[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
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Printed for the use of the Committee on Financial Services
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UNDERSTANDING THE IMPLICATIONS AND CONSEQUENCES OF THE
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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
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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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