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



 
                     UNDERSTANDING THE IMPLICATIONS

                    AND CONSEQUENCES OF THE PROPOSED

                         RULE ON RISK RETENTION

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

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND

                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               ----------                              

                             APRIL 14, 2011

                               ----------                              

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-27




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         UNDERSTANDING THE IMPLICATIONS AND CONSEQUENCES OF THE

                    PROPOSED RULE ON RISK RETENTION


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                     UNDERSTANDING THE IMPLICATIONS

                    AND CONSEQUENCES OF THE PROPOSED

                         RULE ON RISK RETENTION

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

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND

                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 14, 2011

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-27

                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
KENNY MARCHANT, Texas                BRAD MILLER, North Carolina
THADDEUS G. McCOTTER, Michigan       DAVID SCOTT, Georgia
KEVIN McCARTHY, California           AL GREEN, Texas
STEVAN PEARCE, New Mexico            EMANUEL CLEAVER, Missouri
BILL POSEY, Florida                  GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK,              KEITH ELLISON, Minnesota
    Pennsylvania                     ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia        JOE DONNELLY, Indiana
BLAINE LUETKEMEYER, Missouri         ANDRE CARSON, Indiana
BILL HUIZENGA, Michigan              JAMES A. HIMES, Connecticut
SEAN P. DUFFY, Wisconsin             GARY C. PETERS, Michigan
NAN A. S. HAYWORTH, New York         JOHN C. CARNEY, Jr., Delaware
JAMES B. RENACCI, Ohio
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio

                   Larry C. Lavender, Chief of Staff
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

DAVID SCHWEIKERT, Arizona, Vice      MAXINE WATERS, California, Ranking 
    Chairman                             Member
PETER T. KING, New York              GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois         STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois               BRAD MILLER, North Carolina
JEB HENSARLING, Texas                CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin
JOHN CAMPBELL, California            ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan       JOE DONNELLY, Indiana
KEVIN McCARTHY, California           ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico            JAMES A. HIMES, Connecticut
BILL POSEY, Florida                  GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK,              AL GREEN, Texas
    Pennsylvania                     KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 14, 2011...............................................     1
Appendix:
    April 14, 2011...............................................    61

                               WITNESSES
                        Thursday, April 14, 2011

Alvarez, Scott G., General Counsel, Board of Governors of the 
  Federal Reserve System.........................................     9
Cross, Meredith, Director, Division of Corporation Finance, U.S. 
  Securities and Exchange Commission (SEC).......................    10
Cunningham, Henry V., Jr., CMB, President, Cunningham and 
  Company, on behalf of the Mortgage Bankers Association (MBA)...    34
Deutsch, Tom, Executive Director, American Securitization Forum 
  (ASF)..........................................................    36
Harnick, Ellen, Senior Policy Counsel, Center for Responsible 
  Lending (CRL)..................................................    43
Hoeffel, J. Christopher, Managing Director, Investcorp 
  International, Inc., on behalf of the CRE Finance Council......    38
Krimminger, Michael H., General Counsel, Federal Deposit 
  Insurance Corporation (FDIC)...................................    11
Lawler, Patrick J., Chief Economist and Associate Director, 
  Office of Policy Analysis and Research, Federal Housing Finance 
  Agency (FHFA)..................................................    17
Ryan, Bob, Acting Assistant Secretary for Housing and FHA 
  Commissioner, Federal Housing Administration (FHA), U.S. 
  Department of Housing and Urban Development (HUD)..............    15
Schneider, Kevin, President and CEO, U.S. Mortgage Insurance of 
  Genworth Financial, on behalf of the Mortgage Insurance 
  Companies of America (MICA)....................................    40
Smith, Bram, Executive Director, Loan Syndications and Trading 
  Association (LSTA).............................................    41
Williams, Julie, First Senior Deputy Comptroller and Chief 
  Counsel, Office of the Comptroller of the Currency (OCC).......    13

                                APPENDIX

Prepared statements:
    Alvarez, Scott G.............................................    62
    Cross, Meredith..............................................    77
    Cunningham, Henry V., Jr.....................................    86
    Deutsch, Tom.................................................   103
    Harnick, Ellen...............................................   208
    Hoeffel, J. Christopher......................................   231
    Krimminger, Michael H........................................   250
    Lawler, Patrick..............................................   263
    Ryan, Bob....................................................   294
    Schneider, Kevin.............................................   298
    Smith, Bram..................................................   309
    Williams, Julie..............................................   326

              Additional Material Submitted for the Record

Garrett, Hon. Scott:
    Written statement of the American Bankers Association (ABA)..   345
    Written statement of the Education Finance Council...........   349
    Written statement of HVP Inc.................................   351
Hinojosa, Hon. Ruben:
    Letter from various undersigned organizations................   355
Posey, Hon. Bill:
    Written responses to questions submitted to Scott G. Alvarez.   357
    Written responses to questions submitted to Meredith Cross...   359
    Written responses to questions submitted to Michael H. 
      Krimminger.................................................   362
    Written responses to questions submitted to Julie Williams...   364
Schneider, Kevin:
    Chart entitled, ``Qualified Insured Loan Performance'' 
      submitted in response to a question from Representative 
      Biggert....................................................   365


                     UNDERSTANDING THE IMPLICATIONS



                    AND CONSEQUENCES OF THE PROPOSED



                         RULE ON RISK RETENTION

                              ----------                              


                        Thursday, April 14, 2011

             U.S. House of Representatives,
                Subcommittee on Capital Markets and
                  Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:02 p.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Schweikert, 
Manzullo, Biggert, Hensarling, Neugebauer, Campbell, Pearce, 
Posey, Hayworth, Hurt, Grimm, Stivers; Sherman, Hinojosa, 
Lynch, Miller of North Carolina, Maloney, Perlmutter, Carson, 
Himes, Peters, Green, and Ellison.
    Ex officio present: Representatives Bachus and Frank.
    Also present: Representative Renacci.
    Chairman Garrett. Good afternoon. This hearing of the 
Subcommittee on Capital Markets and Government Sponsored 
Enterprises will come to order. And without objection, all 
members' opening statements will be made a part of the complete 
record.
    At this time, I yield to myself for the first 5 minutes.
    Today, we will be examining the ongoing rules and rule-
writing of Section 941 of the Dodd-Frank Act. Section 941 of 
Dodd-Frank mandates that our financial regulators craft rules 
requiring entities involved in the securitization to retain a 
certain level of risk of the assets being securitized.
    The intent of this was to better align the incentives among 
the chain of originators, the securitizers, and the investors. 
I have stated numerous times that risk retention, if it is done 
correctly, in theory can be a constructive addition. But I do 
have significant concerns with the rules as currently written 
and the many unanswered questions that they raise.
    Some of my main concerns are not only with the policy 
implications of the rules but also, quite frankly, with the 
process and the manner in which some of the policies were 
included, and the explicit disregard, quite frankly, of 
congressional intent. Section 941(b) of the Dodd-Frank Act 
creates section 15G of the Securities Exchange Act, which 
specifically exempts all assets which are insured or guaranteed 
by the United States or an agency of the United States. The 
rest of the section specifically says that Fannie Mae and 
Freddie Mac are not agencies of the U.S. Government.
    With that said, it is hard for me to see how much more 
explicit this Congress could have been. It was not the intent 
to have the GSEs exempted from the risk retention requirement, 
yet the rule before us today allows for the GSEs to be exempted 
and it does so by claiming that their guarantee functionally 
acts as a formal type of risk retention. Quite frankly, this 
will severely hinder ongoing efforts by the Administration and 
Congress to encourage more private capital in our mortgage 
market and reduce taxpayer risk.
    By a 34-0 unanimous vote last week in this committee, we 
passed legislation that I introduced which would attempt to 
ensure that the government and the private sector are treated 
equally with regard to risk retention. As most of you know if 
you know this committee, over the last several years there have 
not been a lot of committee pieces of legislation that have 
passed out of this committee in a completely unanimous vote 
like this did.
    So in this case, this should be a clear intention to you 
that Congress believes that you need to alter your rule and 
follow the clear intention of Dodd-Frank on this topic. I look 
forward to working with each of you on this to ensure the final 
draft is structured in a way that does not put the private 
market at a disadvantage in the government.
    Another one of my main concerns is the addition of 
servicing standards to the rule. While I agree that there are a 
number of problems that have occurred in the servicing sector, 
I do not believe that unelected bureaucrats, if you will, 
should be attaching unauthorized policy goals on the next train 
leaving town.
    As you all know, I was on the Dodd-Frank conference 
committee. Over 6 days of discussion during the conference, I 
don't remember any time when servicing standards were 
contemplated, much less discussed during that time.
    I certainly cannot find anything in Section 941 authorizing 
the regulators to include servicing standards in the rule. So 
it is Congress' role to examine the issues in the servicing 
industry and make specific policy proposals, not the 
regulators.
    So these two instances--the exemptions of the GSEs and the 
inclusion of servicing standards--highlight my overreaching 
concerns about the manner in which this rule was drafted. In 
one instance, you have Congress specifically directing the 
regulators to do something and they did the opposite; in 
another instance, Congress didn't provide any authority or 
authorization to do something but they did anyway.
    So I hope that you and the heads of the various agencies 
will reverse course on these issues and actually follow the 
letter of the law and the intention of Congress. This is just a 
microcosm of the absurdity, I guess, of trying to delegate over 
300 rules affecting literally millions of people and 
businesses, not to mention the entire U.S. economy, to dozens 
of agencies and then mandating that it is all done in a year. I 
understand that.
    Finally, in addition to this, there are many other 
important issues that Members need to learn about today, like 
the specific ongoing underwriting standards of QRM, how private 
mortgage insurance should factor into the criteria, and also 
the premium capture cash reserve accounts requirements and its 
possible tremendous negative effects on the residential and 
commercial securitization market.
    With that, the rule has a broad impact on so many people, 
our economy, and the recovery, it is critical that we get this 
right. So I hope today's hearing can begin to move us all in 
that direction.
    And with that I yield now to--there he is--the gentleman 
from Massachusetts for--
    Mr. Frank. Thank you. Let me just say preliminarily, the 
ranking member of the subcommittee, the gentlewoman from 
California, Ms. Waters, is at a full committee markup of the 
Judiciary Committee right now on patent reform. That is also 
where Mr. Watt is, so that is a very significant issue and they 
will not be able to be with us because of that.
    I want to talk just a little bit about the context of risk 
retention. The risk retention context is a very important one.
    I believe that one of the most important factors that led 
to the crisis was the ability of people to make loans without 
bearing the risk of nonpayment of that loan; that was 
transformative in both a good way and a bad way. Thirty years 
ago, we had a situation where people who borrowed money were 
paying back the lender, and lenders frisked people pretty good 
before lending them their money. And then, because of liquidity 
outside of the banking system from a variety of sources and 
because of the ability to securitize through computers and 
other ways, we lost that discipline.
    So it is very important that we put it back in the bill. I 
think it is one of the most important things in the 
legislation. And I should note that it does not simply apply to 
residential mortgages; it applies to commercial, to all manner 
of lending.
    And this policy of people making loans without regard for 
the ability of the borrower to repay was a serious problem. So 
we have this legislation, and we did say that with regard to 
residential mortgages we would make an exemption if we could 
have other assurances that these were good loans--that is, the 
fundamental mechanism for making sure that loans are made 
prudently is the loss that a lender will suffer if the borrower 
can't pay it back, and that is the market discipline on the 
lender.
    To the extent that securitization either evolved into this 
or severely attenuates that, we want some substitute. The 
Qualified Residential Mortgage is a substitute for that market 
discipline.
    I want to make a couple of points. First of all, I disagree 
with those who are acting as if all residential loans in the 
future are going to have to come under that Qualified 
Residential Mortgage exception. It no doubt seems that way now. 
Change is hard for people to grasp.
    We have smaller financial institutions that have made 
mortgage loans and kept them in portfolio because they didn't 
want to take the loss that comes when you go and securitize. We 
have some entities--Wells Fargo--that said they will make these 
loans and securitize them with risk retention.
    Risk retention is not meant to stop securitization; it is 
meant to make it more responsible. And a 5 percent number ought 
not to be deterring anybody with responsible policies.
    And there is the FHA. I agree, as the vote made clear last 
week, that we should not be exempting Fannie Mae and Freddie 
Mac through risk retention. I do believe that we have a very 
solid set of safeguards in the FHA, and that we should continue 
to work on, and I hope we will be further legislating on, those 
safeguards, but there is an argument for not having the risk 
retention apply there and I think you can do that in the FHA 
without it.
    But there are, I hope going forward, going to be loans made 
outside of the Qualified Residential Mortgage. Having said 
that, I do believe that the Qualified Residential Mortgage, 
especially in this period when people need it, it is going to 
be very important.
    And I am persuaded by a number of people that 20 percent is 
too high a number. What we are looking for--and we have to look 
at the statistics as to what experience has been, and I think 
it is a very good argument that you don't have to get to 20 
percent.
    It is also the case that there are qualitative things you 
can do with regard to mortgages, some of which we have done, to 
prevent bad mortgages. And that, I think, further gives us some 
assurance.
    I will say, of those things that have been suggested as for 
the safeguards, private mortgage insurance does not seem to me 
to be one of those that can be a relevant factor here. I don't 
think that is going to discourage the bad loans. Insuring 
people against having made bad loan decisions does not seem to 
me to discourage them from making bad loan decisions.
    So I am very pleased with the framework we have created. I 
think it is essential to reintroducing a healthy respect for 
risk into the lending system, not just in mortgages, but 
elsewhere; but I also believe that the arguments that 20 
percent is too high a number are very persuasive and I look 
forward to further work on that.
    Chairman Garrett. I thank the gentleman.
    To the chairman of the full committee, the gentleman from 
Alabama, for 2 minutes?
    Chairman Bachus. I thank the chairman for convening the 
hearing on credit risk retention as mandated by Dodd-Frank.
    Securitization has both benefits and risk. While 
securitization of assets increases liquidity and lowers the 
cost of credit to homeowners, students, consumers, and 
businesses seeking financing, securitization can also create 
moral hazards by allowing originators and securitizers of 
assets to pass the risk of underlying assets on to investors. 
And of course, we certainly saw that in 2008 in a big way.
    Section 941 of Dodd-Frank sought to reduce that moral 
hazard by better aligning the interests of sellers and buyers 
of asset-backed securities, which is a worthy goal. Proponents 
of this approach advocate or are advanced at requiring 
securitizers to retain some skin in the game, which will 
encourage them to take more care in selecting high-quality 
assets.
    For risk retention to be successful, however, the standard 
must not stifle the securitization of loan products, thereby 
raising costs to consumers and cutting down on the availability 
of credit. The proposed release by the regulators on March 
31st, I think recognizes the differences between asset classes, 
collateral, and financing structures and provides needed 
flexibility for securitizers to determine the most appropriate 
form of risk retention.
    I particularly applaud the testimony of the Federal Reserve 
and the OCC, and there is a lot to associate myself with in 
your testimony.
    But as with any proposal that runs several hundred pages, 
there are aspects of the rule that I think raise questions and 
concerns. For example, the regulators have chosen to address 
extraneous issues, which, in my opinion, are beyond the scope 
of Dodd-Frank, including mortgage servicing standards as part 
of the risk retention requirements. Also, the broad exemption 
provided to loans purchased by Fannie and Freddie, I think is 
problematic.
    And I will close by saying this: I would associate myself 
with page seven of the Fed's testimony, where you say, 
``However, unlike the various other types of risk retention 
discussed earlier, which all involve the acquisition of an 
asset by the sponsor, the GSE's risk exposure is generally in 
the form of an unfunded guarantee, which would not satisfy the 
risk retention requirements of the proposed rules.''
    It really seems to be contrary to the intent and would, in 
my mind, unlevel a level playing field. And I know the intent 
of the Treasury, which has been announced, is to crowd in 
private investment in a crowded market, but I think that would 
work in the opposite direction.
    I appreciate your testimony, and I appreciate your thoughts 
on this in approaching today's hearing.
    Chairman Garrett. Does the gentleman yield back?
    Chairman Bachus. Yes.
    Chairman Garrett. Mr. Hinojosa for a liberal 2 minutes?
    Mr. Hinojosa. Chairman Garrett, I ask unanimous consent to 
submit for today's record a letter from several civil rights 
groups opposing the 20 percent downpayment proposed in the risk 
retention rule, including the National Council of La Raza, the 
NAACP, Americans for Financial Reform, and others.
    Chairman Garrett. Without objection, it is so ordered.
    Mr. Hinojosa. I ask unanimous consent. Thank you.
    Mr. Chairman, I appreciate you holding this important and 
timely hearing.
    I want to welcome the witnesses to the subcommittee and I 
look forward to a continued dialogue with your agencies on the 
importance of homeownership to my constituents in South Texas 
along the Texas-Mexico border.
    Mr. Chairman, I am concerned about the risk retention 
proposal we are addressing here today. We must restore sound 
practices in lending, securitization, and loan servicing 
without shutting out creditworthy borrowers.
    However, requiring a minimum 20 percent downpayment for 
Qualified Residential Mortgages might have a negative impact on 
the ability of minority and first-time homebuyers to obtain an 
affordable mortgage and attain the American dream of 
homeownership. Furthermore, additional requirements mandating 
specific loan-to-value ratios might do more harm than good by 
unduly disadvantaging well-qualified borrowers who lack the 
resources necessary for large downpayments.
    Mr. Chairman, whatever we do to address risk retention and 
the definition of Qualified Residential Mortgages, we should 
not allow a proposal by any agency or agencies to move forward 
that would subject minority and first-time homebuyers to the 
same predatory lending that contributed substantially to the 
recent economic crisis. Requiring a 20 percent downpayment 
might have that effect. I hope that today's witnesses have 
taken this concern into consideration as they drafted the 
proposal on credit risk retention.
    Again, I welcome the witnesses, and I yield back the 
remainder of my time.
    Chairman Garrett. The gentleman yields back.
    The gentleman from Arizona, for 1 minute?
    Mr. Schweikert. Thank you, Mr. Chairman. And I know I have 
only 60 seconds here.
    I have actually been looking forward to this hearing. I 
have dozens and dozens of questions and I am sure our panel 
here will hit every single one of them.
    One has to do with the servicing ending up as part of the 
discussion. Being someone who has a great interest in 
impairment servicing, should that be dealt with separately? Is 
the June 10th deadline for particularly comments--is that still 
on target or should that be extended?
    And one of my greatest concerns here in regards to risk 
retention is, ultimately, what are we trying to accomplish? Is 
20 percent the magic number? Is it 10 percent down with private 
mortgage insurance?
    Is it some mechanic within, a strip on the bond, if the 
securitizer is willing to hold certain of the risk? What 
ultimately defines up and down through the market that 
additional guarantee for the final product, particularly on the 
bond side, that we are trying to protect?
    Thank you, Mr. Chairman.
    Chairman Garrett. And the gentleman yields back.
    Mr. Himes for 2 minutes?
    Mr. Himes. Thank you, Mr. Chairman.
    And let me thank the panel for joining us today for what I 
think is a really interesting and important conversation. As I 
reflect on Dodd-Frank, I think the risk retention provision was 
an example of--as a matter of principle--smart public policy. 
This government could have faced a choice of trying to be blunt 
about what securities were too risky to be contemplated, and 
which were not--how the spectrum of risk might--how different 
securities might fall on a spectrum of risk, but we didn't.
    We chose instead to do something very smart, which was to 
say, ``Go out and invent some securitized product that we 
perhaps don't understand, but you will retain some exposure to 
whatever that beast is that you have created. You will eat your 
own cooking, to some extent.'' And that is a very smart 
principle within regulation.
    The challenge, of course, is that these beasts have very, 
very different profiles. Some of them are extraordinarily 
risky, as we learned; some of them are not. Some of them are 
composed of U.S. Treasury debt.
    And so the challenge, of course, for you is to figure out 
what the right level of retention is for different instruments. 
Dodd-Frank contemplated a 5 percent level with some 
flexibility.
    It is really critical, I think, as you undertake your 
work--and you know this, of course--that risk retention not 
require capital levels so high that liquidity will be 
compromised. And that is a very real risk.
    These securities are complicated. They have different 
profiles. Many of the securities under contemplation here were 
far removed from the problems that we watched in the last 3 or 
4 years.
    So I thank you for the work you are doing, and urge you to 
bear in mind that particularly now, in this economy, liquidity 
is essential. I point, in particular, to the CLO market, which 
the Federal Reserve indicated was perhaps a product that didn't 
require 5 percent retention, in which liquidity could be 
damaged if a 5 percent number were used.
    Obviously, there are many, many other examples of this. I 
appreciate the complexity of your task. But as I stand for the 
principle of retention, which I think is absolutely right, I 
urge you to be very mindful that the process not damage 
liquidity, particularly in those instruments which were far 
removed from the problems that this country experienced in the 
last several years.
    And with that, I yield back the balance of my time.
    Chairman Garrett. The gentleman yields back.
    The gentleman from Texas, for 2 minutes?
    Mr. Hensarling. Thank you, Mr. Chairman. I know votes are 
imminent, so I will attempt not to take up the full 2 minutes.
    We all know that the world works off of incentives, and I 
like to have incentives properly aligned, so on the chalkboard, 
the whole risk retention rule certainly has an appeal to it. 
However, a prescriptive rule is not one I have a high level of 
enthusiasm for, and this one in specific I have great, great 
concern for.
    I think it could impede private capital from coming back 
into the market. I fear it does not serve as a caution light 
but perhaps as an absolute stop sign. I am afraid this may be 
one more of the unintended consequences that we find in the 
Dodd-Frank legislation.
    I must admit, as I was peeking and reading some of the 
testimony and some of the documents that have come across my 
desk, any time you get the mortgage bankers, the mortgage 
insurers, the Center for Responsible Lending, and the 
Congressional Black Caucus to agree on something, maybe this 
committee ought to pay a little bit of attention. So certainly, 
that is what I observed, Mr. Chairman.
    Again, they are sounding the alarm and we need to pay 
attention. And I, again, fear that something that looked good 
on the drawing board may not prove so good in practice. And I 
personally am going to be laser-focused on removing all the 
barriers necessary to get private capital to come back into our 
mortgage markets.
    I yield back to the chairman.
    Chairman Garrett. The gentleman from Texas yields back.
    The gentleman from Texas referenced votes. I think we are 
going to try to--the recommendation is to plow right through 
this, but before we do that, we will hear from the gentleman, 
Mr. Lynch, for 2 minutes.
    Mr. Lynch. Thank you, Mr. Chairman.
    I would like to thank our witnesses as well for appearing 
before us and helping the committee with this work. The risk 
retention rule in Section 941(b), if properly designed and 
administered, will play a critical role for the mortgage 
industry and will be incredibly important to the members of 
this committee and to regulators to get right in order to avoid 
the recklessness that we saw in the last financial crisis as 
well as to try to balance out the need for greater credit 
availability.
    The joint rule on the securitization of asset-backed 
security, which we all know played a central role in the recent 
financial crisis--Dodd-Frank requires banks or securitizers to 
keep some skin in the game for the loans that they are 
originating and bundling and selling to investors. Under the 
proposed rules, securitizers must retain a 5 percent portion of 
the credit risk for assets that they decide to sell to 
investors.
    There is an important exemption, of course, and the 
regulators are able to determine what the exemption looks like. 
Now, my friend, the gentleman from Texas, has talked about the 
proposed rule to include a requirement of a 20 percent 
downpayment and the impact that that might have on credit 
availability to people in his district and mine as well, and 
there is also a provision here that it would require anyone 
from qualifying--excuse me. It would prohibit someone from 
qualifying if they had any delinquency or late payment over 60 
days in the last 2 years.
    That would probably eliminate a large portion of people who 
might otherwise qualify for a mortgage. And I think with the 
abundance of information we have on credit history, we should 
be able to come up with a more fine-tuned approach than simply 
saying someone missed a--was late on a cable bill or a utility 
bill for 60 days and therefore are ineligible for credit.
    I am concerned about how this might affect the 
affordability of a 30-year mortgage. Congress has gone to great 
lengths to promote mortgage finance over the greater part of 
the last century. The GSEs were created because additional 
liquidity was needed in order to--for the market to provide 
long-term fixed-rate mortgages, and a 30-year fixed-rate 
mortgage was not affordable even to families with stable 
incomes.
    As the rule is currently written, however, I am not sure 
the 30-year fixed-rate mortgage, an essential and valued 
product to the American homebuyer, will still be available 
except to the very wealthy. I look forward to hearing from our 
witnesses and I yield back the balance of my time.
    Thank you, Mr. Chairman.
    Chairman Garrett. The gentleman yields back.
    Mr. Stivers, for 1 minute?
    Mr. Stivers. Thank you, Mr. Chairman, for calling this 
hearing on the proposed risk retention rules. And obviously, we 
all agree with the concept of risk retention. I think skin in 
the game makes a lot of sense.
    I do have a lot of folks in my district who are related to 
the automobile industry. I have a Honda plant in my district 
that employs about 4,000 people and they rely on the asset-
backed securities market for critical access to capital and 
ensuring that they can produce and sell cars. And I am a little 
concerned about the narrow crafting of the qualified automobile 
loan as well, and I would like to ask some questions about that 
a little later.
    I think there have been a lot of questions about the QRM 
that I am anxious to ask some questions about going forward.
    I look forward to hearing from all the witnesses. I want to 
thank the chairman for allowing me a little time, and I yield 
back the balance of my time.
    Chairman Garrett. The gentleman yields back.
    And with that, we have just been advised of a slightly 
different vote sequence following this, so we will begin the 
sequence of panelists.
    Without objection, all of your written statements will be 
made a part of the formal record, and you are now recognized 
for 5 minutes.
    Mr. Alvarez?

   STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF 
            GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Alvarez. Thank you, Mr. Chairman.
    Thank you, Chairman Garret, Ranking Member Frank, and 
members of the subcommittee. I appreciate the opportunity to 
discuss the implementation of the risk retention requirements 
of Section 941 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act.
    This statutory provision generally requires securitizers to 
retain some of the credit risk of the assets they securitize, 
often referred to as ``keeping some skin in the game.'' The 
concept behind risk retention and securitization is that it 
promotes incentives for loan securitizers and originators to 
maintain appropriate underwriting standards and to monitor the 
credit quality of assets that they securitize.
    By better aligning the incentives of securitizers with the 
incentives of investors in this way, risk retention 
requirements foster more liquid markets for loans, which 
increases the availability of credit to consumers and 
businesses and lowers the cost to borrowers. The Federal 
Reserve has joined with the other Federal agencies here today 
to invite the public to comment on a proposed rule that would 
implement the risk retention requirements of the Dodd-Frank 
Act.
    In developing the proposal, the Federal Reserve and the 
other agencies carefully considered best market practices for 
risk retention used for various types of assets and various 
types of securitization structures. We also took into account 
how well these forms of risk retention performed during the 
recent market crisis.
    The proposal includes a menu of options for retaining risk 
that allows securitizers to tailor securitization transactions 
according to market practice while at the same time meeting the 
statutory requirements to retain risk. This should encourage 
securitizers to closely screen and control the credit quality 
of the assets they securitize without unduly disrupting 
markets.
    As provided in the Dodd-Frank Act, the agency proposal 
includes an exemption from the risk retention requirement for 
the securitization of ``Qualified Residential Mortgages,'' or 
``QRMs.'' In keeping with the statute, the proposal is based on 
standards that are most associated with lower risk of default 
on residential mortgages, including conservative debt-to-income 
ratios, strong credit history, and a significant downpayment 
requirement for purchase loans.
    The statute contemplates that strong underwriting standards 
offset allowing the securitization to proceed without any risk 
retention requirement on the sponsor or originator. In addition 
to lowering the default risk, this approach is designed to 
improve access to and lower the cost of credit for creditworthy 
consumers.
    A narrow QRM definition should improve access to credit and 
lower borrower cost by encouraging a deep and liquid market for 
residential mortgages that do not meet the definition of a QRM 
and fostering securitization of those loans. On the other hand, 
a broader definition of QRM that encompasses a much larger 
portion of the residential mortgage market could diminish 
access to credit for creditworthy borrowers because the small 
segment of the market left outside a broad definition of QRM 
may not be able to attract sufficient funding from the markets 
to make it practical for lenders to make the loans and for 
those loans to be securitized.
    The risk retention requirements of the Dodd-Frank Act raise 
important and complex issues. The Federal Reserve and the other 
agencies here today look forward to receiving comments on the 
proposed risk retention rules from consumers, borrowers, 
lenders, securitizers, and all others who are interested in the 
proposal. We will weigh those comments carefully before acting 
on the final rule.
    I thank you very much for your attention and am happy to 
answer any questions.
    [The prepared statement of Mr. Alvarez can be found on page 
62 of the appendix.]
    Chairman Garrett. And I thank you.
    Ms. Cross?

STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF CORPORATION 
     FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION (SEC)

    Ms. Cross. Chairman Garrett, Ranking Member Frank, and 
members of the subcommittee, I am pleased to testify on behalf 
of the Commission on the topic of risk retention and 
securitization. On March 30, 2011, the Commission joined its 
fellow regulators in issuing proposals to implement the risk 
retention requirements in Section 941(b) of the Dodd-Frank Act.
    The proposal would permit a sponsor to choose from a menu 
of four risk retention options and also includes transaction-
specific options for three asset classes. A sponsor also would 
be required to establish a cash reserve account in certain 
cases.
    The proposal would permit the 100 percent guarantee 
provided by Fannie Mae or Freddie Mac to satisfy their risk 
retention obligations, but only while they are operating under 
conservatorship or receivership with capital support from the 
United States. The proposal provides an exemption for ABS 
backed by Qualified Residential Mortgages as well as for ABS 
backed by commercial loans, commercial mortgages, or automobile 
loans that meet certain underwriting standards. It also would 
exempt certain other securitizations consistent with the Act.
    The proposal comes from many months of collaboration and 
cooperation. The agencies have included numerous requests for 
comment and we look forward to considering the comments as we 
work together to finalize the rules.
    In addition to risk retention, the Dodd-Frank Act has other 
provisions that require Commission rulemaking for ABS and I 
would like to mention them briefly today. For example, Section 
943 requires the Commission to adopt disclosure rules on the 
use of representations and warranties, which the Commission 
finalized in January. Also in January, the Commission adopted 
rules implementing Section 945, requiring ABS issuers in 
registered transactions to review the assets underlying the ABS 
and disclose the nature of the review.
    Further, Section 942(a) eliminated the provision that 
allowed ABS issuers to automatically stop reporting under the 
Exchange Act and granted the Commission authority to issue 
rules allowing ABS issuers to stop reporting. In January, the 
Commission proposed rules to permit suspension of reporting in 
certain limited cases.
    In addition to these Dodd-Frank Act ABS rulemakings, in 
April 2010, prior to passage of the Act, the Commission 
proposed substantial enhancements to the Commission's ABS 
rules. Importantly, the Commission's April 2010 proposal would 
change the test that ABS issuers must satisfy to qualify for 
shelf registration, which currently requires an investment-
grade rating.
    Two of the proposed new requirements--a 5 percent risk 
retention requirement and an undertaking to continue 
reporting--are covered by the Dodd-Frank Act. Before finalizing 
that part of the April 2010 proposal the staff will develop 
recommendations designed to harmonize the rules with rules 
adopted under the Act.
    The proposal also would require disclosure of asset level 
data for ABS. Section 942(b) directs the Commission to require 
asset level data so the staff is considering this requirement 
as we prepare recommendations for the Commission.
    Other important aspects of the proposal include providing 
investors more time to consider important information about the 
particular ABS offering, requiring issuers to file a computer 
program of the cash flow waterfall provisions, and requiring 
issuers to undertake to provide information to investors in 
certain exempt offerings. We are reviewing the comments 
received on the April 2010 proposal, and as I noted, we will 
work to harmonize the rules with the ABS rules required by the 
Dodd-Frank Act.
    Thank you for inviting me to appear before you today. I 
would be happy to answer any questions.
    [The prepared statement of Ms. Cross can be found on page 
77 of the appendix.]
    Chairman Garrett. I thank you very much.
    Mr. Krimminger?

 STATEMENT OF MICHAEL H. KRIMMINGER, GENERAL COUNSEL, FEDERAL 
              DEPOSIT INSURANCE CORPORATION (FDIC)

    Mr. Krimminger. Chairman Garrett, Ranking Member Frank, and 
members of the subcommittee, I appreciate the opportunity to 
testify on behalf of the Federal Deposit Insurance Corporation 
on the interagency proposal to implement the risk retention 
requirements of Section 941 of the Dodd-Frank Act. The goal of 
the interagency proposal is to reestablish a sustainable 
private securitization market that will once again be an 
important source of liquidity for affordable credit.
    In fashioning new rules for the securitization market, the 
FDIC and the other agencies seek to incorporate the lessons 
learned from the financial crisis. The proposed rule 
implemented in Section 941 addresses a key driver of the 
financial crisis, the misaligned economic incentives within the 
securitization process.
    Just over 2 weeks ago, the FDIC and the other designated 
agencies approved for publication a notice of proposed 
rulemaking to implement Section 941. As specified in the Dodd-
Frank Act, the proposal requires, as a general rule, that 
securitizers retain not less than 5 percent of the credit risk 
of the securitized assets.
    Requiring securitizers to have real skin in the game will 
align their interests with the interests of investors, 
encourage better underwriting, and promote long-term 
sustainable lending. We believe that a strong and vibrant 
securitization market utilizing a 5 percent risk retention 
requirement will best promote sustainable market financing.
    Under the proposal, securitizers will be able to pick from 
a number of options to achieve this 5 percent risk exposure. 
These options reflect existing market practices and are 
designed to provide a large degree of flexibility to market 
participants in structuring transactions.
    At the same time, the proposal will prevent securitizers 
from gaming the risk retention requirement by taking all of 
their profits up front. To prevent this they will be required 
to hold their upfront profits in a premium capture reserve 
account which will be used to pay for asset losses before the 
losses are allocated to the other investors in the transaction. 
The premium capture reserve account complements risk retention 
by ensuring that a securitizer's interests remain aligned with 
the underlying performance and quality of assets.
    Section 941 directs the agencies to create an exemption for 
certain high-quality home mortgages, known as Qualified 
Residential Mortgages or QRMs. The law requires the agencies to 
base their standards for QRMs on historical loan performance 
data.
    To meet this requirement, the proposed rule includes 
underwriting and product features which, from the data 
available to the agencies, demonstrated a strong record for 
reducing the risk of default. Those features include 
verification and documentation of income, past borrower 
performance, a prudent debt-to-income ratio, elimination of 
payment shock features, maximum loan-to-value ratios, a minimum 
downpayment requirement, and mortgage servicing standards. Many 
of these features were ignored during the housing boom and the 
consequences were high delinquency rates and declining house 
prices.
    Many people have expressed concern about the impact of the 
QRM standard on access to affordable mortgages, particularly 
for low- and moderate-income borrowers. The FDIC shares these 
concerns.
    The FDIC and the other agencies want to strike the right 
balance in the rule to ensure that low- and moderate-income 
borrowers have access to affordable mortgage credit. We look 
forward to receiving comments on the impact of the QRM 
standards on these borrowers. We would also welcome comments on 
whether the unique needs of low- and moderate-income borrowers 
can be met through FHA programs and downpayment assistance 
programs.
    It is important to note that the QRM standards are designed 
to facilitate a vibrant and liquid secondary market for non-QRM 
mortgages. The agencies anticipate that non-QRM mortgages will 
constitute a substantial majority of all mortgages. This should 
facilitate a deep and liquid competitive market that makes 
credit available for non-QRM borrowers at reasonable pricing.
    Moreover, because risk retention was already built into 
most securitizations, the agencies believe any cost increase 
associated with the new risk retention requirements will be 
nominal.
    Continued turmoil in the housing market caused by 
inadequate and poor quality servicing underscores the need to 
make sure that future securitization agreements include 
incentives for servicers to mitigate losses when loans become 
distressed. Servicing standards must also provide for a proper 
alignment of servicing incentives with the interests of 
investors and must address conflicts of interest.
    The servicing standards in the QRM proposal address many of 
the most significant servicing issues. For example, the 
servicing standards require that there will be financial 
incentives for servicers to consider options other than 
foreclosure when those options preserve homeownership and 
maximize value for investors.
    Thank you again for the opportunity to testify. I will be 
happy to answer your questions.
    [The prepared statement of Mr. Krimminger can be found on 
page 250 of the appendix.]
    Chairman Garrett. I thank you.
    And I think we have time for one more witness and then the 
votes have been called. I would just advise the rest of the 
members of the committee that after your testimony we will take 
a recess, vote on the two bills that we have, and then come 
right back for the last two.
    Ms. Williams?

