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

                         H.R. __, THE PRIVATE MORTGAGE
                         MARKET INVESTMENT ACT, PART 1

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

                                    HEARING

                                   BEFORE THE

                      SUBCOMMITTEE ON CAPITAL MARKETS AND

                        GOVERNMENT SPONSORED ENTERPRISES

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                          ONE HUNDRED TWELFTH CONGRESS

                                 FIRST SESSION

                                   __________

                                NOVEMBER 3, 2011

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 112-82

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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                       SPENCER BACHUS, Alabama, Chairman

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

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

                      SCOTT GARRETT, New Jersey, Chairman

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

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        November 3, 2011.............................................     1
    Appendix:
        November 3, 2011.............................................    65

                                   WITNESSES
                           Thursday, November 3, 2011

    DeMarco, Edward J., Acting Director, Federal Housing Finance
      Agency (FHFA)..................................................     9
    Deutsch, Tom, Executive Director, American Securitization Forum
      (ASF)..........................................................    35
    Hughes, Martin S., President and Chief Executive Officer, Redwood
      Trust, Inc.....................................................    37
    Ratcliffe, Janneke, Senior Fellow, Center for American Progress
      Action Fund; and Executive Director, Center for Community
      Capital, University of North Carolina at Chapel Hill...........    38
    Wallison, Peter J., Arthur F. Burns Fellow in Financial Policy
      Studies, American Enterprise Institute (AEI)...................    40

                                    APPENDIX

    Prepared statements:
        DeMarco, Edward J............................................    66
        Deutsch, Tom.................................................    77
        Hughes, Martin S.............................................   116
        Ratcliffe, Janneke...........................................   124
        Wallison, Peter J............................................   142

                  Additional Material Submitted for the Record

    Garrett, Hon. Scott:
        Letter to Ranking Member Norm Dicks, House Committee on
          Appropriations, from the National Community Reinvestment
          Coalition (NCRC), dated October 31, 2011...................   154
        Letter to Ranking Member John Olver, Subcommittee on
          Transportation, Housing and Urban Development, from the
          National Community Reinvestment Coalition (NCRC), dated
          October 31, 2011...........................................   156
        Letter to Chairman Hal Rogers, House Committee on
          Appropriations, from the National Community Reinvestment
          Coalition (NCRC), dated October 31, 2011...................   158
        Letter to Chairman Tom Latham, Subcommittee on
          Transportation, Housing and Urban Development, from the
          National Community Reinvestment Coalition (NCRC), dated
          October 31, 2011...........................................   160
    Frank, Hon. Barney:
        Letter to Chairman Scott Garrett and Ranking Member Maxine
          Waters, Subcommittee on Capital Markets and Government
          Sponsored Enterprises, from the National Association of
          Home Builders (NAHB), dated November 2, 2011...............   162
    Westmoreland, Hon. Lynn:
        Written responses to questions submitted to Edward J. DeMarco   163

