see if there's 
anyone peeking back at her from the house next door. Reed, the 
councilman, told me, ``If we don't get some help we're going to turn 
into a third-world nation.''
    Brancatelli doesn't necessarily disagree with the sentiment, but he 
continues to search for reasons to be sanguine. He insisted on driving 
me past a small store called Johnny's Beverage because, he told me, it 
was a key to his community's future. Johnny's Beverage sits in the 
middle of a residential block. Its facade is worn. Dark plastic 
sheeting covers the front windows so you can't see in. A hodgepodge of 
posters and handwritten signs advertise cold beer and wine, cigarettes 
and lottery tickets. A tattered American flag flaps in the breeze. When 
Jerome Jackson purchased the store three years ago, Brancatelli told 
him in no uncertain terms that he wasn't too happy about it and that he 
was going to oppose the transfer of the liquor license. It did not, 
after all, have the aspect of a family-friendly enterprise you would 
want in a residential neighborhood.
    Jackson, who is 52 and barrel-chested, has a retiring demeanor. His 
perch is a narrow space separated from the rest of the store by 
counter-to-ceiling plexiglass. He had managed a store in another 
neighborhood and saved up to buy his own business. He renovated the 
upstairs and moved in (and hung the American flag from a second-floor 
deck he built).
    He then purchased a foreclosed house down the street, where his 
brother could live. The house next door to the store went into 
foreclosure, and Brancatelli heard that Jackson kept watch over it, 
chasing scavengers away and erecting a fence in the rear. He also heard 
that Jackson had alerted the city that there was a foot of water in the 
basement of the vacant, the result of pipes having been ripped out. 
(This is common; Brancatelli has seen back water bills for vacant 
houses as high as $6,000.)
    Brancatelli began to reconsider his opinion of Jackson. He was 
keeping an eye on the neighborhood--and he was committed to staying. 
Brancatelli decided to support the liquor-license transfer and then 
told Jackson that he would help get him the property next door, if he 
agreed to tear it down.
    U.S. Bank, which owned the house, appealed a city condemnation 
order. ``It's the running joke,'' Brancatelli told me. ``The banks 
appeal the condemnations because they say they want more time to make 
repairs to put it on the market to sell. And I go to the hearings on a 
regular basis to say you shouldn't get more time. Here, they owned it 
for more than six months and hadn't made any repairs. They just want 
time to try to unload the property.'' Jackson offered U.S. Bank $2,000. 
He heard nothing. He upped his offer to $3,000. Again, no response. 
When Brancatelli intervened and made it clear that U.S. Bank would be 
stuck with the $8,000 demolition bill, the bank agreed to sell it for a 
dollar to the Slavic Development Corporation. The nonprofit group then 
turned it over to Jackson, who agreed to pay for the razing. 
``Imbeciles,'' Brancatelli said more than once, referring to the banks. 
``They're imbeciles.''
    I spent an evening with Jackson in his store and watched as a young 
disheveled man came in and purchased a pack of cigarettes. He hovered 
around the plexiglass. ``Do you want to buy some tools?'' the man 
    ``No,'' Jackson curtly replied.
    Customers frequently offer Jackson sinks, cabinets and other 
scavenged items. He says that in the few years he has owned the store, 
the community has become more transient. ``I don't know nobody no 
more,'' he said. ``I don't know who to trust.'' Everyone calls him 
Johnny. They assume the store was named after him, even though it has 
been there for decades. The week before Christmas, two men rammed a van 
into the front of the store, intending to rob it. The van got stuck, 
and the robbers fled. But Jackson isn't deterred. He says he hopes one 
day to knock down his store and build a row of small enterprises, 
including a restaurant and a barbershop. He is trying to buy another 
vacant house on the block. Brancatelli now fears he'll lose Jackson. 
``I want to convince him we have a strategy for the neighborhood,'' he 
told me. ``The worst thing you can have happen is to have this store 
close up.''
