[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
TRANSPARENCY AS AN ALTERNATIVE TO RISK RETENTION
=======================================================================
HEARING
before the
SUBCOMMITTEE ON TARP, FINANCIAL SERVICES
AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS
of the
COMMITTEE ON OVERSIGHT
AND GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MAY 11, 2011
__________
Serial No. 112-37
__________
Printed for the use of the Committee on Oversight and Government Reform
Available via the World Wide Web: http://www.fdsys.gov
http://www.house.gov/reform
----------
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COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM
DARRELL E. ISSA, California, Chairman
DAN BURTON, Indiana ELIJAH E. CUMMINGS, Maryland,
JOHN L. MICA, Florida Ranking Minority Member
TODD RUSSELL PLATTS, Pennsylvania EDOLPHUS TOWNS, New York
MICHAEL R. TURNER, Ohio CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina ELEANOR HOLMES NORTON, District of
JIM JORDAN, Ohio Columbia
JASON CHAFFETZ, Utah DENNIS J. KUCINICH, Ohio
CONNIE MACK, Florida JOHN F. TIERNEY, Massachusetts
TIM WALBERG, Michigan WM. LACY CLAY, Missouri
JAMES LANKFORD, Oklahoma STEPHEN F. LYNCH, Massachusetts
JUSTIN AMASH, Michigan JIM COOPER, Tennessee
ANN MARIE BUERKLE, New York GERALD E. CONNOLLY, Virginia
PAUL A. GOSAR, Arizona MIKE QUIGLEY, Illinois
RAUL R. LABRADOR, Idaho DANNY K. DAVIS, Illinois
PATRICK MEEHAN, Pennsylvania BRUCE L. BRALEY, Iowa
SCOTT DesJARLAIS, Tennessee PETER WELCH, Vermont
JOE WALSH, Illinois JOHN A. YARMUTH, Kentucky
TREY GOWDY, South Carolina CHRISTOPHER S. MURPHY, Connecticut
DENNIS A. ROSS, Florida JACKIE SPEIER, California
FRANK C. GUINTA, New Hampshire
BLAKE FARENTHOLD, Texas
MIKE KELLY, Pennsylvania
Lawrence J. Brady, Staff Director
John D. Cuaderes, Deputy Staff Director
Robert Borden, General Counsel
Linda A. Good, Chief Clerk
David Rapallo, Minority Staff Director
Subcommittee on TARP, Financial Services and Bailouts of Public and
Private Programs
PATRICK T. McHENRY, North Carolina, Chairman
FRANK C. GUINTA, New Hampshire, MIKE QUIGLEY, Illinois, Ranking
Vice Chairman Minority Member
ANN MARIE BUERKLE, New York CAROLYN B. MALONEY, New York
JUSTIN AMASH, Michigan PETER WELCH, Vermont
PATRICK MEEHAN, Pennsylvania JOHN A. YARMUTH, Kentucky
JOE WALSH, Illinois JACKIE SPEIER, California
TREY GOWDY, South Carolina JIM COOPER, Tennessee
DENNIS A. ROSS, Florida
C O N T E N T S
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Page
Hearing held on May 11, 2011..................................... 1
Statement of:
DeMarco, Edward, acting director, Federal Housing Finance
Agency; Anthony B. Sanders, distinguished professor of real
estate finance, School of Management, George Mason
University; Joshua Rosner, manager director, Graham Fisher
& Co. Inc.; and Janneke Ratcliffe, executive director,
Center for Community Capital, University of North Carolina
at Chapel Hill............................................. 4
DeMarco, Edward.......................................... 4
Ratcliffe, Janneke....................................... 29
Rosner, Joshua........................................... 20
Sanders, Anthony B....................................... 14
Letters, statements, etc., submitted for the record by:
DeMarco, Edward, acting director, Federal Housing Finance
Agency, prepared statement of.............................. 6
Ratcliffe, Janneke, executive director, Center for Community
Capital, University of North Carolina at Chapel Hill,
prepared statement of...................................... 31
Rosner, Joshua, manager director, Graham Fisher & Co. Inc.,
prepared statement of...................................... 22
Sanders, Anthony B., distinguished professor of real estate
finance, School of Management, George Mason University,
prepared statement of...................................... 16
TRANSPARENCY AS AN ALTERNATIVE TO RISK RETENTION
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WEDNESDAY, MAY 11, 2011
House of Representatives,
Subcommittee on TARP, Financial Services and
Bailouts of Public and Private Programs,
Committee on Oversight and Government Reform,
Washington, DC.
The subcommittee met, pursuant to notice, at 3:22 p.m., in
room 2154, Rayburn House Office Building, Hon. Patrick T.
McHenry (chairman of the subcommittee) presiding.
Present: Representatives McHenry, Guinta, Amash, Quigley,
Maloney and Speier.
Also present: Representatives Issa and Cummings.
Staff present: John Cuaderes, deputy staff director; Tyler
Grimm and Ryan M. Hambleton, professional staff members; Peter
Haller, senior counsel; Christopher Hixon, deputy chief
counsel, oversight; Mark D. Marin, senior professional staff
member; Rafael Maryahin, counsel; Laura L. Rush, deputy chief
clerk; Becca Watkins, deputy press secretary; Peter Warren,
policy director; Nadia A. Zahran, staff assistant; Sean
Sullivan, intern; Jaron Bourke, minority director of
administration; Jason Powell, minority senior counsel; Cecelia
Thomas, minority counsel/deputy clerk; and Davida Walsh,
minority counsel.
Mr. McHenry. The hearing will come to order. Today's
hearing is entitled Transparency as an Alternative to the
Federal Government's Regulation of Risk. I am Patrick McHenry,
the chairman of the subcommittee. Mr. Quigley, from Illinois,
is the ranking member.
Sorry for the lateness of the start of this hearing; we
have just had a significant round of votes on the House floor.
As we begin all hearings in this subcommittee, I feel it is
appropriate to read the Oversight and Government Reform's
mission statement. We exist to secure two fundamental
principles: first, Americans have a right to know that the
money Washington takes from them is well spent and, second,
Americans deserve an efficient, effective government that works
for them.
Our duty on the Oversight and Government Reform Committee
is to protect these rights. Our solemn responsibility is to
hold government accountable to taxpayers, because taxpayers
have a right to know what they get from their government. We
will work tirelessly in partnership with citizen watchdogs to
deliver the facts to the American people and bring genuine
reform to the Federal bureaucracy. This is the mission of the
Oversight and Government Reform Committee.
I now recognize myself for 3 minutes for an opening
statement.
Today we examine the rule writing of Section 941 of the
Dodd-Frank Act, which mandates Federal regulators promulgate
rules requiring entities to retain a certain amount of risk on
securitized assets. We will compare the rules of risk retention
and its special exemptions to policies and rules that would
ensure adequate transparency and standardization under Section
942 of the Dodd-Frank Act, which requires the SEC to modify
Regulation AB to include loan level disclosure.
The focus of this comparison is to examine the effect that
transparency and risk retention have on the market. Most
importantly, how does each influence the availability and cost
of credit to borrowers and small businesses?
As Federal agencies issue rules and announce comment
periods, risk retention has become hotly debated. I appreciate
the intention of requiring a little skin in the game, as we
will say, the theory being that if an issuer retains a piece of
the ongoing responsibility for the loans that they write, they
have an incentive to make better loans and price them
appropriately. However, like all government rules and mandates,
there are exemptions provided for certain entities.
To begin with, Dodd-Frank exempts FHA from risk retention
requirements. It holds this coveted advantage in the
marketplace due to the full backing of the U.S. taxpayer.
However, Dodd-Frank does not impose restrictions on FHA's
underwriting standards, moving the agency into a position of
accepting lower qualified mortgages, more or less appearing to
defeat the stated intention that this administration has said,
to reduce taxpayer exposure to the housing market.
In addition to exempting FHA, the QRM rulemaking does not
permit private mortgage insurance to compensate for lower down
payments. I have concerns about this. This raises a concern
that we are driving out prudently underwritten low down payment
option mortgages particularly for first-time home buyers, which
I think further exacerbates the imbalance between the private
market and FHA lending.
Second, Fannie Mae and Freddie Mac are exempted under the
proposed risk retention rule, which runs contrary to the
language laid out in the Dodd-Frank Act. And before anyone
forgets Fannie and Freddie, this exemption appears to go
against the administration's proposal, the broad proposal that
they have to reform Fannie and Freddie and wind down the GSEs.
Third, there is no secret that risk retention favors large,
well capitalized banks, as compared to smaller, less
capitalized banks. Only the largest financial institutions have
the balance sheet to retain, for extended periods, the 5
percent of all securitization they can plead. This leads one to
ask the question, How will risk retention rules affect the
operations and competitiveness of our community and small
banks, and small businesses that access their loans through
those institutions?
In addition, today's hearing gives us an opportunity to
gage the value of risk retention in loan level disclosures and
how government can push forward policies to open up our capital
markets without opening the flood gates of unintended
consequences. One thing is for certain: our families and
businesses cannot afford overreaching government policies that
increase the cost of credit and stifle economic growth. It is
an imperative that our rules and regulations enable the market
to appropriately price the cost of capital to our families and
small businesses, while recognizing the importance of private
capital in the housing sector.
I look forward to our panel's testimony.
With that, I recognize Mr. Quigley for 4 minutes.
Mr. Quigley. Thank you, Mr. Chairman.
Our priority in the final analysis must be to ensure that
the reforms are implemented that would prevent a repeat of the
2008 financial crisis. That crisis sparked the worst economic
downturn since the Great Depression. There can be no financial
crisis amnesia when it comes to implementing Dodd-Frank.
One of the chief causes of the meltdown was the originate-
to-distribute model of mortgage lending. Through this model,
securitization was used as a means for financial institutions
to escape all of the risk associated with the mortgage loans
they underwrote.
On October 23, 2008, former Federal Reserve Chairman Alan
Greenspan explained in testimony before this committee, ``Too
many securitizers and lenders believed they were able to create
and sell mortgage-backed securities so quickly that they never
put their shareholders' capital at risk and, hence, did not
have the incentive to evaluate the credit quality of what they
were selling.''
These practices led to riskier loans and misaligned
incentives between lenders, securitizers, and investors in
mortgage-backed securities. This originate-to-distribute model
has ultimately been cited as a key driver of the current
foreclosure epidemic. That is why a vital piece of Dodd-Frank
Wall Street Reform and Consumer Protection Act is its provision
on risk retention, Section 941. By requiring securitizers to
have ``skin in the game,'' we make lenders and investment banks
more accountable for the loans they have made and facilitated.
The title of this hearing suggests that we should view
transparency as an alternative to risk retention. I think there
is a likely wide consensus on both sides of the aisle that
increased transparency is a laudable goal. However, I would
emphasize that increased transparency must not come at the
expense of accountability. The proposed risk retention rule,
which so many agencies worked to generate, puts a measure of
accountability into effect.
As the Dodd-Frank Act's risk retention provisions are
implemented, we must ensure that creditworthy families are able
to access affordable loans. We must also ensure that the
Nation's 5,000-plus community banks are not disadvantaged in
their ability to serve their customers.
I look forward to the testimony of our witnesses on these
issues and thank them for being here today.
Mr. McHenry. I thank the ranking member for his opening
statement.
With that, let me introduce the panel, and then we will
swear you in.