                         H.R. ___, THE PRIVATE MORTGAGE
                         MARKET INVESTMENT ACT, PART 1

                                  ----------

                           Thursday, November 3, 2011

                 U.S. House of Representatives,
                    Subcommittee on Capital Markets and
                      Government Sponsored Enterprises,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 10:05 a.m., in
    room 2128, Rayburn House Office Building, Hon. Scott Garrett
    [chairman of the subcommittee] presiding.
        Members present: Representatives Garrett, Schweikert,
    Royce, Manzullo, Biggert, Neugebauer, Campbell, McCotter,
    Pearce, Posey, Hayworth, Hurt, Grimm, Stivers, Dold; Waters,
    Sherman, Hinojosa, Miller of North Carolina, Maloney, Moore,
    Donnelly, Peters, and Green.
        Ex officio present: Representative Frank.
        Also present: Representatives Westmoreland and Renacci.
        Chairman Garrett. Good morning, everyone. I now call to
    order this hearing of the Subcommittee on Capital Markets and
    Government Sponsored Enterprises on the Private Mortgage Market
    Investment Act. We welcome everyone to this hearing today.
        We will begin with opening statements, and I will yield
    myself 3 minutes to do so.
        Today, the subcommittee is holding a hearing on the Private
    Mortgage Market Investment Act. The legislative text is a
    product of many discussions that we have had, both formally--
    like the subcommittee's recent hearing up in New York City--and
    informally, about the steps that need to be taken to bring
    private capital markets back to our Nation's secondary mortgage
    market.
        Currently, the Federal Government is guaranteeing or
    insuring over 90 percent of the U.S. mortgage market. And
    everyone on both sides of the aisle and all market participants
    claim that they generally support the efforts to bring
    additional private capital back to the secondary mortgage
    market.
        There are two things that must be done to have private
    capital begin to reenter this space. First, we must begin to
    roll back some of the government's involvement in the housing
    market. The subcommittee has already passed 14 bills so far
    this year with the intent of reducing the government's
    footprint and setting the course for the abolishment of Fannie
    Mae and Freddie Mac. This is a key and vital part of getting
    private capital going again, because as long as the cheaper
    government option is available, that will be the route that is
    chosen.
        Second, we must take actions to facilitate increased
    investor interest in this secondary market by facilitating
    continued standardization and uniformity within the market,
    increasing transparency and disclosure, and providing legal
    certainties through a clear rule of law. If we do that, there
    will be robust investor participation in the housing market
    without exposing the American taxpayer to trillions of dollars
    of additional risk.
        The legislation we are discussing today essentially sets up
    a new quasi-securitization market. The FHFA is tasked with
    establishing a number of categories, or mortgages, using
    traditional underwriting standards, that is, different levels
    of credit risk associated with each category. Also, the FHFA is
    responsible for creating standardized securitization agreements
    for this marketplace.
        Each securitization agreement will standardize the
    servicing arrangements of the loans, process the loans, go
    through a modified representation of warranties, and provide
    the investors the ability to put back in quality loans.
    Securities that meet this specific underwriting guideline for a
    category and contain the standard agreements will be eligible
    for exemptions from SEC registration.
        So this standardization and registration exemption will
    allow for a futures market as well in these qualified
    securities. And investors with varying credit risk appetites
    will then be able to buy these securities that meet these
    investment needs.
        Next, the legislation also removes one of the biggest
    regulatory impediments to private capital re-emerging. It does
    so by striking risk retention provisions from the Dodd-Frank
    Act. I agree that risk retention has benefits and we have
    talked about that. The way this is currently being implemented
    will create multitudes of negative unintended consequences in
    the marketplace.
        For one, I am not sure, really, when you think about it,
    what good the risk retention rule that we have right now will
    do if we exempt Fannie and Freddie and Ginny and loans with
    downpayments of 5 percent or more. That sounds like, if you
    consider it, just about every loan that is made out there.
        Also, Fannie and Freddie had risk retention previously and
    we see where that got us. So I believe that a better form of
    risk retention is an improved standardized regs-and-warrant
    system that includes a structure that ensures investors' claims
    will be honored at the end of the day.
        The legislation also provides a much-needed fix to the QM,
    the Qualified Mortgage definition created by the Dodd-Frank
    Act. We ensure that loans that need this text laid out by the
    statute are able to qualify for a true safe harbor, instead of
    remaining subject to unnecessary and burdensome legal
    liability. And to bring private investment back to our mortgage
    market, it is essential that the rule of law is clear,
    specific, and upheld. Investor rights and contracts must be
    honored.
        So, by: first, facilitating the adjudication of
    disagreements between investors and issuers; and second,
    clarifying the rules around the first-lien holder's rights; and
    third, preventing government-forced loan modifications that
    would negatively impact investors, investors will finally have
    the certainty that they need to get back into the market.
        Finally, in regards to transparency and disclosure,
    investors should be empowered, if you will, and enabled to do
    their own analysis of the assets underlying the securities that
    they are investing in. So by disclosing more detailed loan
    level data, while at the same time protecting the privacy of
    the borrowers, and by allowing more time for the investors to
    study that additional information, investors will be able to
    conduct more due diligence and lessen their reliance on rating
    agencies.
        So that is a capsule, if you will, of what we are doing
    with this legislation. With regard to the Director's testimony
    that we are about to hear, and the ongoing work over at the
    FHFA, let me just say to you directly, I think that you are
    doing a very good job under very, very difficult circumstances.
    And I know that you have been called upon by some more extreme
    elements asking that you allow for Americans basically to pay
    for other Americans' mortgages.
        I appreciate the positions that you have taken, because you
    sit here and as you stand in your positions, you are basically
    the last wall, if you will, protecting the taxpayers from
    literally billions and billions and billions of additional
    losses over these entities. I thank you for the work that you
    have done.
        With that, I yield back.
        And I yield 2 minutes to Mr. Miller.
        Mr. Miller of North Carolina. Thank you, Mr. Chairman.
        There is a lot to like in Mr. Garrett's bill. It is very
    similar to legislation that I have introduced in this Congress
    and in the previous Congress, as well: H.R. 1783, the
    Foreclosure Fraud and Homeowner Abuse Prevention Act of 2011.
    And the differences, for whatever reason, we have not yet
    worked across the aisle on this legislation, but I would
    certainly welcome the chance to.
        It appears that the differences that we have are not deep
    philosophical differences. There is no partisan divide. We are
    trying to do the same thing in a somewhat different way. But it
    seems to be a practical difference, not a philosophical
    difference.
        I certainly support the idea of standardizing contracts,
    like pooling and servicing agreements, making clearer and more
    transparent the underlying loan files and making sure that
    servicing standards are uniform. Those are all things that are
    in the bill that I have introduced.
        I certainly welcome the idea of amending existing laws to
    make the mortgage security market function like other asset
    securities markets. That appears to be the--we appear to be
    trying to accomplish the same thing in this respect, but the
    bill under discussion today would really just create an
    entirely new mortgage market, a secondary mortgage market from
    scratch when there appears to be a clear model for doing it and
    grant great discretionary power to FHFA to fill in the blanks
    when there is a model that appears to work. Any grants in an
    agency that we originally thought would be an oversight
    agency--remarkable powers over an important part of our
    economy.
        There are other provisions where the intent makes sense,
    but not exactly the way they go about it. I introduced
    legislation in the last Congress to prohibit servicers from
    being an affiliate from owning or any affiliate of the
    servicers owning secondary mortgages or second liens, where the
    servicers are servicing leans that are effectively owned by
    someone else, where the beneficial ownership is with someone
    else.
        This bill prohibits any servicer from holding a second
    mortgage, which goes beyond that conflict of interest, and it
    is not clear why it should, why it would not make more sense
    simply to make the prohibition, which I welcome generally, only
    where the servicer actually does not own the mortgages that
    they are servicing.
        It goes on. There are other issues where we are trying to
    get to the same place. We simply are taking different paths,
    but the paths are not incompatible at all. So I hope that there
    will be the opportunity to work on this issue across party
    lines.
        Thank you very much. I yield back.
        Chairman Garrett. The gentleman yields back.
        And I will just say that, absolutely, and especially on
    some of the points that you have raised, this is a draft
    version of legislation here, we are not wed to some of the
    provisions in here on that last point, which is a very
    complicated issue, and we look forward to--it is not only
    complicated, but divergent views on exactly how you actually
    get to the end of the day on that--so look forward to working
    with it.
        The gentleman from Arizona, for 2 minutes.
        Mr. Schweikert. Thank you, Mr. Chairman.
        I would like to actually start this by thanking you, Mr.
    Demarco. You and your staff have, in many ways, almost been
    stunningly acceptable when we have had very technical
    questions, when we have just wanted to cut through some
    folklore. There are very few people in the bureaucracy I found
    here in Washington who will return a phone call that fast and
    be willing to be that detailed with it. So there is a great
    appreciation there.
        As I have shared many times with the chairman and many of
    the members here, my personal fixation is the proper pricing of
    risk, because I believe that the failure to properly price risk
    is actually what has caused many of the cascades we see around
    us today. As I am being told, Freddie Mac lost another $6
    billion last quarter. We are basically suffering through sins
    of the past, but sins of not pricing risk.
        The other thing I do want to stand here and make clear is
    that I understand this was a draft bill. There are a lot of
    things in here I am excited about. There are a lot of things I
    am hoping as we hear testimonies we will ferret out and work
    through the details and the mechanics.
        But the number of folks who come to my office, Mr.
    Chairman, and talk about risk retention, particularly in asset-
    backed credit cards, automobiles, all those other things, and
    many of those markets actually held up surprisingly well. Maybe
    we should not be going where we are going. Are we going to
    ultimately do more damage to the economy and the ability to
    finance our future?
        And with that, Mr. Chairman, I yield back my time.
        Chairman Garrett. The gentleman yields back.
        Mr. Peters, for 2 minutes.
        Mr. Peters. Thank you, Mr. Chairman, for holding this
    hearing.
        I think we all agree that the American housing market is
    severely depressed, which, in turn, is holding back our entire
    economy. I believe that there is also widespread bipartisan
    appreciation for the fact that the existing GSE system is a
    failure.
        Allowing Fannie and Freddie to pass on massive profits to
    their shareholders and huge bonuses to their executives and
    employees while sticking taxpayers with losses was a huge
    mistake and it should never be repeated.
        However, given the importance of the housing industry to