    BY MID-2007, IT BECAME CLEAR to Brancatelli that his was a city at 
the mercy of lenders and real estate wholesalers, who now owned 
thousands of abandoned properties in the city. Somehow, the city needed 
to hold these new land barons accountable for their vacant houses, so 
many of which were in utter disrepair.
    Brancatelli and others looked to Raymond Pianka, the judge in the 
city's lone housing court. In 1996, Pianka gave up his seat on the City 
Council to accept this judgeship. His judicial colleagues derisively 
refer to it as ``rat court,'' because its main function is to make sure 
that owners mow their lawns, trim their hedges, clean up their garbage, 
repair leaning porches or hanging gutters--in short, that they make 
their homes inhospitable for rats. No one foresaw that this lowliest of 
courts would become one of the most powerful instruments in the city's 
fight for survival. ``The court's the only tool we have,'' Brancatelli 
said. ``When we get them into court, we can't let them go.''
    In 2001, when it became clear how Raymond Delacruz was wreaking 
havoc on city neighborhoods by flipping houses, it was Pianka who ran 
him out of town. The city's building and housing department cited 
Delacruz for code violations on a house he hadn't flipped fast enough. 
When he didn't show up in court, Pianka had his chief bailiff stake out 
Delacruz at a doughnut shop. Pianka placed him on house arrest, 
ordering him to spend 30 days in the dilapidated structure he owned but 
had not maintained. Shortly after his sentence was up, Delacruz moved 
to Columbus, where he continued his flipping, and was eventually 
convicted for fraud that included swindling a bank vice president.
    Housing codes, which were established in the mid-19th century, set 
minimum standards for housing quality. They traditionally help maintain 
both a city's aesthetics and safety. In Cleveland today, they seem to 
be all that keeps the city from crumbling. In 2007, Pianka realized 
that the banks weren't showing up in court after being cited for code 
violations. ``They were thumbing their noses at the city,'' he told me. 
``They were probably thinking, It's Municipal Court. What can they do? 
And we thought, How loud can this mouse roar?'' Pianka set up what he 
called his Clean Hands Docket. If a bank didn't respond to a warrant, 
Pianka refused to order any evictions it requested.
    Pianka's staff also dug up a little-used 1953 statute that allowed 
for trials in absentia, and every other Monday afternoon for the last 
year and a half Pianka has held trials with a judge and a prosecutor 
but no defendant. The first case involved Destiny Ventures, a firm 
based in Oklahoma that buys foreclosed properties in bulk and then 
sells them. It was cited in 2007 for violations on one of its houses, 
but didn't show up in court. The idea of a trial without a defendant 
was so unusual that when the prosecutor said he had no opening 
statement, Pianka prodded him. ``You're going to waive opening 
statement?'' he asked. ``Don't you want to give the court a little road 
map about the strategy?'' A housing inspector testified that Destiny 
Ventures had done nothing to correct the code violations on the vacant 
two-story clapboard house in question. The windows were punched out, 
the front door was wide open and roof shingles were missing. Pianka 
fined Destiny Ventures $40,000, and then had a collection agency sweep 
the company's bank accounts for the money. Brancatelli celebrated by 
taping a copy of the check to his office wall. In a recent phone 
interview, an owner of Destiny Ventures, Steve Nodine, said, ``It's 
unconstitutional the way they fine people.'' His firm now refuses to do 
business in Cleveland.
    One morning this fall, I visited Pianka before his Monday court 
session. His office, on the 13th floor of the Justice Center, overlooks 
Lake Erie and the new Cleveland Browns Stadium. It might be one of the 
nicer views in the city, but he would just as soon overlook the city's 
residential neighborhoods. When I entered his chambers, he was on his 
computer scanning Web sites to tap into the real estate chatter. He 
found a Cleveland house on eBay selling for $500. In the photos, Pianka 
could make out mold on the walls and noticed a large portable heater, 
which he said was illegal. He shook his head. He has no power to haul 
people into court. Building and housing inspectors issue citations for 
code violations, and then the city's law department decides whether to 
prosecute. Pianka hears only misdemeanor offenses, but he can both fine 
and jail defendants.