 STATEMENT OF JULIE WILLIAMS, FIRST SENIOR DEPUTY COMPTROLLER 
 AND CHIEF COUNSEL, OFFICE OF THE COMPTROLLER OF THE CURRENCY 
                             (OCC)

    Ms. Williams. Chairman Garrett, Ranking Member Frank, and 
members of the subcommittee, I appreciate the opportunity to 
testify on behalf of the Office of the Comptroller of the 
Currency this afternoon regarding the interagency proposal to 
implement Section 941 of the Dodd-Frank Act on risk retention 
in asset-backed securitization.
    The agencies' risk retention proposal is designed to carry 
out the congressional direction in Section 941 that 
securitizers have, in effect, skin in the game to incent them 
to exercise diligence regarding the quality of the loans that 
they securitize. Reflecting that premise, the exemptions from 
risk retention that are provided by the proposal are 
conservative and focus on demonstrably high-quality loans.
    In order to facilitate robust securitization markets that 
would include risk retention, the proposal provides flexibility 
with several options for how the risk retention requirement may 
be satisfied. We are very cognizant that implementing the 
statutory risk retention requirements presents complex issues 
with multiple public policy implications for competition, 
credit quality, credit access, and credit costs. Achieving the 
right balance will be very challenging.
    For that reason, the OCC has stressed the importance of the 
comment process to help the agencies get that balance right. My 
written testimony summarized the terms and features of the 
proposed rule and highlights three particular issues of note, 
which I will touch on here.
    The first issue concerns the proposed criteria for 
Qualified Residential Mortgages, QRMs, that are exempt from any 
risk retention requirements. The agencies have proposed 
conservative underwriting standards to define QRMs. These 
standards were developed through evaluation of available 
historical loan performance data as directed by the statute.
    The preamble discusses several possible alternatives to 
this approach, however. One would be to permit the use of 
private mortgage insurance for loans with LTVs higher than the 
80 percent level specified in the proposed rule.
    The due diligence procedures and underwriting standards 
imposed by private mortgage insurers could be viewed as 
consistent with the goals of Section 941 to incent careful 
underwriting of securitized assets. However, to include private 
mortgage insurance in the QRM criteria, Congress required the 
agencies to determine that the presence of private mortgage 
insurance lowers the risk of default, not that it reduces the 
ultimate amount of loss. Thus, we will be interested in the 
data that commenters can provide that addresses that point.
    The second issue I note is the question of whether the QRM 
criteria should include mortgage servicing standards. The 
proposed rule requires inclusion of terms in the mortgage 
transaction documents under which the creditor commits to have 
specified servicing policies and procedures designed to 
mitigate the risk of default. The agencies have included 
numerous requests for comment about the approach to servicing 
standards contained in the proposed rule.
    We believe there is a need for comprehensive and uniform 
mortgage servicing standards that apply not just to high-
quality securitized loans but to all facets of servicing, from 
loan closing to payoff or foreclosure. In our view, mortgage 
servicing standards should apply uniformly to all mortgage 
servicers and provide the same standards for consumers 
regardless of whether a mortgage has been securitized.
    To further this effort and discussion, the OCC developed a 
framework for comprehensive mortgage servicing standards. Other 
agencies have contributed their ideas and there is now under 
way an interagency effort to develop a set of comprehensive 
nationally applicable mortgage servicing standards.
    The third issue I note is the treatment of Fannie Mae and 
Freddie Mac and the agencies' proposal to recognize as a 
permissible form of risk retention the Enterprises' 100 percent 
guarantee of principal and interest payments on the MBS 
sponsored by the Enterprises for such time as the Enterprises 
are in their current conservatorship. Through this guarantee, 
the Enterprises effectively retain 100 percent of the credit 
risk in the transaction.
    Treatment of the Enterprises presents a very difficult 
combination of issues. Imposition of a risk retention 
requirement under the regulation could produce results that 
seem contrary to current U.S. Government policies to shrink the 
assets of the Enterprises and manage the risk. On the other 
hand, absence of a risk retention requirement contributes to 
their distinct status.
    Congress has begun to consider fundamental questions about 
that status and the future structure and role of the 
Enterprises, and the agencies have committed to revisit and 
change the retention approach for the Enterprises as 
appropriate when those changes occur. I appreciate the 
opportunity to appear before the subcommittee this afternoon, 
and I look forward to addressing your questions. Thank you.
    [The prepared statement of Ms. Williams can be found on 
page 326 of the appendix.]
    Chairman Garrett. Thank you, Ms. Williams.
    And Mr. Ryan and Mr. Lawler, we will have to wait for your 
testimony.
    The committee will stand in recess. We will come back right 
after the second vote, which should be fairly shortly.
    [recess]
    Chairman Garrett. The hearing will come back to order. If 
we can close the two back doors, that would be great.
    And we will start where we left off. Now, we just gave you 
an extra 30 minutes to go over your notes, if you wanted to 
make any other changes, Mr. Ryan, and--
    Mr. Ryan. I am going to change it on the fly here. Don't 
worry.
    Chairman Garrett. There you go. The gentleman is 
recognized.
    Mr. Ryan. Thank you.
    Chairman Garrett. Thank you.

 STATEMENT OF BOB RYAN, ACTING ASSISTANT SECRETARY FOR HOUSING 
  AND FHA COMMISSIONER, FEDERAL HOUSING ADMINISTRATION (FHA), 
     U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT (HUD)

    Mr. Ryan. Chairman Garrett, Ranking Member Frank, and 
members of the subcommittee, thank you for the opportunity to 
testify today. As this committee knows, during the economic 
crisis, bundling and packaging mortgages to sell on Wall Street 
not only fed the housing boom but also led to the erosion of 
lending standards that deepened the housing bust.
    In response, the Dodd-Frank Wall Street Reform law required 
that securitizers and originators have skin in the game, to 
retain at least 5 percent of the credit risk. That is the goal 
of this rule.
    Today, I am here to speak to the part of the rule, QRM, 
that seeks to define the safe mortgage which would not be 
subject to risk retention requirements because the risk of 
default is low. Getting this definition right is critical. Too 
wide a definition could impede the rule's ability to build 
market confidence in securitization; too narrow a definition 
could significantly raise the cost of mortgage credit and 
reduce its availability to American families.
    As such, with this proposed rule we sought to balance the 
need for strong, clear underwriting standards and the 
continuing need to provide sustainable homeownership 
opportunities for responsible families. Indeed, we only need to 
look at this economic crisis to understand that good 
underwriting is absolutely essential--that is, taking into 
account the borrower's capacity to repay a loan, their credit 
experience, the value of the property being financed, and the 
type of mortgage products that they are purchasing. Each of 
these components is critical to ensuring that responsible 
borrowers receive sustainable mortgages.
    Mark Zandi, of Moody's Analytics, recently did a comparison 
of subprime loans originated at the height of the housing 
bubble to 30-year fixed-rates, fully amortizing with full 
documentation on owner-occupied properties whose borrowers have 
prime credit scores. He found that subprime loans performed 2 
or 3 times worse. Stated income documentation loans performed 3 
times worse. And negatively- amortizing ARMs performed 3 to 4 
times worse than mortgages with stronger underwriting 
standards.
    And at FHA we stuck to the basics during the housing boom, 
with 30-year fixed-rates, traditional products, and strong 
underwriting requirements. At the same time, FHA has a long, 
successful history of loans with low downpayments.
    This is not to suggest that FHA was immune to the pain that 
this housing crisis caused. This is why we have pressed forward 
with the most sweeping combination of reforms to credit policy, 
to risk management, to lender enforcement, to consumer 
protection in the agency's history.
    As stated, the proposed rule is designed to create a class 
of loans with a lower likelihood of default. Much of the debate 
has focused on the appropriate LTV ratio. While there is no 
question that larger downpayment correlates with better loan 
performance, downpayment alone tell part of the story, as 
indicated by both Zandi's findings and FHA's experience.
    That is why the proposed rule includes, among other things, 
two alternatives. The first would require a 20 percent 
downpayment, while the alternative considers a 10 percent 
downpayment with the inclusion of credit enhancements.
    Because the 10 percent alternative in this rule has the 
potential to minimize risk while enabling a large share of 
those who would otherwise be unable to access homeownership to 
do so in a safe and responsible way, we believe it deserves 
serious consideration and we look forward to those analyses. 
Toward that end, the proposed rule includes a number of 
questions. We look forward to receiving feedback on these 
issues.
    Answering these challenging questions will help us to 
strike the right balance between strong underwriting and 
ensuring that responsible borrowers have access to affordable 
products. Determining the appropriate balance is at the heart 
of our efforts, not only at the FHA and HUD but across the 
Administration.
    Thank you for the opportunity to testify today and I look 
forward to your questions.
    [The prepared statement of Mr. Ryan can be found on page 
294 of the appendix.]
    Chairman Garrett. Thank you, Mr. Ryan.
    Mr. Lawler, please?

 STATEMENT OF PATRICK J. LAWLER, CHIEF ECONOMIST AND ASSOCIATE 
   DIRECTOR, OFFICE OF POLICY ANALYSIS AND RESEARCH, FEDERAL 
                 HOUSING FINANCE AGENCY (FHFA)