We have Mr. Edward DeMarco, the Acting Director of the
Federal Housing Finance Agency; we have Dr. Anthony Sanders,
professor of finance in the School of Management at George
Mason University; we have Mr. Joshua Rosner, a partner at
Graham Fisher & Co.; and we have Ms. Janneke Ratcliffe, the
executive director of the Center for Community Capital at
University of North Carolina at Chapel Hill.
With that, it is standard procedure of this committee to
swear in all the witnesses, so if you would please stand and
raise your right hands.
[Witnesses sworn.]
Mr. McHenry. Let the record show that all witnesses
answered in the affirmative.
With that, as most of you are familiar, we have this
lighting system here in Congress: green, red, and yellow. Look,
we are Members of Congress; we need very basic things. So I
will recognize you for 5 minutes, and with 30 seconds remaining
you will get the yellow light, which means simply wrap up, and
red means stop.
So, with that, Mr. DeMarco, you are recognized for 5
minutes to give an opening statement.
STATEMENTS OF EDWARD DEMARCO, ACTING DIRECTOR, FEDERAL HOUSING
FINANCE AGENCY; ANTHONY B. SANDERS, DISTINGUISHED PROFESSOR OF
REAL ESTATE FINANCE, SCHOOL OF MANAGEMENT, GEORGE MASON
UNIVERSITY; JOSHUA ROSNER, MANAGER DIRECTOR, GRAHAM FISHER &
CO. INC.; AND JANNEKE RATCLIFFE, EXECUTIVE DIRECTOR, CENTER FOR
COMMUNITY CAPITAL, UNIVERSITY OF NORTH CAROLINA AT CHAPEL HILL
STATEMENT OF EDWARD DEMARCO
Mr. DeMarco. Very good. Thank you, Mr. Chairman.
Chairman McHenry, Ranking Member Quigley, members of the
subcommittee, thank you for this opportunity to testify. The
Federal Housing Finance Agency believes that enhancing the
quality and quantity of data available to investors in
mortgage-backed securities is an important step to encourage
the return of private capital to the mortgage market.
To do so, we need to ensure that those owners with capital
have the data needed to estimate and price mortgage credit and
prepayment risk. Such transparency is a critical component of a
healthy and efficient secondary mortgage market, whether or not
issuers retain financial liability for some portion of the
credit risk of the assets they securitize.
Risk retention, meanwhile, is a complementary measure
designed to give securitizers an economic stake in the credit
performance of the loans, just like investors. Risk retention
seeks to protect investors and reduce information asymmetries
by requiring that issuers of asset-backed securities have a
financial stake in the performance of loans underlying a
security, or, as it has been said, skin in the game.
Through risk retention, securitizers will have a
disincentive to acquire poor quality loans for securitization
because they will be required to actually hold a portion of the
credit risk rather than passing it all on to investors. This
exposure to credit risk should, in turn, make securitizers more
careful with the quality of loan originations.
As a result of these improved incentive alignments,
investors are expected to be more willing to provide capital
for residential mortgages and other types of loans. This may be
an important step in facilitating the return of private capital
to the residential housing market and other lending markets
that benefit from securitization.
Regulators published the proposed rule to implement the
risk retention requirements of the Dodd-Frank Act in March. In
developing that proposal, the agencies sought to implement the
provision as legislated, allowing for a range of securitization
structures. The public comment period on the rule extends until
June 10th and the agencies invited comments on more than 100
different questions.
The MBS disclosures of Fannie Mae and Freddie Mac have
expanded over the years to offer more detailed information to
investors. Both enterprises provide aggregate pool level
information that in many respects aligns with the Securities
and Exchange Commission's Regulation AB requirements. In
addition, Freddie Mac provides some amount of loan level
information, and both enterprises in the past year have
enhanced their disclosures on mortgage delinquencies.
Enhancing loan level disclosures on Enterprise MBS both at
the time of origination and throughout a security's life is on
our agenda. I believe that improving Enterprise MBS disclosures
over time will help establish consistency and quality of such
data. Moreover, it will contribute to an environment in which
private capital has the information needed to efficiently
measure and price mortgage credit risk, thereby facilitating
the shifting of this risk away from the government and back
into the private sector. This will take time to accomplish, but
this is the direction in which we at FHFA are heading.
In sum, FHFA views risk retention and enhancing disclosure
of the mortgages backing MBS as complementary reforms. We also
see value in moving the enterprises over time toward the loan
level disclosures that the amendments to Regulation AB proposed
by the SEC would require.
Enhancements of Enterprise MBS disclosures have continued
to occur since they were placed in conservatorship in 2008, and
FHFA will continue down that path. We will also work closely
with the other agencies to review the public comments on the
interagency risk retention rulemaking before releasing a final
rule that is consistent with the statutory framework. I believe
that we are making progress on many fronts as Congress is
beginning to take up housing finance reform.
Thank you for this opportunity, and I would be pleased to
answer questions.
[The prepared statement of Mr. DeMarco follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. McHenry. Thank you.
Dr. Sanders.
STATEMENT OF ANTHONY B. SANDERS
Mr. Sanders. Chairman McHenry, Ranking Member Quigley, and
distinguished members of the subcommittee, thank you for
inviting me to testify today.
Dodd-Frank requires that securitizers retain at least 5
percent of the risk in all loans that do not qualify as a
qualified residential mortgage and are sold in the
securitization market. In theory, 5 percent risk retention
would lead securitizers to be more careful in the loan
origination underwriting process.
To be sure, 5 percent retention would be the simplest
approach to implement to encourage approved loan origination
underwriting but, unfortunately, risk retention appears to be
the least useful approach. There are four points that I would
like to make.
First, the house price collapse that resulted in house
price declines that far exceed 5 percent, for example, Las
Vegas fell 56 percent from peak to trough. Five percent would
have been blown through very quickly.
Second, risk retention does not directly address
origination risk. Representations and warrants that are found
in mortgage loan purchase agreements and related documents
directly address origination risk. The avalanche of loan
repurchase requests in the aftermath of the housing collapse
makes reps and warnings less viable for non-agency-backed
securities.
Third, the FHA, Fannie Mae, and Freddie Mac are exempt from
the risk retention rules. Exempting these players from the
mortgage market defeats the spirit of the risk retention since
the loan originator would be tempted to sell or be insured by
Fannie, Freddie and the FHA, rather than keep the retained
risk.
Fourth, given Reg. AB, Dodd-Frank 942, and the anticipated
transparency of the ABS markets, the retention rule implies
that qualified institutional investors are not sophisticated
enough to understand origination risks and need to be protected
beyond greater transparency. Fannie, Freddie, and others do not
require additional security of 5 percent risk retention since
they perform substantial due diligence and analysis before
purchasing securities. And also securitizers can hedge the
risks of risk retention and typically, in industry experience,
they oftentimes keep the piece 5 percent risk retention anyway.
In summary, it is unclear how risk retention will be
implemented, vertical versus horizontal versus L cuts, and even
if it is effective in reducing origination risk.
There are more effective alternatives to risk retention:
transparency and improved representations and warranties.
One solution to origination risk is to provide greater
transparency to investors. Transparency would permit more
accurate pricing. Greater transparency potentially reduces the
asymmetric information between securitizers and investors.
There has already been a movement in the industry toward
this. Prospectuses and prospectus supplements promote both
agency and non-agency MBS, provide detailed breakdowns of
underlying loans in terms of critical risk measures such as
loan-to-value ratio, loan type, and credit score. Freddie Mac
has taken loan transparency to a new level in 2006 by providing
a file of loan level information. The non-agency market, as
well as the FHA, could provide similar loan level disclosure.
I would prefer that securitizers provide transparency
themselves, rather than be forced through regulation, however.
Some investors may prefer having less information disclosed,
which would result in higher expected yields, compared to fully
disclosed loan information. Investors should retain the right
to choose how much information and what they want disclosed by
securitizers.
But additional loan disclosures is one prong of the
approach to improving loan quality. The other is to enact a
securitization certificate approach to reducing securitization
risk. Even though securitizers could release great loan level
information, the market would still be concerned that the
information is inaccurate. There should be mechanisms to ensure
that the disclosed information is actually correct.
The securitization origination certificate approach has the
potential to be effective because it directly addresses
origination risk and contains a fraud penalty. The certificate
would travel with the loan and would verify that the loan was
originated in accordance with the law and that the underwriting
data was accurate and that the loan met all the required
underwriting requirements.
The certificate would be backed by a guarantee from the
originating firm and demonstrate that they had financial
viability. The seller must provide means of demonstrating
financial responsibility, either capital or insurance, for the
loans to be put in a securitization. There should be a penalty
for violations of reputations and warranties beyond repurchase
obligations and tracking of violations of representations and
warranties available to all investors.
Thank you again for the opportunity to testify. I look
forward to your questions.
[The prepared statement of Mr. Sanders follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. McHenry. Thank you, Dr. Sanders.
Mr. Rosner.
STATEMENT OF JOSHUA ROSNER
Mr. Rosner. Thank you, Chairman McHenry, Ranking Member
Quigley, and members of the subcommittee, for inviting me to
testify on this important issue.
Current problems in the economy stemming from opacity and
information asymmetry of the asset-backed market are not
addressed by the Dodd-Frank risk retention rule. While the rule
is well intentioned, it is also misguided. Dodd-Frank reasons
that if lenders and issuers retain some financial liability for
the underlying loans they sell, they will have a greater
incentive to make better loans and securities.
On the surface this appears to make sense. If a lender or
securitizer knows he will have to drink some of the poison he
offers to others, then he would think twice about creating the
potion. But as we saw in the past crisis, the banks in direst
need for direct government support found themselves in that
predicament precisely because they had swallowed large portions
of the poison they had sold to others. Bear Stearns and Merrill
Lynch didn't even have operational controls, available
information, or an ability to fully model their exposures.
As we have seen, even with a 5 percent risk retention of
each structure, different structures of similar underlying
collateral remain highly correlated. Thus, if securitization
returns and grows, risk retention will create a future systemic
risk of already too big to fail firms transferring those risks
to the taxpayer.
A better solution is to create industry standards of useful
and timely disclosures of loan level collateral information so
parties to securitization could analyze the assets' underlying
pools. Even after the disaster, information asymmetry between
buyer and seller remains the standards. I advocate
reconsideration of the risk retention rule, but doing so
without first addressing the dangerous opacity that remain in
the market would only increase risks. This is especially so
given that legislators have already reduced information
available to investors through elimination of the Reg. FD
exemption for rating agencies.
Currently, with no pre-issuance road show period during
which investors have the ability to analyze a deal and its
underlying collateral, the primary market for securitizations
is different from the equity markets. Deals usually came to
market before a collateral pool was even complete, forcing
investors to rely on rating agencies' pre-issuance circulars.
These tools have proven laughably inadequate.
Instead, data on specific underlying collateral in each
pool should be made available for a reasonable period before a
deal is sold and brought to market. Such a requirement would
enhance investor due diligence, foster the development of
independent analytical data providers, and reduce reliance on
rating agencies. Capital and markets would be less volatile if
investors could fully model the expected performance of
underlying loan level collateral and regularly reassess their
deviance from expectations.
Uniformity in contract is also required. PSAs and reps and
warrants define features like rights to put back loans with
underwriting flaws, responsibility of servicers and trustees,
and the relationship between different tranches. They can be
several hundred pages long. Key terms defining contractual
obligations can differ significantly, and they are not
standardized across the industry, across securities with the
same type of collateral, or even by issuer.