    the larger economy, we need to make sure that we are moving
    forward with caution. Chairman Garrett's proposed legislation
    is a constructive and helpful addition to the ongoing debate
    throughout the future of housing finance reform. I think the
    bill attempts to replicate some of the things that the existing
    GSEs do right. It will provide transparency and standardization
    that will make it easier for investors to have confidence in
    the market for private label securities.
        However, I am concerned that Chairman Garrett's bill does
    not do enough to ensure that 30-year fixed-rate mortgages are
    affordable to the middle class. We should not abandon the
    system that has, for decades, made the American dream of
    homeownership a reality for millions of middle-class Americans
    just because irresponsible lending exploited a weakness. In
    fact, I think we should work to eliminate that weakness while
    strengthening the system.
        Representative Campbell and I have introduced legislation
    that would retain a limited role for government in the
    securitization markets to ensure that we would continue to have
    deep liquid secondary mortgage markets. My colleagues,
    Representative Miller and McCarthy, have also introduced
    bipartisan legislation on this topic, and I would hope as the
    subcommittee continues to debate these important issues, that
    those bills would also be given a full and thorough debate.
        Mr. Chairman, I think it is very important that these bills
    come before the committee and are subject to a hearing, and I
    look forward to you scheduling such a hearing in the near
    future.
        As a society, we value homeownership as a pathway to a
    better life. Therefore, it is appropriate that our country
    create opportunities so that we can extend the American dream
    beyond just the wealthiest Americans and ensure that owning a
    home remains affordable for the middle class. And I hope that
    we are able to accomplish that with this going forward.
        I yield back the balance of my time.
        Chairman Garrett. The gentleman yields back. Thank you very
    much.
        Mrs. Biggert is recognized for 2 minutes.
        Mrs. Biggert. Thank you, Mr. Chairman, and thank you for
    holding today's hearing on your proposal, a discussion draft
    entitled, ``The Private Mortgage Market Investment Act.''
        In March, Treasury Secretary Geithner testified before our
    committee and said, ``The administration and Congress have a
    responsibility to look forward, reconsider the role government
    has played in the past and work together to build a stronger
    and more balanced system of housing finance.'' I agree.
        Today's draft is part of this committee's deliberative
    dialogue about how to stabilize the housing market, reduce
    taxpayers' liabilities, and facilitate a reentry of private
    sector capital for single-family and multiple-family housing.
    We have learned that, for private capital to assume an
    increased role in housing finance, investors need regulatory
    certainty, relief, and common sense.
        What they don't need is rushed and unworkable rules like
    the QRM or unfair competition from Federal programs like Fannie
    Mae, Freddie Mac, or FHA. I look forward to today's discussion
    and yield back the balance of my time.
        Chairman Garrett. Mr. Frank is recognized for 6 minutes.
        Mr. Frank. Thank you, Mr. Chairman.
        I would note that the ranking member is on her way--
        Chairman Garrett. Oh, the gentleman is recognized for 5
    minutes; the remainder of the time.
        Mr. Frank. Yes, if the gentlewoman from California arrives,
    I will yield her part of that time; she may have been delayed.
    But I thank you for that.
        I appreciated, Mr. Chairman, that you said to the gentleman
    from North Carolina that this was a draft bill. The reason I
    say that, and I would yield some time for an answer, is we have
    been informed that a markup on the subject of securitization
    was scheduled for November 15th. But I would think, consistent
    with your saying this is a draft bill, that would not be for
    this bill. I would yield if you would--is there an intention to
    mark up this bill on the 15th? I would think, you having said
    it was just a draft, that was probably not the case, but I
    wanted to clear up the confusion.
        Chairman Garrett. We are focused on this, on this bill. My
    comments with regard to the draft are just what we are talking
    about here.
        Mr. Frank. My question is, is that--there was a markup
    scheduled by the committee for the 15th, I believe, in the
    subcommittee on securitization. My question is, is this
    legislation the subject of that markup?
        Chairman Garrett. I don't have a date certain on any
    markups. If I could that I do that, I would, but I--
        Mr. Frank. I had a more specific--so that 15th date is not
    a markup date for this bill?
        Chairman Garrett. I do not have a definite markup date for
    this bill from the committee chairman--
        Mr. Frank. All right. I appreciate that, because then that
    clears it up, because we had been told there was a markup on
    the 15th on securitization, and there was an assumption it
    might be in this bill. But I take it from that now--
        Chairman Garrett. Yes, I have not gotten--
        Mr. Frank. Yes?
        Chairman Garrett. I have put requests in to try to move
    things along. Well, not request, but I want to move things
    along--
        Mr. Frank. I appreciate it, but the fact that you said it
    was a draft bill, I would think it would be unlikely. And I
    would also say, in light of this--and this is a very important
    topic, and I appreciate the tone so far, and I think we have
    some very important issues to grapple with. And I appreciate
    the kind of non-dogmatic tone of some of the testimony people
    recognize that there are questions here.
        I think, Mr. Chairman, my recommendation would be that we
    probably would want at least another hearing on this. I noticed
    that we have one group of witnesses, and you don't want to get
    too many witnesses and bore the heck out of each other, but we
    don't have any direct lenders here. We don't have a--and I
    would ask unanimous consent to put into the record at this
    point a letter from the National Association of Home Builders
    (NAHB) expressing some doubts about this. The NAHB looks
    forward to working with the subcommittee to strengthen and
    improve the draft legislation but remains concerned that the
    larger reform effort currently under way would remove all
    Federal support of the Nation's mortgage market.
        And it says that, while NAHB supports the objective of the
    draft bill, we look forward to contributing thoughtful
    recommendations to enhance provisions. We remain concerned
    about dismantling all government backing.
        So I would assume at some point, we would want to hear from
    the home builders, the REALTORS, and some of the direct
    lenders, as well as other groups that have an interest. And I
    would ask that this be put into the record.
        Chairman Garrett. Without objection, it is so ordered.
        Mr. Frank. And then I would also have some questions. I
    would say my major assumption of concern here is the repeal of
    securitization; I think risk retention; I think the ability to
    make loans and not have to stand behind them was a problem, and
    I think there was a--the proposal was to replace risk retention
    as an assurance here would affect with a fairly complicated set
    of regulations that would come from the FHFA classifying
    different mortgages.
        My own view was that there was a--we would be better off
    with risk retention because that makes one government policy
    and then leaves it to the market, leaves it to the lender to
    decide. I think we have a fairly elaborate set of rules here. I
    noticed in Mr. Wallison's testimony that he had some questions
    about some of the specific restrictions that are put on who can
    do this and that.
        Frankly, at first glance it seems to me the solution that
    is in the bill as an alternative to risk retention is
    excessively elaborate and relies too much on the decision of
    regulators and the judgment of regulators and not enough on a
    market incentive. And I think risk retention does that. It does
    impose the basic retention, but after that it is entirely up
    the market. And that is one of the ones that I would hope we
    would pursue.
        And then the final question I have, Mr. Chairman, is where
    we stand in terms of housing finance legislation in general. We
    have 14 bills, I believe, that have been approved by the
    subcommittee. And we all know that in April, the Majority
    criticized us for delaying subcommittee deliberation by 1 day,
    and we have still not gotten to full committee.
        So I guess would accept blame for 1 day's delay, and the
    Majority takes the blame for about 7 months delay. And I think
    other people are interested. We had the Hensarling bill that
    was offered as an amendment to financial reform and where there
    was criticism for not being included. That bill is off in limbo
    somewhere. It was reintroduced and has never been mentioned.
        So I think there is a question. This is to replace the
    current GSEs, but I think there is interest in what the plans
    are for the Majority to deal with the Hensarling amendment that
    abolishes Fannie and Freddie and the 14 bills, and maybe more
    to come, that make changes to Fannie and Freddie. I think it
    would be helpful if they at some point could be clarified.
        Chairman Garrett. The gentleman yields back. Mr. Dold is
    recognized for 2 minutes.
        Mr. Dold. Thank you, Mr. Chairman. Right now, through the
    GSEs, the taxpayers are effectively on the hook for over $5
    trillion in total mortgage debt, and the GSEs are also
    responsible for nearly all new mortgages originated in this
    country since the financial crisis. And while taxpayers remain
    exposed to enormous and increasingly potential liability in our
    current financing system, our housing market remains severely
    challenged.
        This situation is plainly unsustainable for both taxpayers
    and the housing market participants. Instead of a mortgage
    market dominated by the Federal Government and taxpayer
    guarantees, we need new and creative solutions that create the
    conditions for the private sector's return to our mortgage
    financing market without taxpayer guarantees.
        To create those private sector conditions, we must have a
    legal framework that establishes and enforces uniform
    standards, transparency, and legal certainty for the private
    sector lenders and investors.
        And I think Chairman Garrett's discussion draft, which we
    are considering today, goes a long ways towards creating those
    private sector conditions. So I want to thank the chairman for
    his work and his leadership on this important issue, and I
    certainly look forward to hearing from our witnesses today. I
    yield back.
        Chairman Garrett. We have just a minute-and-a-half left on
    our side. I will just claim a minute of that, and just to
    recoup where we are. So from one sense I get--some would
    suggest we are moving too quickly, and some other perspectives
    that some would argue that we are moving too slowly.
        I guess in comparison to the way that Dodd-Frank moved,
    which moved through the committee actually without even many
    subcommittee hearings and not through regular order, I guess we
    are moving at the appropriate speed because we are doing this
    through the subcommittee process and we are doing it through
    hearings and what-have-you.
        Comparatively, others say we are moving too quickly. We
    have had so far 17 hearings so far on housing finance. And the
    ranking member lists a number of organizations and groups and
    trade associations that would probably like to chime in on some
    of this legislation.
        By and large, each and every one of us has been able to be
    at the table where Mr. DeMarco is right now and have had the
    opportunity during the course of those 17 hearings to answer
    the questions from either side of the aisle at any particular
    facet of housing finance.
        Also, the question has been raised with regard to the other
    legislation that has been out there. Again, we have had 17
    hearings for those pieces of legislation and others, the
    general topics of those to be discussed and to be questions
    raised to the members of the panel.
        And I would suggest also that today, if anyone from either
    side of the aisle has questions on any other piece of
    legislation, Mr. DeMarco would be more than happy to discuss
    them, because he has already raised some of those points in his
    testimony.
        I think time on both sides has expired. And with that, I
    will yield to our first witness, Mr. Edward J. DeMarco, Acting
    Director of the Federal Housing Finance Agency.
        Again, I thank you very much for your work, and for your
    testimony today.