    Mr. Lawler. Thank you very much, Mr. Chairman, Ranking 
Member Frank, and members of the subcommittee. Thanks for the 
opportunity to testify on this rule.
    I am going to focus on two areas that received a lot of 
attention by the agencies and have also been the subject of 
early public commentary: one, the tightness of the underwriting 
standards for the QRM exemption, especially the required 
downpayment; and two, the special risk retention rules proposed 
for Fannie Mae and Freddie Mac.
    For the QRM definition, the Act directs the agencies to 
take into consideration those underwriting and product features 
that historical loan performance data indicates results in a 
lower risk of default. We did.
    FHFA contributed by examining Fannie Mae and Freddie Mac 
acquisitions that were originated from 1997 to 2009. The 
evidence from these data and a host of other sources shows that 
LTV is one of the best indicators of risk.
    We are proposing that the QRM definition include home 
purchase loans with at least 20 percent downpayment. Lowering 
that to 10 percent would have increased the share of qualifying 
Enterprise loans originated in 2009 by just 5 percentage 
points, from 27 percent to 32 percent.
    The additional loans would be much riskier, though. Their 
serious delinquency rates were consistently 2 to 2\1/2\ times 
higher than the rates for QRM loans. Because these are 
Enterprise loans, virtually loans of LTVs above 80 percent had 
mortgage insurance, so allowing higher LTV loans only if they 
had mortgage insurance would not have improved the results.
    Concerns have been raised about the impact this standard 
would have on the availability or cost of finance for 
homebuyers who are unable to put 20 percent of the purchase 
price down. We are going to receive a lot of comments on this 
and we will consider them carefully.
    But I want to be clear that the proposed rule was not 
designed to prohibit high LTV loans. It is designed to 
encourage the production of good quality rather than bad 
quality high LTV loans. The rule could affect interest rates on 
non-QRM loans, but only to the extent they are not eligible for 
GSE or Ginnie Mae securities, and only to the extent that the 
rules retention requirements exceed what securities investors 
will require anyway.
    In evaluating the potential impact of risk retention it is 
important to distinguish between the effect of existing risk-
based pricing and the effects that might be caused by risk 
retention. Significant differences in rates based on credit 
risk already exist today.
    In considering how much risk retention might add to 
borrowers' costs, it is well to keep in mind that interest 
rates on jumbo loans, which do not currently have any serious 
securitization options, QRM or non-QRM, available--those rates 
have been about 60 basis points above those on the largest 
loans available for securitization through Fannie Mae or 
Freddie Mac. In effect, that spread is currently the cost of 
not being able to securitize any portion of those loans. It 
seems reasonable to anticipate that in a market environment 
that is receptive to private label securities, the effect of 
risk retention on mortgage rates would be much smaller than 60 
basis points because risk retention would only prevent lenders 
from securitizing 5 percent of their loans.
    Although the Act authorizes the agencies to make exemptions 
separate and apart from the statutory exemption that applies to 
Ginnie Mae securities, the NPR does not exempt the Enterprises 
from the risk retention requirements. Rather, it recognizes 
that the Enterprises currently retain 100 percent of the credit 
risk on their guaranteed MBS, which is the maximum possible and 
far exceed the 5 percent retention required by Section 941. 
Therefore, the proposed rule would deem the Enterprises' 
security guarantees to qualify as a satisfactory form of risk 
retention.
    Retention of 5 percent of the securities issued would not 
result in a greater alignment of Enterprise interests with 
those of investors, and it would be inconsistent with the 
Enterprises' agreements with Treasury that require a 10 percent 
per year wind-down in mortgage assets held for investment. 
Simply excluding assets held for the purpose of meeting the 
risk retention rule from calculations to determine whether the 
Enterprises have met their portfolio reduction requirements 
would prevent forced sales of other assets or violations of the 
agreements but it would not address the purpose of these asset 
reduction provisions that are in the agreements with Treasury.
    And the purpose of those was to reduce the interest rate 
and operational risks associated with these portfolios for the 
benefit of taxpayers. Nor does it seem likely that requiring 
the Enterprises to hold 5 percent of their newly issued 
securities would encourage any private capital to enter the 
market to any significant degree. The added Enterprise costs 
would only be a few basis points.
    There are more efficient and effective means to reduce the 
market share of the Enterprises without unnecessarily 
increasing taxpayer risk. Congress, the Administration, and 
FHFA have been considering a number of these.
    In conservatorship, the Enterprises' underwriting standards 
have been strengthened and several price increases have helped 
to better align pricing with risk. FHFA will continue to review 
further changes along these lines and we hope to continue to 
work with Congress on evaluating legislative approaches to 
encourage greater private sector participation.
    Thank you, and I would be happy to answer questions.
    [The prepared statement of Mr. Lawler can be found on page 
263 of the appendix.]
    Chairman Garrett. I thank you, Mr. Lawler.
    And I thank the entire panel for their testimony as well. 
So I will begin with questioning, and maybe I will take it from 
where Mr. Lawler left off, but I will open this up to the 
entire panel.
    With regard to the QRM, if you have a security that falls 
outside of the purview of a QRM, then you have to have retained 
the 5 percent risk. And if you retain the additional 5 percent 
risk, what has to happen if you are a company, is then you have 
to post additional capital.
    What you are alluding to here, and Director DeMarco was 
saying as well, was that if you do that, that is an added cost 
to a company to retain that capital. Your solution in the 
proposed rule to do this is that the GSEs do not have to retain 
that, and the idea here, as I understand what you are saying, 
is that the fact that it is guaranteed by all of us, the 
taxpayers, that basically is enough to cover the 5 percent 
retention or the capital requirement there.
    Now, you heard my comments before that we have a problem 
with that because we see that potentially, it would have the 
effect of at least pushing some--perhaps, Mr. Lawler will 
disagree as to the percentage--but it would provide an 
impediment to the private market coming back into the 
marketplace. Why? Because if I have to retain 5 percent over 
here, why should I do that if I know the GSEs don't have to do 
that? So, it is easier just to still go into the GSEs.
    So there is the rub, right? There is the problem with this.
    We had the legislation that we talked about--or I talked 
about earlier in order to try to address that, basically to do 
what the original congressional intent was, which would say no 
exemption for it, but I understand the problem here. This is 
what Mr. DeMarco was also saying, that effectively you could 
put a burden on the other cross purpose, which is to wind down 
the portfolios.
    I will digress on there for just 10 seconds as--maybe 
because if the portfolios are this big now and they have to 
continuously shrink down over a period of time, a segment of 
that market could be segmented out and said, this is the 
segment that is going to be ideally for the 5 percent retention 
requirements. Now, I understand that--I guess, Mr. Lawler, 
maybe you said this, that may then force a sale of some assets 
that you don't want to sell right now because the portfolio has 
to come down, so that is one problem.
    So if that is not the solution to it--and I know what you 
are saying as far as some of the other underwriting criteria 
that you are already trying to do over there--are there 
additional solutions to this problem that we haven't thought 
of, raising other costs, raising G fees, or something else on 
top of this? Would that be a solution to try to proverbial--set 
the proverbial level playing field that we are always trying to 
get to, which we never get to?
    I guess I will start with Mr. Lawler, but I would 
appreciate everyone's two cents on this.
    Mr. Lawler. I definitely think there are alternative means. 
The risk retention rule is designed to align the interests of 
investors and originators and securitizers so that they are all 
concerned about making loans that are too risky since there is 
skin in the game. The Enterprises already have those interests 
aligned in that they are taking all of the risks, and we can't 
improve on that.
    But the concern that you have about the private sector 
getting a chance to move in is a concern that we share. It is 
not unique to the risk retention rule. If the risk retention 
rules will add a few basis points of cost the difference in 
cost for Fannie and Freddie as opposed to private--potential 
private entrance is much bigger than that.
    And to address that, we need to consider some of the other 
means that I know that you are considering, which include 
pricing, could include other underwriting standards for Fannie 
Mae and Freddie Mac, could include loan limits, could include 
risk sharing. There is quite a wide variety of things we could 
do that would shrink the GSEs' share over time, so I think we 
had better address that.
    Chairman Garrett. Okay.
    My time is going quickly and I have a bunch more questions 
on this. Can you just run down the panel?
    Mr. Ryan. Let me add, I think this is a very challenging 
situation. There is no question that there are a couple of 
purposes. On the risk retention, they do put their security on 
the balance sheets. You are not changing the credit risk; you 
are just adding interest rate risk. That doesn't necessarily 
accomplish the objective.
    I think that they are separable. We can address the 
shrinkage of the GSE footprint. We have said so in the 
Administration's work plan, housing reform plan. We can 
certainly go after greater credit enhancement through either 
the mortgage insurance companies, through other securitization 
exercises to reduce the exposure to the credit risk that the 
GSEs have. You do have the loan limits as well to start to get 
at that.
    But it is definitely a complex and challenging issue and 
that we are, again--I think all of them will be looking forward 
to comment on.
    Ms. Williams. Mr. Chairman, I think there would be options 
along the lines of what has been described. The thing that is 
very tricky here is the unintended consequences of some of the 
compensating options that might be suggested. So I think you 
have raised some good questions for us to be thinking about.
    Chairman Garrett. Thank you.
    Mr. Krimminger?
    Mr. Krimminger. Mr. Chairman, we certainly share some of 
the concerns that have been expressed. So we primarily, in 
looking at this from an interagency working group, were 
seeking, giving the fragility of the housing market, to 
essentially not try to impair, if you will, the current GSE 
housing market and just basically leave the situation unchanged 
to defer to Congress on how Congress would wish to deal with 
the GSEs going forward. That was the primary motivation.
    Chairman Garrett. Okay. We would just argue that they 
didn't because we didn't want the exemption there, but--
    Ms. Cross. We at the Commission shared your concerns about 
the treatment of the GSEs. I would note from the SEC's special 
mandate here, which is investor protection, there isn't 
additional investor protection that would come above the 100 
percent guarantee from some more risk retention, so from that 
standpoint, it is--we were fine with this approach but were 
concerned about the impact of the special treatment.
    Chairman Garrett. Mr. Alvarez?
    Mr. Alvarez. The Federal Reserve has long had concerns 
about the GSEs and their place in the market, but the 
advantages GSEs have in the market I don't think will come from 
a QRM definition, whether they are in or out of QRM; they come 
from their special status, and that is something Congress will 
have to address and we will revisit and change our rules in 
accordance to that.
    Chairman Garrett. The gentleman from Massachusetts?
    Mr. Frank. I want to begin by reference to the servicing 
requirements, because I am all for, and I know there has been 
an argument that this somehow violates the intent of Congress. 
And people will argue about the intent of Congress. I would say 
people have a right, obviously, to vote however they want, but 
people who consistently vote against a bill are rarely 
considered the most authoritative interpreters of its intent 
since they wished it had never been anything.
    I don't recall that there was any particular intent in 
Congress one way or the other. We spent a considerable amount 
of time on this. I have checked; we didn't discuss the 
servicing one way or the other.
    I do agree, for instance, with the Center for Responsible 
Lending that the problems with servicing have contributed to 
the problem and I think it is entirely appropriate to put good 
servicing standards in here. I think they do help keep the loan 
from defaulting if done properly, and I hope that this will be 
done, that servicing standards will be applied everywhere we 
can, including in ways that will get to the non-banks.
    So I am all for including the servicing standards here, and 
people can be for that or against it, but invoking a 
nonexistent congressional intent on the issue I don't think 
makes a great deal of sense.
    Second, on the GSEs--and I don't want the GSE issues to 
overcome the most important question today, which is, is 20 
percent too high, and if it is, what is the right number? I 
would say this to Mr. Lawler, here congressional intent was 
very clear: We ought to be covered. The only argument I see 
against it is that it will make it harder for you to reduce the 
portfolio, and the answer is we can deal with that with 
exemptions.
    I have to say, I did--I think your argument is a little 
inconsistent when you say on page 9, if we retain the 5 percent 
this would not address the purpose, which was to reduce the 
size of the Enterprises' retained portfolios to limit taxpayer 
risks. Well, you can't tell me that you are already at 100 
percent risk on the one hand but that the 5 percent would limit 
your--would further increase your risk.
    It has to be one or the other. If you are already covered, 
then the 5 percent can't--how does that add to your risk?
    Mr. Lawler. The reference there was to the agreements with 
the Treasury.
    Mr. Frank. I understand that, but purpose, you said, was--
all right. We will ask Treasury to--
    Mr. Lawler. The purpose of--
    Mr. Frank. Let me ask you this: If Treasury said it was 
okay, would you be all right with it? Is that your problem? We 
will talk to Treasury--
    Mr. Lawler. We shared the Treasury's interest--
    Mr. Frank. Okay, then don't use them. If you want to 
independently make the argument, don't hide behind them.
    Let me just say that we have had a serious set of issues 
about Fannie and Freddie. I think we have various views on it.
    If Congress acts soon--and I don't know whether we are 
going to pass 1 bill, or 8 bills, or 16 bills, or 24 bills, or 
whatever the Majority strategy is--but if we act, you are going 
to get covered and I--there is a lot of concern about special 
treatment of Fannie and Freddie. Please give it up.
    There is no real harm here. It almost becomes a matter of 
turf. The SEC thinks it would be a good idea. It can't add to 
the taxpayer risk if you are already 100 percent at risk.
    I would just urge you to go along with the risk retention. 
It does not seem to me to make a great deal of difference one 
way or the other. It may be more a matter of the optic, but the 
optics are important.
    But I really want to get to the central issue that we 
should be getting to here: 20 percent. Let me start with FHA. 
You had some experiences. Twenty percent is way higher--the FHA 
objected when we talked about going to 10 percent. I agreed 
with that.
    I know it is different in the FHA. Does 20 percent strike 
you as the right number? Do you think we could get the same 
bang for the buck in terms of good loans at 20 percent--at 10 
percent or 8 percent?
    Mr. Ryan. Congressman, we--
    Mr. Frank. That is a pretty specific question, so focus.
    Mr. Ryan. We are concerned about 20 percent and the 
impact--
    Mr. Frank. It might be too high?
    Mr. Ryan. Too high, yes. We are definitely concerned. And 
we are seeking feedback and comment--
    Mr. Frank. Okay.
    Mr. Ryan. --on what are the performance benefits that come 
with taking it from a 10 percent down to a 20 percent down 
relative--
    Mr. Frank. I have been skeptical of the homeownership push, 
and critical of it in some ways, but 20 percent does seem very 
high.
    To what extent are there tradeoffs? I will say this: I am 
skeptical that private mortgage insurance does it. Private 
mortgage insurance has its uses; I don't think it is--you are 
going to look at the history. I don't see that as being a 
substitute.
    And I have run into this problem: We are in some socially 
sensitive areas here. Delegating to the private mortgage 
insurance companies the right to decide who gets to buy a house 
and not seems to me problematic. I want to have tough standards 
but I worry about that through the delegation.
    But let me ask Mr. Alvarez, what is your sense about a 
tradeoff between a lower downpayment percentage but tougher 
standards and enforcement of the qualitative standards?
    Mr. Alvarez. That is actually what most lenders do. They 
trade off these different standards.
    And that is a very intelligent thing to do but it is very 
sophisticated, it requires judgment, it requires experience in 
the market that you are dealing with. We didn't feel we were in 
a good position as regulators here to make those tradeoffs on 
behalf of--
    Mr. Frank. Can I ask just one more--let me ask, I guess 
this is the key question we are having: We would all agree, 
ideally if those qualitative standards were well administered 
they would be a substitute, you could bring down the 
downpayment. Is there a problem--and I guess this is--is there 
a way for you, the collective regulators, to supervise the 
qualitative standards? The nice thing about 20 percent is it is 
a number, or 10 percent, so it is easy; it is yes or no.
    I guess the issue would be--and you can't all answer it 
now--do we have the regulatory capacity to enforce qualitative 
standards as the way to protect against bad loans as opposed to 
the simpler number? I guess that is the issue, and I would ask 
you all to let me know in writing. I don't want to take any 
more time now.
    What would we have to do to develop the capacity to be able 
to use--we would all agree that if you could do that, it would 
be better than an unduly high standard, and I would be 
interested in your views on that.
    Thank you, Mr. Chairman, for the time.
    Chairman Garrett. And I thank you.
    The gentleman from Arizona?
    Mr. Schweikert. Thank you, Mr. Chairman. Actually, the 
ranking member sort of sparked part of this thought.
    In regards to drafting the QRM, was the goal when you were 
doing sort of the rulemaking or the writing of the proposal--
was it purely looking at the statutory request to do this or 
was there a look back saying, ``Here is what the bond markets 
are. Here is what the securitizers would be able to buy things. 
This will be a triple A paper,'' or was it also looking at the 
other side saying, ``Look here, we are able to see where 
delinquency rates and defaults would happen?''
    What drove the decision-making? Was it on this side of the 
equation, so it is the default side? Was it the statutory? 
Where is there a market?
    Whomever wants to share?
    Ms. Williams. I can start. We obviously have to start with 
the language of the statute that has been enacted, but it is 
against the backdrop of the experience that we have witnessed 
over the course of the last 5 or 6 years. And so those market 
factors--the different tradeoffs, the different objectives that 
the agencies want to accomplish going forward--they are all in 
the mix of the discussions and that is why I said there is a 
lot of balancing of a lot of important and complex issues that 
go into what will finally be adopted by the agency.
    Mr. Schweikert. Mr. Chairman, is it Ms. Williams? And 
forgive me. I am embarrassed; I am not wearing my glasses so I 
can't even read those nameplates from here.
    But in that case, it might be 10 percent down if I had 
someone with a very high FICO score or vice-versa. You start to 
see this scaling. Was that part of the formula, looking at 
where--if I am looking at the statutory things, I am more 
concerned about what is my risk of default. Do you end up with 
a formula design?
    Ms. Williams. The statutory standard specifically refers to 
historical loan performance data that indicates a lower risk of 
default, and so there were a variety of factors--I might defer 
to Pat to talk more about this--that were looked at by the 
agencies in this process, and some were more telling than 
others about risk of default.
    Mr. Schweikert. And as you are also speaking, can I throw 
sort of one other quirky thing, because I often have a concern 
over here that if--many of us were passionate about making sure 
there is liquidity again, the ability to move money back into 
our mortgage markets but also have good quality paper. If I was 
saying, these are the mortgages I am going to buy, I would want 
title insurance built in there as part of my checklist.
    I know mortgage insurance, PMI, is on the default side, but 
yet if I am the bond holder, or on this side the investor, I am 
probably okay with that even though it may not have helped me 
on this side of the equation. Am I wrong in what I was looking 
for?
    Mr. Lawler. I don't think so, if I understood you 
correctly. We assume that we would--the markets would thrive in 
both QRM and non-QRM if we made enough loans, made it 
reasonable and enough good quality loans fit both categories. 
If you designed the QRM so it covered almost any loan that 
people would be willing to have anything to do with then those 
loans that were outside of that area would find it very 
difficult to find a home, and the rates on those loans would go 
up a lot more.
    Mr. Schweikert. And I may take one step sideways on you. 
Okay, QRM loans--back into the definition of what is secure, 
ultimately, as you put this package--kind of what the QRM 
loan--is it always 20 percent, or is it someone with 10 percent 
but happens to have over here mortgage insurance? Is it someone 
with 10 percent but incredibly high credit quality? What 
ultimately becomes the matrix to provide as much options and 
velocity of sales?
    Mr. Lawler. We read the statute to suggest that QRM loans 
should be especially good loans that didn't need any risk 
retention, that risk retention should be the norm but here is a 
group of loans that simply, without knowing anything more about 
them, would not need risk retention. And so we thought about 
more complicated classifications of combinations of credit 
scores and LTVs, for example, and many other--
    Mr. Schweikert. So would you end up looking on something 
like a mortgage insurance product as being an alternative to 
the risk retention instead of the definition of the QRM?
    Mr. Lawler. We did look at what the effect of mortgage 
insurance was. We tried to find data of loans without mortgage 
insurance but it was hard to find useful data. What we did find 
is most of the loans with mortgage insurance have high LTVs. 
Even with mortgage insurance they were a lot riskier.
    Mr. Schweikert. Yes.
    Mr. Lawler. So we kept it down low and we tried to keep the 
definition simple. It still took a couple hundred pages. We 
tried to keep this simple so that it would be manageable and 
that we weren't trying to define all of the good loans, but a 
simple group of loans that we were confident were good enough 
that they wouldn't need risk retention.
    Mr. Schweikert. Okay. Thank you.
    And thank you, Mr. Chairman. But something is wrong in our 
life when ``simple'' is a couple hundred pages.
    Chairman Garrett. It strikes me the same way too, yes.
    The gentleman from California for 5 minutes?
    Mr. Sherman. I am an old tax lawyer. I am here to say 
simple is a couple hundred pages.
    [laughter]
    I think I have discovered a new law, which I don't want to 
take responsibility for, so I am going to call it ``Hank 
Paulson's Law,'' and that is that no crisis is so dire that 
those who caused it cannot become its ultimate beneficiaries. 
And I am interested in how the regulations before us and other 
regulatory actions will affect the five big banks, the largest 
financial institutions that were at the heart of this problem 
in late 2008.
    There are two interlocking boards of regulators. One has 
the responsibility to determine which entities that are too-
big-to-fail should be broken up, and so far that regulatory 
body has decided, ``None. They are all our buddies. We love 
these guys. They like being big.'' And more important, they 
have the lowest cost of funds because they are bigger than they 
have ever been and they are, indeed, too-big-to-fail.
    So by not breaking them up, by letting them get big, by 
living with us through the 2008 process we have already shown 
the country that they will get bailed out if they are so big 
they could drag the entire economy down with us. One board of 
regulators has made sure that they have the lowest cost of 
funds.
    We have regulations before us from this body of regulators 
that will allow them to parlay that lowest cost of funds into 
total dominance of real estate finance because we now have 
definitions of QRMs that are so restricted that the vast bulk 
of real estate lending will be under the iron grip of those 
with the lowest cost of funds who, did I mention before, are 
too-big-to-fail and the ones that caused the crisis to begin 
with.
    And so I would like to address this to Mr. Alvarez. Have 
you considered the impact of the proposed QRM definitions on 
smaller banks and financial institutions?
    It seems to me the larger banks would have the capacity to 
make and securitize non-QRM loans while the community banks, 
with a higher cost of funds, will not be able to do so at a 