It was not until the crisis that investors considered this
lack of standardization. Thus, when panic set in and investors
began to question the value of their securities, they knew that
they didn't have time to read all the different several hundred
page deal agreements, reinforcing the run on the market which
caused securities values to fall further than fundamentals
justified.
Legislation should create both servicing standards and a
single standardized PSA governing each collateral asset class
with investor and public interest at core. Standards must also
focus on addressing a lack of clear definitions in
securitization markets. Without a common language, the value of
data is diminished. Conversely, if everyone is using the same
common language, then it becomes very hard to game the system.
Amazingly, 3 years after the crisis, there is still no
single standard accounting or legal definition of either
delinquency or default. Currently, delinquency can be
determined either on a contractual or recency of payment basis.
Even among firms that would define it identically, each
servicing agreement can have different interpretations of
delinquency reporting. Some may report advances that a servicer
makes to a pool, which could be applied to reduced stated
delinquencies; others servicers may not. The wild west
mentality in securitization needs to be replaced with
transparency and an agreement on terms and standards.
Thank you.
[The prepared statement of Mr. Rosner follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. McHenry. Thank you, Mr. Rosner.
Ms. Ratcliffe.
STATEMENT OF JANNEKE RATCLIFFE
Ms. Ratcliffe. Good afternoon, Chairman McHenry, Ranking
Member Quigley, and members of the subcommittee. As mentioned,
I am with the UNC Center for Community Capital. I also serve on
the Mortgage Finance Working Group convened by the Center for
American Progress to offer a plan for responsible housing
market reform. Please note that the views expressed are my own
and that focus on the mortgage market aspects of the questions
raised today.
I am honored to be asked to discuss how transparency and
accountability can help restore confidence in the once robust
U.S. mortgage system. Confidence in that system was shattered
among investors and borrowers at both ends of the system, and
the taxpayers who find themselves propping it up. Only the full
faith and credit of the government has kept the market open
and, ultimately, private capital must bear a greater share of
the load.
The crisis was a result of abuses that arose in a
regulatory vacuum and a climate of inadequate transparency,
lack of accountability, and misaligned interests. The Dodd-
Frank Act identifies key steps toward a market that is safer
for investors, taxpayers, and for borrowers. One of these is
transparency. Lack of transparency in the private label market
enabled adverse selection and underpricing of risk because
issuers knew more than investors.
Certainly, better loan level information and product
standardization will help usher back in the private market. But
even with good loan level data, private market investors will
face potential principal-agent problems and conflicts of
interest. Nor will this help borrowers, many of whom took on
loans when the true costs and consequences were masked by
complexity.
The system cannot function well unless borrowers' interests
in repaying their loans and investors' interests in being
repaid are served by the agents in between them. So risk
retention can help address these principal-agent problems by
aligning incentives and holding issuers more accountable, as
Dodd-Frank intends.
While the regulatory proposal largely mirrors this intent,
we are concerned that a too narrow QRM box may discourage
private capital participation and possibly disrupt the fragile
market. For example, the down payment criteria may put a pro-
cyclical damper on the fragile housing recovery, particularly
if mortgage insurance is not taken into account. That would be
a pity, as we have ample experience about the right way to
finance lower down payment mortgages.
At UNC we study a large pool of mortgages made in the
decade preceding the crisis under affordable housing and CRA
programs. The borrowers had access to prime fixed rate, long-
term amortizing mortgages that they could afford to repay.
These households have experienced low default rates and, on
average, meaningful equity buildup. We found that non-prime
loans made to similar borrowers were several times more likely
to have defaulted than those in our study. Key factors
associated with these higher defaults were adjustable rate,
broker channel, and prepayment penalty.
These findings underscore that risk retention should apply
to product and process factors that increase risk, not to
characteristics of borrowers. That said, overall, the risk
retention provisions will certainly improve accountability and,
with greater transparency, should put more natural market
imposed limits on the total amount of risk taken on by the
system.
But even transparency, standardization, and risk retention
are not, in and of themselves, enough to return the market to
long-term vibrancy and resilience, and attract the amount of
private capital needed. These are just two of the tools needed
to rebuild the market. The system must also provide for broad
and constant liquidity for a nearly $11 trillion market,
mechanisms that limit volatility, access to affordable and
sustainable financing for home ownership and rental housing,
including for underserved segments, and preservation of the
long-term fixed rate mortgage, which provides economic
stability at the household and macroeconomic levels.
All this can be achieved with private capital serving the
lion's share, with the provision of a limited Federal backstop
that is highly protected by adequate private capital in the
first loss position, and that is explicit and that is paid for.
Such a mechanism will provide investors the confidence to
deliver a reliable supply of capital for both rental and home
ownership options every day and in every community over
economic cycles through large and small lenders, alike.
In summary, restoring confidence in the mortgage market
will require greater transparency and greater accountability,
though we recommend a broader QRM definition than regulators
have proposed. However, the ultimate impact of these measures
is highly dependent on the form that the mortgage secondary
market takes.
As you move forward in this complex process, it is
important to bring private capital back, it is important to
protect the taxpayers, but it is also important to restore the
financial system so that it works better for the American
households who rely on it for economic security. Transparency
and confidence throughout the system depends on having informed
borrowers who have access to sound, well underwritten loans.
[The prepared statement of Ms. Ratcliffe follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. McHenry. Thank you, Ms. Ratcliffe. Thank you for your
testimony.
I appreciate the whole panel's testimony.
With that, I am going to recognize the Vice Chair, Mr.
Guinta, of New Hampshire, for 5 minutes for the first round of
questions.
Mr. Guinta. Thank you, Mr. Chairman.
Thank you all for coming and testifying this afternoon.
The first question I would like to throw out to the panel.
My question is simply this: Who is purchasing these mortgage-
backed securities and what level of sophistication do these
buyers have? Then, second, are these the types of buyers that
need assurances through risk retention or is it, in your
opinion, that because of their qualification they don't need
assurances?
We can start with Mr. Rosner.
Mr. Rosner. The buyers are qualified institutional buyers;
they are sophisticated investors. The very nature of the
structure of selling MBS is that you have to sell the equity
RMBs tranch before you can sell the investment grade rated
tranches, so typically the buyer who is the key buyer is the
one who is going to do the most due diligence if the
information is available.
Given the ability to look at loan level data before a deal
comes to market, they will therefore be the determinant of
price by determining what they perceive as value. I don't think
they need assurances as much as they need clarity of contract
and as much as they need the loan level data probably in
preformatted industry standardized format to do that analysis
for a period before a deal comes to market.
Mr. Guinta. Dr. Sanders.
Mr. Sanders. Thank you. I agree with what Josh is saying,
and I would say that PIMCO, LAMCO, Fannie, Freddie, and most of
these investors were talking about, the QIBs, are extremely
sophisticated investors; they do their homework, due diligence.
I agree with Josh that it would be nice if they could get
information on loan level details ahead of time. In fact, I am
surprised they haven't been requesting that over time. But if
you look at it again, as I said, pro-supps and prospective
supplements issued by various, they do go into fairly detailed
loan level analysis, but it is not as much as like Freddie gave
out on their loan levels, which is what I would like to see
going forward.
Mr. Guinta. Ms. Ratcliffe, would you agree that they need
clarity of contract rather than the assurances?
Ms. Ratcliffe. I think that they are both important. There
was not as much loan level data information, and clearly having
that available to the investors should help their ability to
assess the risk, there is no question of that. I still think
that doesn't take care of all the principal-agent problems that
might arise. There could still, of course, be
misrepresentation; there could still be adverse selection. And
even with full data, a lot of the complicated models were used;
people were not necessarily coming up with the right answers.
So I think there are a lot of different risks inherent in the
system, and each of these solutions we propose addresses a
different set of issues, so I am not sure it is an either/or.
Mr. Guinta. Mr. DeMarco.
Mr. DeMarco. I would only add to what the panelists have
said is that when we think about the holders or investors in
mortgage-backed securities, probably important, we want to know
who they are and how they are responding to these things to
distinguish between those that are investing in private label
mortgage-backed securities for which the credit risk is managed
through the securitization structure and each of the investors,
no matter where they are in that structure, understand they are
undertaking credit risk; and those that are investing in Ginnie
Mae mortgage-backed securities or now with Fannie and Freddie
in conservatorship and operating with the backstop of the
Treasury Department, the sense of government support, the
credit analysis and the credit review of the investors and also
what they are looking for in security is clearly going to be
different for some of those investors relative to investors in
private label mortgage-backed securities.
Mr. Guinta. Ms. Ratcliffe, I want to go back to something
that you mentioned. You said that only really essentially
solves part of the problem relative to misrepresentations.
Don't we have other laws, though, on the books now that are
sufficient relative to misrepresentation?
Ms. Ratcliffe. I think it is a matter of the processes and
tools that are available, the remedies that are available to
the investors. I think we had some proposals made here that
would again address some of those a little better, I think.
I guess, while I have the mic, I might also add that the
investors who are making these investments today in the private
market, not in the Fannie-Freddie securities, they are a very
small universe of investors right now who are undertaking
actually extensive and lengthy due diligence. So if what you
are talking about instead is a situation where private
investors could return in large scale, it would probably be a
very different scenario.
Mr. Guinta. And then I only have a few seconds left, but to
Mr. Rosner, can you just talk very quickly about the unintended
consequences that you see in risk retention?
Mr. Rosner. Well, again, the assumption in the risk
retention rule is that the banks acted, the issuers acted
maliciously in all circumstances and that forcing them to
retain risk would solve for that. Quite often what we have
found is that they made assumptions based on models which
proved to be deeply flawed and historic assumptions that proved
to be inaccurate and retained risks themselves. Forcing them to
retain risks and creating a system where everyone is
mismodeling the same problem, the same collateral at the same
time will risk creating a situation where the correlation ends
up demonstrating again to cause a systemic crisis as it did,
and that would be better to have those risks dispersed in the
hands of investors rather than concentrated back in our
depository institutions or investment banks.
Mr. Guinta. Thank you very much.
I yield back.
Mr. McHenry. I thank you.
At the request of the subcommittee ranking member, I will
first yield on their side of the aisle to the full committee
ranking member, Mr. Cummings.
Mr. Cummings. Thank you very much, Mr. Chairman. I want to
thank you all for calling this hearing.
As I listened to you, Mr. Rosner, I could not help but
think about all the people who are out of their houses, the
ones in my district who have lost big time; the ones who come
to foreclosure conferences, and I have held six of them in the
last 2 years, crying.
And it is very unfortunate how short our memories can
sometimes be. It appears that some members of the committee do
not recall that one of the frequently cited statements
articulating the causes of the financial crisis was made in
this very hearing room at the very table that you all are
sitting at.
On October 23, 2008, at the height of the financial crisis,
the full Committee on Oversight and Government Reform held a
hearing entitled, The Financial Crisis and the Role of Federal
Regulators, at which former Federal Reserve Chairman Dr. Alan
Greenspan, testified, ``What went wrong with global economic
policies that had worked so effectively for nearly four
decades, too many securitizers and lenders believed they were
able to create and sell mortgage-backed securities so quickly
that they never put their shareholders' capital at risk and,
hence, did not have the incentive to evaluate the credit
quality of what they were selling.''