       STATEMENT OF EDWARD J. DEMARCO, ACTING DIRECTOR, FEDERAL
                         HOUSING FINANCE AGENCY

        Mr. DeMarco. Thank you. Chairman Garrett, and members of
    the subcommittee, thank you for having me here this morning.
        I am pleased that the subcommittee is beginning the serious
    work of considering housing finance reform options which will
    lead to the ultimate resolution of the Enterprises Fannie Mae
    and Freddie Mac. My written statement provides a brief review
    of some of FHFA's work since I last appeared before you. I will
    focus now on the need for legislation.
        Placing the Enterprises into conservatorship was designed
    to maintain market stability while providing lawmakers time to
    consider the appropriate course for housing finance reform and
    the transition from the current Enterprise structure.
    Conservatorship is not a long-term solution, yet we just passed
    the 3-year anniversary of conservatorship.
        We all knew it was going to be difficult to develop a
    housing finance reform solution, but we must move forward on
    this process. As the conservatorships lengthen, FHFA must
    continually make decisions regarding investments in business
    platforms and human capital in the face of an uncertain future.
        To state the obvious, the key question in the debate on
    housing finance reform is the future role of government. We
    should be clear about this question at the outset. It seems
    safe to say that there will always be some portion of the
    mortgage market that will be assisted by government programs.
        In the future design of our housing finance system, careful
    consideration should be given to targeting subsidies to
    specific groups that lawmakers determine warrant that benefit.
    For example, the explicit government guarantees that the
    Federal Housing Administration and the Veterans Administration
    provide reflect policymakers' judgments as to the public
    benefits from targeting certain eligible borrowers with those
    problems.
        Acknowledging that there will be a role for government, the
    next question is what type of structure is necessary to replace
    the activities that are currently undertaken by the
    Enterprises. There seems to be relatively broad agreement that
    the Government-Sponsored Enterprise model of the past where
    private sector companies were provided certain benefits and
    charged with achieving certain public policy goals did not
    work.
        That model relied on investors providing funding for
    housing at preferential rates based on a perception of
    government support. This perception proved true, and the cost
    to the American taxpayers is now more than $170 billion.
        In place of this system, the chairman's discussion draft
    would establish a functioning mortgage-backed securities market
    by replacing some of the standard-setting that the Enterprises
    provide today with a regulatory regime that sets those
    standards. This model would not rely on a government guarantee
    to attract funding to the mortgage market, but rather would
    look to standardization and rules for enforcing contracts to
    provide a degree of certainty to investors.
        The process of undertaking housing finance reform is
    difficult. The discussion draft is a thoughtful approach to a
    framework that does not rely on a government guarantee. In the
    end, lawmakers must decide what structure will provide a
    functioning housing finance market that does not place
    taxpayers at risk.
        Mr. Chairman, I would like to thank you for helping to move
    the housing finance reform discussion forward by offering your
    discussion draft and by holding this hearing. I believe that
    private capital markets can and should reclaim a prominent
    position in providing housing finance, and your draft proposal
    broadens the discussion of how that might be done.
        I recognize this subcommittee and the full committee have
    difficult and important decisions to make in the coming months,
    and FHFA looks forward to offering technical assistance to both
    the Administration and Congress as a consideration of policy
    alternatives proceeds. Thank you.
        [The prepared statement of Acting Director DeMarco can be
    found on page 66 of the appendix.]
        Chairman Garrett. With 50 seconds to spare. Thank you. So I
    will begin. I yield myself 5 minutes myself to begin the
    questioning. Thank you for your testimony.
        Obviously, there is widespread disagreement from various
    factions with regard to what to do in general with regard to
    GSE and GSE reform, but I think there is pretty broad
    acceptance of the idea that we don't want to have a system--one
    of the terms you mentioned--with an implicit guarantee going
    forward.
        So, you looked at our draft legislation. Basic question: Is
    there anything that you see in what you have before you that
    would create any implicit guarantee in this legislation?
        Mr. DeMarco. No, Mr. Chairman. Based on the review I have
    been able to undertake to date, I don't see how would one
    interpret or perceive an implied guarantee as a Federal
    taxpayer in the general framework that is outlined here. I
    believe it is pretty clear that this is putting investors on
    the hook for assessing and bearing mortgage credit risk.
        Chairman Garrett. Okay. That segues into actually the next
    couple of questions. What we try to do here is to create a
    system where the FHFA is able to go out and set up uniformity,
    homogeneity in the securitization side and then the
    underwriting side.
        So let us just stop right there already and ask you if this
    were to occur, how do you see that playing out, if you will?
    How do you see those two aspects into fruition at the end of
    the day? And as to the point on the investors, what would you
    be doing to attract either a broad sector of investors
    interested in this or a narrower sector of investors in this?
        Mr. DeMarco. I think that we would certainly be striving to
    have a deep, sufficient, and liquid mortgage market. And so, we
    would want to attract a broad set of investors to that.
        I think that in the framework that your bill proposes, a
    key responsibility to FHFA would be in defining both the
    securitization structure and the classification of mortgages,
    that it be done in a way that allows for the market to reach
    that depth of liquidity and clarity about credit risk that
    would be necessary and appropriate to get efficient pricing of
    that credit risk by investors.
        So I would envision that we would undertake doing this
    classification process in a way in which we were striving to
    achieve relatively deep pools of homogeneous mortgages, so that
    investors could have confidence, both in the forward market
    that would be created, and then in the execution in the
    secondary market. And investors could understand the risk
    characteristics of particular groups of mortgages.
        Chairman Garrett. Just a side note there, you mentioned the
    forward market. And what would be the benefit of creating that
    liquidity in the forward market?
        Mr. DeMarco. Sir, it allows investors to be able to make
    commitments for investing in mortgages before the pools
    themselves are actually structured. But in order for investors
    to do that, there needs to be pretty good clarity and certainty
    regarding the characteristics of the mortgages that are being
    committed to be delivered into the marketplace.
        Chairman Garrett. But even further than that--okay, that is
    from the investor's side of the--
        Mr. DeMarco. --from the borrower's standpoint, it allows
    the borrowers to commit and the lender to commit to a borrower
    a mortgage rate that can be locked in during the process of
    completing the transaction.
        Chairman Garrett. And speaking hypothetically, if this were
    in place today, and I know it is not today, but the depth of
    the pools as far as what is being offered, how would you see
    that growing over time? We know what happened with regard to
    the CLL right now and where that is, but were that to change,
    how does that change as far as the depth of each of these
    pools, as far as what they--the interests of the investors in
    it?
        Mr. DeMarco. Part of what is to be determined really in the
    marketplace in this framework is how these securities would be
    broken up and offered to investors that were looking for
    particular characteristics.
        Chairman Garrett. Okay.
        Mr. DeMarco. But look, we have an almost $11 trillion
    single-family-mortgage market. If you get several groups of
    classifications, I think there would be great deal of depth and
    liquidity that would emerge in the marketplace, given the size
    of the overall market.
        Chairman Garrett. That is an interesting point. And some
    people have raised some questions about this as we went
    through. I have a couple of seconds left, and a point on that
    is that you need that depth and you need that liquidity for the
    trade to occur and in order for the rates to be there,
    regarding the issue of the 30-year fixed and the rest; correct?
        Mr. DeMarco. That is right.
        Chairman Garrett. And so, in the statute we could have
    picked it to say it is going to be one or it is going to be 22
    of these categories. But you are really saying, at this point
    in time, that is not a statutory provision that you want to do;
    right?
        Mr. DeMarco. I believe that is right. I believe that is
    sort of determined by getting feedback from investors and
    really from a whole set of stakeholders, so that we can get the
    most efficient grouping possible.
        Chairman Garrett. Great. I appreciate it.
        I yield back.
        The gentleman from Massachusetts is recognized.
        Mr. Frank. Thank you, Mr. Chairman.
        First, I will acknowledge that you and I have very
    different definitions of the regular order you mentioned in the
    subcommittee. I will say if you look at the procedures with
    regard to the Financial Reform Bill, there were more hearings,
    markups, amendments, recorded votes, and Floor time than any
    other bill I can remember. But I don't believe it is regular
    order to have subcommittee consideration and then have 6 months
    go by and no committee consideration.
        Regular order assumes a progression. We have 14 bills, some
    of which were marked up in April in subcommittee, and there has
    been no sign that any of them are going to go to the full
    committee. And there is a--this bill is premised on the
    situation when there is no more Fannie and Freddie, but this
    committee has the power to deal with that and hasn't moved on
    anything in that regard.
        So I don't think, as I said, subcommittee alone is not
    regular order. That assumes a progression. We are getting late
    in the year, and I think the uncertainty is not helpful.
        Beyond that, I have a couple of questions. Mr. DeMarco, I
    note you said the conservatorship was appropriate. And that
    came from this committee in 2007, 2008 working with Mr.
    Paulson.
        One of the questions was, and the goal of course of the
    conservatorship, was to stop the bleeding to a great extent,
    and to try to preserve some function in the housing market
    without the losses that had preceded it. That essentially
    worked. I know that we don't want to keep the conservatorship
    ad infinitum and you don't want to be sentenced to a lifetime
    as the conservator. I appreciate that.
        Mr. DeMarco. That is a fact, sir.
        Mr. Frank. Has that essentially worked out? Would you say
    it is appropriate?
        Mr. DeMarco. Mr. Frank, I believe it has. I believe we have
    brought the stability to the marketplace so that mortgage
    finance continues to operate fairly effectively during the
    duration of the conservatorship.
        Mr. Frank. And I think you have done what we all can try to
    do and it is hard to do. And I give credit to Mr. Paulson and
    this committee, which did it. We worked together and with
    thanks to your predecessor and yourself. We always try in these
    things to be able to get the good things to happen and minimize
    the bad things.
        Is it correct to say we sort of reached it? That is, as we
    look at the losses, and we can't be sure, it is only 3 years.
    But what is your estimate? What is the situation with the loans
    that have been made since conservatorship, or the purchases?
    What do you expect the loss rate to be with the post-
    conservatorship acquisitions, as opposed to the previous ones?
        Mr. DeMarco. I believe for both Enterprises, the post-
    conservatorships books of business will be profitable books of
    business--
        Mr. Frank. And I appreciate that. This committee did that
    in 2007, 2008.
        Now, the next question is--you don't want to be the
    conservator forever, but somebody is going to be doing
    something forever if this bill passes: ``The Director of the
    Federal Housing Finance Agency shall for purposes of this
    section prescribe classifications for mortgages having various
    degrees of credit risk rating from a classification of
    mortgages having literally no credit risk to a classification