cost-effective and competitive rate. In fact, one of the 
consequences of a narrow QRM standard might be to force smaller 
banks to become merely agents or supplicants to the larger 
institutions whose low cost of funds would allow them to retain 
any interest.
    So have you considered the effect of these rules on the 
smaller financial institutions and would it be a bad thing if 
the effect of these rules just made the too-big-to-fail much, 
much, much bigger than they are now?
    Mr. Alvarez. We have thought about this. We actually think 
small banks will be fine under this proposal for a variety of 
reasons.
    Mr. Sherman. Can you pull your microphone up again a little 
closer?
    Mr. Alvarez. Sorry.
    Mr. Sherman. Do you know of any small banks who think that 
way too, or you just think this about them?
    Mr. Alvarez. We have put our proposal out for comment, so 
if I am wrong about this, I will certainly hear quite a lot 
about it.
    Mr. Sherman. You are hearing about it. I represent quite a 
number of--
    Mr. Alvarez. If I could explain how it works, I think with 
the small banks--first, keep in mind a lot of small banks do 
mortgages in their local area and keep those loans on their 
balance sheets. They are not affected by this at all.
    To the extent that they want to securitize, small banks 
often generate loans that are in the GSE space, so they would 
be insured by the--
    Mr. Sherman. But you know the GSE space is about to shrink. 
The chairman, perhaps, would like to see that more quickly. And 
so these rules that you are working with have to be designed to 
deal with not only the world as it is but as the chairman would 
like it to be.
    Mr. Alvarez. So that will be your decision and we have 
committed that--
    Mr. Sherman. But you didn't draft these rules thinking, 
``Well, these rules will crush local financial institutions, 
but only after the chairman gets his way with regard to GSEs.''
    Mr. Alvarez. We have committed that after Congress 
addresses the GSE issue, we will adjust these rules to take all 
that into account. We must take the GSEs as they are today. 
That is the only option that we have.
    And so to the extent a small bank is generating loans that 
can be in the GSE space, they will be as they are today. Also--
    Mr. Sherman. If I can interrupt, if you were serious about 
that you would have--and I realize this would lengthen your 
document, much to the consternation of one of my colleagues--
you would already have that in the rules. You would say, once 
under 40 percent of the loans in this country are FHA or GSE, 
then we are going to have these rules apply.
    But to tell me, ``Oh, the small banks have nothing to worry 
about because the authors of the regulations that will doom 
them will ride to their rescue just as soon as the GSEs are 
smaller entities,'' without that being self-effectuating, with 
that being just a glint in the eye of those who are currently 
serving, I--if you get any favorable comments from small banks, 
please share them with me.
    Mr. Alvarez. The other two points I would ask you to 
consider are that the small banks can generate loans that meet 
the QRM definition, and those that do not meet the QRM 
definition would be securitized under the same discipline of 
the 5 percent risk retention that would apply to any other 
bank. There is no distinction in the requirement between large 
and small banks.
    Mr. Sherman. These rules, with their restrictions, are 
going to drive the small banks out. They know it; the big banks 
know it; and you regulators would be more savvy if you 
understood it as well.
    I yield back.
    Chairman Garrett. Thank you. The gentleman yields back.
    And I am very much encouraged by the gentleman's confidence 
in my ability to get done what I want to do with regard to 
GSEs.
    Mr. Hurt, for 5 minutes?
    Mr. Hurt. Thank you, Mr. Chairman.
    I thank the witnesses for being here.
    I wanted to follow up on what Mr. Sherman was talking 
about. I represent a rural district in south side, Virginia. Of 
course, small banks, medium-sized banks make up a large part of 
those who put capital on the street and I think are responsible 
for the economic recovery that we are seeing and are a vital 
part of the future economic recovery that we all want.
    And I just wanted to follow up with Mr. Alvarez about, do 
you believe that this proposed QRM definition will have a 
negative effect on small banks, and does it favor large banks 
to their detriment? I would like to see if we could get a 
direct answer on that question, and then I would like it, if 
possible, to have Mr. Krimminger maybe address the same 
question?
    And Ms. Williams, if you could also address the question?
    Mr. Alvarez. As I mentioned to Congressman Sherman, the 
rules apply equally in all respects to small banks and large 
banks. There isn't a distinction here or an incorporated 
advantage to one over the other in how the QRM definition 
works, how the GSE exception--or framework works, or any other 
part of the risk retention rules.
    We have asked the small banks and others for their comments 
on this. We are very interested in that. There is a lot in the 
Dodd-Frank Act that imposes burdens on small banks in that they 
have to worry about compliance. The idea of compliance is 
itself a burden on the small banks and we are working to try to 
ease that compliance burden wherever possible.
    But the risk retention requirement itself does not deviate 
depending on the size of the bank.
    Mr. Hurt. And do you think that it should, in light of the 
disadvantages that it may impose upon those smaller entities 
that cannot absorb the costs of compliance?
    Mr. Alvarez. I don't think in the risk retention area that 
an exception for small banks makes sense.
    Mr. Hurt. Can you say why?
    Mr. Alvarez. Because they are generating mortgage loans and 
then the question is, when those are securitized, sold to 
investors, is there assurance to investors about the quality of 
the loans? One way that the Congress has chosen to ensure that 
there is discipline around the quality of the loan is to have 
the securitizer, who is not the small bank that originated the 
loan, but the securitizer who is putting the packages together 
to sell into the market, retains some of the interest in the 
loans so that they are clear that these loans meet good 
standards or meet the standards they have disclosed to their 
investors that they should meet.
    In the crisis, the advantage the securitizers had about the 
quality of the loans gave them an advantage over the investor 
as they knew what the quality was; the investor did not know 
what the quality of the loans and the securitizations were. 
There was nothing to keep the securitizer disciplined about 
keeping the quality of the loans high because they could--even 
where they took on risk retention pieces--they were able to lay 
that off, hedge it or sell it for counterbalances.
    That is all taken away by this risk retention proposal, but 
that is at the securitizer level. I think the originators will 
still be able to originate as they have.
    Mr. Hurt. Mr. Chairman, I would like for Mr. Krimminger and 
Ms. Williams, if they could, to address the same line of 
questioning.
    Mr. Krimminger. Yes, Congressman. I think one of the things 
that Mr. Alvarez pointed out is really key. The congressional 
statute and the rule was really focused on the role of the 
securitizer, which is the larger bank that aggregates loans 
from smaller institutions, by and large, and then does the 
securitization.
    Part of the rule, though, does make a specific provision 
that will help small banks in this marketplace. That part of 
the rule simply says that in order for the securitizer to pass 
the risk retention requirement down to the lender or 
originator, the originator has to have originated 20 percent of 
the pool of mortgages that is being securitized. Most of the 
small institutions that are selling loans for aggregation and 
securitization do not originate 20 percent of an individual 
pool, so in most cases all of this risk retention will be held 
at the securitizer level or the larger bank level, not the 
smaller or community bank.
    So in conclusion, we do not think that the risk retention 
rules disadvantage the smaller institutions because there is 
that particular provision that will help protect them from 
having to bear the risk retention that the securitizer should 
be bearing.
    Mr. Hurt. Thank you.
    Ms. Williams. I agree with what has been said. The business 
model of the community banks, their retention and portfolio or 
their use of the GSEs, put them in a position where they are 
not advantaged by this proposal, the way it is structured.
    Mr. Hurt. Thank you, Mr. Chairman.
    Chairman Garrett. The gentleman yields back.
    The gentleman from Massachusetts?
    Mr. Lynch. I thank the chairman.
    One sort of simple question: With respect to the definition 
of a Qualified Residential Mortgage, I noticed you have some 
limitations here regarding the qualifications of the purchaser. 
I could understand a loan-to-value ratio, the debt-income 
ratio. On credit history, however, it says here that if any 
borrower has any current debt due past 30 days or if they had 
a--any debt obligation more than 60 days past due they are 
immediately disqualified from qualifying as a QRM.
    I am just curious--that would seem to be rather harsh. If 
someone falls behind on a cable bill or a telephone bill, it 
might be more reflective of bad bookkeeping or forgetfulness 
than a lack of creditworthiness. And I am just curious, as a 
representative of a government that has a current year deficit 
of $1.65 trillion, I think it might be a little bit 
hypocritical to say we are going to put a rule down that if you 
fall more than 60 days behind on a bill, you are not going to 
be able to get a Qualified Residential Mortgage.
    And I am just curious if there is some thinking out there 
that supports having such a bright line and a rather harsh 
requirement.
    Mr. Lawler. It was difficult to try and put together a list 
of--
    Mr. Lynch. I bet.
    Mr. Lawler. --characteristics like that. Normally, 
underwriters use credit scores. We were uncomfortable with 
tying our rules to credit scores that are produced by specific 
private companies.
    Mr. Lynch. Yes. Mr. Lawler, I don't want to spend all my 
time on this, but I just want to suggest something.
    Look, with today's technology we have an abundance of 
information on every individual borrower. We really have an 
abundance of knowledge and we might be able to fashion some 
better line of demarcation for judging their creditworthiness 
than just saying, okay, you went 60 days behind on your cable 
bill or a hospital bill, that are notorious for going back and 
forth.
    My own hospital, I owe them $8 one month and they owe me $3 
the next month and it goes back and forth so I can see how 
somebody could fall into a trap on that. I am just concerned 
about that because it is a 2-year penalty. Once you fall behind 
60 days, you are disqualified for the next 2 years from 
qualifying as a Qualified Residential Mortgage.
    The other piece I have is I want to go back to risk 
retention. And while I understand we are going back and forth 
about the amount of that, I want to talk about the form of that 
risk retention. I know you have some very clear models out 
here--the vertical slice where the securitizer retains 5 
percent of each tranche right down the line, which is easy to 
understand and it is reasonable; or the horizontal slice, where 
the securitizer retains a first-loss position equal to 5 
percent of the probable value of all the asset-backed security 
interests; and the securitization, I can understand that.
    But the bottom one here is sort of a catch-all, and it says 
a representative sample. The securitizer retains a randomly 
selected pool of assets materially similar--key phrase--to the 
assets and the asset-backed securities.
    I am curious, would materially similar--would that include 
a synthetic instrument that tracked a real mortgage? So that is 
not in there. And materially similar--I understand, you know--
help me with this.
    I think your microphone is off. I am not sure.
    Mr. Lawler. --and then you take--do statistical tests to 
see that the ones that you pulled out randomly really do 
reflect generally the characteristics of the broader pool.
    Mr. Lynch. Okay. Would the triple A tranche of property in 
Maine be materially similar to a tranche of property in 
Arizona? Is that--
    Mr. Lawler. No, no. So you go--
    Mr. Lynch. Is that laid out somewhere, because I know it is 
a common term in securities law but this gives light to some 
variance that I am not exactly comfortable with.
    Mr. Lawler. We gave as much specificity as we thought we 
had to. It is something we can revisit. But it is meant to be 
inclusive of relevant risk factors and location is certainly an 
important risk factor.
    Mr. Lynch. Okay. Are we just going to import the commercial 
or securities definition of materially similar, and we are 
going to be good with that, or are we going to try to draft 
something that is more--
    Chairman Garrett. The gentleman will answer and then your 
time will be over.
    Mr. Lawler. We did try to draft something that was a little 
more complicated, again, at the risk of trying to add another 
30 pages to the rule. We tried to keep it brief, but it is 
something we can explore, whether it is adequate.
    Mr. Lynch. All right.
    I thank the chairman. Thanks for your indulgence.
    Chairman Garrett. Thank you.
    The gentleman from Ohio?
    Mr. Stivers. Thank you, Mr. Chairman.
    My first question is for Mr. Lawler. I was looking through 
your statistics in your analysis that you put together, and it 
is unclear to me--it looks like you did an analysis with 
individual criteria and then you did an analysis with all the 
criteria and removed one at a time. Is that how you performed 
this?
    Mr. Lawler. Yes.
    Mr. Stivers. So you didn't do some kind of regression 
analysis of multiple characteristics to see which multiple 
characteristics work in tandem the best? Because if you had 
done that, you might be able to tell us a little more 
effectively. I know you removed loan-to-value individually so 
you can tell us what it does to both loan--I was just looking 
at that--what it does to both the loan volume and the 
delinquencies, but you can't really tell us what the impact of 
multiple criteria without that one is, or can you? Thank you.
    Mr. Lawler. --held everything at the QRM definitions and 
just moved that to see what the effect was.
    Mr. Stivers. So obviously the volumes went up slightly--not 
as much as they would have on the debt-to-income and payment-
to-income. The volume of loans actually would have increased 
the most on those, but the delinquencies also look like they 
increased a decent amount on those and looks like delinquencies 
got worse when you removed the FICO scores or some type of, I 
guess it was FICO scores, and the loan-to-value was somewhere 
in the middle between those two. Is that about right?
    Mr. Lawler. Yes.
    Mr. Stivers. And the reason I am asking, obviously, is all 
of us are concerned about access and 20 percent down is a lot 
of money. What FHA talked about earlier, they have continued to 
offer loans that have lower percent downpayments and they have 
not seen as many problems because they had real underwriting 
criteria, and they didn't take stated income loans, and so they 
haven't seen the same kind of problems that folks who didn't 
have real underwriting had.
    My grandfather was a banker and he made loans on loan-to-
value. My father was a banker; he started making loans on cash 
flow. And as your analysis shows, cash flow is the best 
determinant of whether somebody is going to pay their loan or 
not.
    I don't know if you could go back and help us figure out, 
because I think we all want to try to find the middle ground 
here on access to the American dream, but maybe some of the 
folks who did your analysis could go back--and this is helpful 
data, but really helping us see how much of this could be made 
up by some other factor. Obviously, all of these loans had 
mortgage insurance so mortgage insurance doesn't change these 
numbers. Is that right?
    Mr. Lawler. The high LTV loans--
    Mr. Stivers. Yes, the ones that weren't 20 percent.
    Mr. Lawler. That is right.
    Mr. Stivers. It would be really helpful to me. I think your 
data is great and it helps us see what we are trying to do 
here, the way forward, but if you could help us as we are 
trying to all figure out how to deal with loan-to-value as a 
constraint to access to homeownership, we would love your help.
    Mr. Lawler. And we certainly will be considering all the 
comments and evaluating all the data we can. We don't mean it 
to be a constraint to access to mortgage credit.
    I don't think any of the agencies here think a 90 percent 
LTV loan is a bad loan, per se. It was simply to try and 
segregate out what would not need any risk retention at all and 
the predicate for that is that risk retention would not make 
loans impossible to get or even extraordinarily more expensive.
    Mr. Stivers. But they would make them more expensive?
    Mr. Lawler. Perhaps a little bit.
    Mr. Stivers. Obviously, they would.
    Mr. Lawler. Not necessarily, because if you tried to put 
together a security today with non-QRM loans the market would 
require more than 5 percent risk retention.
    Mr. Stivers. Did any of you look at overcollateralization 
as an option for the risk retention, that we make other people 
do overcollateralization of things. Is that an option?
    Mr. Lawler. We were looking at a particular kind of 
security--asset-backed securities--that don't have 
overcollateralization--
    Mr. Stivers. No, I understand that. But I am asking if 
anybody has looked at it as an option.
    Mr. Lawler. Not in this exercise, but it is certainly an 
important possible funding--method of funding--
    Mr. Stivers. Thank you.
    My final question is to the entire panel, and it deals with 
my concern for many of the other asset-backed securities that 
have been caught up in this regulation.
    Chairman Garrett. I will let the panel get that answer back 
to you in writing, if you want to state the question to them.
    Mr. Stivers. Sorry. Thank you. I didn't realize I was out 
of time. I don't have my glasses on. Sorry, Mr. Chairman.
    I yield back my nonexistent time.
    Chairman Garrett. There we go.
    The gentlelady is recognized.
    Mrs. Maloney. I want to thank the panelists. It is a very 
busy time for us with all the budget, and so I was not able to 
hear all of your questions. But what I am hearing from my 
constituents, and even Members of Congress, is before the 
crisis we were over here with very lax standards. The joke in 
New York was, if you can't pay your rent, go out and buy a 
house. They didn't require any documents. Nothing.
    Now, we have gone over here where it has become very, very 
difficult to get a loan. And I had two constituents tell me 
that they required so much paperwork--they required their 
cancelled checks for 2 years, they required their divorce 
settlement to review it, they required just--said it took 2 or 
3 months just to get the paperwork together to get the loan. 
And then, of course, many people are questioning the 20 percent 
down in the draft rule.
    So I just would like anyone who would like to comment on, 
have we gone too far in the other direction? There is a lot of 
discussion now about the difficulty of getting the housing 
market moving and we know that the housing, according to Zandi 
and other economists, is 25 percent of our economy. If we are 
not going to be generating a lot of activity in the housing, it 
is going to be a drag on the economy.
    So specifically, I just wanted to know if you think we have 
swung too far in the other direction, and your draft rule 
requires a 20 percent downpayment in order for the Qualified 
Residential Mortgage and exempt from risk retention. Could you 
give me or describe the research you did regarding what 
percentage of home purchasers this would preclude comparing to 
a lower standard of either 10 percent or 5 percent and also 
describe what research you did regarding the relative 
difference in loan default and losses from a 20 percent 
standard compared to, say, a 10 percent or a 5 percent 
standard, assuming that all other QRM requirements were kept in 
place?
    And I would like to also hear some comments on the contrast 
between the private sector financing these loans and FHA. Does 
FHA also have the 10 percent down requirement? And if it 
doesn't, if they are not equal then you are giving--now it is 
more difficult to get the private sector back on their feet 
and--which many people would like to see happening, or maybe 
they can't. But why is there a difference between an FHA and a 
private sector QRM downpayment percentage?
    And I just open it to anyone and everyone to respond.
    Mr. Lawler. I will start on a couple of items. We looked at 
what volume of Fannie Mae and Freddie Mac loans would have met 
the 20 percent downpayment and the other QRM conditions, and 
for 2009, the latest year we looked at, 27 percent of 
homebuyers would have met it; for all loans 31 percent would 
have met it.
    This rule would take effect 1 year after it was 
promulgated. In the meantime, and perhaps after that, depending 
on what Congress does, we have Fannie Mae and Freddie Mac who 
buy loans with more than 80 percent down, certainly.
    FHA is a very important source of--you talked in the 
beginning about very tough underwriting standards. FHA has 
increasingly tough underwriting standards but not nearly as 
tough as those you described, I would guess, and that is an 
important outlet for people.
    And so there are other sources, and again, when designing 
this, we didn't mean for non-QRM loans to be unavailable, only 
that they would require risk retention when used in securities.
    Mrs. Maloney. Would anyone else like to comment?
    Mr. Ryan. Congresswoman, I will add that the macroeconomic 
effects of the various choices on downpayment and the 
underwriting criteria are an important consideration. We need 
that input; we need to understand kind of the implications 
there.
    There is no doubt we need to make sure we have tight, 
strong underwriting guidelines, that we are managing that 
credit risk, but we absolutely need to make sure that we don't 
overcorrect. It is a natural tendency, kind of after a large 
event like that.
    We need to go back, and as the colleagues here have done, 
and we need to continue to look at the data. We need more data 
about those loans that have had a long history of low 
downpayments and how they have performed and whether that 
adequately meets our consideration about the quality 
underwriting and the performance, and what are the implications 
on the volumes of loans that are being eliminated by imposing 
overly strict underwriting standards?
    Dr. Hayworth. [presiding.] Would the gentlelady care to 
submit the remainder of her questions in writing to the panel?
    Mrs. Maloney. Sure.
    Dr. Hayworth. Thank you.
    And the Chair yields herself 5 minutes or however fewer 
than that may be needed in view of the time constraints we are 
under.
    A question for Mr. Lawler: Was a 10 percent figure--10 
percent loan-to-value figure--ever considered when you were 
working on the downpayment issue?
    Mr. Lawler. Yes, we did. We considered quite a range of 
possibilities, including 10 percent. We even considered the 
possibility of having a 5 percent risk retention bucket, a 
zero, a QRM, and something in between.
    And we asked a lot of questions in the rules for comment on 
those.
    Dr. Hayworth. Okay.
    Mr. Lawler. And the 10 percent--we observed that the 10 
percent downpayment had a lot more defaults associated with it 
than 20 percent.
    Dr. Hayworth. So this was a statistical analysis that you 
optimized at 20 percent, essentially?
    Mr. Lawler. As best we could. There was a big difference 
between loans that did and did not have 20 percent--
    Dr. Hayworth. That was where you found a step off, so to 
speak?
    Mr. Alvarez, this question probably is best directed toward 
you, but for the panel: Title 14 of Dodd-Frank also, of course, 
has the qualified mortgage safe harbor. Those rules are also 
being promulgated currently. I realize that rules on QRMs are 
behind. This clearly is a very challenging issue to resolve on 
a number of levels.
    But will there be any effort to harmonize these 
definitions?
    Mr. Alvarez. Yes, absolutely. In fact, the statute requires 
that the QRM definition not be broader than the qualified 
mortgage definition. The qualified mortgage definition, of 
course, is under the Truth in Lending Act. It has a few 
different kinds of focuses.
    We expect that that we will make a proposal about a Q.M. 
definition shortly and of course it will have to be finalized, 
so it is on a slightly behind track, but a similar track. And 
then we will harmonize the two definitions.
    Dr. Hayworth. Okay. That would seem to be a very important 
coordination to pursue.
    How much more time do you think you are going to need with 
these rulemakings, just out of curiosity, as the industry waits 
with bated breath? I am not trying to put you on the spot, but 
I am just--
    Mr. Alvarez. No, no. This one is out for comment until the 
beginning part of June, so we will need at least that much time 
and then some bit of time afterwards depending on how the 
comments come through, and how many we get, and what the 
complexity is. This is a very important rule. We want to make 
sure we get this right.
    We are putting a lot of resources into it. All the agencies 
have worked very hard on this one. So we are going to try to do 
the best we can as quickly as we can. We are behind the 
schedule that Congress set for us but we are going to try to do 
it as quickly and as well as we can.
    Dr. Hayworth. Very well. And I appreciate very much your 
answer, sir, and the participation of the entire panel.
    In deference to the need for us to vote, at this time, with 
thanks, we will dismiss the panel. And as the Chair, I want to 
note that some of our members may wish to submit questions in 
writing to the panel and the record will remain open for 30 
days in order for members to submit questions to you and to 
place your responses in the record.
    This hearing is now in recess and it will return following 
votes. The second panel will begin when we return.
    And thank you, again, for your time.
    [recess]
    Chairman Garrett. Welcome back, everyone.
    I appreciate this next panel's forbearance. And so without 
objection, your written testimony will be made a part of the 
record, and you will each be recognized for 5 minutes.
    Mr. Cunningham is recognized for 5 minutes.