    Pianka, who has a bushy mustache, often seems amused, so it's easy 
to underestimate his resoluteness. The chief magistrate told me she has 
heard Pianka curse only once. It was in late 2007. He had fined Wells 
Fargo $20,000 for code violations but told the bank he would rescind 
the fine if it spent that amount rehabilitating the structure. Wells 
Fargo fixed up the house, and it was, for Pianka, a success story. When 
he drove the chief magistrate to the address to show off the house, 
there was nothing there, just a vacant lot. The city, he discovered, 
had razed it, unaware of the repairs.
    Pianka lives on a beautiful block in Cleveland's Detroit-Shoreway 
neighborhood, where there is a stunning variety of architecture. But 
even on his street, there have been three foreclosures. For months, 
Pianka helped keep watch on a majestic 19th-century Victorian down the 
street. One neighbor paid for the electricity so the vacant house would 
be protected against vandals by an alarm system. Pianka shoveled the 
snow in winter and often parked his car in the driveway so it would 
appear as if someone were living there.
    Pianka is an amateur historian, and his office shelves are filled 
with books on Poland, his grandfather's native country. During my 
visit, he retrieved a book about wartime Warsaw and opened it to a 
photograph of a lone man with a wheelbarrow collecting bricks from the 
rubble of a building's ruins. ``He's putting the city back together,'' 
Pianka told me. ``We just have to make the best of things. We have to 
do it because nobody else will.''
    One of his assistants poked her head in the doorway. ``It looks 
like we're going to have another packed house,'' she announced, and 
Pianka headed for the courtroom. A line of people snaked into the 
hallway. When the bailiff called their names, they approached the 
lectern, usually without an attorney. Pianka asked one man how he 
wanted to plead. ``I plead whatever it takes,'' he replied. Most of the 
defendants are simply asking for guidance, or at least some 
understanding, and the word is that you can trust Pianka. ``He's the 
most loved judge in Cleveland,'' Brancatelli told me. A good number of 
the defendants are facing foreclosure themselves and don't have the 
means to keep up their property. Until recently, many might have 
refinanced, but that is no longer an option.
    One of the first cases I observed involved Sally Hardy, who is 52 
and works as a housekeeper at a nursing home. She asked Pianka if she 
could confer briefly with the prosecutor, which she did, and then began 
to cry softly. ``What'd you say to her?'' Pianka asked the prosecutor 
in an attempt to lighten the mood. Hardy jogged out of the courtroom in 
tears. When she returned, Pianka apologized. ``I'm sorry,'' he said. 
``These are emotional times, and sometimes it feels like the weight of 
the world is on your shoulders.'' Her house was in foreclosure, she 
told Pianka, but she had rescued it. Pianka brightened. ``That's a 
great accomplishment,'' he told her. He ordered her into a program that 
assists struggling homeowners; a housing specialist will work with 
Hardy to find money to repair her roof and porch.
    Mayra Caraballo, a 39-year-old mother of two, appeared in court in 
response to code violations on her home. She explained to Pianka that 
she no longer owned the house. She had lost her job at a processing 
plant, and an adjustable rate had kicked in on her mortgage, boosting 
her monthly payments to $1,100, from $800. She had left after receiving 
a foreclosure notice. The house was quickly stripped of everything but 
the furnace. Pianka asked a clerk to check into the house's ownership; 
he suspected that the lender had withdrawn the foreclosure at the last 
minute, as is becoming more common. The clerk tracked down the trustee 
on the mortgage, Deutsche Bank, and confirmed that the foreclosure had 
indeed been withdrawn. Pianka calls these situations ``toxic titles.'' 
``You're in limbo,'' Pianka told a shocked Caraballo. ``There's no hope 
in your getting out of this property as a result of foreclosure. We're 
seeing this more and more.''