    of mortgages having substantial credit risk, with the goals,''
    etc. And then, it lists all these things. That is a pretty big
    job.
        So this bill contemplates an FHFA in perpetuity, and it is
    a--the Director, I believe, read the bill. That is a pretty big
    job for the Director. What kind of staff do you think this
    would require? What kind of a permanent operation would we need
    to undertake the responsibility given to the Director of the
    FHFA under this bill?
        Mr. DeMarco. I certainly won't say that I have worked
    through that. The bill is pretty new here. But I would note
    that FHFA today has approximately 520 employees. We are still
    growing, but I would expect that we have quite an examination
    workforce in our current structure, because the current
    structure is focused on an immense undertaking in making
    soundness examinations of Fannie and Freddie.
        This bill would replace that and there wouldn't be that
    function going forward. So as far as the size, I am not sure
    how much it would change. I think we would see a change in the
    direction and principal elements of work, from safety and
    soundness examinations, to assessing the mortgage market and
    establishing standards.
        Mr. Frank. So, all right, I think that is relevant. But
    people shouldn't think, apparently, if this package were to go
    through and we abolish Fannie and Freddie and adopt this, that
    we would substantially see it go away. And I must say, my own
    concern is that it is a very specific set of ongoing sort of
    government intervention in the market.
        In addition to that, you would have to establish a variety
    of things. You would be described as mortgage default,
    delinquency, home documentation. And then you would do the
    standards servicing reporting, standards for modification. This
    is really a very significant government intervention in the
    mortgage market.
        That is why I said my--and I am saying it--is we are told
    it is more efficient or better than risk retention. I think
    risk retention has a greater simplicity. And I am concerned
    about the capacity of any Federal agency to take on the degree
    of supervision of the mortgage market on an indefinite basis
    that this bill calls for.
        I yield back.
        Chairman Garrett. The gentleman yields back.
        The gentleman from Arizona?
        Mr. Schweikert. Thank you, Mr. Chairman.
        Part of this is also a chance to ask a couple of questions.
    Could you walk me through some of the assets that the GSEs hold
    right now in performing paper, in impaired paper, in actually
    the number of properties that they hold title to?
        Let us start there, because I have always been very curious
    if there are a number of assets there that would help you prime
    the pump, if they were sold without a guarantee, or--and just
    getting that pricing model? What would the market pay and what
    would the market absorb?
        Mr. DeMarco. Right, right. So in broad strokes, the two
    companies together have in order of magnitude $5 trillion worth
    of mortgages, single family and multi-family, that they either
    own and finance directly on their balance sheet, or that they
    provide guarantees to market investors. The financed portfolios
    of both companies are declining over time, and there is a
    minimum required shrinkage of those portfolios.
        I don't know the exact number off the top of my head.
    Fannie Mae I think is on the order of a little over $700
    billion right now, and Freddie Mac is in the $600 billion
    range. But those are shrinking over time. There is a change in
    the characteristic of that financed portfolio. It is moving
    less from whole loans in their own mortgage-backed securities,
    to being mortgages that have been purchased out of mortgage-
    backed securities, either for loan modification purposes, or
    because they are delinquent.
        Mr. Schweikert. I thank this gentleman, Mr. Chairman, Mr.
    Demarco.
        And so, just to make sure, let us take that $700--
        Mr. DeMarco. Billion.
        Mr. Schweikert. --$700 billion. And those are ones where
    you hold the total paper?
        Mr. DeMarco. Where we own the total paper. So not only do
    we have the credit risk on them, but we also have the market
    risk of having to bundle them and hedge that market rate risk.
        Mr. Schweikert. Oh, and then hedge that risk.
        Mr. DeMarco. And then, you asked about REO properties?
    These are properties that they have title to because the
    property has gone through foreclosure. Currently, the count for
    that is a bit less than 200,000 properties. It is in the
    190,000-or-so properties.
        Mr. Schweikert. Okay.
        Mr. Chairman, Mr. DeMarco, has there ever been--and forgive
    me, but I saw some article on this, but this is something that
    I didn't follow up on--requesting pricing, saying, ``Here is
    our portfolio of performing paper. Here is our impaired
    paper.'' What would you market? What would you pay as for parts
    of this, with a guarantee and without a guarantee?
        Mr. DeMarco. Yes, sir.
        In September, I gave a speech in which I was sort of
    looking forward to the next things on the horizon for us as
    conservator, things that I think are appropriate, both to our
    conservator mandate and to preparing to attract more private
    capital back into the mortgage market to reduce the taxpayers'
    overall exposure.
        And at the time, I talked about two things. The potential
    for, or my expectation that we would continue to see gradually
    increasing guarantee fees.
        But the second, and this goes to your question, was that we
    would work on engaging more loss sharing with private capital
    for the mortgage activity, the new mortgage acquisitions Fannie
    and Freddie are doing. There are two broad ways that I outlined
    in my remarks that could be done.
        One is to increase the depth of participation of private
    mortgage insurance companies providing insurance guarantees on
    mortgages. The other is that there are ways in the
    securitization process to break up pools of mortgages in a
    fashion you may sell a portion of the pool to mortgage
    investors, and do so without any Fannie or Freddie guarantee,
    and hence, without a taxpayer guarantee, and start to get a
    more true market price for the credit risk.
        So these are options that we are exploring.
        Mr. Schweikert. Mr. Chairman, Mr. DeMarco, any of that data
    coming in to you? Have you had anyone call you and say, ``Hey,
    we would love to buy a few billion dollars and we will buy it
    without the guarantee, and here is what we are willing to pay
    on the yield?''
        Mr. DeMarco. We have certainly invited that with respect to
    the disposition of REO and got a lot of public interest. And I
    believe as we prepare to move in a more formal sense on the
    risk sharing, we will get those kind of offers.
        I have informally had market participants suggest an
    openness to purchasing that sort of paper.
        Mr. Schweikert. Okay. Mr. Chairman, down to the last 30
    seconds.
        Part of this--and I am very pleased with what you have been
    doing on the REO side. I am one of those who genuinely believes
    our real estate market will not come back in this country until
    we get these properties in people's hands, whether they are
    investors or first-time home buyers.
        When you have a couple hundred thousand properties out
    there, we need to get those back into productive use.
        Thank you, Mr. Chairman. My time has expired.
        Chairman Garrett. The gentleman yields back.
        Mr. Miller is now recognized for 5 minutes.
        Mr. Miller of North Carolina. Thank you, Mr. Chairman.
        Mr. DeMarco, in my opening statement, I spoke of the
    conflicts or potential conflicts of holding seconds and then
    servicing firsts held by others, beneficially owned by others.
        Do you see any--and I have asked the leading servicers, all
    of whom are affiliates, subsidiaries of the biggest banks, what
    business reason there was for that apparent, or at least that
    alignment of interests that are not identical which creates at
    least potential for conflicts.
        And all I got was that there were cross-marketing
    opportunities, which seemed to be not a particularly persuasive
    reason. Do you see any reason to have that alignment of
    interest?
        Mr. DeMarco. I do, Mr. Miller. As a general proposition, I
    think one of the lessons to be taken from the last several
    years is the difficulties that second liens have posed for
    resolving problems with first liens.
        And I think the potential conflicts of interest need to be
    identified, and how seconds that come in after firsts, altering
    really the risk characteristic of the first. All of these
    things need to be studied, and I think should be part of
    housing finance reform.
        Mr. Miller of North Carolina. Okay. When you began your
    answer, I thought you were disagreeing with me, but you were in
    fact agreeing with me. You do not see a reason to have
    servicers of mortgages beneficially owned by others holding
    seconds on those. There is no--
        Mr. DeMarco. I believe that is part of the conflict of
    interest. Whether there is another way of resolving that
    conflict by providing in law about what has to be done is
    another option. But as the way things stand now, I agree with
    you, sir.
        Mr. Miller of North Carolina. Do you not have the market
    power? Could you just not by contract require that? I have been
    frustrated at the enormous market power of Fannie and Freddie
    of holding half the mortgages--of legacy mortgages--and having
    almost complete monopoly power with respect to new mortgages
    and the unwillingness to use that market power. Not statutory
    power, not regulatory power, but just market power. Why have
    you not required that by contract?
        Mr. DeMarco. If the question is why I have not required by
    contract that second liens can't come in or restrictions on who
    may make those second liens, rather than put legal counsel on
    the spot, I am going to believe that is legally within my
    ambit. But I will say, Mr. Miller, that I will go back and we
    will study that question. If I am incorrect in my answer, I
    will report back to you.
        Mr. Miller of North Carolina. All right. And you and I have
    also discussed principal modification. And I have handed you, I
    think, a peer-reviewed economic study from the Federal Reserve
    Board of New York that shows that modifications that reduce
    principal lead to performing loans that reduce losses to
    mortgage holders.
        And I, again--Fannie and Freddie have been unwilling to
    reduce principal. There is now a pending settlement that may in
    fact not go through of Bank of America and the Bank of New York
    Mellon.
        And an essential part of that is that the investors in
    those mortgages are insisting that Bank of America give up
    servicing, kick out servicing where mortgages go into default
    to smaller servicers, higher-touch servicers, and that they
    reduce the principal to produce a mortgage that will not go
    through the hideous losses of foreclosure but is something that
    the homeowner can pay.
        Have you talked with the folks at PIMCO, or at BlackRock,
    who seem to have come to a different conclusion about what is
    in their best interest?
        Mr. DeMarco. If I may pause for just a second, Mr. Miller.
    I wanted to check that my recollection was correct. Mr. Miller,
    my understanding of the proposed settlement agreement that you
    are referring to does not contain a mandate for principal
    forgiveness in it.
        It does actually contain some requirements that Bank of
    America and any sub-servicer that would result from this would
    service these loans according to the standards actually that we
    have developed at FHFA in the form of our Servicing Alignment
    Initiative to promote loan modifications and those sorts of
    activities. I don't believe there is a mandate for principal
    forgiveness in there. But it does go to the servicing and the
    loss mitigation strategies we have.
        Mr. Miller of North Carolina. The former Mac program does
    have in the statute I think, certainly in the regulations, not
    just underwriting standards, which would be a really good thing
    that we make mortgages to people who can actually pay it back
    in the future. The other didn't work that well as a business
    model.
        But it also sets out procedures for when a mortgage goes
    into default and provides for principal modification. Have you
    looked at how that program has worked and whether that works?
        Mr. DeMarco. I have not looked at that particular program;
    no, sir. I do understand that the chairman's bill would have
    part of what we would establish in terms of standards--would in
    fact be loss mitigation protocol. That would be part of the
    servicing standards that would be developed so that market
    investors would have certainty about how a servicer was
    expected to minimize the investor's loss in the event of a
    delinquency in the mortgage.
        Chairman Garrett. I thank the witness, and the gentleman
    yields back. And Mrs. Biggert is recognized.