Acting Director DeMarco, isn't one of the fundamental
lessons of the financial crisis that catastrophic danger can be
created when lenders are allowed to avoid all risk and, in
essence, all accountability for their actions?
Mr. DeMarco. I think that is certainly a concern here, Mr.
Cummings. The only thing I would moderate in that is that
actually, whether we did not have the form of risk retention
that Dodd-Frank has, yet many of these, virtually all of these
issuers, securitizers, and loan originates of these awful
mortgages were retaining risk in some fashion because they have
virtually all gone out of business. The managers and owners of
the firm have lost their capital. The risk retention in other
forms through things like representations and warranties, they
didn't work as well as they should have, and some of the
panelists have pointed out. But your point is basically well
taken, sir.
Mr. Cummings. Let me ask you this. While we can debate
additional policy proposals that would provide further
safeguards within the securitization process, are we at risk of
repeating the conduct which led us to the 2008 financial crisis
unless there is some form of risk retention? I understand you
are saying there is already some.
Mr. DeMarco. Yes, sir, I think that risk retention in some
form may be an important part of a better operating system
going forward. But I think the other things that are being
raised at this hearing, including improved transparency and
disclosure to investors, is also absolutely critical to
avoiding the kinds of problems we have had.
Mr. Cummings. In other words, Ms. Ratcliffe, there is
nothing wrong with having both, is that right, having the
transparency and the risk retention? Because when I think about
what our country has gone through, almost brought to our knees
based upon what has happened here, it seems like we would err
on the side of protection and being very careful, as opposed to
just having one or the other. Transparency I just don't think
is enough. Ms. Ratcliffe.
Ms. Ratcliffe. I would agree. Again, there is a whole host
of problems to be solved. Transparency will solve some of them.
And again, as I mentioned in my comments, transparency for
investors is not the same thing as transparency for borrowers,
which also needs to be seen to. Risk retention is part of the
solution. Standardization fits within that as well, because if
you have well understood product parameters and structures,
both for borrowers and investors, that also enhances their
ability to use the data they have to accurately assess risk and
compare risks and price loans and comparison shop.
Mr. Cummings. Well, let me ask you this, so we do indeed
have some agreement that a policy of risk retention, something
that we achieved last Congress with the enactment of Dodd-
Frank, is a necessary safeguard against the market practices
which led to the financial crisis. I know some of you all may
disagree; I see you shaking your head, Mr. Rosner.
Ms. Ratcliffe, The Wall Street Journal commissioned a study
which found that 61 percent of subprime loans originated in
2006 went to people with scores high enough to qualify for a
prime loan with far better terms. Isn't it true that the
originate-to-distribute model ended up pushing countless
consumers into more expensive and, thus, riskier mortgages than
the consumers were eligible for based on their credit scores
and other characteristics?
Ms. Ratcliffe. It would appear so, and I would add that in
my comments I mentioned the 30-year fixed rate mortgage, which
is a good example of transparency and standardization. This is
a product which, in and of itself, makes for a safer loan. Over
time, the borrower's debt to income improves; as the loan pays
down, the borrower's loan to value improves; so it inherently
enables greater number of households to sustain home ownership
safely.
It also enables a potential homeowner or potential
mortgagor to be able to compare one loan to another in the
Sunday paper or online very easily because there is really only
one factor, so it is much easier to know if you are getting a
good deal or not. Once borrowers were led into a marketplace
that had much more complex products and features and options to
consider, like the starter rate and the teaser rate and the
maximum lifetime payment and so on and so forth, it made it
much more difficult for them to make good product selections,
and that introduced a level of systemic risk, especially with
the adjustable rate mortgage features. When rates changed and
borrowers could no longer afford to make their products, that
is a level of systemic risk that better product standardization
and transparency could have alleviated.
Mr. Cummings. Thank you, Mr. Chairman.
Mr. McHenry. I thank the ranking member and I recognize
myself for 5 minutes.
Dr. Sanders, Mr. Rosner, this question is directed to you.
In my opening statement I referenced the fact that Fannie and
Freddie are exempt from this 5 percent risk retention.
Currently, we just recently wrote a check, or the Treasury, the
American taxpayer is in, just in the last week, for over $8
billion for Fannie and Freddie. This was after we are in for
many, many multiples of that currently. What problems do you
foresee with Fannie and Freddie being exempt from this risk
retention rule? How do you foresee that playing out?
Mr. Rosner. At a time where we hear Treasury and the
administration talk about reducing the role of FHA, Fannie and
Freddie, and trying to revive private markets to exempt Fannie
and Freddie from the risk retention rule will actually only
support and enhance their dominance in the market and will
create an arbitrage where private lenders will have an enhanced
or a necessary situation where they end up having to sell to
the enterprises.
Mr. McHenry. Why?
Mr. Rosner. Because the enterprises actually are considered
already to fully retain the risk; therefore, they don't have to
play in the risk retention.
Mr. McHenry. No, no. I mean why would private entities not
be able to compete with that?
Mr. Rosner. Oh, because private entities would end up
having an unfair economic disadvantage of having to compete by
holding a 5 percent position against the enterprises who don't.
Mr. McHenry. OK. Thank you.
Dr. Sanders.
Mr. Sanders. I would clarify that. I agree with what Josh
was saying, but it is still clouding them again. Once you
exempt Fannie, Freddie and the FHA from risk retention rules,
the originators and securitizers, if they are forced to hold
this and they have to make a decision between holding 5 percent
or getting rid of it and giving it to Fannie, Freddie and the
FHA, we have made it a very clear path and an easy path just to
keep Freddie, Fannie, and the FHA at 95 percent market share;
and I think that goes against what the administration has said
they wanted to do. I almost call this the Fannie-Freddie
enabling act, as opposed to Dodd-Frank.
Mr. McHenry. Mr. DeMarco, do you agree with these
sentiments?
Mr. DeMarco. Thank you, Mr. Chairman. As one of the
regulators responsible----
Mr. McHenry. As the overseer of Fannie and Freddie?
Mr. DeMarco. As the overseer and one of the regulators
responsible for putting out this proposed rule, if I could just
clarify a couple things. I am sorry this strikes folks as
technical, but it is the way we view it. Fannie and Freddie are
not exempt from risk retention. The proposed rule stipulates
that because Fannie Mae and Freddie Mac actually retain 100
percent of the credit risk in the mortgages----
Mr. McHenry. Actually, to correct you there, the American
taxpayer has 100 percent of the credit risk.
Mr. DeMarco. Yes, sir, and I am incredibly mindful of that,
and we are working very hard to protect the American taxpayers'
investment in these companies. But the rule, what the statute
requires is for the securitizers, the issuer of an asset-backed
security, to retain a portion of the credit risk, and the
regulators have simply acknowledged in the proposed rule that
Fannie Mae and Freddie Mac, when they issue a mortgage-backed
security, they are retaining 100 percent of the credit risk. To
the extent that one wants to see their portfolio begin to
shrink and reduce their footprint, forcing them to buy back or
hold 5 percent of the securities that they issue is actually
going to inflate their balance sheet. And while I am very
supportive of the notion that we need to move the U.S. mortgage
market away from one that is so much reliant upon government-
related entities, I am not sure risk retention is the most
effective or practical means for starting to move the
government out and restore private sector participation.
Mr. McHenry. What is?
Mr. DeMarco. I think that having the Congress of the United
States take up a comprehensive housing finance reform where we
can figure out what the ultimate resolution of Fannie Mae and
Freddie Mac are going to be as part of it.
But the other thing is to really get private capital to
come back into the U.S. mortgage market and be willing to
evaluate price and undertake mortgage credit risk, those
investors, that private capital is going to want to know what
are the rules of the road and what is the long-term role of the
U.S. Government in the housing market, and those investors are
going to want clarity about where the government is limiting
its involvement and just what is being really put back as
available for the private sector so that it is not competing
with entities that are operating with direct support and
involvement from the U.S. Government.
Mr. McHenry. Mr. Rosner, back to you. In terms of the QRM,
currently private mortgage insurance is not a part of this
solution or this definition under QRM. Can you discuss would
that have a negative impact, do you think?
Mr. Rosner. Well, the private mortgage insurance industry
has demonstrated that it offered no economic value in risk
transfer. They were used largely because of the 1992 act, which
required the 80-plus LTB to get credit enhanced on the
enterprises. In the private market they haven't really been
used. They have been not demonstrated to have been effective in
underwriting their rescission rates on claims have been
extraordinarily high, and most of them are operating under
waivers with their State insurance regulators.
So the notion that private mortgage insurance has really
helped the situation in any way I think is fallacious and I
don't think there is any evidence of that, as witnessed by the
economic performance of their insured loans relative to a
broader pool of loans.
Mr. McHenry. My time has expired, but, Ms. Ratcliffe, it
looks like you are interested in answering that question.
Ms. Ratcliffe. Well, I would mention that the MI companies,
through the end of 2010, paid $22 billion in claims to the
GSEs, which is 14 percent of the taxpayer payments up to that
point in time. So there is some economic benefit in that
capital source market.
Mr. McHenry. Mr. Rosner.
Mr. Rosner. That was with a rescission rate that was,
across the industry, north of 20 percent at this point, it
seems, and you are forgetting that they collected premiums. So
really it was a return of, not a return on that insured
premium.
Mr. McHenry. Thank you.
I recognize Mr. Quigley for 5 minutes.
Mr. Quigley. Thank you, Mr. Chairman.
Director DeMarco, less than a month ago the Financial
Services Committee held a subcommittee hearing entitled,
Understanding the Implications and Consequences of the Proposed
Rule on Risk Retention, at which your agency's chief economist,
Patrick Lawler, testified, ``One of the widely recognized
causes of the financial crisis of 2008 was the poor quality of
loans collateralizing many asset-backed securities, with
subprime loan mortgages being the most flagrant culprits. Too
often lenders made loans they would not have been willing to
hold themselves only because they knew they could sell them to
securitizers at an attractive price.''
Are your thoughts and testimony consistent on that in your
mind, with that statement?
Mr. DeMarco. I am not sure where that statement is
attributed to, but yes, sir.
Mr. Quigley. It was in his testimony.
Mr. DeMarco. It was in Mr. Lawler's testimony?
Mr. Quigley. Yes.
Mr. DeMarco. I think that is consistent with what I have in
my testimony, sir, about part of the problem that led to both
the housing crisis and the economic crisis was the bad
underwriting that led to loans being securitized and certainly
a securitization model in the private label market that was
pushing these loans through to investors and really a reliance
upon the notion that house prices were going up, rather than
really doing due diligence and good credit review of the loans
to ensure that the borrowers had the capacity to repay and had
a credit history to suggest that they would.
Mr. Quigley. Does that strike you, back to the question you
were answering earlier, that transparency is an important asset
in all of this, but it is not mutually exclusive with proper
securitization? Wouldn't the two go hand-in-hand?
Mr. DeMarco. Yes, sir. What I would like to say about
transparency is if the public policy objective is to see
private risk capital re-enter our mortgage-backed security
market in a meaningful way so that mortgage credit risk is
backed by private capital, not by the government, for that to
succeed, one of the necessary steps is for those investors to
have access to a much more robust set of data both at the time
of origination of the security and throughout the life of the
security so that those investors can properly evaluate and
price the mortgage credit risk and prepayment risk of those
mortgages. So we clearly have a lot of work to do to enhance
the disclosure regime, the transparency for private label
mortgage-backed securities to really be able to function in a
robust way in this market.