    Pianka sees these toxic titles as an effort by lenders to dodge 
responsibility for vacant houses. Later, I called Deutsche Bank to ask 
about Caraballo's house. ``We don't own the property,'' a spokesman 
told me. ``We're the owner of record, but the investors who bought the 
mortgage-backed securities own it.'' Pianka chuckled when I told him of 
the bank's response. ``That's their mantra: we don't own it,'' he said. 
``It's handy for them to say, `Oh, it's not us.' It's part of this big 
shell game they're playing.'' I checked in with Caraballo, too. She's 
now renting and working part time at a day care center. She told me 
that she would like to move back into the house, but she's not sure she 
has the money to replace all the hardware that has been stripped by 
scavengers or to make the necessary repairs.
    Over the last year and a half, the housing court has collected $1.6 
million in fines from defendants who didn't show up for their trials. 
Last April, Pianka fined Washington Mutual $100,000 for a vacant 
property on the city's west side. Washington Mutual, now owned by 
JPMorgan Chase, appealed, and in December, the Eighth District Court of 
Appeals in Ohio ruled that trials in absentia were not permitted in 
misdemeanor cases, essentially putting an end to Pianka's efforts. 
JPMorgan Chase disputes the code violations, but a spokeswoman said the 
bank was not planning to send a representative to court to respond to 
the city's charges.
    ``We just have to figure out some other ways,'' Pianka told me. He 
has suggested that the city could name corporate officers when 
prosecuting code violations. He told me that a Cleveland police officer 
was so angered by all the abandoned properties that he volunteered last 
month to serve warrants to bank officers should they ever be issued. In 
the meantime, early last year, Cleveland sued 21 lenders, arguing that 
their vacant houses created a public nuisance, virtually destroying 
some neighborhoods. Ten of those lenders have since gone under, been 
acquired or gone into bankruptcy. The case is slowly winding its way 
through federal court.
    ``This crisis changes weekly,'' Pianka told me. ``It's a torrent of 
water coming at us. We can divert it one way or another. But we can't 
stop it.''
    ON FEB. 29 LAST YEAR, Derek Owens, a 36-year-old police officer on 
patrol, spotted a group of young men drinking beer in the open garage 
of an abandoned house. Neighbors previously complained of teenagers 
both selling and using drugs in the row of vacant houses on the street. 
When Owens and his partner got out of their squad car, the men fled. As 
Owens chased them, one of the men stopped in the driveway of yet 
another abandoned house, turned around and opened fire. One shot hit 
Owens in the abdomen, and he died several hours later.
    When Brancatelli heard of Owens's murder, he wondered who owned the 
abandoned house and garage where the young men were drinking. He made 
some phone calls and discovered that he knew the owners, Eric and 
Sheila Tomasi, a couple from Templeton, Calif., who had been buying up 
foreclosed houses in Cleveland as an investment. Eric Tomasi soon 
called. He had heard about the shooting. Brancatelli liked the Tomasis, 
and suggested that it might be a good idea to begin repairs on the 
house. The neighbors, he told Tomasi, were up in arms over the vacant 
houses in their community. The Tomasis soon sought permits to do work 
and began to fix up the house.
    Brancatelli had met the Tomasis a few weeks earlier at a suburban 
hotel where a private company was auctioning off foreclosed homes. 
Brancatelli was there to scare off speculators. He passed out a flyer, 
which read in part: ``Dealing with the increasing problem of abandoned 
and vacant homes is at the forefront of our efforts to continue 
improving our community. * * * You should be aware that some of these 
homes were the source of incredible community concern and some resulted 
in criminal prosecution of mortgage brokers.''
    This is what Brancatelli calls ``the next tsunami''--companies and 
individuals who are buying foreclosed houses in bulk and then quickly 
selling them for a profit, often without making any repairs. The 
companies have appellations like Whatever Inc., Under Par Properties 
and Tin Cup Investments. Brancatelli thought all the equity had been 
wrung out of these properties, but clearly he was mistaken.