        Mrs. Biggert. Thank you, Mr. Chairman.
        Nice to see you here, Mr. DeMarco.
        Mr. DeMarco. Thank you.
        Mrs. Biggert. Question, does Fannie Mae and Freddie Mac and
    FHA's dominance of the mortgage market allow for innovation in
    the private sector? We already heard about some of the
    businesses being shut down and jobs lost because they can't
    complete with the taxpayer-backed government programs like FHA.
    So should we continue to allow the government-sponsored housing
    programs to compete and edge out the private sector?
        Mr. DeMarco. To the first part with regard to innovation, I
    don't believe that the model of having Fannie Mae and Freddie
    Mac in conservatorship is one really conducive to innovating
    new products. In fact, as a conservator I have said we are not
    introducing new products.
        So I think that the sort of market framework that would
    allow for innovation and introduction of new instruments and so
    forth would better happen outside of the realm we are in today.
        Mrs. Biggert. Okay. Then, in the White Paper, Treasury's
    option one was a privatized system of housing finance with the
    government insurance role limited to the FHA, the USDA, and the
    Department of Veterans Affairs, assistance for narrowly
    targeted groups of borrowers. And that looks like a lot like
    the plan that Republicans have been promoting for a couple of
    years. And so, what is your view of option one?
        Mr. DeMarco. I believe option one that the Treasury
    Department put forward is certainly a credible option. I
    believe that Chairman Garrett's discussion draft is one of the
    first next developments, if you will, or refinements of
    Treasury's option one in that it provides a basic framework for
    Treasury's option one to be implemented legislatively.
        Mrs. Biggert. Okay. Then do you do believe that if FHFA
    creates mortgage buckets and defines the standards to fit into
    those buckets, the private sector will perceive that the
    mortgages in the buckets are implicitly guaranteed by the U.S.
    Government?
        Mr. DeMarco. No. That is not how I understand it would work
    in this bill, and I don't see anything in the bill that should
    give that sort of assurance to investors.
        Mrs. Biggert. I think that is always something that we are
    really working to make sure that we don't fall into maybe a
    trap like that again. And those are my questions. I yield back.
        Chairman Garrett. The gentlelady yields back.
        Mr. Hinojosa is recognized for 5 minutes.
        Mr. Hinojosa. I am next?
        Chairman Garrett. You are.
        Mr. Hinojosa. Good. Thank you.
        Chairman Garrett. I am just looking past you at the same
    time and--
        Mr. Hinojosa. Thank you very much, Mr. Chairman.
        Mr. DeMarco, how will the Private Mortgage Market
    Investment Act impact FHFA's ability to effectively regulate
    and be conservator of Fannie Mae and Freddie Mac?
        Mr. DeMarco. I would perceive this legislation as actually
    being in tandem with other legislation that has already been
    pending before the subcommittee and the full committee. I don't
    believe this is intended to be undertaken with an ongoing
    indefinite conservatorship of Fannie and Freddie. I believe
    this is framed to be a replacement. How that transition works,
    I believe remains to be worked out.
        Mr. Hinojosa. Does FHFA have the capacity and the expertise
    in-house to implement such a program that will go into effect
    no later than 6 months from the enactment?
        Mr. DeMarco. Interestingly, Congressman, there are a number
    of things that we would be required to do in this legislation
    that in fact we are already doing. The Servicing Alignment
    Initiative we have undertaken as conservator of Fannie and
    Freddie to establish more robust and consistent and effective
    mortgage servicing standards is something that we are already
    well along with and has already--the implementation of it has
    begun. That would be a key component of what would go into the
    standard setting that the chairman's discussion draft would
    have.
        Mr. DeMarco. The second thing is I have already made clear
    that as conservator of Fannie and Freddie, I am working towards
    changing their securitization process so that mortgage market
    investors would have detailed loan level data on the loans
    underlying a pool. This is also a provision that is part of the
    chairman's bill. This is something that we are working towards
    already.
        So I believe that there are certain things that we have
    under way already, and we certainly have the expertise in-house
    to be able to develop that. So I think some of the work we are
    doing in our current role fits well with what is proposed in
    the new role.
        Mr. Hinojosa. What does the secondary mortgage market look
    like with no government guarantee on the long-term fixed-rate
    debt?
        Mr. DeMarco. The long-term fixed-rate mortgages, I believe,
    look like one that is pricing the risk according to what it
    actually is. You will get a true market price of the risk, not
    just the credit risk, but the interest-rate risk associated
    with a long-term fixed-rate asset by--the concept behind the
    grouping of mortgages is to give greater homogeneity in the
    securitization process so that investors would understand, this
    is a class M-type of pool, this is a class-P type of pool, this
    is a class-S type of pool.
        And investors know what the key credit characteristic
    differences are between those different pools, and we would see
    that priced accordingly in the marketplace.
        Mr. Hinojosa. In listening to the dialogue that you had
    with my friend and colleague Congressman Miller regarding the
    principal modification, and your response was principal
    forgiveness. There is a heck of a lot of difference. And what
    we have been discussing here in our committee is that, if we
    are going to be able to make it possible for the person who
    buys the house for $300,000, and then it drops in market value
    to $200,000, they still have an indebtedness for some part of
    $300,000.
        We are asking consideration of those modifications, and I
    need for you to give me some clarification because I am not
    clear on your response to Congressman Miller.
        Mr. DeMarco. I will apologize to Congressman Miller if I
    misunderstood his question, and hence didn't give an
    appropriate answer. But to your question, Congressman, about
    principal forgiveness, here is how I have looked at this as the
    conservator of Fannie Mae and Freddie Mac. I believe that we
    have an obligation to minimize taxpayer losses from the
    applicable business that they have. I also believe that we have
    an obligation. It is, in fact, in statute to be maximizing our
    efforts to avoid foreclosures, recognizing the net present
    value to the taxpayer. That is a statutory mandate that we
    have.
        So what we are doing in the loss mitigation space with
    Fannie and Freddie is that there is a whole protocol that is in
    place at each company that the mortgage servicers are supposed
    to execute on their behalf. What this protocol is about is when
    a borrower goes delinquent on their mortgage, there is supposed
    to be immediate outreach to that borrower to find out what the
    reason for the mispayment is.
        If the borrower is going to be incapable of continuing to
    make the full mortgage payment that they are obligated to, the
    first alternative we turn to is a loan modification appropriate
    for this borrower. The borrower committed to continuing to make
    a payment they can afford, and then they are committed to
    staying in the house. If so, that is the outcome we all want to
    see, and that is our first priority.
        The way we go about that, the first step is, in fact,
    following the precepts of the Treasury Department's Home
    Affordable Modification Program, or HAMP. The HAMP program is
    designed to define what is an affordable payment. And it has
    been defined since the beginning as a payment that is equal to
    31 percent of the borrower's monthly income. So the notion is
    31 percent of income would go to pay the mortgage. So there
    will be a series of modifications made to the mortgage to get
    the borrower into a payment of that size.
        We are, in fact, doing that, and Fannie Mae and Freddie Mac
    together have completed just under one million loan
    modifications. If the HAMP modification doesn't fit the
    borrower, they don't qualify, Fannie and Freddie each have
    proprietary modifications that will address the particular
    situations of the borrower. So that is--
        Mr. Hinojosa. I understand.
        Mr. DeMarco. --what we are doing. But principal forgiveness
    in that context, we have found we can get the borrower to that
    payment without doing principal forgiveness, and we better
    protect the taxpayer by preserving an upside potential if the
    borrower is successful in their modification.
        Mr. Hinojosa. I thank the gentleman for his answer.
        Mr. DeMarco. Thank you.
        Chairman Garrett. And I thank you. The gentleman yields
    back.
        The gentleman from California is recognized for 5 minutes.
        Mr. Campbell. Thank you, Mr. Chairman, and thank you, Mr.
    DeMarco.
        As was discussed earlier, there is general agreement that
    the conservatorship was the right thing to do in 2008. There is
    also general agreement that the conservatorship and that the
    current system is not the permanent solution and that we need
    to replace it with something. I think the question before us
    here today is whether or not this bill is the sole and
    sufficient replacement for Fannie and Freddie as opposed to
    some of the other alternatives that are authored by other
    members of this committee, including myself.
        So my first question for you would be, if Fannie and
    Freddie were to disappear tomorrow, and this bill were the sole
    replacement for that, is that sufficient? Could this PLMBS
    serve the entire marketplace?
        Mr. DeMarco. It could not do it tomorrow.
        Mr. Campbell. Why not?
        Mr. DeMarco. Because this would take some time for
    standards to be developed and articulated. And in order to
    attract private capital and to build out the infrastructure to
    do the securitization that is proposed in this bill, private
    capital is going to want to know what these standards are, what
    the securitization requirements are going to be, and then make
    the necessary and appropriate investments in infrastructure and
    in risk management to be able to execute it.
        Over time, can that develop, and can that be implemented?
    If the market has certainty that these are the rules of the
    road, and if these rules of the road are not going to be
    changing every 3 months, I believe that the private market can
    step in and do a great portion of what is currently being done
    by Fannie and Freddie.
        Mr. Campbell. A great portion, I note. Okay.
        Let us talk about what would happen, do you think, to FHA
    and the Federal Home Loan Banks--to the volume through them--if
    Fannie and Freddie were gone and this was the sole solution?
        Mr. DeMarco. FHA, even with Fannie Mae and Freddie Mac
    operating in conservatorship, really has an unprecedented
    volume today relative to any time in recent history. And I
    believe that for lawmakers, for you all to consider the housing
    finance system broadly, I would expect that consideration of
    FHA's role here, whether it expands, contracts, gets redefined
    as there are certain targets would be all part of what you all
    would figure out.
        Mr. Campbell. Because if you left it alone they would--a
    huge portion of the market would probably go through FHA if
    Fannie and Freddie disappeared and you just had this in its
    place, wouldn't you suspect?
        Mr. DeMarco. I wouldn't necessarily draw that conclusion,
    no.
        Mr. Campbell. If there were no changes, if they could--they
    used to be the lender of last resort, and now they have become
    the lender of first resort for many people, particularly
    anybody with less than 20 percent down.
        Mr. DeMarco. There are an awful lot of creditworthy
    borrowers out there who would, I believe, find market execution
    at an attractive price without having to go through FHA.
        Mr. Campbell. Okay. This bill actually has a lot of
    government restriction and control over the marketplace. And
    one of the things that requires FHFA to do is to promulgate
    underwriting standards. Could this not be construed as a stamp
    of approval by FHFA, and therefore have you opened to
    litigation or to legal liability from investors were those
    portfolios to go bad in the future?
        Mr. DeMarco. I believe that the discussion and careful
    review of the discussion draft on that point can and should
    continue. I would say, at first blush, it looks to me as though
    the bill is taking great pains to make clear that, in fact, is
    not permissible and that is not intended.
        Mr. Campbell. That it is not permissible to--because you
    are essentially filling--under this bill, as I figure--the role
    of the bond rating agencies.