The risk retention that has been proposed and was
implemented in Dodd-Frank and that the regulators are in the
midst of trying to implement now, what that is designed to do,
in some ways it is to say, look, part of this problem that we
had is really bad underwriting, we have been doing bad loans,
and we want to get more accountability before that loan hits an
investor in the form of a mortgage-backed security. We want
someone else in that pipeline to have greater responsibility
for the quality of that loan and the quality of the
underwriting.
So what Congress settled on in Dodd-Frank is a risk
retention requirement that puts that onus principally on the
securitizer, and what Dodd-Frank says is the risk retention
should be that the securitizer retains a portion of the credit
risk because they are in the best position to be able to
oversee and have some stake in whether the loan as originated
is a good quality loan or not.
So that is how this is seen as an investor protection
really designed to make sure, through this form of the
securitizer, that the securitizer is paying attention to the
quality of the loans, to Mr. Cummings' point earlier and to
yours that there are loans that were being made here for which
the people at the front end of the process appeared not to be
doing anything in terms of proper diligence in making the loan.
Mr. Quigley. Thank you.
Dr. Sanders, I am not sure if you got a chance to weigh in
on the question that was asked, whether these are not mutually
exclusive issues.
Mr. Sanders. No, I have not been able to weigh in on that
other than my testimony. But I think greater transparency is a
great thing and it will help drive better pricing. And I agree
with Mr. DeMarco it will attract better capital. My concern at
the beginning was that I am concerned that risk retention
sounds great, but it sends a false comforting signal to the
market because, as I said, housing prices, if they fall again,
is going to wipe out risk retention in the snap of a finger.
Second, the other issue is that the securitizers themselves
can hedge risk retention. I know from my experience, when we
would be holding the first loss pieces, we could go out and use
either interest rate swaps or credit derivatives and just hedge
out the risk retention. So, from our vantage point, it made it
neutral.
But the point I want to make is I don't like the false
signal that everyone suddenly thinks because we have risk
retention, the days of bad underwriting and we don't need
transparency. I am just worried about that being the case. But,
again, transparency is good and beefing up the reps and
warranties in case of violations is really an important step to
go forward.
Mr. Quigley. Thank you. I yield back.
Mr. McHenry. I thank the ranking member.
With that, we yield to Ms. Speier of California. She is not
here, so Mrs. Maloney from New York is recognized for 5
minutes.
Mrs. Maloney. Risk retention is basically having skin in
the game, is that correct? Wouldn't you say they are holding on
to a piece of it? That is the way loans used to be made in
banks, and we didn't have a problem when that was done.
So I really don't understand, Mr. Rosner, in your testimony
you express in your written testimony skepticism regarding the
risk retention requirement in Dodd-Frank and whether the
proposed rule will ensure better lending, better underwriting
or safer markets. And in it you said, on the surface this
appears to make sense; if a lender or securitizer knows he will
have to drink the poison in the chalice he offers to others,
then he would be more careful. That is one of your quotes. Am I
quoting you correctly, Mr. Rosner, and correctly with regard to
the reasoning behind the proposed rule?
Mr. Rosner. You are quoting me correctly, but you are
quoting the first part of the quote. If you continue on, what
it says is the lender would have a, on the surface, increased
interest in making sure the loan was appropriate, but as we saw
in the case of Bear Stearns and Merrill Lynch, they died
because of risk retention, and they didn't offload the risk,
which would have been sensible if they really understood that
they were creating poison. Instead, they retained it.
So, in a world where people are mismodeling or
misconsidering or underconsidering, or don't even have the
information to understand what risks they retain, as Stan
O'Neal highlighted in his testimony to the FCIC, he didn't even
realize that his firm retained the risk that it did. You are
causing these firms to concentrating risk and several firms,
therefore, to have highly correlated risks to each other; when,
if you had lenders having the loans they made scrutinized by
investors, the investors would price those risks at such a
level where the likelihood is that loan would not be made in
the future because it would not be purchased at a rate that
could allow the borrower to afford it.
Mrs. Maloney. Well, everybody is for transparency, but
Chairman Bernanke testified before several committees that
transparency is not enough, that some of the lending vehicles
and some of the loans, some of the financial products are so
complicated that people don't understand them. I even had
before us in one hearing, we had the head of Freddie Mac say
that he read his credit card disclosure statement, the fine
print, for hours with his wife over dinner, and they couldn't
figure out what it meant. So one way to make sure that the
lender is a little more careful is if he has a little bit of
skin in the game, I would think.
Now, how is it better that you have no skin in the game and
all you are doing is getting a fee and moving it off the next
day, so you have absolutely no skin in the game? It appears to
me you would be more careful if you had risk retention, which
has been the traditional way of banking. That is the old way of
going to your community bank and getting a loan. Bankers were
very careful in what they did because they were responsible for
that loan.
But the way it became is that no one had any skin in the
game; you collected your fee and went to Florida. And we lost
$15\1/2\ trillion in household wealth. We almost went off the
cliff. And most economists say that the fact that there was no
skin in the game, no risk retention contributed greatly to it.
So give me your thinking again on that so I can understand.
Mr. Rosner. First of all, in the summer of 2001 I wrote a
lengthy paper called a home without equity is just a rental
with debt, warning that with the changes that we had seen
structurally, which were being unrecognized, we would end up in
exactly the place we did. The end of 2004, 2005, 2006 I spent
time with people at the Fed, with people at Treasury, with
people at various regulators warning that we had passed the
peak and we were in for it. In February 2007 I put out a paper
on the credit crisis that was about to happen in the CDO MBS
market and how it would impact the real economy.
If you are asking me to defend the Fed's understanding of
what was about to happen, or their look now at what happened, I
won't do so. I will continue to say that if investors had the
ability to properly price loans, the loans would be
prohibitively expensive where the risks are too high for
borrowers to take them, and that is a major part of the
solution. It is the one that is the most honest answer----
Mrs. Maloney. My time is running out. I just want to get
one more question. In arguing against risk retention, you
stated in your testimony, ``To force investment banks to
increase concentrations of held securities will only increase
their risks.'' That appears to be exactly the point; it will
increase their risks; their incentive to focus on better
underwriting, better quality of securities and better outcome
in the market. So if you increase their risk, wouldn't they be
more careful?
Mr. Rosner. Only if they are capable of assessing the risk.
As we demonstrated in this crisis, most of them had neither the
operational, nor modeling prowess to properly assess risk.
Mrs. Maloney. You mean investment bankers could not assess
the risk?
Mr. Rosner. That is exactly right.
Mrs. Maloney. That I find hard to believe. I mean, I think
they understand risk more than most people.
Mr. Rosner. Well, most of them aren't in business today
because they didn't understand the risk.
Mrs. Maloney. Well, also they didn't have skin in the game.
They could just gamble.
Mr. Rosner. No, Merrill Lynch and Bear Stearns did have
skin in the game; Lehman Brothers did have skin in the game.
Those who were able to rush to the exits and get their skin in
the game out of the house in the few months prior to the full
unfolding of the crisis didn't have skin in the game, but they
too, prior to that, did have skin in the game, many of them,
and would have met the same fate as those that are no longer
with us.
Mrs. Maloney. So you say the answer is more transparency.
Mr. Rosner. I say the answer is allow investors to risk
price because, again, the investors' interests are actually
aligned with the borrowers' interest. Even now, as we are in
crisis, the investor understands that a 20 percent principal
write-down in many case many well make a lot more sense than a
70 percent loss given default, and it is oftentimes the
investment bank or the servicer affiliated that doesn't want
that to happen.
So the borrower and the investors' interests are tied,
their interests are tied together because one has an interest
in getting paid and the other has an interest in paying. So you
need to make sure that they have the information to properly
assess and price the risk.
Mrs. Maloney. Well, I would say give them the
information,----
Mr. McHenry. Thank you. The gentlelady's----
Mrs. Maloney [continuing]. But give them risk retention
too. I think that would be safer.
Anyway, my time is up.
Mr. McHenry. I thank the gentlelady, who is also a member
of the Financial Services Committee. Thank you for your input
and your questions.
I recognize the full committee chairman, Mr. Issa, of
California, for 5 minutes.
Mr. Issa. Mr. Chairman, I won't take 5 minutes, and I
appreciate being recognized here.
Mr. McHenry. Well, I would be happy if you yielded me the
balance of your time. I would appreciate that.
Mr. Issa. And I shall, Mr. Chairman.
Mr. McHenry. Thank you.
Mr. Issa. Having just come in, this may have been asked,
but I appreciate the concept of somebody retaining skin in the
game, but let me just ask a rhetorical question for a moment.
Hopefully it won't take the chairman's time. Your certified
public accountants don't retain skin in the game, even though
they do an audit; they get paid, they provide a service.
In a sense, although we understand some of the things that
went wrong in some cases, where people were packaging up and
selling products, aren't there times in which what you really
need is full disclosure, but ultimately, when you buy a car,
the car dealer doesn't necessarily keep any skin in the game,
but if he sells you a bad car, you go back to him. So as much
as I appreciate the nature of the rule, don't we also have to
have out clauses if certain other things are met? Mr. Rosner.
Mr. Rosner. Yes. That is why, in my testimony, I feel very
strongly that before a deal comes to market, investors should
have a right to inspect the loan level data and there needs to
be standardized pooling and servicing agreements, there need to
be standardized representation and warranty agreements that
really do define, on a collateral standardized basis, what the
rights and obligations of various parties are. This is one of
the things that Fannie and Freddie did do well.
Now, yes, they retained the risk; nonetheless, investors in
their instruments fully understood that, deal-to-deal, they
were actually contractually identical. We have a situation
where you had as many as 300 different pooling and servicing
agreements, each with different rep and warrants attached to
it, leading to the crisis. And when people started seeing early
payment defaults rise and jitteriness in the markets, people
said, you know what? I am going to get rid of these positions
because I don't have time to read 300-page documents, and I
will come sift through the rubble on the other side. And,
unfortunately, that led the stampede from which we are all
suffering and the housing financing system came to a grinding
halt as a result.
Mr. Issa. I appreciate that.
As promised, I yield the balance to the chairman.
Mr. McHenry. I thank the chairman for yielding.
Mr. DeMarco, in terms of some of the steps you have taken
in FHFA in terms of disclosures, there is a uniform mortgage
data program, there have been some significant delays with
that, but I do want to say thank you because these are
significant steps for disclosures, but I also realize there
have been some limitations with this.
Mr. DeMarco. Well, when we announced it last May, we said
it was a 2-year project, and we are continuing to push ahead
and, in fact, there are some positive steps and results that
have arisen from this. But it does take time, sir, and we are
continuing to do it, and I do think it is an ingredient to the
sort of things that you and the panelists have been talking
about to have enhanced disclosure.
That assumes some things about the data that are being
disclosed: Are the data consistently defined? Are they being
reported in a consistent manner, regardless of who the loan
originator is or who the appraiser is? So what this uniform
data program is, it is actually sort of the foundation for this
transparency we are trying to get within the marketplace, a
uniform set of definitions and means of reporting data so that,
regardless of who the originator is and who the securitizer is,
there is that kind of standardization in the market, which
should be able to make the transparency that we are all
advocating actually work.
Mr. McHenry. Thank you.
Mr. Rosner, so in terms of transparency, what are the
unintended consequences of transparency?
Mr. Rosner. None.
