[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

                              ----------                              
                                                                   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

                              ----------                              


                        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.]

                                 
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