        Mr. DeMarco. No, sir. I believe what we are doing is we are
    setting definitions and rules in terms of mortgages with this
    group of characteristics that will be classified as this class;
    rules with a different set of credit risk characteristics would
    be given this class title. And so, mortgage investors will know
    when an offering is made for this class, there is homogeneity
    about the risk characteristics. And then for this different
    class, there is homogeneity about the risk characteristics.
        And the interesting thing about--
        Mr. Campbell. Can I stop you, sir, because my time is going
    to run out?
        Mr. DeMarco. Certainly.
        Mr. Campbell. I want to get to this last question. You are
    not just the Director of FHFA, but you are a noted economist.
    If the 30-year fixed-rate mortgage were to vanish as a result
    of this--no government guarantee because the private market
    doesn't want to accept the duration risk and the interest rate
    risk, etc., in addition to a credit risk--so if there were no
    30-year fixed-rate mortgages, what effect would that have on
    housing prices? Because a lot of what we are talking about here
    is trying to keep--because if the housing market falls further,
    the economy will fall, and a lot of jobs will disappear, and
    that is what we don't want to have happen.
        Mr. DeMarco. Mr. Campbell, there is a predicate to the
    question I wouldn't necessarily agree with, that the
    implication is this bill would cause that to happen.
        Mr. Campbell. My question for you--
        Mr. DeMarco. But I understand. So the question is, if we
    suddenly outlawed 30-year fixed-rate mortgages, would there be
    an effect on house prices? There could be, but there could also
    be an effect on mortgage interest rates, which are also
    affecting house prices. And in some ways, this could--there are
    trade-offs there.
        There are a lot of borrowers who don't use 30-year fixed-
    rate mortgages, and there are some borrowers for whom, in their
    particular circumstances, a 30-year fixed-rate mortgage is
    probably not the optimal instrument for them.
        Chairman Garrett. I thank the gentleman from California for
    his questions.
        The gentlelady from California is recognized for 5 minutes.
        Ms. Waters. Thank you very much, Mr. Chairman. And let me
    thank Mr. DeMarco for his presence here today, and thank you
    for inviting him to come and testify on your draft legislation.
        Title III of the discussion draft prevents Federal
    departments or agencies from engaging in forced principal
    write-downs. And I am not clear, looking at the bill, whether
    or not you are talking about a ban on principal write-downs as
    it applies to new loans or existing loans; however, and this is
    with respect to any securitized mortgage loan, you have stated,
    Mr. DeMarco, you said that given the calculations of FHFA,
    principal write-downs on Fannie Mae and Freddie Mac loans are
    not appropriate at this time.
        Even though you have qualified that by saying ``at this
    time'', do you think that a statutory prohibition on principal
    write-downs is appropriate, or should the Director of FHFA have
    the flexibility to pursue principal write-down to future data
    demonstrate that it is appropriate?
        The reason I ask this question is that--and it has been
    stated by my colleague, one of my colleagues--that many of us
    are very, very sympathetic to the homeowners who are
    underwater. And we really do believe principal write-downs make
    good sense. And we believe that principal write-downs will keep
    many of our homeowners in their homes, but for principal write-
    downs, they will end up perhaps being foreclosed on.
        So my question, again, is what I already kind of stated:
    Should this be in law? Should we ban or prohibit principal
    write-downs in law or would you like to have some flexibility
    in dealing with this issue?
        Mr. DeMarco. At least with respect to the first part of the
    question, Ranking Member Waters, I believe it is equally
    legitimate for the Congress of the United States to legislate
    that the use of taxpayer funds to write down principal of other
    mortgages is an appropriate public policy and to provide for
    that. And I believe it is equally legitimate for the Congress
    of the United States to pass a law saying that is not an
    appropriate use of taxpayer money.
        I really believe that is, at this point, a question for
    lawmakers. I have made clear, given my current responsibility
    as conservator with the source of funding that I have today, my
    view of why I am not doing it. But I believe it is really up to
    lawmakers to make that sort of determination because we are
    talking about the use of taxpayer funds. And I believe that
    rightfully fits as a determination of lawmakers.
        Ms. Waters. All right. Let me just segue to another issue
    that I have talked with you about, but I guess I am interested
    in the timing now. I am, and I think other members are very
    pleased, about the request for ideas that you put out relative
    to disposal of the 300,000 REOs that you have on the books.
    Could you tell us something about the timing of that? How fast
    is this going to move and when can we see requests for
    proposals go out?
        Mr. DeMarco. Right. So thank you for that. The subcommittee
    is aware that we recently made an important set of
    announcements regarding the HARP refinance program. I will say
    that the agency has been focused on that as the first priority.
    Now that work is just about complete, moving to this REO
    question and finalizing our review of these 4,000 submissions
    is our next priority. And I would hope to be at least making
    some positive movement forward over the next few months with
    that. I believe that we need to get going with it.
        Ms. Waters. Thank you very much. I yield back the balance
    of my time.
        Chairman Garrett. The gentlelady yields back.
        The gentleman from Florida, Mr. Posey?
        Mr. Posey. Thank you, Mr. Chairman. Mr. DeMarco, first, I
    just want to say I applaud your written testimony, on page
    three where you say that you are going back and attempting to
    recover some compensatory damages. The question is, hopefully
    yes; or so, are any of the Federal law enforcement agencies
    working with you to recover some punitive damages?
        Mr. DeMarco. I can only speak to the actions that I have
    taken, Mr. Posey. So what we have done is we have undertaken
    the lawsuits that are public, the complaints that are public. I
    am not in a position to speak for law enforcement agencies of
    the government.
        Mr. Posey. So you are not aware that they are then?
        Mr. DeMarco. I can't speak for what law enforcement is
    doing, Mr. Posey.
        Mr. Posey. I am not asking you to speak for what they are
    doing. I am asking you if you are aware if they are working
    with you, behind you, beside you, if they are aware of what you
    are doing and have an interest in it?
        Mr. DeMarco. From time to time, sir, we are certainly
    approached by law enforcement about various things that they
    are reviewing and we always provide our full cooperation to law
    enforcement. So certainly, as a general matter, are there
    issues out there that law enforcement is pursuing in the
    mortgage area? The answer is yes. And we are providing our
    support to them when asked.
        Mr. Posey. Okay. Do you notify law enforcement when you
    discover fraud as you attempt to recover damages here?
        Mr. DeMarco. We have a mortgage fraud reporting regime at
    Fannie Mae and Freddie Mac. There is a great deal of reporting
    that is done. And they will oftentimes come back to us and ask
    for additional information or guidance--
        Mr. Posey. Thank you. I think last time, we heard that the
    defense fees for the Fannie and Freddie executives were in
    excess of $162 million. Can you give us an updated number now?
        Mr. DeMarco. Not off the top of my head. I would be happy
    to provide it in writing. I suspect given the pace of this, it
    has not changed much since my last appearance.
        Mr. Posey. I understand that since you were here, a court
    has ordered at least one of the executives to repay some
    bonuses that were apparently received and not deserved. Could
    that be viewed as any type of adjudication of guilt and maybe a
    reason for the American taxpayers to stop paying the defense
    fees for those crooks?
        Mr. DeMarco. Mr. Posey, I am not aware of the particular
    issue or circumstance that you just described. So I would have
    to find out exactly what ruling was made that you are referring
    to and then I have to assess that. I am not aware of, off the
    top of my head, the ruling you are talking about.
        Mr. Posey. Okay. I am going to make a couple of statements
    and ask you to tell me what is wrong with them. Number one, for
    about 60 years, we have had FHA loans, 3 percent downpayment
    loans, which require an extra 0.5 percent mortgage insurance
    premium. And to a large extent, the extra 0.5 percent mortgage
    insurance premium has paid enough through its accumulation for
    the losses that have been incurred through the loans. So
    basically, it is been a pretty good, sound system.
        VA, which has no downpayment, only has a loss ratio of
    about 2.5 percent, which is incredible, because of the great
    job they do at underwriting and working with their clients. So,
    I think that is one argument for not reinventing the wheel. I
    will ask for your comments in a minute.
        Number two, the mortgage bubble wasn't caused by mortgage
    limits or low downpayments. I would wager that at least three-
    quarters of the people in this room, if they follow the
    national trend, bought their home, at least their first home,
    on a 3-percent-down FHA loan and didn't default on it, as most
    people didn't. Most of the bubble and the crisis was caused by
    fraud enacted between the borrowers and lenders. And if we are
    to eliminate that fraud, the system should work without
    additional regulation, red tape and so forth.
        Can you see anything patently wrong with those statements?
        Mr. DeMarco. I apologize. Certainly, mortgage fraud has
    been an important element of the debacle over the last several
    years, but I would not say that borrowers generally--let me set
    FHA aside.
        FHA actually had a very small book of business during this
    peak period, but I believe highly leveraged acquisitions of
    houses with zero percent down or close to zero percent down in
    fact was very much a contributing factor to the housing bubble
    and to the loss the taxpayers have absorbed.
        I would go further to your point about FHA and VA and say
    that these are certainly credible, explicitly government-
    guaranteed programs with targeted populations of eligible
    borrowers. And I believe it is every--I fully expect that
    wherever we end up in housing finance, we will continue to have
    robust FHA and VA programs.
        And one of the decisions for lawmakers is in a post-Fannie
    Mae/Freddie Mac world whether there is consideration to be
    given in terms of altering in any way the program or
    eligibility of FHA or VA.
        Mr. Posey. Okay. I don't want to cut you off, but I am
    running out of time here on my 5 minutes.
        Chairman Garrett. Actually, you are over your time, so--
        Mr. Posey. Can I have just one quick follow up? Thank you,
    Mr. Chairman.
        Chairman Garrett. If there is--
        Mr. Posey. It has been my impression that Congress pushed
    Fannie and Freddie to make many of the loans that we now
    regret. And I hold Congress culpable for that. Do you think
    that is a fair assessment?
        Mr. DeMarco. I certainly think that Congress established
    certain circumstances that drove Fannie and Freddie, but I will
    not relieve the executives of those companies for making very
    poor and imprudent business decisions prior to conservatorship.
        Mr. Posey. Thank you.
        Thank you very much, Mr. Chairman.
        Chairman Garrett. The gentleman now yields back.
        The gentleman from California?
        Mr. Sherman. We have recently seen some bonuses at Fannie
    and Freddie. I wonder if you have a comment on that.
        Mr. DeMarco. Yes, sir. I will say several things about the
    recent news. The first is that the compensation programs that
    are being reported about are the same compensation programs
    that have been in place since 2009, at the same levels that I
    have extensively testified about before Congress.
        And I will say that a number of executives have turned over
    at the companies. We seek in every instance to be bringing in
    new executives at lower compensation than their predecessors.
    And finally, I believe that this compensation problem will be
    solved fastest when Congress gets on with coming to a final
    resolution of the conservatorships.
        Mr. Sherman. This bill that we are talking about today is
    either a very small bill in its importance or a very large one.
    It is certainly useful to have standards of weights and
    measures for ounces and pounds. And it would be good to have
    federally-published standards for mortgage-backed securities.