Mr. McHenry. What are the unintended consequences of 5
percent risk retention?
Mr. Rosner. I should correct that. I should correct the
unintended consequences of transparency are that there is a
thinner economic opportunity or a thinner margin for the
issuers, and so they will have less of an arbitrage; it will
negatively impact, to some degree, their income. But the
benefits will be passed on both to borrower and investor by the
narrowing of that spread.
Mr. McHenry. As opposed to a 5 percent risk retention,
which raises the cost of credit for consumers, thereby if
credit costs more, those that are extending it make more,
right?
Mr. Rosner. And I think to Dr. Sanders' point, the other
risk of risk retention, besides the correlation in the
increased cost, is that it may lead to an increased false sense
of comfort that the work was done, again, by the issuer and,
therefore, the investor doesn't have to focus on it as much.
Mr. McHenry. So rather than fixing this systemic risk
problem, Dr. Sanders, in your testimony you say it actually
creates more systemic risk.
Mr. Sanders. That is correct, because the risk retention
rules as written simply, just as Josh said, Mr. Rosner said
that we have all sorts of problems it creates, false sense of
security, it leads us down the wrong road, and those are big
issues. But when we get back to the whole nature of what risk
retention doesn't do, as I have said, Wall Street can hedge
away that risk already. So it is not really a--or sometimes
badly, and then they get caught stuck with the risk, but it can
increase the systemic risk of the institutions themselves.
Can I add one more thing? If we are talking about trying to
get loans to lower income households and more credit impaired
households, I view risk retention and the QRMs as actually
cutting people out of the market that want to get back in with
somewhat impaired credit, etc. I don't think this is very good
for consumers that have gotten, I think, 40 percent have had
serious credit score degradation. This isn't going to help;
this is going to make it worse. With full disclosure of
information and no risk retention, then we are aware exactly
what the subprime loans are, then I think the private sector
can move forward with that and that is the good solution.
Mr. McHenry. Have you looked at, for instance, auto
financing or subprime auto financing, securitization?
Mr. Sanders. Yes.
Mr. McHenry. Did that world fall off and look like the
housing securitization?
Mr. Sanders. Housing was something completely different
because the automobile industry didn't have all price of cars
fall 60 percent at once, together, not in all areas. But, no,
housing was unusual because it fell off a cliff, and that is
why risk retention wouldn't help that. But again, reps and
warranties----
Mr. McHenry. But how are they able to actually have
subprime securitization for autos, for instance, and people are
buying this, people are purchasing, sophisticated investors are
purchasing these things? Mr. Rosner.
Mr. Rosner. First of all, you have to remember the
difference in the duration of the asset. You are talking about
a 30-year mortgage versus, typically, a 60-month auto loan.
Mr. McHenry. So that is the only difference?
Mr. Rosner. That is a major difference. The auto industry
also, the non-captive lenders, really did learn their lesson in
the late 1990's; they went through a crisis very similar.
Obviously, it had less broad economic impact to what the
mortgage originators did recently. Both actually blew up, the
original subprime mortgage industry and subprime auto finance
industry both blew up in the late 1990's, and the auto industry
ended up sort of reconsolidated mostly by the captives, so
there was much more by way of control. But again the duration,
I think, is the biggest difference.
Mr. McHenry. OK. Interesting.
With that, Ms. Speier is recognized for 5 minutes.
Ms. Speier. I have a somewhat facetious question to ask
you, no, I think all of you. Have you just missed out in the
last 3 or 4 years altogether? I spent 3 years on the Financial
Services Committee, thousands of hours, literally, hearing
testimony over and over and over again, and everyone said the
same thing on both sides if the aisle: if you don't have any
skin in the game, it is real easy to play the market. And it
just seems like it is common sense.
Now you, Dr. Sanders, suggest that if there is full
disclosure, you really don't need risk retention. Full
disclosure to whom?
Mr. Sanders. Not quite. I am saying you need full
disclosure plus you need to tighten up the representations and
warranties to protect the underwriting. And again reps and
warranties already gives skin in the game. That is what I am
puzzled about.
Ms. Speier. Excuse me. Full disclosure to whom?
Mr. Sanders. Full disclosure to investors.
Ms. Speier. To investors. All right. Do you think that the
investors that invested in Goldman Sachs, in their Abacus deal,
I think it was Abacus, in which they were, for another client,
shorting the same product that they were promoting in the
market? Do you think that was full disclosure?
Mr. Sanders. No, I don't think it was full disclosure. But
then again it comes back to what investors would invest in
Abacus when they couldn't see what was inside of it. That has
always puzzled me.
Ms. Speier. Now, full disclosure oftentimes to the public,
and certainly to government, is full disclosure to the
regulators so they can, in fact, oversee what is going on. And
I am reminded that when AIG was profiting handsomely from CDOs
through their financial products division in London and had
stretched themselves to immeasurable places, I asked the
question did the Office of Thrift Supervision know what a CDO
was, and they answered no. So I think that it is very
simplistic, frankly, to suggest that somehow full disclosure is
the panacea.
The American people aren't stupid and the American people
get it. If you don't have skin in the game, if the banks don't
have to retain some form of risk, then why wouldn't you sell
garbage over and over and over again? Because you have no skin
in the game; you have nothing to lose. If you and I were to
flip a coin and it was tails, you win and heads, I lose, why
would I play with you? But that is what you are somewhat
suggesting.
I apologize for not really asking a question, but let me
just respond to and ask your comments. The Financial Crisis
Inquiry Commission, many hearings, reviewed many documents, and
in part of their report they said, on Wall Street, where many
of these loans were packaged into securities and sold to
investors around the globe, a new term was coined: IBGYBG, I'll
be gone, you'll be gone. It referred to deals that brought in
big fees up front while risking much larger losses in the
future, and for a long time IBGYBG worked at every level.
I guess I would just like you to comment on that. Mr.
Rosner.
Mr. Rosner. First of all, there are typically four risks
that regulators consider: operational risk, liquidity risk,
credit risk, and reputational risk. And all of the firms that
really abused the reputational risk in exactly the way you are
talking about are the ones that really did go out of business.
Ms. Speier. You think Goldman Sachs had a reputational
risk?
Mr. Rosner. Well, hold on, no. Now you are going back to
the question on the Abacus deal, and that actually, the
transparency, the collateral would have actually been helpful
and transparency to the other side investor seems to be a
different issue, and that may be a securities issue. It seems
that the SEC felt it was potentially, and addressed it as such.
But even there I would point out that we get back to the same
issue, which is if investors had the information available to
them to do the full analysis, they would have and might not
have participated in that deal. We are talking about qualified
institutional buyers; these are sophisticated investors.
And I will add one last piece, which is regarding whether
the regulator did know what was going on with AIG. I would
point out, as I pointed out----
Mr. McHenry. The gentlelady's time has expired. I will give
the gentleman the opportunity to finish the question.
Mr. Rosner. In an early 2007 paper I wrote, I highlighted
the fact that none of the Federal financial regulators had
access to the CDO deal data because none of them were qualified
institutional buyers. The first was the FCIC, and that didn't
happen until 2007. That is a problem with transparency.
Ms. Speier. Mr. Chairman.
Mr. McHenry. Yes.
Ms. Speier. I realize my time has expired, but I am just
curious, and if you think it is appropriate to ask the
question, maybe you will ask it. I am wondering if any of the
panelists feel that----
Mr. McHenry. Well, you are asking it, so go ahead and ask.
It is fine. Just the two of us here; we can work this out.
Ms. Speier. Good.
I am curious that you believe that there are institutions
now that are too big to fail in this country, and what is the
remedy?
Mr. McHenry. We will ask the whole panel. I would be
interested in everyone's comment as well. Good question.
Mr. Rosner. Absolutely. No question. It is one of the
things that, as a financial service industry analyst, bothers
me the most. I would have loved to have seen Dodd-Frank include
a simple paragraph that said any institution that requires
extraordinary government asset purchase, debt guarantees or
more than 60 days at the Fed window would be operating under
immediate supervisory action and their executives and board
would be prohibited from employment in the financial service
industry for a period of 5 years in any capacity.
I think that would have forced them to decide either to
shrink themselves to a point where they were manageable or
increase their expenditures on risk management to make sure
that they dealt with their risks. But we have chosen to pretend
that they are not to keep them afloat and, in fact, to codify
their too big to fail advantages in many parts of Dodd-Frank.
Mr. McHenry. Dr. Sanders.
Mr. Sanders. Well, yes, of course there are too big to fail
firms, but one thing I want to point out is that the chairman
of the Federal Reserve, Chairman Bernanke, and the Federal
Reserve system already had the regulations in place to prevent
too big to fail, and they just chose not to follow their own
regulatory guidelines.
Mr. McHenry. Ms. Ratcliffe, if you would like to comment as
well?
Ms. Ratcliffe. I think to some extent it is not just
institutions, but systems that sometimes we just can't afford
to let fail, and I think the important thing is to recognize
those and proceed accordingly, rather than pretending that
there isn't a situation where government is going to have to
step in to keep systems afloat.
Mr. McHenry. Mr. DeMarco, I don't know if you want to jump
into that one. Not that you have enough balls in the air.
Mr. DeMarco. I don't believe any firm should be considered
too big to fail, and I believe that under Dodd-Frank the
regulators have been given tremendous challenge and set of
responsibilities to ensure that we operate the oversight of a
financial system in the future so that institutions are not too
big to fail. And it will remain to be seen what we are doing
now to implement our Dodd-Frank responsibilities to see how
this works, but I do not believe that institutions should be
considered too big to fail, and I believe Congress has
challenged the regulatory community with that objective.
Mr. McHenry. Mr. DeMarco, I have two final questions for
you, if I may. If many players get out of the mortgage
securitization business because of this risk retention, holding
this capital, how does that play out? Does that make it better
for the consumer or worse?
Mr. DeMarco. Currently, virtually all mortgages being
originated, well over 90 percent are being securitized through
Fannie Mae, Freddie Mac, or Ginnie Mae, so implementation of
the risk retention rule, even as proposed, in the near term,
until we reach a resolution of conservatorships with Fannie and
Freddie, will have limited impact.
So I think that, combined with the fact we put out a
proposed rule here and asked over 170 questions, so the
regulators are looking for a lot of input from the marketplace
from the whole array of stakeholders in this and people that
have a view. Panelists here have expressed views. I expect we
will be getting comments like that, comments coming from
different angles, and I believe that the group of regulators
charged with implementing this fully intend we are expecting a
considerable volume of comments and we intend to take a very
careful review of that. It is not that common to ask 170-some
questions in a proposed rulemaking. The regulatory community is
looking for input so that can better inform what we do in terms
of the final rule.
Mr. McHenry. So how does this risk retention rule add
value?
Mr. DeMarco. Sir, the intention that Congress had in doing
this I think has been pretty well debated on each side here,
but it is intended to add value by making an explicit statement
and creating an explicit particular structure so that issuers
of asset-backed securities retain credit risk here so that they
will better discipline and pay greater attention to the
underwriting that is done at the time of loan origination to
enhance the quality of the loans that are then pooled and sold
to investors in asset-backed securities.
That is the theory we are operating behind here and that is
the intended outcome. It does certainly seem to better align
the incentives. There are some legitimate concerns that
panelists here and others have raised, and the regulators are
going to take a look at that to see whether the proposal ought
to be changed in any way.
