[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
FANNIE MAE, FREDDIE MAC & FHA:
TAXPAYER EXPOSURE IN THE HOUSING MARKETS
=======================================================================
HEARING
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
JUSTIN AMASH, Michigan
TODD ROKITA, Indiana
FRANK C. GUINTA, New Hampshire
ROB WOODALL, Georgia
Professional Staff
Austin Smythe, Staff Director
Thomas S. Kahn, Minority Staff Director
C O N T E N T S
Page
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
FANNIE MAE, FREDDIE MAC & FHA: TAXPAYER
EXPOSURE IN THE HOUSING MARKETS
----------
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
crisis.
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
methodically.''
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
Mac.
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
stunted.
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.
Sincerely,
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
20515.
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
economy.
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
units.
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
industry.
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
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.
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
borrowers.
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.
Resources
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
conservatorship.
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
conservatorship.
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
financing.
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?
STATEMENTS OF DEBORAH J. LUCAS, ASSISTANT DIRECTOR,
CONGRESSIONAL BUDGET OFFICE; ALEX J. POLLOCK, SENIOR FELLOW,
AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH; AND
SARAH ROSEN WARTELL, EXECUTIVE VICE PRESIDENT, CENTER FOR
AMERICAN PROGRESS & CENTER FOR AMERICAN ACTION FUND
STATEMENT OF DEBORAH J. LUCAS
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
billion.
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
risk-taking.
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:]
http://www.cbo.gov/doc.cfm?index=12213
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
recommendations.
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
here.
[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
securities.
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
times.
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
points.''
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
prescribe----
(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
days.
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
omitted]
To help address the obvious problems created by the inflation of
agency debt, I recommend that this provision should be reintroduced and
enacted.
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?
STATEMENT OF SARAH ROSEN 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
GSEs.
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
assumptions.
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
Administration.
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
risk.\1\
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
like.
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
deficit.\5\
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--
market.html.
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
force.
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
questions.
endnotes
\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
http://financialservices.house.gov/Media/file/hearings/111/
Printed%20Hearings/111-153.pdf.
\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/
Primer%20on%20Credit%20Reform%20by%20Stanton.pdf.
\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
do?
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
vary.
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
correct.
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
that?
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
nature.
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,
correct?
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
particular.
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
understand.
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
right-on.
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
difficult?
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
homeownership.
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
company.
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
Wartell.
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.
Wartell.
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
homes.
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,
right?
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
colleague.
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
country.
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
Reserve.
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
short.
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
correct?
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
bubble.
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
institutions.
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.
Lucas?
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
retirement.
Mr. Rokia. Thank you, Mr. Chairman. Very educational. Yield
back. Thank you witnesses.
Mr. Garrett. Gentleman yields back. Gentle lady from
Florida.
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,
correct?
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
thin.
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
disagrees?
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
follow:]
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
loans?
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
comments
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.
questions
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
spending.
(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
changes.
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
fortunate.
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
publicly.
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
comment.
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
adopted.
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
Times.
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
bets.
______
[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
world.
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
benefit.''
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
Harriman
----------------------------------------------------------------------------------------------------------------
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
Chase
----------------------------------------------------------------------------------------------------------------
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
GE)
----------------------------------------------------------------------------------------------------------------
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
point.
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
regulators.
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
discretion.
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
week.
______
[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
value.
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
other.
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
SEC.
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
businesses.
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
banks,
``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
slump.
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
Florida.
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
banks.
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:]
www.treasury.gov/resource-center/data-chart-center/tic/Documents/
shla2008r.pdf
______
[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
investments.
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
relations.
``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
investigations.
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
dollars.
``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.
Geithner.
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
discontent.
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
expense.
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
institutions.
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
records.
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
crisis.
``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
Citigroup.
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
industry.''
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
Electric.
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
cop.
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
context.''
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
Citigroup.
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
them.''
By the fall of 2007, that was becoming clear. Citigroup alone would
eventually require $45 billion in direct taxpayer assistance to stay
afloat.
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
reception.
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
resolved.
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
said.
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
leadership.
``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
said.
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
defaults.
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
back.
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
Treasury.
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
confidential.
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.
bailout.
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
spokesman.
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
check.''
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
taxpayers.''
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
crisis.
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
Government
Securities Dealers Statistics Unit of the Federal Reserve Bank of New
York
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
testified.
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
Gillette.
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
stake.
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
Links:
[1] http://motherjones.com/politics/2008/09/700-billion-bailout-
plans-fine-print
[2] http://motherjones.com/politics/2010/01/what-else-could-14-
trillion-buy
[3] http://motherjones.com/politics/2010/01/real-size-bailout-
treasury-fed
[4] http://motherjones.com/kevin-drum/2009/06/un-bailout
[5] http://motherjones.com/politics/2009/07/how-you-finance-
goldman-sachs%E2%80%99-profits
[6] http://motherjones.com/mojo/2009/03/obama-looking-revealing-
names-aig-execs-who-received-bonuses-cuomo-gets-some-aig-bonus-
[7] http://channel.nationalgeographic.com/series/dog-whisperer
[8] http://www.nytimes.com/2009/10/19/business/media/
19askthetimes.html?pagewanted=all
[9] http://motherjones.com/mojo/2009/11/greenberg-still-unrepentant
[10] http://www.timesonline.co.uk/tol/news/world/us--and--americas/
article6907681.ece
[11] http://motherjones.com/politics/2010/01/wall-street-big-
finance-lobbyists
[12] http://motherjones.com/politics/2010/01/financial-crisis-wall-
street-anger
[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-
wall-street-washington-obama
[16] http://motherjones.com/politics/2010/01/joseph-stiglitz-wall-
street-morals
______
[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
back.''
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
disappear.
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
asked.
``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
helpless.
``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.]