    STATEMENT OF HENRY V. CUNNINGHAM, JR., CMB, PRESIDENT, 
   CUNNINGHAM AND COMPANY, ON BEHALF OF THE MORTGAGE BANKERS 
                       ASSOCIATION (MBA)

    Mr. Cunningham. Thank you, Chairman Garrett.
    It is no exaggeration to say that the rule we are examining 
today will have profound effects on our housing and commercial 
real estate recovery and determine who can and cannot buy a 
home for years to come. If finalized in its current form, the 
result will be much higher costs for the vast majority of 
consumers and diminished access to credit for many others.
    Let me speak first to the most controversial part of the 
rule, the Qualified Residential Mortgage exemption. Recognizing 
that loans subject to risk retention would carry higher costs, 
Congress wisely instructed regulators to exempt safer products 
from the requirement. While Congress left some of the key 
decisions to regulators, your intent was clear: to require 
sound underwriting and proper documentation while excluding 
nontraditional risky ventures.
    Yet, regulators took this authority and opted to exclude 
most mortgage products, making QRMs the exception instead of 
the rule. FHFA reports that less than one-third of the loans 
purchased by Fannie and Freddie in 2009 would have met these 
requirements. This is all the more notable because 2009 was the 
most cautiously underwritten market in generations.
    Let me bring this home to you. I am an independent mortgage 
banker operating in North Carolina, hardly the epicenter of the 
housing crisis.
    I ran an analysis on our 2010 book of business, and 58 
percent of our purchase loans and 74 percent of our refinance 
loans would not have met the QRM standards. That is astonishing 
because 97 percent of that same book of business in 2010 were 
fixed-rate mortgages.
    Mr. Chairman, I have been in the mortgage business for 37 
years. During that time, I have found that underwriting is an 
art, not a science.
    No one borrower characteristic will predict whether a loan 
will default, yet this rule hardwires some of the least 
flexible underwriting standards any of us has ever seen. The 
hardest hit would be first-time homebuyers, minorities, and 
middle class families, for whom the downpayment requirement 
would be nearly insurmountable.
    The ommission of mortgage insurance, which Congress 
specifically asked regulators to consider, is also troubling. 
And the debt-to-income ratios may exclude even more qualified 
borrowers than the downpayment requirement.
    The proposal raises several other major concerns. For 
instance, it is not clear that the regulators reflect a 
relationship between the QRM and FHA's significantly lower 3.5 
percent downpayment requirement.
    The Administration's recent GSE White Paper professed a 
preference for reducing the government's footprint in housing 
finance and paving the way for a robust private mortgage 
market. The obvious contradiction between the QRM and FHA's 
requirement will force more borrowers to seek FHA loans and 
takes us in the opposite direction.
    Another controversial piece of the rule is the national 
servicing standards. If ever there was a regulatory overreach, 
this is it. Never in the year-long debate over risk retention 
were servicing standards proposed or discussed. Congressional 
intent couldn't have been more clear and directed to 
origination practices, not servicing.
    Moreover, servicing standards are currently being developed 
through separate regulations and will include requirements well 
beyond those contained in this rule. Respectfully, this is 
neither the time nor the place to insert these provisions.
    MBA is also concerned that risk retention would apply for 
the life of the mortgage. Underwriting deficiencies typically 
emerge shortly after a loan is originated. Any requirements 
beyond this time will further constrain funds and increase cost 
to borrowers.
    On the commercial side, MBA believes regulators have worked 
diligently to propose rules that would support a responsible 
and vibrant CMBS market. However, some elements of the proposed 
rule, such as the premium capture cash reserve account, are 
unworkable. MBA will seek clarification and modification to 
ensure workable rules are in place that will not hamstring the 
CMBS market.
    So where do we go from here, Mr. Chairman? Considering the 
gravity of the rule, the many concerns it raises, and the 
nearly 200 questions embedded in it, MBA believes the comment 
period should be extended to permit a full discussion of the 
rule's profound implications. We also strongly urge this 
rulemaking to be synchronized with Dodd-Frank's qualified 
mortgage safe harbor.
    Finally, we urge Congress to call on the regulators to 
recognize the enormous restraints the risk retention rule would 
put on homebuyers, especially the steep downpayment and DTI 
requirements, and to come back with a more flexible approach to 
underwriting. We thank you for your interest in this important 
topic and look forward to answering questions.
    [The prepared statement of Mr. Cunningham can be found on 
page 86 of the appendix.]
    Chairman Garrett. Mr. Deutsch?

    STATEMENT OF TOM DEUTSCH, EXECUTIVE DIRECTOR, AMERICAN 
                   SECURITIZATION FORUM (ASF)

    Mr. Deutsch. Thank you, Congressman Garrett. My name is Tom 
Deutsch. I am the executive director of the American 
Securitization Forum, which represents over 330 member 
institutions that serve as both issuers, investors, and broker-
dealers in the securitization marketplace representing all 
forms of asset classes in the securitized marketplace, which 
includes residential mortgages and commercial mortgages as well 
as auto loans, credit cards, student loans, asset-backed 
commercial paper, as well as lots of emerging and esoteric 
asset classes--rail cars, different types of timeshares. There 
is an extensive array of securitizations that are affected by 
this rule that are well beyond the mortgage debate that I will 
discuss in some detail today in my testimony.
    We are here today to not only applaud the regulators for 
parts of their rules, but we are also here to point out many of 
the areas where they didn't seem to accept many of the comments 
that we provided in November and December of 2010. We requested 
a lot more specificity related to these different asset 
classes, and in particular, I will discuss three key areas in 
the auto sector, asset-backed commercial paper, as well as the 
student loan market, before I get back to the mortgage-related 
issues.
    But first, let me be very clear: ASF, our investor, and our 
issuer members are very supportive of the goals of aligning 
incentives between issuers and investors. We also support 
targeted solutions in certain asset classes where better 
alignment can be made.
    But we strongly oppose efforts to try to create unhelpful 
retention in asset classes that demonstrated very strong 
performance in the recent credit downturn, and that is where 
investors in particular don't believe there are any 
misalignment of incentives in those asset classes.
    In particular, I would note that in these other asset 
classes, in these other areas, would force keeping additional 
capital on the books both of banks and depository institutions 
as well as captive auto finance companies, student loan 
lenders, etc., that are not in the business of retaining 
capital and credit but are in the business of originating them 
to be able to provide credit to consumers.
    Moreover, FAS 166 and FAS 167 accounting considerations, 
which can force consolidation of securitizations for risk-based 
capital purposes--these can lead to absurd results if a bank 
holds only 5 percent of a first loss position and also services 
the loan but yet requires them to reserve capital for 100 
percent of the risk for the transaction even though they had 
sold off 95 percent of the risk. So there are important 
regulatory capital, accounting, and legal considerations that 
have to be addressed throughout these rules that have not been 
fully addressed currently.
    So let me provide a couple of examples of areas where we 
found that there are significant rationale where the regulators 
did not necessarily get it right in certain asset classes. Let 
me start with asset-backed commercial paper.
    This is a market right now that has $379 billion of 
outstandings currently. This is a key hub of middle market 
funding for businesses throughout America--for residential 
mortgage loans, credit cards, lots of trade receivables, 
student loans, etc.
    The sponsors of these types of vehicles provide credit 
support vehicles and that create more than--well more than the 
5 percent of risk retention that is required by the Act. 
Investors, in particular, in this asset class strongly believe 
that issuers' and investors' interests are currently well-
aligned in this aspect, yet we were shocked that the regulators 
didn't propose that these credit support facilities that 
investors strongly support are not eligible to be a part of the 
requirement to meet the risk retention rules. This omission 
must be addressed or substantial middle market funding in this 
$378 billion asset class will be lost.
    Second, prime auto loans: There was an exemption that was 
created for auto loans within the securitization transaction--
within the proposed rules. Unfortunately, those would provide 
zero relief to this asset class. That is, not a single auto 
securitization in the history of the securitization market 
would currently be eligible for that exemption.
    It appears as if someone who was a mortgage specialist 
wrote these rules because they created things like a 20 percent 
minimum downpayment on a car loan. I am not very sure how many 
people actually put 20 percent down on a car loan prior to 
purchasing them.
    Finally, on FFELP student loans, which are currently 97 
percent government guaranteed, yet they are still required to 
maintain a 5 percent risk retention by the issuer. It seems 
very odd to me that--and makes no sense that unless the 
government is threatening or possibly could ultimately not 
stand behind their obligations on these student loans why you 
would have to retain a 5 percent risk retention when there is 
only 3 percent credit risk associated with these products.
    Finally, let me agree with Mr. Cunningham. Many of the 
areas related to servicing standards should not be included in 
the proposed rules.
    But moreover, let me turn to the premium cash reserve 
account that will be discussed in many of these rules. Let me 
make very clear, although we have heard that there are some 
differences between the regulators on this premium cash reserve 
account as to the appropriate meaning of it, the way that it is 
currently written effectively would put the RMBS and the CMBS 
markets in a deep freezer out on the back porch. It simply 
would shut down these markets because of the way that these 
rules are written.
    We understand that the regulators believe that they may 
have miswrote part of those rules, but we look forward to 
getting clarification and correction of that because otherwise 
the impacts on the RMBS and the CMBS markets will be 
significant.
    I thank you very much for the time here and look forward to 
questions.
    [The prepared statement of Mr. Deutsch can be found on page 
103 of the appendix.]
    Chairman Garrett. And I thank you.
    Mr. Hoeffel, please, for 5 minutes?