    At this auction, Brancatelli was introduced to the Tomasis. They 
are both in their 40s. Before investing in real estate, Sheila Tomasi 
owned a small chain of clothing stores and Eric Tomasi was a mortgage 
broker and before that managed a chain of sporting-goods stores. 
Brancatelli found them surprisingly open, unlike some of the other 
wholesalers--or ``bottom feeders'' as some derisively refer to them--
who wouldn't return his phone calls or e-mail queries. He invited the 
couple to a gathering of local housing activists, and they laidout 
their business plan. Brancatelli was curious to find out how anyone was 
making money in a market where houses were selling for a few thousand 
dollars on eBay.
    The Tomasis said that they owned about 200 houses in Cleveland. 
(They purchased 2,000 homes last year, in 22 states.) They explained 
that they, unlike most other wholesalers, provide each buyer with the 
mechanicals--pipes, a boiler, a furnace, all the basic materials that 
had been stripped--that the purchaser would then be responsible for 
installing. Brancatelli derived some comfort from this description. 
From his background with a nonprofit housing group, he knew the theory 
that people who put sweat equity into a house will be more committed to 
its upkeep and to making the mortgage payments. The financing the 
Tomasis laid out, though, made Brancatelli squirm. The purchaser would 
pay $500 down and then make monthly payments of no more than $450, 
which was below local rental prices. But the interest rate was 10 or 11 
percent. What most concerned Brancatelli was that the Tomasis 
eventually hope to package the mortgages and sell them to investors.
    ``It's Groundhog Day all over again,'' Brancatelli remembers 
thinking to himself. ``Intuitively, it doesn't make any sense that a 
person from California would be buying hundreds of distressed 
properties in a place that's in a downward spiral. It has nothing but 
the makings of someone coming to pillage our neighborhood.'' But did 
that mean he shouldn't work with the Tomasis? If he considered them the 
enemy, he wondered, where would that get him? Eric Tomasi assured 
Brancatelli and the others that they had a shared interest. ``I want to 
put people in homes,'' he said. ``And you want to get homes occupied.''
    Pianka says Brancatelli faces a difficult choice: work with the 
Tomasis to make sure their properties are maintained and then sold to 
people who make the payments, or contest the Tomasis' efforts and lose 
any oversight. In December, while I was driving through Slavic Village 
with Brancatelli, we passed a Tomasi-owned house that wasn't secured. 
He left a message for Tomasi: ``Eric, calling about 6921 Gertrude. The 
door's open in the back. Give me a call. Hope things are well.'' Tomasi 
sent someone out to board it up. ``Even if I didn't like this guy, I 
don't have the ammo to fight him,'' Brancatelli later told me. ``Let's 
see if this is a model we can work with.''
    THERE ARE REASONS to be wary. During my time in Cleveland, I came 
across two properties owned by an investment company that goes by the 
name Thor Real Estate. The first I stumbled across while driving 
through the city's west side with Jay Westbrook, a city councilman. We 
passed a compact two-story house that had been vacant just a few weeks 
earlier. Westbrook peeked through the windows and, much to his 
surprise, saw some activity. A young, stocky man was inside installing 
new floors. He introduced himself as Oswan Jackson and told us he had 
just bought the house. He planned to move in with his wife, who was 
pregnant with their first child. He seemed disoriented, like many new 
homeowners, overwhelmed by the amount of work he needed to do. ``I 
didn't know there were code violations,'' he told Westbrook. The 
foundation was failing and the roof needed replacing. He said the 
purchase price was $24,580 for the house: $500 down and $290 a month. 
``We'll make it work for you,'' Westbrook cheerfully told him. 
``Welcome to the neighborhood.'' A few days later, after a colleague 
researched the property, Westbrook learned that the house had been in 
such poor condition that it was condemned three weeks after Jackson 
signed the contract--and that Jackson owed the back taxes on the 
property, which amounted to $4,000. The last I spoke with Jackson, he 
planned to walk away from his new home.