But we are operating with a given statute that says several
things: it says that the risk retention is focused on the
securitizers, it says--I would like to correct one thing that
was said earlier. The securitizer with their retained risk is,
under the law, not allowed to hedge that risk. And we are going
to get a lot of comments to see what the market participants
view as the potential implications.
Mr. McHenry. So that is, to Mr. Sanders' point, the
systemic risk element added here. If you can't hedge that risk,
financial institutions, do they seek to hedge as much of their
risk as they can? I am asking this rhetorically. Of course you
do. If I have an asset, I want insurance on it. I think most
people do that.
Dr. Sanders, I do want to ask you this because in the
previous securitization market--let's just go back a couple
years--in order to sell a securitized product on the market,
you have to first sell really the mezzanine, right, before you
can really sell--that is sort of the first piece you have to
sell. So many firms would retain that in order for them to sell
off, basically that first loss position they retain.
Mr. Sanders. Yes. It has been industry practice in any deal
I have ever seen they usually retained at least 5 percent, and
sometimes up to 20 percent of the deal in the private label
market. We are not talking about agencies. That has always been
the case.
Mr. McHenry. OK. So what would be the problem of saying
this is a bank regulation, for instance, going back. You
realize that banks are holding more capital on the books, so
you raise the regulatory amount that they have to hold on their
books, and what do banks do? They then raise the amount of
capital they hold beyond that because they don't want to
purchase that regulatory mandate, right? Why not just simply
recognize what the market is doing and say that is great and
this rule doesn't have a major impact? What would you say to
folks who would say that?
Mr. Sanders. I would say the private sector had already
been doing that as industry practice, and the whole housing
price crash wiped out even their first loss pieces, as we know.
Those got torched very early on. So it not even effective. But
what my concern with now going through and stating a 5 percent
regulatory is that we will see, suddenly, everyone maybe even
shrink from 20 percent risk retention and go down to 5 percent.
So this could actually make institutions more risky, to hold
less.
Mr. McHenry. Ms. Ratcliffe, do you agree? Disagree? What
are your comments?
Ms. Ratcliffe. I disagree. There is going to have to be
capital to support the risk somewhere in the system.
Mr. McHenry. Where does that come from?
Ms. Ratcliffe. Well, it can come from a number of sources,
but it has to be out there and it has to be a level playing
field. And for nobody to take any risk on the loans is not
going to help us. I think we did see a lot of people try to
hedge their risk and think they laid it off on somebody else
who thought they knew what they were doing and they thought
they had enough transparency and they thought they had good
enough models, and they were wrong.
Mr. McHenry. So basically your answer is simply we need
Fannie and Freddie back, because that makes it all work. That
seems interesting to me.
Dr. Sanders, would to respond to that?
Mr. Sanders. No. Actually, we are going through--Mr.
DeMarco made an excellent point. We have to get private capital
back on the mortgage market, and I think Freddie, Fannie and
the FHA, bless their hearts, unfortunately with a guarantee,
are keeping rates so low, I mean, basis points over Treasury
rates, that if we want to attract capital back, we actually
have to kind of have more private sector participation without
the guarantee that will boost yields and attract investors
back. So I really want to go with what the administration said
earlier, start pairing them down, if not dismantle them.
Mr. McHenry. Mr. Rosner.
Mr. Rosner. I totally agree with that. You know, there is a
truth that doesn't want to seem to be heard on Capitol Hill,
which is mortgage rates have to rise. And no one in Washington
wants to accept that as the necessity or as the reality
required for private capital to come back. That is what is
going to have to happen, one way or another, to revive a
private label market or even have a properly risk priced
government supported market.
I would also point out, though, that there were, and I
agree with Ms. Ratcliffe in terms of capital is a big piece of
the answer, and would also remind you that a lot of the
problems that we saw, sort of secondary and side effect
problems that we saw, were arbitrages on the difference between
regulatory capital requirements of various parties. If you
remember, the insurance regulators had much lower capital level
requirements than the Federal regulators, and that became an
opportunity to arbitrage or theoretically transfer risk to
insurers who weren't capitalized enough to hold those risks.
Mr. McHenry. All right, Ms. Ratcliffe, I want to give you
an opportunity to followup or respond to that, if you would
like. And then I realize Mr. DeMarco has had to leave, so we
have one final question for the whole panel. But I do want to
give you an opportunity to comment.
Ms. Ratcliffe. Yes. I want to just say that I think the
transparency and risk retention accomplish sort of
complementary, but different, things, and the other thing that
together that they can help do is just reduce the overall
amount of risk that the system takes on. These are, really, the
natural market mechanisms that ought to dampen the willingness
of all parties along the spectrum to take on risks so they
wouldn't necessarily take on the same magnitude of risks they
took on back in 2004 to 2006. So in that case I would argue
strongly that the net effect of both of those would be overall
reduction in systemic risk.
Mr. McHenry. OK. OK. Obviously there is some disagreement
on that from the panel, but my final question, and we will
start with you, Ms. Ratcliffe, and go right down the line,
final question, I promise: Do you think that the most powerful
tool to address this challenge, to address this problem, the
most powerful tool, market-based tool would be transparency?
Ms. Ratcliffe. And the challenge is, sir?
Mr. McHenry. Well, the challenge is--I don't know if you
have been--this question of securitization, private sector--OK,
let me give you context. In light of Fannie and Freddie and the
government being 90 percent of the mortgage market, with Mr.
DeMarco having the largest housing portfolio in the world under
his control, and I would say we realize you do not seek such.
This is not part of ambition, we understand; we realize you
have one of the most challenging jobs in Washington. But in
light of that, is transparency the most powerful tool to make
sure that we can have a private sector market for mortgages?
Ms. Ratcliffe. I think it is----
Mr. McHenry. Yes or no? I mean, if you think no, it is
fine, and we can keep rolling here.
Ms. Ratcliffe. I will say that I think there are some
better tools.
Mr. McHenry. Such as?
Ms. Ratcliffe. Capital, regulatory capital, level
regulatory capital playing field.
Mr. McHenry. So 5 percent is good?
Ms. Ratcliffe. That is not adequate necessarily for
systemic capital.
Mr. McHenry. Ten?
Ms. Ratcliffe. It depends on the types of risk the system
takes on.
Mr. McHenry. Twenty?
Ms. Ratcliffe. That would depend entirely on the risk
profile of the loans that were made. I would suggest that would
represent a fairly high risk market that we wouldn't want to
return to, that level of inherent risk.
Mr. McHenry. Mr. Rosner.
Mr. Rosner. If you are talking about to solve the problems
of the securitization market itself and the risk transfer, yes,
transparency in a standardized, manageable format with
corresponding standardization of contract and representation
and warranties I think are the best solution.
Mr. McHenry. Can that be done in the private sector?
Mr. Rosner. It absolutely can be. Unfortunately, I think
that task has been led not with investors' interests at core,
but with issuers' interests at core. So I think that we need to
see that paradigm changed or regulators need to get more
involved to foster an environment where that is being created
on behalf of the investor community.
Mr. McHenry. Dr. Sanders.
Mr. Sanders. I would say transparency absolutely is the
most important one. And again I am just going to say one last
time I think for those households that have credit impairment
after the housing bubble crash, I think risk retention rules
are going to work in the exact opposite direction; it will
cutoff credit to households that really want it, and that
really scares me.
Mr. McHenry. Mr. DeMarco.
Mr. DeMarco. To have private at-risk capital invested in
asset-based security undertaking that credit risk, having
transparency is essential. But if I may go further, it is
essential that there be full and appropriate and high-quality
data there. To some of Mr. Rosner's points, there does need to
be attention to standardization, to terms of contracts. There
may be a role for government in doing that because the
government can take a look at all the stakeholders, not just
one party. But one might argue as well that would be executed
by private groups doing it.
But I do think that transparency, it is not just being
transparent, but what is it we are being transparent about?
There has to be the right data properly and timely disclosed
and understandable to the investors. That is the full
definition of transparency that would be essential for private
risk capital to really return to investing in mortgage-backed
securities where they are undertaking the actual mortgage
credit risk.
Mr. McHenry. Well, thank you. I appreciate your time.
I am sorry. Yes, I recognize the ranking member.
Mr. Cummings. I have been patiently waiting.
Mr. McHenry. And I would say to the gentleman that Mr.
DeMarco's time, we have pushed him beyond his time, so if you
start with him and let him go, he would probably appreciate it.
Mr. Cummings. Oh, sure. I certainly will do that.
Mr. McHenry. I recognize the ranking member.
Mr. Cummings. I want to understand, Mr. DeMarco, when you
say transparency and then I hear Mr. Rosner say some people
that I would expect to understand the stuff that is transparent
don't understand it. I am confused. You just said a moment ago
that I think you said the investment bankers. I don't know, I
can't remember who you said. The question was asked who would
understand. In other words, if that information was available,
would folks understand it, and you can correct me if I am
wrong, I could have sworn you said there are certain people
that would not. No?
Mr. DeMarco. I don't think I said that.
Mr. Cummings. OK. So if we had transparency--let me go to
you, Ms. Ratcliffe, and then I will come back to you, Mr.
DeMarco. The transparency, who would benefit from that, Ms.
Ratcliffe?
Ms. Ratcliffe. We have talked a lot about transparency to
investors.
Mr. Cummings. Right.
Ms. Ratcliffe. But I have also, in my comments, addressed
the importance of transparency to borrowers. I think you need
to have both. Transparency should be to the benefit of both
ends of it. I still believe that accountability is critically
important to the equation, and transparency without
accountability may not get us anywhere.
Mr. Cummings. When I talk to my community banks, they have
skin in the game, and the community banks in my district that I
talk to said that their problem was not mortgages. The problem
was mortgages from the standpoint that maybe people couldn't
pay them back, but their problem was other things like people
losing their jobs and unable to make the car payments and all
that kind of stuff.
So when a lot of people think about skin in the game, they
think about their community banks, and the community banks had
an interest; they serviced their loans, they made sure that
they didn't give no-doc loans, and they knew that they would be
out of business if they gave enough loans that were toxic. So
to the layperson it seems like it would make sense for somebody
to have some risk here.
And then, Mr. Sanders, you were talking about people who
want to come back into the game. Well, a lot of people I am
talking about won't be in a position to get back into the game,
period, maybe even in a lifetime. So I am trying to figure
out--and then I think about the fact of all these people who
have lost so much, and I still don't think that a lot of folks
get how significant this foreclosure problem is. Sometimes I
wonder whether there is a disconnect with the people out there
who are losing their houses and basically that is all they had.
So I am trying to figure out why don't we err on the side
of making sure, again, going back to the community bank thing,
making sure that these folks have some kind of incentive to do
the right thing and due diligence and all that kind of stuff,
and have layers of protection, layers of different sets of
eyes. You follow me? Am I missing something?
I will start with you, Mr. DeMarco, since you have to go.
You look like you are straining to understand what I am trying
to say.
Mr. DeMarco. No, sir.
Mr. Cummings. OK, good.
Mr. DeMarco. I believe I understand what you said, and I
would echo several things. I think that there has been a real
damage to thousands of families across this country as a result
of many difficulties and problems in the way our finance system
was working earlier this decade. And I think the toll on
American families and on their communities, on their neighbors
and so forth, has really been stunning, and there are some
communities that are going to take many years to recover from
this. And I think that is something we all should be very
concerned about, and certainly for our agency we are doing our
best with foreclosure alternatives to try to help as many
people stay in their homes as they can.