    STATEMENT OF J. CHRISTOPHER HOEFFEL, MANAGING DIRECTOR, 
 INVESTCORP INTERNATIONAL, INC., ON BEHALF OF THE CRE FINANCE 
                            COUNCIL

    Mr. Hoeffel. I thank you, Chairman Garrett, and members of 
the subcommittee. My name is Christopher Hoeffel.
    I am managing director at Investcorp International and I am 
here representing the Commercial Real Estate Finance Council. 
The Council is unique in that it represents all of the 
constituents in the commercial real estate capital market, 
including lenders, issuers, investors, and servicers, among 
others.
    Before I highlight some of our concerns about the proposed 
regulations, I would like to frame what is at stake. There is 
approximately $7 trillion of commercial real estate in the 
United States. Prior to the economic crisis, CMBS provided each 
year as much as 50 percent of debt capital for commercial real 
estate.
    Between now and 2014, more than $1 trillion of commercial 
real estate loans will mature and will require refinancing. 
Without CMBS, there is simply not enough capital capacity 
through traditional portfolio lenders to satisfy this credit 
demand. It is for that reason that Treasury Secretary Geithner 
and other policymakers agree that no economic recovery will be 
successful unless the securitization markets are revived and 
healthy.
    Although CMBS markets have reemerged with approximately $30 
billion to $50 billion of new issue expected this year, we are 
still walking on eggshells. Financial regulatory reform and the 
implementation of Dodd-Frank could have the effect of shutting 
down the flow of capital completely and permanently.
    The impact of these rules is, understandably, a matter of 
great concern for property owners and borrowers. We are 
therefore grateful to have the opportunity to highlight some of 
the potentially serious issues with the regulations as 
proposed.
    However, at this point we have far more questions than we 
have answers. Several elements have sparked extensive internal 
debate.
    First, the proposal includes a new concept called a premium 
capture cash reserve account that, as drafted, appears to 
eliminate the economic incentives for issuers to securitize 
loans. At a minimum, the creation of this wholly new 
requirement will dramatically change deal economics and 
potentially securitization structures.
    Second, for CMBS specifically, we appreciate the regulators 
creating a special B-piece buyer retention option. In our space 
the traditional structure has included a B-piece buyer that 
purchases the first loss bond position, re-underwrites every 
loan included in the bond pool, and negotiates the right to 
remove loans from the bond pool that they deem unacceptable.
    The proposal would require, however, that an operating 
advisor participate in any transaction in which the B-piece 
buyer is also--has special servicing rights for troubled loans, 
which is generally the case. The servicer would have to consult 
the advisor prior to making any major loan-related decisions 
and the advisor would have the unilateral power to replace the 
servicer if, in the operating advisor's opinion, the servicer 
is not meeting its contractual duties.
    Recent CMBS transactions have included variations of this 
type of operating advisor construct and we are pleased to see 
that the regulators embraced a concept that has evolved in the 
free market since the liquidity crisis. However, the regulatory 
proposal would go further than the market has and would vest 
the operating advisor with a much stronger all-or-nothing 
servicer replacement power.
    Although many CMBS investors are supportive of the 
inclusion of an operating advisor function there is a concern 
that the function as proposed under the regulation would both 
dissuade some B-piece buyers from investing in CMBS altogether, 
due to insufficient controls over their first loss position, 
and add a layer of scrutiny that might lead to a ``too many 
cooks in the kitchen'' scenario under which loan servicing and 
decision making are inefficient to the detriment of both 
investors and borrowers.
    A third concern is that the proposal requires permanent 
retention by either sponsors or B-piece buyers. This type of 
permanent investment constraint is unprecedented and could 
severely limit the universe of institutions that could function 
as retainers. Many of our industry participants have begun to 
discuss whether it might be advisable to limit the duration to 
a finite number of years and then limit subsequent buyers of 
the retained interest to qualified transferees whose attributes 
could be defined in the regulations.
    Fourth, the proposed regulations include a commercial real 
estate specific retention exemption for loan pools composed 
exclusively of qualifying commercial real estate loans that 
satisfy certain underwriting conditions. It does not appear, 
however, that this exemption, as currently drafted, would bring 
any benefit, as essentially no commercial real estate loans 
would satisfy these requirements.
    As I hope I have demonstrated, the stakes here are enormous 
and the questions are many. The regulators have been under 
pressure to issue the proposal in accordance with the Dodd-
Frank stipulated schedule and we are now under a 60-day clock 
to fully evaluate and respond to these proposals.
    Given that the final rules will not be effective until 2013 
for commercial real estate, and given that these rules will 
also be implemented in conjunction with other accounting and 
regulatory reform, we urge you to consider allowing the 
regulators to extend the comment period to enable all of us to 
get these regulations right. We can still keep the final 
effective dates the same.
    If we don't draft the regulations correctly, the 
consequences would mean significant drying up of capital that 
could reverse the still fledgling economic recovery. Thank you.
    [The prepared statement of Mr. Hoeffel can be found on page 
231 of the appendix.]
    Chairman Garrett. And I thank you.
    Mr. Schneider, for 5 minutes?

STATEMENT OF KEVIN SCHNEIDER, PRESIDENT AND CEO, U.S. MORTGAGE 
  INSURANCE OF GENWORTH FINANCIAL, ON BEHALF OF THE MORTGAGE 
             INSURANCE COMPANIES OF AMERICA (MICA)

    Mr. Schneider. Thank you, Mr. Chairman. I am Kevin 
Schneider, president of Genworth's mortgage insurance business, 
and I also represent MICA, the Mortgage Insurance Companies of 
America. I will focus my remarks today on changes that will 
take place as a result of the proposed risk retention rule, and 
specifically the provisions related to Qualified Residential 
Mortgages, or QRMs.
    As the committee knows, the concept of QRMs in Dodd-Frank 
is intended to accomplish three key objectives: provide market-
based incentives to strengthen the underwriting standards; 
stabilize the housing markets by promoting sound non-government 
lending; and reboot the mortgage securitization market by 
creating a robust, liquid QRM mortgage asset class.
    Unfortunately, by failing to include low downpayment loans 
with mortgage insurance, the current QRM proposal misses the 
mark on what the bipartisan sponsors intended when the offered 
the QRM exemption. As the sponsors have stated on numerous 
occasions, they considered, and deliberately rejected, 
including a minimum downpayment as part of QRMs.
    Private mortgage insurance, by definition, provides real 
risk retention backed by hard capital and has been doing so for 
over 50 years. Mortgage insurance minimizes defaults and lowers 
losses when borrowers do get into trouble.
    Getting the rule wrong will have a devastating effect on 
markets, communities, and families. For decades, millions of 
creditworthy Americans, perhaps including many of the people in 
this room, have been able to purchase homes with downpayments 
of as little as 3 percent to 5 percent thanks to private 
mortgage insurance. Most have never missed a single payment.
    But the draft QRM rule effectively says these Americans are 
no longer a good credit risk. The rule penalizes those with 
unvarnished credit but only modest savings.
    As a consequence, the housing market recovery will continue 
to stagnate, and let me explain why. Last year, the median 
price of an existing home was $153,000. If the 20 percent rule 
was in effect, a first-time homebuyer would need to save 
$30,600 for a downpayment. It would take a family earning 
$50,000 annually nearly 11 years to save this amount even in 
the best of times.
    In 2009, half of all homebuyers made a downpayment of less 
than 20 percent. The 20 percent downpayment requirement could 
have kept more than 16 million borrowers out of the market or 
forced them to pay substantially higher mortgage rates.
    Even a 10 percent downpayment would have harmed nearly 9 
million borrowers. And the data show that there is no good 
reason to keep these borrowers out of the market for 
sustainable low downpayment mortgages.
    I have provided comparative data for the record which show 
that loans with mortgage insurance perform better than those 
without M.I. In fact, with all other characteristics being 
equal, insured mortgages become delinquent 32 percent less 
frequently than comparable uninsured loans.
    The facts are clear. Quality underwriting drives good loan 
performance.
    Since 1957, the Nation's mortgage insurers have helped 25 
million Americans buy or refinance their homes with low 
downpayment mortgages. The M.I. industry currently has enough 
private capital to insure $700 billion in new mortgages, enough 
to support nearly 4 million of new low downpayment loans over 
the next several years.
    Mortgage insurers acknowledge the important role that FHA 
plays in serving the low downpayment market. However, every day 
our private capital competes with FHA to serve first-time and 
low-income homebuyers. Without parity for private mortgage 
insurers, this proposed rule will shift virtually all low 
downpayment lending to the FHA, whose market share already has 
risen from 5 percent of the overall market in 2007 to 20 
percent today.
    Additional business to the FHA means American taxpayers 
will continue to bear 100 percent of the risk for all low 
downpayment loans. By incorporating mortgage insurance into a 
final QRM rule, we can continue the type of safe low 
downpayment lending that for decades has allowed millions of 
Americans to achieve the dream of homeownership.
    On behalf of Genworth Financial and the Mortgage Insurance 
Companies of America, I thank you for the opportunity to 
testify before this committee.
    [The prepared statement of Mr. Schneider can be found on 
page 298 of the appendix.]
    Mr. Schweikert. [presiding.] Thank you, Mr. Schneider.
    Mr. Smith?

STATEMENT OF BRAM SMITH, EXECUTIVE DIRECTOR, LOAN SYNDICATIONS 
                 AND TRADING ASSOCIATION (LSTA)

    Mr. Smith. Good afternoon, Chairman Schweikert. My name is 
Bram Smith and I am the executive director of the Loan 
Syndication and Trading Association, or the LSTA.
    The LSTA has more than 300 member firms which consist of 
all types of participants in the syndicated commercial loan 
market. These include large and regional U.S. banks, foreign 
banks, insurance companies, fund managers, and other 
institutional lenders. The LSTA undertakes a wide variety of 
activities to foster the development of policies and market 
practices in the loan market.
    The U.S. commercial loan market is critical to the success 
of American businesses. There are $1.2 trillion of outstanding 
funded syndicated commercial loans to U.S. companies.
    Institutional lenders such as insurance companies, mutual 
funds, and CLOs provided $500 billion to these syndicated 
commercial loans. CLOs alone provided $250 billion.
    My testimony today will focus on one aspect of commercial 
loan lending--CLOs. While the LSTA represents the interests of 
all loan market participants, not just CLOs, we appreciate the 
opportunity to offer our views on how the recently proposed 
risk retention rules under the Dodd-Frank Act would impact the 
CLO market.
    Unfortunately, attempting to apply the risk retention rules 
to CLOs is like trying to fit a square peg into a round hole. 
They simply do not fit.
    The current proposal would have a profoundly negative 
impact on the formation of CLOs. This could significantly 
reduce lending to American corporations and impact their 
ability to expand and create jobs.
    Why won't the proposed rules work for CLOs? As the 
regulators have noted, fundamentally this rule is about 
reforming the originate-to-distribute model for securitization 
and realigning the interests in structured finance.
    However, CLOs are not originate-to-distribute 
securitization. CLOs differ from originate-to-distribute 
securitizations in a number of ways.
    First, CLOs are a way for asset managers like Invesco or 
Eaton Vance to create investment pools of syndicated loans. 
These independent third party asset managers have a fiduciary 
responsibility to their investors. They seek out and purchase 
pieces of individual loans they believe are good investments, 
just like they would for a mutual fund.
    They buy a limited number of corporate loans, each of which 
is rated and priced daily. They research and analyze them 
individually.
    They then actively manage the portfolio to minimize losses 
and maximize returns. This is very different from typical ABS, 
which are static pools with no asset manager.
    In addition, the interests of the CLO manager and its 
investors are already aligned. The CLO manager is not paid an 
upfront fee. The only money it makes is from successfully 
managing this portfolio of corporate loans. If the CLO does not 
perform, the manager is not paid the vast majority of its fee.
    It is important also to note that CLOs performed remarkably 
well through the global financial crisis. CLOs suffered 
practically no defaults and investors in CLO notes suffered 
virtually no losses.
    The Dodd-Frank Act mandated a Federal Reserve study of risk 
retention. The study concluded that, ``CLOs are different from 
most asset classes.'' It recommended that the rule makers 
consider, among other things, the economics of different asset 
classes and securitization structures in designing retention 
requirements.
    Unfortunately, by lumping actively managed CLOs together 
with static originate-to-distribute securitization structures, 
the proposed rules do not take into account the unique 
characteristics of CLOs. Indeed, we are faced with a retention 
structure that threatens the very viability of CLOs. While we 
appreciate the agencies' efforts to write many risk retention 
options, for the reasons described in detail in our written 
testimony none of them is workable for CLOs.
    The proposed rule requires retention of 5 percent of the 
par value of all CLO securities rather than 5 percent of its 
credit risk. The horizontal first loss retention option is the 
only one even marginally feasible for CLOs, but the credit risk 
in this option is approximately 18 times greater than what was 
required by Dodd-Frank. This level of risk retention is 
unwarranted and unworkable for CLOs.
    Finally, the qualified commercial loan exemption is written 
so narrowly that even loans to some of the strongest companies 
in America, such as AT&T, John Deere, and PepsiCo, would not 
qualify, thereby rendering the exemption unusable.
    In conclusion, CLOs are not static originate-to-distribute 
ABS. Therefore, CLOs do not fit within the spirit of the risk 
retention provisions of the Dodd-Frank Act and we believe it is 
appropriate and prudent to expressly exclude them. But if the 
agencies nevertheless see fit to include CLOs, it is important 
to consider ways to optimize the alignment of interests without 
shuttering this important source of financing to U.S. 
companies.
    We appreciate the opportunity to testify and we look 
forward to working constructively to help produce the best 
possible final rule. Thank you.
    [The prepared statement of Mr. Smith can be found on page 
309 of the appendix.]
    Mr. Schweikert. Thank you, Mr. Smith.
    Ms. Harnick?

 STATEMENT OF ELLEN HARNICK, SENIOR POLICY COUNSEL, CENTER FOR 
                   RESPONSIBLE LENDING (CRL)