    The second house was on East 113th Street. The front steps were 
missing; piles of brush and rubbish clogged the driveway. One side was 
tagged by a local gang, an indication that it had been used as a 
gathering place. Posted to the front porch was a sign that read: 500 
Down, 295 a month. In January on Craigslist, the owner advertised it 
this way: ``I have a beautiful home at 3637 East 113th Street, 
Cleveland, OH 44105 Move in now! No credit check!'' One neighbor I 
spoke to wondered why anyone would want to buy it. ``It looks like 
there's nothing left for that house to give,'' the neighbor said.
    The dispiriting part of the story behind these houses, certainly 
from Brancatelli's point of view, is that Thor Real Estate had been in 
partnership with the Tomasis. The Tomasis say they are now separate 
entities, but in court, the Tomasis have admitted that properties have 
been transferred between the two companies, and on occasion Eric Tomasi 
has offered to speak for Thor on code-violation cases. Once again, it's 
hard to know who owns what.
    In January, Sheila Tomasi appeared in housing court. Sheila Tomasi 
is a personable, cheerful woman with high cheekbones and honey-streaked 
hair. The Tomasis purchased a house for their own use near Cleveland, 
and she was back for a couple of weeks to appear in court and to check 
on their properties. It wasn't the Tomasis' first time in Pianka's 
court, and on that day, five of the Tomasis' properties were cited for 
code violations. During her appearance, she told the court about a new 
owner, a single mother of seven, who had hired a contractor to install 
new pipes provided by the Tomasis. But it was a shoddy job. So, the 
Tomasis hired a plumber themselves and paid him $1,300 to redo the 
work. They added that charge to the woman's monthly mortgage payments. 
``I can't go to sleep at night if we can't give someone a good start,'' 
Tomasi told me on an earlier occasion. ``You want to groom them and get 
all the hiccups out of owning a home: that they're getting all their 
improvements done, that they're paying their taxes. We want to make 
sure that everything's going O.K.''
    Tomasi also confirmed to the judge that they were considering the 
purchase of another 1,000 homes in the city. ``That's the nature of 
what's happening here,'' Pianka sighed. ``We feel in many ways 
    ``You've moved to Cleveland at least temporarily,'' he said. 
``That's important, and taking care of your inventory properties, 
making sure you come into compliance with the law. There aren't enough 
inspectors to follow you around.'' Tomasi nodded. Pianka continued, 
``If we find out you have a property and it's flying below the radar, 
there are going to be severe consequences.''
    ``Yes, your honor,'' Tomasi replied.
    Then, as if thinking aloud, Pianka said, ``It is really tough being 
a city municipality because we're subject to international banks, 
national banks, acts of Congress, buyouts of mortgages. * * * We have 
no control over those entities, so I guess we're going to have to try 
to work with you.''
    He fined the Tomasis $50,000 but gave them time to either raze the 
properties or repair them. ``I'd like you to appreciate what we're 
dealing with in Cleveland,'' he told Tomasi. ``Now if you don't have 
some good reason, I expect a good check made out to the clerk.''
    Pianka left the bench shaking his head and later told me he better 
understood why Brancatelli was willing to work with the Tomasis. ``What 
are you to do?'' he said.
    When I told Brancatelli about the court proceedings and about the 
Tomasis' mention of purchasing another 1,000 homes, Brancatelli said, 
``It's just really strange times.''
                       correction: march 08, 2009
    The cover article on Page 28 this weekend about efforts by 
Cleveland and other cities to deal with the growing number of 
foreclosures misstates the name of an area in Louisiana with a recent 
exodus of people comparable to that of Cleveland. It is Orleans Parish, 
or New Orleans--not New Orleans Parish.

    [Whereupon, at 12:40 p.m., the Committee was adjourned.]