Second, with respect to community banks, if I could make a
larger point that I think may resonate with some of the
concerns you are raising, when I look at the mortgage market
today and the way it is structured, I see tremendous
concentration. I see concentration in mortgage origination, I
see tremendous concentration in mortgage servicing, and it does
make me wonder where is, as we contemplate changes to the
country's housing finance system, that we go about that in a
way in which the role of the community bank, the community
lender is not shut out and, in fact, we think about ways to
better foster the involvement of community lenders in not just
making loans, but continuing to service loans in their
community. They have the direct touch with the borrower and
they are in a good position to be able to understand the
borrowers' needs and help them before they get into trouble.
So I think about some of the things we have done, sometimes
meaning to be prudential in our actions, has led to a
concentration that is actually causing or could be said to be
causing harm in our communities, and I think as we go forward
and think about housing finance reform, what is going to be the
role of government in housing finance, what is the post-Fannie,
Freddie world look like, I think we should be very mindful of
the role of community lending institutions and that we don't,
in an effort to tighten things down everywhere, create an
environment in which community institutions cannot participate
and be robust and constructive participants, whether it is in
housing finance or other parts of consumer finance.
I hope that is responsive.
Mr. Cummings. Yes. It is very helpful. So they are the
ultimate skin in the game folks, right? Am I right, Ms.
Ratcliffe?
Ms. Ratcliffe. One of the----
Mr. Cummings. Mr. DeMarco, I don't want to hold you up. My
time has run out anyway, but----
Mr. McHenry. I would say to the ranking member if we could
dismiss Mr. DeMarco.
Mr. Cummings. Yes, of course.
Mr. McHenry. I want to thank you for your service to your
government. I appreciate your testimony today. Thank you for
dealing with the schedule as well, and we apologize for that.
Thank you.
Mr. DeMarco. Well, thank you very much, Mr. Chairman and
Mr. Cummings. I appreciate being excused, but my staff and I
are fully prepared to followup in whatever way would be helpful
to the subcommittee.
Mr. Cummings. Thank you very much.
Mr. DeMarco. Thank you so much.
Mr. McHenry. With that----
Mr. Cummings. You were getting ready to answer my question,
Ms. Ratcliffe?
Ms. Ratcliffe. Yes. Certainly to the extent that if
community banks are willing to take the 5 percent risk or hold
the loans on portfolio and take 100 percent of the risk, they
are the ultimate skin in the game. And I think this speaks to
one of the points we haven't addressed much here today is the
alignment on the servicer side that there is also some
provisions for in the risk retention rules, that there is
evidence that lenders who are servicing their own loans in
their own portfolio tend to be more likely to pursue remedies
that keep the borrowers in their home and minimize losses all
around than those who are servicing for others. So that is
another one of the alignment of interest problems that risk
retention could seek to address that really full information
doesn't get at.
Mr. Cummings. Just one last question. Going back to what
you just said, 5 percent seems like a little bit compared to
what a community bank would be dealing with. So I am just
wondering if you are going to have a retention, do you think 5
percent is sufficient? In other words, to do the things that
you just said, what you just said, about them servicing and try
to keep the borrower in the house and all that kind of stuff,
it seems like the bigger the bank, the less--it seems like they
are much further away. And I just base this on what I see in my
community. They are much further away from the borrower, so you
don't have those relationships. So I am just saying 5 percent,
I wonder if that even does it. You follow me?
Ms. Ratcliffe. Of course, it is hard to know, but I believe
that relatively modest amounts of risk retention are effective,
especially when structured right, and the regs have a number of
different alternatives for looking at the structure, are enough
to begin to get at some of the principal-agent problems. They
are not necessarily going to be enough to protect the entire
financial system, and that is sort of a different objective, is
having enough capital systemwide to pay for the losses than
just the behavioral aspects of a risk retention model.
I would also add that small institutions can participate in
the mortgage market by holding loans in portfolio, potentially
provided. We will see how the regs come out, maybe by keeping
some of the risks in securities. They can also participate by
selling loans to Fannie and Freddie, and those agencies right
now, and hopefully some kind of successor function, would allow
smaller institutions to continue to offer the same kinds of
products in communities around the country that the large banks
can offer competitively.
Mr. Cummings. Mr. Rosner, you had something?
Mr. Rosner. Yes. The community bank, I think, has been a
very different type of player and, yes, they do retain the
risk. Not only do they know their customer, they know the
customer's company, usually; they know the local economics of
the market in which they are lending; they have a lot more
information with which to assess risk and, therefore, for many
reasons have much more comfort in holding that risk.
The large firms, when you have, as we saw, an increasing
concentration of loans that are being made by a handful of
players such that, as of now, last quarter, 56 percent of
originations were done by three players, if you think that a
lender in California knows anything of substance about a
borrower in New York or any other community, he really doesn't,
it is just a number. And when you have firms that are
inherently too big to fail, they know that even if they are
forced to retain 5 percent, it is not their 5 percent, it is
the taxpayers' 5 percent.
So we haven't addressed that. And the risk retention, as I
said before, I fear is almost a false sense of comfort because,
as we saw even in the FCIC report, a lot of the senior-most
managers of many of the firms did not even understand or know,
and weren't apprised of the risk that their firms retained as
it was, in many cases risks that ultimately sunk those firms.
So I think, as Mr. DeMarco pointed out, we do have to figure
out a way to get deconcentration of lending, deconcentration of
servicing. And I am just not sure that in a world where we
already have institutions that have extraordinary benefits and
think of themselves as too big to fail, that giving them the
right or almost the responsibility to hold more and more risk,
holding the taxpayer more and more hostage, is the right
answer.
Mr. Cummings. Mr. Chairman, you have been quite lenient,
but I have to say this. First of all, I want to thank all of
you for your testimony; it has been very helpful.
I just hate the idea of, Mr. Rosner, kind of throwing up
our hands and saying, you know, we cannot control this. That is
what it seems like. And it just seems to me that in a Nation
where we can send somebody to the moon, it seems like we ought
to be able to straighten out this mess so that it doesn't
happen again and so that it makes sense so that little people
or regular just everyday people are not crushed. I mean
crushed. And as I say to my constituents, I think what I am
seeing right now probably is the greatest transfer of wealth in
my lifetime from middle class to upper class. There is a
tremendous transfer of wealth and it is really kind of sad, and
it has come in so many forms, and foreclosures is one.
Thank you very much.
Mr. McHenry. And I appreciate the ranking member. If the
Members do want to make a comment about the gentleman's
statements, I am happy to hear it. Mr. Chairman, I have just
been interested in the questions and good feedback, and I think
we have had a good panel, and it is a good question. I mean, is
that sort of the idea, Dr. Sanders, Mr. Rosner, Ms. Ratcliffe,
just throwing up your hands and just say we can't do it, or
what is that answer?
Mr. Sanders. I will try this first. I moved here from
Phoenix, Arizona, so about foreclosures, I am painfully aware
of what it does to the community and how households suffer when
that happens, and I have seen community banks out there just go
away; and that is bad, because I am a big supporter of
community banks for all the reasons Mr. Rosner said, which is
very good.
But again I get back to the point that there really is
something that we can do; it is strengthen representations and
warranties, which is, by the way, the ultimate skin in the
game, it is not 5 percent. Because what happens is if a bank
such as Wells Fargo or one of their subsidiaries misleads
investors, investors then file, and there are tons of these
suits lined up in court and they will in some cases collect the
money back.
And again, to go back to Mr. Cummings' question, you were
saying, well, that is after the fact they will collect money.
Well, going forward, if you strengthen these and make it clear
that we will enforce these laws, we will enforce these
regulations that are on the books and have transparency, we
will see a lot different market going forward, but we really
have to have those things. And that is not waving my hand; I
want to move forward. I am just concerned that risk retention
gets focused on and it doesn't achieve what we think it is
going to do.
Mr. Rosner. Many of the underlying problems that brought us
to where we were were illegal activities, both on behalf at
times of borrowers and at times of lenders. It seems that they
exist in the servicing world as well. We have seen no
enforcement, which I find to be astonishing. I have spent most
of my, since leaving the traditional sale side, have spent my
entire career highlighting and warning of exactly the issues
that we have come to live with and doing analysis on that.
I am not at all throwing up my hands. What I am suggesting
is that we have to avoid the false sense of solving something
that we are not solving, and the closest we get is make sure
that the information out there is so clear, so standardized and
so manageable that you can't hide reality from either borrower
or from investor.
Mr. McHenry. Ms. Ratcliffe.
Ms. Ratcliffe. I agree with all that. I think that it is
quite possible that if all we did was increase transparency for
investors and let them run all these tapes and fields, records
through their models, that too could potentially create a false
sense of security. I mean, to your earlier point, I think the
saddest thing about this situation is that it didn't really
have to happen.
Why didn't the market ask for the reps and warrants then?
Why didn't the private investors get those? Why didn't they get
more information then? Mr. Rosner saw it coming. It seems like
private investors could have used what information they had;
they had enough information to be able to anticipate some of
these events. You did.
Mr. Rosner. They didn't really have the information, i.e.,
the information that we are talking about, the loan level
information. And, unfortunately, I am not here to make excuses
for the investor community, but the reality is you have a broad
and very diffuse investor community, 10,000 or so firms who, to
get them to even offer comment letters on rulemaking processes
or accounting rules to which they are extremely exposed is
almost impossible.
So you have that relative to a handful of firms who are
ultimately making the rules, and there has been no regulatory
intervention on behalf of the investor, who, by the way,
harms--you have to remember that a lot of those people who have
lost their houses have been doubly harmed because they have
lost their pension assets, they have lost other investment
assets. They have been harmed all along the way. They are
investors. Most investors, most professional investors are
managing money for many of those same people.
Ms. Ratcliffe. So I agree with everything Mr. Rosner said.
I just wanted to say that this is not rocket science. I think
the mortgage finance system, for a number of years, really has
worked fairly well for a lot of people and we do know what it
is going to take to get it right. These are, in a lot of ways,
common sense things, and this either/or discussion is a little
misleading. We need the transparency; we need the risk
retention; we need the skin in the game; we need the capital;
we need transparency in markets. We know what we need here.
Mr. Cummings. Thank you all very much.
Mr. McHenry. All right, thank you for your testimony. I
appreciate the ranking member's questions as well.
I would just say, in closing, thank you for staying for an
extended period of time. I certainly appreciate your candor in
answering these questions. It is a highly important issue. And
let's make no mistake about it, there is skin in the game, as
there always has been with securitization, at all levels. The
question is what can we do to foster more transparency in this
marketplace.
Clearly, Dodd-Frank doesn't address this. I think the
takeaway from today is that more transparency would not be a
harmful thing to my constituents who seek a mortgage; it
wouldn't be a harmful thing to investors, because they would at
least have greater certainty in the products they are
purchasing. I think those are some enormous takeaways that we
can agree to in a wider array, so I certainly appreciate you
addressing those issues.
It certainly is an important issue not simply here in
Washington or on Wall Street, but for Main Street, for average
Americans and average homeowners, even those that are paying
their mortgage. But we want to make sure we get this right, and
that is what this hearing is about, and I certainly appreciate
your information, informing us as public policymakers about
that.
Thank you, and the hearing stands adjourned.
[Whereupon, at 5:12 p.m., the subcommittee was adjourned.]