    Ms. Harnick. Good afternoon, Mr. Schweikert.
    I will focus my remarks also on the impact of the proposed 
rule on the market for home mortgages. We agree with the 
agencies that Qualified Residential Mortgages should consist 
only of loans that have responsible and sustainable terms and 
that are underwritten to ensure the borrower's ability to repay 
based on documented income.
    Where we disagree with the agencies is in our strong belief 
that these high-quality loans should be broadly available to 
creditworthy families. They should be the loans of choice for 
most borrowers.
    The proposed rule would do exactly the opposite of what we 
here suggest. It would create a category of responsible 
mortgages but would make them available only to a small 
proportion of creditworthy families.
    Those lacking sufficient wealth to make a 20 percent 
downpayment would be excluded. Twenty percent down means 
$34,000 down for a home at the median sale price nationwide, 
and $80,000 in places like Staten Island, or Oakland, 
California, where many working families live.
    This would leave out most families, including the majority 
of the middle class, regardless of whether they currently own 
or rent. This will take many qualified homebuyers out of the 
market.
    Shrinking the pool of homebuyers would hurt current 
homeowners whose homes would therefore be harder to sell. So 
what will these current homeowners do if they can't sell the 
home?
    Will a family whose adjustable rate mortgage is about to 
have a rate increase be able to refinance the loan? Not easily. 
The proposed rule requires even larger downpayments for 
refinanced loans.
    Nationwide, more than half of current mortgage holders 
could not meet these new requirements. The problem is 
exacerbated by the rule's debt-to-income requirements and a ban 
on families who are 60 days late on any bills. These 
restrictions are too rigid and are more restricted than 
necessary to ensure the family can responsibly sustain 
homeownership.
    All of this, of course, will take an even greater toll on 
families of color and those with low to moderate incomes who 
otherwise could have successfully purchased a modest home. This 
is bad for our economic recovery and we think contrary to 
congressional intent.
    In codifying the list of criteria to be considered and 
defined in the QRM, Congress did not include downpayments, an 
item that was specifically considered. And Congress was wise 
not to include a downpayment requirement.
    While I would not claim that downpayments bear no 
relationship to default risks, the data show that for loans 
that are responsibly structured and underwritten, low 
downpayments are not a substantial driver of default. 
Certainly, the amount by which large downpayments reduce 
defaults is too small to justify the large proportion of 
American families who would be excluded.
    Some might say that families excluded from the Qualified 
Residential Mortgage should get a mortgage that doesn't meet 
QRM standards. But a key point of these reforms is to make sure 
that the safest mortgages become the norm. The idea was not to 
relegate a large part of the population to second-tier credit, 
nor should FHA become the primary source of credit for American 
families.
    While it helps in this regard that Fannie Mae and Freddie 
Mac would still be able to securitize loans to families 
excluded from Qualified Residential Mortgages this does not 
solve the problem. The proposed rule would put the government's 
stamp of approval on the idea that loans with less than 20 
percent down are substandard.
    Bank examiners and lenders will consider non-QRM loans to 
be less safe and sound. This will make them more expensive and 
harder to come by.
    When lending was done the old-fashioned way lenders stayed 
with the borrower until the loan was repaid. They had strong 
incentives to ensure that the borrower could afford the loan, 
that any features that could produce payment shock were 
appropriate for the borrower, and to work with the borrower 
through periods of short-term crisis to avert unnecessary 
foreclosure.
    In this way the underwriting structure and servicing of the 
loans all minimized the risk of default. These three features 
should define a Qualified Residential Mortgage, and such 
mortgages should be available to all creditworthy families.
    I am happy to answer your questions.
    [The prepared statement of Ms. Harnick can be found on page 
208 of the appendix.]
    Mr. Schweikert. Thank you, Ms. Harnick.
    Mrs. Biggert?
    Mrs. Biggert. Thank you, Mr. Chairman.
    And I thank all the witnesses for being here. It has been 
quite a long day with our votes.
    My first question is for Mr. Schneider. Does mortgage 
insurance reduce the risk of default?
    Mr. Schneider. Yes. As a practical matter, the relevant 
comparison when you are trying to compare mortgage insurance 
and how it does against default is mortgage insurance against 
piggyback loans, which is really the only other alternative to 
low downpayment loans.
    One can think of a piggyback loan literally almost like 
risk retention because those loans were done in lieu of 
mortgage insurance for low downpayment lending and those loans 
were kept on balance sheets. You could also think of mortgage 
insurance the same way because in mortgage insurance there is a 
significant loss position taken by the mortgage insurer, so 
also risk retention.
    When you compare the performance of those two, a study was 
done of the CoreLogic servicer database on over 5 million loans 
that were originated from 2002 through 2007, really the height 
of the crisis. Controlling for origination year, documentation, 
loan purpose, combined loan-to-value, FICO, and geography, when 
you looked at all those attributes being equal, insured loans 
compared to those piggyback loans outperformed the piggyback 
loans consistently.
    They became delinquent 32 percent less of the time. When 
they did become delinquent, they were cured through the support 
of the servicer and the mortgage insurer 54 percent more often 
and ultimately defaulted 40 percent less than the piggyback 
loan, so--
    Mrs. Biggert. So could you say that the mortgage insurance 
reduces the severity of loss instead of the actual risk of 
default?
    Mr. Schneider. No. I would say that it does both.
    What I just described was both a reduction in the actual 
incident of default and--as well as the severity given a loan 
default. When a loan ultimately does go to claim, the mortgage 
insurance pays in the first loss position, so unequivocally it 
reduces the severity of the--
    Mrs. Biggert. Thank you.
    Mr. Cunningham, does the rule proposal maintain or worsen 
the playing field between the GSEs and the private 
securitizers?
    Mr. Cunningham. The rule, as it is currently proposed, 
would allow for those GSEs to be exempt from QRM, so therefore 
it would, in my opinion, worsen the position of private 
capital.
    Mrs. Biggert. Ms. Harnick, do you believe that there should 
be any downpayment requirement? And if so, how much?
    Ms. Harnick. We believe certainly for mortgage lending 
there should be some money down, but we don't believe that 
there should be a requirement set out in the QRM rules. The 
amount--as I said in my prepared statement, it is not that the 
size of the downpayment has no relationship to default; it is 
that the number of families excluded is not justified by the 
relatively limited amount of default reduction you get when 
other factors are in place to make sure the loan is 
responsible.
    Mrs. Biggert. Why is it that you wouldn't tie it to the 
QRM?
    Ms. Harnick. The reason I wouldn't tie it to the QRM is 
that the downpayment requirement really is a wealth-based 
restriction, and so it is the sort of restriction that should 
be put in place only if it significantly improves the 
performance of the loans relative to the people excluded, and 
it just doesn't do that. And I can say from the lending 
experience of our sister organization, Self-Help Credit Union, 
for example, we found that for some families, $500 or $1,000 is 
enough skin in the game to keep them paying well and for other 
families, a large downpayment isn't enough to keep them paying 
well. But the best drivers are these other factors.
    Mrs. Biggert. Thank you.
    Mr. Deutsch, how will the proposed rule impact the smaller 
banks and financial institutions? Will they have more trouble 
with or be out of game compared to the larger banks?
    Mr. Deutsch. I think all the banks will have a much harder 
time being able to originate loans. I think there will be some 
disproportionate impact on the smaller banks in particular 
because private label securitizations will have a more 
difficult time coming back, as Mr. Krimminger outlined in the 
previous panel. Having aggregator transactions by reducing the 
ability for those to get off the ground, there will be less 
ability for the capital markets to purchase them through the 
smaller banks and will create more limited capital that they 
will be able to originate.
    Mrs. Biggert. Thank you.
    My time has expired. I yield back.
    Mr. Schweikert. Thank you, Chairwoman Biggert.
    Mr. Manzullo?
    Mr. Manzullo. I would like the record to note that none of 
the people who voted for this bill are present at this second 
panel. They should be here to answer to you and so you can give 
them the reasons why this horrible piece of legislation is 
going to further stifle credit.
    Let me ask a general question here. States such as, I 
believe, California and possibly Nevada do not have 
requirements for deficiency judgment. The State of Illinois 
does, which--you guys are already shaking your heads and you 
know what the question is.
    Do you believe that the States that don't have a deficiency 
payment, whereby a person can simply walk away from his house 
and not be slapped with a judgment of the difference between 
the amount of the note and the sales price, does that increase, 
in your opinion, the default rates? Does it serve as an 
incentive not to stick it out and work it out on your house? 
Anybody?
    Mr. Deutsch. I will take a first shot at--
    Mr. Manzullo. Yes, sir.
    Mr. Deutsch. Absolutely. We would be supportive of more 
recourse back to the borrowers for taking out loans that they 
ultimately have to pay back. Creating these walk-away borrowers 
has been a significant problem, I think, for mortgage lenders 
and institutional investors who purchase mortgage-backed 
securities.
    By not having recourse, a borrower can just sort of simply 
walk away, turn their keys in, it does create very significant 
challenge in being able to price the risk, particularly in a 
housing market downturn.
    Mr. Manzullo. Do you have any idea of the number of States 
that don't require deficiencies judgments? Anybody?
    Kevin, do you have any idea how--
    Mr. Schneider. I don't know offhand what the number is.
    Mr. Manzullo. Okay. Because what is interesting is that the 
people who took out the loans, who signed the documents in the 
States where there is no deficiency, are now going to be 
required to go to a bank, and so if they default, the bank 
holds the bag but the consumer walks away with no liability. 
Does anybody think that makes sense?
    I thought that you were going to volunteer to give an 
answer down there?
    Ms. Harnick. I was reaching--it is beyond the topic I was 
prepared to testify on, but I am just sitting here thinking, in 
the commercial mortgage space, I haven't heard anyone object to 
the idea that a borrower on the commercial loan, for example, 
can go to bankruptcy court and get released on the mortgage, 
and it is effectively a similar concept. The note holder gets 
the value of the mortgage--the value of the property in 
connection with the bankruptcy sales but no more.
    Mr. Manzullo. But so can the homeowner in the States that 
have a deficiency judgment--bankruptcy.
    Ms. Harnick. That is correct. But I am saying we haven't 
heard much objection to this in the commercial mortgage space, 
and for most families, at least in our lending experience, most 
families do not walk away from the home if they have any way to 
save it. And so the effort to go after the family for the value 
of the personal property home and whatever else can be 
extracted seems a very poor social outcome and probably not 
financially--
    Mr. Manzullo. It is a financial obligation. If you sign a 
note for $100,000 and you default on your loan, and the assets 
sell for $60,000 and you still owe $30,000, to me that is a 
moral obligation that attaches to that, and sometimes what I 
have seen taking place here--I haven't been able to go through 
all the testimony--is that the people who come in here from the 
government agencies talk about having all new types of loans 
and new consumer product divisions and new regulations, and yet 
it wasn't until October 1st of 2009 that the Fed required 
written documentation of a person's earnings. And it took a 
year. It took a solid year for the Fed to come out with that 
regulation.
    Maybe I look at this thing too simply, but people were 
allowed to buy homes who couldn't even make the first payment 
and they were actually called ``liar loans.'' And I am not even 
talking about subprime, but there is still a market for 
subprime where somebody who has a good job and doesn't have a 
large downpayment can buy a house, and therefore there is 
another reason for mortgage insurance on it.
    But it just amazes me that something that could have been 
fixed that simply wasn't done. And now they want to have all 
these rules which would really mess up securitization, 
especially on the commercial end, with regard to your family.
    Mr. Schweikert. Thank you, Mr. Manzullo.
    Mr. Sherman?
    Mr. Sherman. Mr. Cunningham, what is the Mortgage Bankers 
Association's view on this 20 percent downpayment requirement? 
How is that going to affect home prices in a world where the 
GSEs are playing a diminished role, as so many of my 
colleagues--well I would say, I guess, colleagues to my left--
could be. Sort of creepy that way, isn't it?
    Mr. Cunningham. The mortgage bankers certainly believe that 
a 20 percent downpayment is too stringent a requirement. We 
think that it will increase the cost of credit to borrowers, 
and decrease the availability of credit to borrowers. 
Ultimately, fewer borrowers would result, and in the end, 
prices will have a harder time stabilizing.
    Mr. Sherman. There is a different price elasticity for 
different products. At my local pizzeria, they don't cut the 
price if they have fewer buyers that day; they just make fewer 
pizzas. The amount of housing stock we have in this country 
could go up but it isn't coming down, and even a 5 percent or 
10 percent decline in effective demand from people who can get 
a mortgage--could see a tremendous decline in price.
    Now, I would like to turn to the role of private mortgage 
insurance, either Mr. Cunningham or Mr. Deutsch. Private 
mortgage insurers have been shown to mitigate and cure loan 
deficiencies--or reduce loan deficiencies--because you have a 
second set of eyes.
    But also, the entire concept of retained interest is that 
we want somebody in the private sector who really knows what is 
going on to be on the hook. And it occurs to me that mortgage 
insurers might be just as smart--they are certainly just as 
private and they are certainly on the hook to the same degree 
as would a lender who retains an interest.
    Shouldn't the downpayment of loans that are--that qualify 
reflect the private mortgage insurance involved, or should we 
require just as high a downpayment even if there is private 
mortgage insurance?
    Mr. Cunningham. I think that a smaller downpayment would be 
justified with a credit enhancement or private mortgage 
insurance.
    Mr. Sherman. And if the purpose of this retained interest 
is to say somebody in the private sector who understands the 
loan--may not have made the loan but understands it, because it 
is my understanding that the securitizer doesn't have to be the 
entity making the loan; you could have small banks making the 
loans, selling them and getting a little shafted on the price 
when they sell them to the big banks who could then retain the 
interest.
    So the law is structured so that somebody in the private 
sector has to be on the hook and that has to be the 
securitizer. Securitizer doesn't make you--there is no magic 
with that. The securitizer, though, is knowledgeable as to the 
portfolio, has skin in the game, is in the private sector.
    Should we simply regard the mortgage insurance company 
being on the hook as the same as a retained interest by the 
securitizer? Should we view the entire team of private sector 
folks involved in securitization and say, looking at the team, 
are they on the hook?
    Mr. Cunningham. First of all, I don't think that the 
exemption for Qualified Residential Mortgage loans excluded low 
downpayment mortgages. It specifically considered it and 
decided not to exclude low downpayment mortgages but left it up 
to the regulators for consideration.
    Regulators have chosen to come back and require 20 percent 
downpayment. I think further consideration of lower downpayment 
mortgages is certainly a worthwhile conversation and I think 
lower downpayment mortgages--well underwritten, well 
qualified--
    Mr. Sherman. Let me try and squeeze in one more question.
    Mr. Cunningham. Yes.
    Mr. Sherman. Going back to life as we hope to see it again, 
what percentage of first-time homebuyers are able to come up 
with 20 percent down, back when you could--say in 2007, 2006, 
the world we hope to restore?
    Mr. Cunningham. Mr. Schneider may have better information 
on this than I do, but I think that in 2009, probably of the 
buyers who purchased in 2009, close to 47 percent or so put 
down less than 10 percent.
    Mr. Sherman. Less than 10 percent? So even in 2009, with 
higher underwriting standards, half of the effective demand is 
from those who don't even have 10 percent?
    Mr. Cunningham. Remember, when I say that, that includes 
FHA mortgages in addition--
    Mr. Sherman. Right.
    Mr. Cunningham. --to conventional mortgages, so it is 
inclusive.
    Mr. Sherman. I yield back.
    Mr. Schweikert. And to my friend to the right, actually on 
that same track as you were actually--great question.
    Mr. Scheneider, could you also--because I would like to 
hear your response to--
    Mr. Schneider. It is dead on, Congressman. I represent the 
mortgage insurance industry and we believe the congressional 
intent in the QRM definition was absolutely to include 
something--credit enhancements such as private mortgage 
insurance that did provide significant capital to get 
significant private equity in a first loss position that could 
be the equivalent of the risk retention that is suggested in 
the bill.
    Private mortgage insurance--you could think about it as an 
independent set of underwriting standards that provides the 
appropriate friction in the system to make sure the originator 
is really kept honest. And when you have your own private 
capital at risk and you are in a first loss position after the 
borrower's equity, which is exactly what the private mortgage 
insurance industry does, we have demonstrated that it does 
reduce both the incidence and severity of loss for low 
downpayment lending and can certainly support a much lower 
level than a 20 percent down requirement as proposed in the 
bill.
    Mr. Sherman. May I ask the indulgence of the Chair to ask--
    Mr. Schweikert. Yes. Let me yield you a minute of my time.
    Mr. Sherman. --one more question, and that is, the risk 
retention that the big banks plan to have is if they make a 
$100 loan and it drops in value to $50, the folks retaining the 
interest are on the hook for 5 percent of that $50 loss--$2.50, 
if I calculated that correctly. In contrast, if you have 
private mortgage insurance on a mortgage that was $100 but now 
it is worth only $50, how much are you on the hook for?
    Mr. Schneider. The private mortgage insurance industry 
generally provides 25 percent to 30 percent mortgage coverage 
on the unpaid principal balance of the loan, so it would be 
25--
    Mr. Sherman. So if for some reason--
    Mr. Schneider. --percent riskier--
    Mr. Sherman. --they lent $100 and it had to go to 
foreclosure and they only realized $50 you would be on the hook 
for $25?
    Mr. Schneider. $25--
    Mr. Sherman. Which is 10 times the risk the big banks would 
pay with--if they retained a 5 percent--
    Mr. Schneider. That is our loss position.
    Mr. Sherman. Yes.
    I yield back.
    Mr. Schweikert. Thank you. And in many ways, you asked the 
question I was going to head toward.
    I am elated to have you but I also--I have so many 
questions. Many of you, you don't mind not going home tonight, 
do you?
    [laughter]
    Is it pronounced Mr. ``Hoeffel?''
    Mr. Hoeffel. ``Hoeffel.''
    Mr. Schweikert. ``Hoeffel.'' Help me work through the 
reserve account--the premium reserve account. Mechanically, how 
do you see that actually working?
    Mr. Hoeffel. The way it has been drafted is that any excess 
spread that is monetized needs to be retained in the structure 
of securitization through the term. Now, the reason people 
aggregate pools of loans and bundle them into securitizations 
and sell them is clearly they hope to be able to sell the 
transaction for more than the cost of putting the bundled 
transaction together, much like having a sandwich shop. You 
want to sell the sandwich for more than it costs to put the 
bread and the ingredients together.
    But what this is doing is saying any profit you make--
because the profit in the securitization generally comes from 
excess spread--needs to stay in the transaction as additional 
credit support for the bond.
    That might be good for investors but then there is really 
no reason for the industry to exist because banks and loan 
aggregators, if they are not going to make any money or even, 
in this case, in the most extreme case, cover the cost of their 
personnel and their loan funding--
    Mr. Schweikert. You are beating me, almost, to where I was 
going. So where would the premium or fee for the securitizing 
of bringing the debt instrument to market come from?
    Mr. Hoeffel. Where does it come from?
    Mr. Schweikert. If the capture was held aside?
    Mr. Hoeffel. Say you bundle a portfolio of loans that all 
have an interest rate of 8 percent and then you create a 
security so that the securities have the benefit of 
diversification so it is not just one 8 percent loan; it is a 
portfolio of 300 loans at 8 percent, so you have some credit 
diversification. The hope is that you would sell the securities 
for a blended coupon of something less than 8 percent--say it 
is 7--
    Mr. Schweikert. No, I am very comfortable with the--
    Mr. Hoeffel. In effect, the bondholders are paying you more 
than par value for the loan because they are paying you a price 
that yields a lower yield on the sum total of the bonds than 
the face amount. So you are basically selling for more than the 
face amount of the bonds, and that is where the excess comes 
from.
    Mr. Schweikert. But if you have the premium recapture 
account--
    Mr. Hoeffel. That excess, that 1 percent or 2 percent that 
is in there stays in the transaction so--
    Mr. Schweikert. So then I will--my question again. So you 
are putting the package together. How are you paid?
    Mr. Hoeffel. With the premium capture account? You are not 
paid.
    Mr. Schweikert. Okay. That is sort of where I was sort of 
heading, the long way around. I am sorry. Maybe I did a very 
poor job.
    In my last 6 or 7 seconds, Mr. Schneider, and maybe I am 
working on the conceptual problem here because I see us talking 
about the QRM and then I talk about over here, the 5 percent. 
In many ways, I think we are having a conversation we are 
talking around each other.
    Okay, qualifying loan over here, the 20 percent, this is 
the credit quality. It is a nice, safe instrument. But when we 
talk about PMIs, the mortgage insurance, it is not necessarily 
about this instrument; it is about my threatened risk to the 
purchasers on the other end of that instrument.
    And so over here, I have my qualifying mortgage, which I 
wouldn't have to have a reserve account for. But over here, if 
I had somehow insured the pool--the individuals--I could 
actually be offering loans with less than 20 percent down but 
it is not the insurance on that individual loan, in many ways; 
it is the fact that it is another way to insure it so it is not 
a risk out to the market.
    Is anyone else with me that we may be talking around each 
other on two different sort of subjects here? Let me see if I 
am making sense.
    QRM--it is just about the individual loan, and we can 
accept that.
    Mr. Schneider. The underwriting quality of an individual 
loan.
    Mr. Schweikert. Mortgage insurance comes into effect when 
it is already in default.
    Mr. Schneider. Mortgage insurance is provided potentially 
on a loan at the point of origination and the discussion about 
mortgage insurance vis-a-vis QRMs is, does that allow a lower 
downpayment--a low downpayment mortgage to qualify as a QRM?
    Mr. Schweikert. In some of the discussion we had in the 
earlier panel--and I know I am way over my time and I am going 
to yield myself about another 20 seconds, but in the panel we 
had before the discussion was, well, we don't want to discuss 
mortgage insurance because that is after it goes into default 
we gain the enhanced credit quality and--
    Mr. Schneider. And you reduce the amount of loss associated 
with this because--
    Mr. Schweikert. Yes, but that happens to be after the loan 
goes. And the QRM was on this side, saying we are trying to 
find those loans that won't. And my fear is by creating that 
type of box we are going to lock out a lot of families from 
being able to get a home.
    Mr. Schneider. I couldn't agree with you more. By not 
allowing lower downpayment lending through the support of the 
credit enhancement the private mortgage insurance provides I 
think we are dramatically trading off an opportunity to have 
more creditworthy borrowers be able to participate in the 
market and help us take some of this inventory off--
    Mr. Schweikert. Forgive me. I am way over my time.
    Mrs. Biggert?
    Mrs. Biggert. It seems like the QRM appears to ignore or 
dismiss several matrix--full documentation of loans, mortgage 
insurance, and others--of prudent mortgage underwriting, and in 
fact QRM seems to set up an arbitrary box of standards for a 
limited number of borrowers. And so I have heard from several 
non-government individuals and groups that the analysis is a 
mysterious data set that Federal regulators used and it does 
not reflect other market data on sound mortgage underwriting.
    Would you agree with that? And maybe start with Mr. Smith, 
because I don't think we have heard from you.
    Mr. Smith. I would love to comment but that is not our 
field. Where we specialize is really on corporate loans and 
CLOs, so I will defer to my fellow panelists.
    Mrs. Biggert. Then, I will go to Mr. Schneider.
    Mr. Schneider. Yes, Congresswoman, I would say that as 
described this morning, in the earlier panel--the comparison 
that was made on the data analysis was between a below 80 LTV 
loan and above 80 LTV loan. There is no doubt an above 80 LTV 
loan is a riskier product.
    The discussion needs to be, when you do an above 80 LTV 
loan is there a way to do it safely? Is there a way to do it 
that reduces both the incidence and severity of default? And 
that is what our data has proven and I would like to submit 
formally for the record a chart I have that we did not submit 
earlier that illustrates that performance differential that I 
talked about earlier in my testimony.
    Mr. Schweikert. Okay. Without objection, we would be happy 
to have it.
    Mrs. Biggert. Would anyone else like to comment on that?
    Mr. Deutsch. Yes, if I might address it. I think one of the 
key aspects of this is if you--if these metrics prove that 
these loans outside of what the proposed QRM are so unsafe or 
unwieldy it really begs the question of the statistics that 
they did include in their release that said only one out of 
five loans right now that the GSEs--ultimately the American 
taxpayer--are guaranteeing--only one out of five of those loans 
would qualify as a QRM right now, which says that the other 80 
percent of those loans that the American taxpayer are on the 
hook for right now are ``unsafe or less safe than the QRM.''
    I think it really begs the question of, why isn't the QRM 
defined substantially similar to what a current conforming loan 
looks like that the American taxpayer is on the hook for?
    Mr. Hoeffel. I would say that underwriting mortgages can be 
very complex, and certainly on the commercial side we have been 
trying to outline all the different considerations that are 
made for mortgage loans, so I think it is also similar for 
residential loans, that using just one or two metrics like LTV 
can be misleading because you can have a low LTV loan that has 
bad characteristics or you can have a high LTV loan that has 
very strong characteristics and they may have vastly different 
default probability. So it really needs to be a layered 
analysis on the definition of a high-risk or a low-risk loan.
    Mrs. Biggert. Okay. And then just one more quick question, 
if I may.
    We are trying, I think, to get less government--get 
government out of the mortgage finance business and encourage 
the private sector to replace the taxpayer-backed government 
financing, so I am concerned that the GSE reform and a narrow 
QRM more borrowers will try to utilize FHA versus the private 
sector and then the taxpayer-backed FHA program will be 
especially attractive if FHA permits a 3.5 percent downpayment. 
How should Congress address this problem and should FHA serve a 
more limited role?
    Mr. Schneider?
    Mr. Schneider. Congresswoman, I would like to respond to 
that. As I mentioned and outlined in my testimony, I think one 
of the things that is very critical right now is there is some 
form of parity between what is the allowed requirements in the 
private sector and what is going on in the FHA.
    The FHA provides 100 percent coverage on any loans that go 
into default. That means the taxpayer is on the hook for 100 
percent of those loans.
    That is the stated intent of the Administration through the 
White Paper, we are going to start ratcheting that down, and as 
we think going forward specifically about QRMs and we don't 
have some type of parity between the private sector and what is 
allowed in the FHA, you are absolutely right. Business will 
continue to run to the FHA. The American taxpayer will continue 
to be on the hook. And private capital will not be allowed to 
come back into the sector.
    Mrs. Biggert. Thank you.
    Mr. Cunningham. One of the other considerations is the 
downpayment. As you pointed out, the disparity between a 20 
percent downpayment, as proposed, versus 3.5 percent would 
obviously push borrowers towards an FHA loan. Making that 
downpayment requirement less would provide more parity in the 
marketplace and encourage more private capital.
    Mrs. Biggert. Thank you.
    Ms. Harnick. I would simply agree that FHA should be 
serving the pool of borrowers who either are first-time 
homebuyers or who need help affording reasonable credit, but 
that in general, borrowers who are creditworthy should be able 
to go and get mortgages in the first tier of the market. This 
idea of having two tiers is unhelpful, I think, economically 
and for the taxpayers.
    And I would simply note some of the data that Moody's 
Analytics has released showing that even 3 percent downpayment 
loans perform well if properly underwritten and the other 
respects we have been talking about, that should not be forced 
to FHA.
    Mrs. Biggert. Thank you.
    I yield back.
    Mr. Schweikert. Thank you, Chairwoman Biggert.
    Mr. Sherman?
    Mr. Sherman. Ms. Harnick, if we had a 20 percent 
downpayment requirement, what effect would that have on 
minority homeownership?
    Ms. Harnick. On minority homeowners, the effect would be 
even more devastating than on white families because most 
families in America have most of their wealth in their homes. 
That is just a fact of the way our economy is structured. But 
for families of color, overwhelmingly the home is the primary 
place that they build wealth.
    And I should say, among, for example, renters, who are 
largely the pool of available first-time homebuyers, only the 
wealthiest 25 percent of minority renters have an excess of, I 
think it is something like $3,000 or $5,000 in cash flow.
    Mr. Sherman. And I believe that renters in our society in 
total averaging negative net worth. Is that true?
    Either Mr. Cunningham or Mr. Deutsch, if you could explain 
to me whether--what is the cost of funds of the Big Five banks 
as compared to everyone else who might retain a 5 percent 
interest in a mortgage?
    Mr. Cunningham. I think it is fair to say that the cost of 
funds for the Big Five banks is probably less than it is for 
smaller community lenders.
    Mr. Sherman. And as I have editorialized before, the reason 
for that is--a huge reason for that is the too-big-to-fail 
syndrome, where we see smaller financial institutions every 
decade go under and uninsured depositors are--or those with 
more than the amount covered by FDIC insurance--are out of 
luck, whereas there is a general perception that if that 
happened to one of the Big Five, it would be the taxpayers, not 
the investors. That is why they have a lower cost to fund.
    I yield back.
    Mr. Schweikert. Thank you, Mr. Sherman.
    Mr. Manzullo?
    Mr. Manzullo. I understand that it is about $1.2 trillion 
in loans secured by commercial real estate that are going to be 
coming due within the next 5 years, and that it is a very 
common practice to take monthly appraisals as the value of 
these real estate holdings go down then to go to an institution 
and say, ``I would like to refinance,'' and they say, ``Well, 
you owe more than what this shopping center/commercial 
building, etc., is worth.''
    Notwithstanding that minor problem, my concern--and, Mr. 
Smith, if you could help me on this because from my 
understanding of CLOs is that you work in a participation 
agreement with a lender, and based upon your testimony, your 
CLOs performed extraordinarily well and yet you are being 
blamed by these rules applying to you when in fact they should 
not. And so my question--and actually the answer to it appears 
on pages three and four--but you didn't have the opportunity to 
give all the testimony--is to explain here why the CLOs 
performed well and therefore why you should be exempt from risk 
retention requirements. Do you like that question?
    Mr. Smith. Yes. Thank you.
    Mr. Manzullo. Okay.
    Mr. Smith. And before I start, I was noticing all the 
questions being focused on mortgages and commercial mortgage so 
I am glad to have a chance here to talk about this small but 
extremely vital market, even though it only totals $250 
billion.
    Mr. Manzullo. That is a lot of money.
    Mr. Smith. For most people it is, but when you compare it 
to the securitization market, which is 10 or 12 or however it 
is defined now we can understand--I can understand, I think, a 
little bit how the agencies perhaps--I don't want to use the 
word ``overlooked'' it, but didn't concentrate on it and figure 
out the nuances and why it is different.
    So as I mentioned before, I would feel very strongly that 
it is not an originate-to-distribute model, which most of the 
other securitizations that we have discussed this afternoon 
are. So why has it performed better?
    There are many reasons. Some of the major ones are is what 
comprises a CLO, and these are corporate senior secured loans 
that are secured by all the assets or nearly all of the assets 
in the company. And those loans go through a rigorous process 
not only by the bank syndicates but by the individual buyers of 
the loan, the CLOs, in this case; so many eyes get to look on 
these.
    Number two, it is the structure of the CLO which allows and 
provides for managers to go ahead and individually select these 
loans on a one-off basis, an independent third party basis. 
They are paid to do this. They are very similar to asset fund 
managers and they use all the information that is available.
    When I think about what is available out there in terms of 
transparency, it starts all the way at the beginning. A lot of 
information about each individual loan provided by the 
borrower, provided by the banks, provided by the syndicator.
    On the other side, what does the investor get? The investor 
who invests in the CLO--they get a phonebook in terms of volume 
of information every quarter about each individual loan, how it 
is performing, what is its price stat, and any other issues 
that have come up.
    And what makes it interesting is that there are only 150 to 
250 individual loans in each of these CLOs, so it is very 
manageable. The CLO manager, who is an investment advisor and 
covered--and has fiduciary responsibility to his investors, has 
a lot of other transparencies that help out. These are all 
rated; these are all priced every day.
    There is a vibrant, robust secondary market in secondary 
loans that he uses for indications of how loans are performing 
and where the value is. He takes advantage of that secondary 
market to balance his portfolio, sell some loans perhaps to 
avoid losses and to buy other loans to maximize returns.
    And lastly, and perhaps key, is that the incentives that 
have been set up in CLOs--the over 630 CLOs that are out there 
today--align the interests, we think, I think, of the investors 
with the asset managers.
    And so why do I say this? I say this because they get a 
very small fee--the senior fee--annually to operate and manage 
these funds. The second fee, the subordinate fee, which can 
comprise as much as 80 percent--as much as 80 percent of the 
total annual fee he gets, he only receives that if interest is 
paid to all the other tranches in the securitization.
    And actually, I forgot the most important thing. The CLO 
manager gets no money when the CLO is closed. He only gets his 
money on an ongoing basis, an annual fee.
    And then there is an extra fee that may or may not occur 
well down in the life of the CLO--5, 6, or 7 years--more of a 
profit sharing. If the CLO has generated for the equity holder 
a return or an amount of money over a certain agreed to level 
then he gets to share in that.
    So we think all the alignments are--make sure that the 
asset manager is thinking about what the right moves are and to 
perform well for his investors. So I guess that was a long 
answer, but I think that--
    Mr. Manzullo. --but I would like to ask, if possible, a 
follow-up question, because this is really important at this 
point. Assuming the regulation kicks in, based upon what you 
have just stated, tell me how that would interweave, or 
destroy, or the actual impact on the CLO.
    Mr. Smith. Sure. The risk retention, as contemplated now, 
has five options and none of them really work for CLOs. The one 
that has been talked about the most is the 5 percent vertical, 
so I will approach this in two vote--it two facets.
    Number one, 5 percent is a lot of money for these CLO 
managers. Remember, they are not originating this because they 
are not banks; they are buying. It is very similar to what a 
mutual fund manager is, and nobody is thinking of asking mutual 
fund managers to have 5 percent risk retentions on anything 
they buy. And so 5 percent is a large number.
    We have conducted a survey, terminated back in November--
only 13 percent of our members said that they could come up 
with 5 percent on a vertical slice to hold as risk retention. 
Of those 13 percent, many of them said just because they could 
probably wouldn't because the return on that 5 percent--because 
you would be taking 5 percent of the triple A's, 5 percent of 
the double A's, all the way down to the equity--that wouldn't--
they probably wouldn't meet their return hurdles because 
capital is scarce in all of these companies. So we don't think 
that will work.
    Now, another alternative suggested, and we think it is just 
mathematically wrong, is take that 5 percent vertical and turn 
it into a 5 percent horizontal, so you are the first loss. You 
are the first loss.
    And remember, Dodd-Frank says you should take 5 percent of 
the asset risk here, and this is 5 percent--really taking 5 
percent of the entire portfolio and making that the first loss. 
We don't think any of our members will, if that is the way it 
goes, will put that money down.
    However, we think we can work with the agencies and 
demonstrate that their proposal is much more excessive than 
what Dodd-Frank calls for. We have done some calculations. It 
looks like it could be as much as 18 times as much.
    So if there is a first risk position that was much lower 
than 5 percent that might work for some. My big challenge here 
is that one of the recommendations that the Federal Reserve 
study said on risk retention was, what would be the impact on 
risk retention for all types of managers, so small, medium, and 
large? We think almost any risk retention will have a 
detrimental effect on the small--detrimental effect on the 
small and medium-sized managers. They just don't have the 
money.
    Mr. Manzullo. I know the hour is late. I do have a quick 
question of the witness, Ms. Harnick. Would I--
    Mr. Schweikert. I will yield to--actually, this has become 
sort of an open discussion--
    Mr. Manzullo. I appreciate that.
    In your testimony, Ms. Harnick, on page two you state, 
``Almost 4 years ago our organization released a report warning 
that the reckless and abusive lending practices in the previous 
2 decades would lead to approximately 2 million subprime 
foreclosures.'' Now, you don't wear the hat of a prophet, and 
what was going on back then didn't require a prescient mind, 
but there were members here going back as far as 2000, when the 
first GSE reform bill was introduced, that were concerned about 
it.
    It came up again in 2005. In 2005, we had another bill and 
there was something called the Rice amendment that would have 
tightened up these lending requirements. And many of us were 
just really, really upset looking to any agency to step in and 
say, ``You simply cannot keep on lending to people without good 
proof of their ability to repay.''
    Tell us what you were saying 4 years ago?
    Ms. Harnick. So first of all, what I wanted to say when I 
heard you speaking earlier about how it was amazing that it 
took as long as it did to require documented ability to repay, 
you would think that would have been a first principle. But I 
must tell you that we were among the people pushing for that 
and the resistance was extremely strong from people who said 
basically, ``Lenders know their business. Why do you, Ellen 
Harnick, think you know what is better for a lender than a 
lender? They can protect their own interests and if these loans 
really were risky they wouldn't make them because the market 
would correct.''
    What made us in 2006 draw the conclusion we did was that we 
looked at the structure of the subprime loans and we figured 
out that they were dependent, really, on ever-appreciating home 
prices because the loans after 2 years would explode and the 
borrowers--the lenders were only establishing ability to repay 
for the first 2 years. And so it was clear that the homebuyer 
had to refinance before the 2 years were up because they 
couldn't afford the new payments.
    But to accomplish that, they paid a prepayment penalty of 
something like 300 to 350 basis points, which they could only 
accomplish by taking a bigger loan in their refinance. And they 
could, of course, only do that if the home appreciated enough 
to support the bigger loans.
    So what we did then was we looked at the pace of home price 
appreciation and saw that it was slowing. See, even before home 
prices began to decline we looked at the pace--the slowing pace 
of appreciation and just thought, ``This simply can't 
continue.'' And so we did the math and came up with an estimate 
that turned out to be unfortunately conservative.
    But our real concern all along has been some of the points 
you yourself have emphasized today. And I will say, the tragedy 
for us was that for many of the borrowers who got these 
ridiculous exploding 2/28 ARMs qualified for a 30-year fixed-
rate loan at a very small increase on the initial payment, and 
those people would--many of those people would be in those 
homes today.
    Mr. Schweikert. Thank you, Mr. Manzullo.
    And I appreciate everyone's tolerance. I know we are not 
paying much attention to the clock but at least we are getting 
the information and discussion. And with only three of us up 
here, why not?
    Mr. Deutsch, talk to me about what is working right now in 
the securitization market. Because your organization, you cover 
all types of securitization. What is working, what is frozen 
right now?
    Mr. Deutsch. First, let me say I am jealous of many of my 
counterparts here on the panel who have one or two asset 
classes to focus on; I have about six or eight just in my 
testimony today.
    I think what is working normally right now is, for example, 
auto securitization. At this point, it is my view that we have 
an absolutely normal functioning auto securitization market.
    There is somewhere around $40 billion annually that is 
being issued. It is certainly down from the peak, but obviously 
in America right now you are not--Americans aren't buying as 
many pickup trucks or cars as they were 2 or 3 years ago 
because they have a less optimistic perspective.
    Mr. Schweikert. On the consumption of auto securitization, 
is the securitization market consuming the paper that is 
available?
    Mr. Deutsch. There is actually a very high demand right now 
from the investor community for auto paper. It is, you know--
    Mr. Schweikert. And if these rates go--as you understand 
them to be, if they were implemented what would that do to that 
type of securitization?
    Mr. Deutsch. It would significantly reduce it. And one of 
the key factors for that is that the originators of most auto 
loans in America are not banks; they are auto captive, auto 
finance companies.
    They are not necessarily in the business to make loans. 
They are fundamentally in the business to sell--to make and 
sell cars and have a captive auto finance company that goes 
along with it.
    Those companies are not built to take risk retention. They 
are not built to hold capital as part of those captive auto 
finance companies.
    Now, certain of them can and they do as part of those 
securitizations. They have built this in over the course of the 
last 20 years in the auto securitization so that they do retain 
certain amount of risk which is not eligible under these rules.
    Mr. Schweikert. But are they retaining part of that risk as 
part of their income and their business model?
    Mr. Deutsch. They are retaining that risk because investors 
demand it. They say, ``I want you to retain some risk and I 
will buy this securitization.'' And that market is functioning 
now--
    Mr. Schweikert. Does securitization sell at a premium 
because they are holding a risk?
    Mr. Deutsch. They don't sell at a premium. And 
fundamentally these investors--if you have $40 billion coming 
into the market from these institutional investors they are 
clearly signaling--they think their interests are aligned with 
those of those who are selling. If those interests are already 
aligned why add new capital requirement that ultimately will 
reduce that availability not only for investors to buy but also 
for consumers to take out those loans?
    Mr. Schweikert. Okay.
    Mr. Hoeffel. If I might, Mr. Schweikert, one thing--one 
area that is also performing is the commercial mortgage side. 
We are starting to see a growth in CMBS issuance that has 
evolved without government intervention. The industry itself 
has created best practices, better disclosure. It has brought 
investors back into the market--
    Mr. Schweikert. Any particular category of underlying asset 
that is working now?
    Mr. Hoeffel. It is all commercial asset types. They tend to 
be larger assets in core markets more than in smaller markets. 
I think that is more a function of just the general economic 
health of the regions where the properties are located more 
than from investor appetite.
    Mr. Schweikert. I would yield my time, but why would I 
start doing that now? And Chairwoman Biggert has been very, 
very patient with a freshman at the Chair.
    Same question, though, on your markets: If these rules went 
into effect what would that do to the commercial mortgage-
backed security market?
    Mr. Hoeffel. Risk retention itself would have some effect 
on cost, potentially, because we would have to force a 5 
percent retention where one doesn't exist now. But we have 
always had some form of risk retention through the B-piece 
buyer, so we don't think risk retention in a vacuum would stop 
the industry, it would just increase the cost of borrowing and 
create some additional frictional costs.
    But with this premium recapture, if that is part of the 
risk retention regulations that would, as you mentioned--
    Mr. Schweikert. I remember, you and I have been through 
that one.
    Mr. Hoeffel. Yes.
    Mr. Schweikert. All right. Thank you.
    Chairwoman Biggert?
    Mrs. Biggert. I have no further questions.
    Mr. Schweikert. Anyone else?
    I think you may be very blessed to be rid of us. And thank 
you for also being willing to be so flexible because doing a 
little more open process at least allowed us--because some of 
you had some great answers, and just letting it flow instead of 
cutting you off when the little red light popped up.
    Without objection, the following statements will be added 
to the record: the Education Finance Council; HVP Inc.; and the 
American Bankers Association.
    And the Chair notes that some of the members may have 
additional questions for the panel which they may wish to 
submit in writing. Without objection--I wonder if I can object 
to my own motion--the hearing record will remain open for 30 
days for members to submit written questions to these witnesses 
and to place their responses in the record.
    And with that, this hearing is adjourned.
    [Whereupon, at 6:20 p.m., the hearing was adjourned.]

                            A P P E N D I X




                             April 14, 2011


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