    But this could be an enormous bill if it is somehow a step
    toward abolishing Fannie and Freddie and not replacing it with
    anything similar.
        What does the secondary mortgage market look like to you if
    there is no government guarantee of long-term fixed-rate
    mortgages?
        Mr. DeMarco. As I said earlier in the hearing, I don't see
    the FHA or VA going away. So I believe there will in fact
    continue to be guarantees of 30-year fixed-rate mortgages. And
    I further believe that in the construct that is here, it would
    certainly be an opportunity for mortgage investors to price and
    to be willing to accept 30-year fixed-rate mortgages without a
    government guarantee.
        Mr. Sherman. What does it look like if--to the average home
    buyer right now, if they have a qualified loan, conforming
    loan, they are paying a certain rate of interest. How much
    higher is that going to be without the government guarantee? I
    know what it was in my area 5 years ago before mortgage-backed
    securities got an ugly name, but what kind of increase are we
    going to see for somebody who is borrowing and not borrowing
    from FHA or VA?
        Mr. DeMarco. That is a fairly complicated question, because
    one needs to be more specific about the borrower. But I can
    make a general observation for you, Mr. Sherman, that I think
    would be helpful, which is that we continue to have a mortgage
    market that is outside the Fannie/Freddie realm.
        And certainly looking, not just recently, but back at past
    history, suggests that we are on somewhat on the order of
    three-eighths to one-half of a percentage point greater on
    mortgage rates. But those borrowers also look like a different
    credit profile, it is not just--
        Mr. Sherman. Same credit profile. Let us say we were
    talking about 75 basis points, what does it do to the value of
    homes in this country if for the vast majority of buyers, the
    interest rate is three-quarters of a point higher than it would
    be otherwise?
        Mr. DeMarco. I don't have an immediate answer for you on
    that, Mr. Sherman. Certainly, there is a connection between
    mortgage interest rates and house prices. And I would say that
    the incredible subsidization over a long period of time through
    Fannie and Freddie with affecting mortgage interest rates has
    been capitalized into the value of homes, inflating those
    values.
        Mr. Sherman. Do you have any evidence or studies that would
    disagree with what I have seen, which would be another 15
    percent to 20 percent decline in the value of homes?
        Mr. DeMarco. I don't have studies to point to with regard
    to value--
        Mr. Sherman. Yes, you can. You don't have anything that
    would disagree with that and what does it do to the national
    economy if every--if the average home in this country declines
    by 15 or 20 percent over the next year as a result of action
    taken in this room?
        Mr. DeMarco. Obviously, a substantial decline in house
    prices would not be good for the economy or for the taxpayer.
    But we will see how this actually evolves, what sort of
    transition there is, and so forth.
        Mr. Sherman. I yield back.
        Chairman Garrett. Thank you, the gentleman yields back.
        The gentleman from New Mexico is recognized.
        Mr. Pearce. Thank you, Mr. Chairman.
        Mr. DeMarco--nice to see you.
        Just to kind of get the record straight, the last time you
    were here in committee, we had a little dust-up. And just to
    put it into the record, you came into the office and made a
    very professional presentation on the status of the
    institution. I appreciate that and still work from those notes.
    So thank you, and just to get that into the record.
        Mr. DeMarco. I appreciate it.
        Mr. Pearce. If we pursued just a little bit the line of
    questioning that Mr. Posey was on, what would be the definition
    of fraud? You were hesitant to say that a great percent of the
    loans are fraudulent. What would be the definition of fraud?
    And I will go ahead and give what I am thinking about.
        I have been in discussion with one of the bottom-line
    lenders from Wall Street, and her performance bonuses were
    based on kicking loans out the door. You have to get them in,
    and kick them out. And she wouldn't compromise the standards.
    The other people sitting at the desks making loans were getting
    higher bonuses. Her supervisor gets bonuses if they get
    bonuses. And so, she is under pressure to make the loans. Would
    that be, in your estimation, fraudulent? Or it doesn't cross
    the ethical line, but it is up there?
        Mr. DeMarco. As you have described it, I would not perceive
    it to be fraud, as long as credit characteristics are being
    appropriately reported to the buyer or investor in the
    mortgage.
        Mr. Pearce. And I think where I am going with this is
    nowhere tricky, just any market is going to have that same
    pressure, whether it is this bill in front of us, or the
    market, frankly, that is operating toward you right now. It is
    a pressure that is going to be there. Is there any way to
    regulate that pressure? Is there any way to deal with it?
        It is not technically fraud, but if there are mortgages out
    there that are not going to perform as well, and they are not
    categorized that way in order to get their bonuses, that is a
    problem in the system that I don't know how you get around,
    myself.
        Mr. DeMarco. Certainly, incentive compensation programs can
    be looked at as creating either positive or adverse incentives
    for how credit markets are functioning. So, incentive comp
    programs are pretty critical here, whether we are talking about
    executives or whether we are talking about rank-and-file
    employees.
        But that the mortgage fraud issue generally can run quite a
    wide gamut of participants. It can involve appraisers. It can
    involve lenders. It can involve borrowers. It can involve
    companies that are actually pooling and securitizing mortgages.
    Fraud can occur at any number of places, including those.
        Mr. Pearce. If we can switch gears for just a second, a
    continuing drumbeat of concern that I have from the small banks
    in New Mexico is that if we go to some private market, they
    will never get the rates of return that they can in the large
    markets. And that they are suspicious of movement away from--
    they don't like the explicit guarantee, but the implicit
    guarantee.
        What reassurance could we give people in New Mexico--the
    lenders--that they are going to be okay? That the private
    mortgage market will actually provide liquidity to them? Is
    that a reassurance that is possible, and is it one that is
    advisable to give?
        Mr. DeMarco. I think that is a great issue that concerns me
    a lot. I would answer it slightly differently. And that is, as
    we consider housing finance reform, whether it is the
    chairman's discussions, or after any other framework that is
    put forward.
        One of the things that I would suggest policymakers and
    lawmakers alike should be assessing is: What does this
    framework offer to small and mid-size lenders, whether it is
    community banks, mortgage bankers, and so forth, to be able to
    be active participants in the mortgage market, so that we would
    have a more competitive marketplace; and one that it is not
    dominated, either at the mortgage origination point, or the
    mortgage servicing point--that it is not dominated by a handful
    of very, very large institutions?
        Mr. Pearce. Okay.
        I yield back, Mr. Chairman.
        Thank you for your response.
        Chairman Garrett. The gentleman yields back.
        And before we go to Mrs. Maloney, just for the edification
    of the gentleman from California, the gentleman raised a good
    question with regard to the compensation issues and what needs
    to be done about that.
        The gentleman is reminded that we had legislation, H.R.
    1221, the Equity in Government Compensation Act--that was
    actually sponsored by the full chairman of this committee--
    which would basically try to address that and suspend the
    current compensation packages for employees of Fannie and
    Freddie and establish a compensation system that is consistent
    with the executive schedule, which I guess would be a lot less
    than was out there.
        That passed the committee 27-6, I believe, however, the
    gentleman from California voted ``no'' on that piece of
    legislation. So just to set the record straight, we are trying
    to address that situation.
        And with that, I yield to the gentlelady from New York.
        Mrs. Maloney. Thank you.
        And welcome, Mr. DeMarco. We appreciate your comments on
    what is the 15th proposal this subcommittee has reviewed in the
    area of secondary mortgage markets this year.
        I know that this question is not exactly on point with what
    we are reviewing today, but since you are here, I wanted to
    follow up on something I have been involved in with your office
    over the past several months. It concerns a recent story that
    was in the October 19th issue of the New York Times, entitled,
    ``Rush to Drill for Natural Gas Creates Conflicts with
    Mortgages.''
        And it has raised important questions about how many of
    these new gas leases on private property in many States that do
    not have a history of such leases, and how this will impact on
    mortgages. The article reports that there are concerns that
    these leases do not ensure compliance with certain standards
    set by a secondary lending institution.
        Earlier this year, I sent you and your staff questions on
    this area. And I appreciate your response. But your counsel's
    response raises question in light of the recent Times story.
    The piece showed there seem to be conflicts between these gas
    leases and mortgage rules, which could become a problem with
    investors who may want to get rid of their mortgage-backed
    securities.
        And now that the technical defaults that these leases could
    create on mortgages, it may force Fannie or Freddie to buy
    these mortgages back. And if this happens, I assume it could be
    incredibly expensive for the U.S. taxpayers, since 90 percent
    of residential mortgages are owned by Freddie and Fannie. And
    so, many people have already signed these oil and gas leases.
        So my question is, as the regulator, what is FHEA doing to
    audit the score of such a threat?
        Mr. DeMarco. Thank you, Mrs. Maloney. As you noted, my
    staff has been working with you and your staff to better
    understand this emerging issue and its implications, including
    its risks for Fannie and Freddie. And as you noted, we have
    provided one set of responses. With regard to the more recent
    development that you referred to, I will confess that I am not
    up to speed on that.
        And if you would indulge me, I would be happy to get a more
    fulsome response and to get back with you in your office
    regarding this latest development, and to make sure that we
    provide a full answer to your question.
        Mrs. Maloney. Thank you. Your agency's letter said you were
    waiting to see what EPA determines about whether fracking is
    environmentally dangerous. And I believe that determination is
    irrelevant. Something does not have to be environmentally
    dangerous for it to negatively impact property values or
    violate mortgage rules.
        Just take the example of a landfill. It is not considered
    dangerous, but it definitely lowers the value of property. Most
    people would not like a landfill in their backyard. And
    regardless of what EPA and the studies find, most research says
    that drilling negatively impacts property values, and as the
    Times' document showed clearly, drilling leases violate
    Fannie's and Freddie's rules.
        So the question remains, if FHFA or Fannie or Freddie are
    going to do an audit to see how many mortgages across the
    country have non-compliant leases on them. This is a serious
    issue. It could cost billions going forward.
        Mr. DeMarco. So, Congresswoman Maloney, as I said, I will
    be very happy to go back and take a serious look at whether an
    audit is in order, whether that is feasible and practical, what
    it is we would expect to get out of it. I am sorry. I am just
    not prepared to do--
        Mrs. Maloney. Following up, are there any efforts in FHFA
    to see how many mortgages in the United States are overlaid
    with noncompliant leases? Is there any effort to look at that?
        Mr. DeMarco. I am being advised, Mrs. Maloney, that these
    leases which you are referring to may or may not be recorded.
    And so, our ability to be able to effectively gather this
    information is uncertain at the moment. But I am told that the
    staff is looking at this and will continue to, and I will be
    happy to follow up promptly with your office to advise you of
    where we stand.
        Mrs. Maloney. Thank you very much.
        And my time has expired. Thank you.
        Chairman Garrett. And I thank you, gentlelady.
        The gentleman from Texas?
        Mr. Neugebauer. Thank you, Mr. Chairman, for holding this
    hearing. And thank you for putting forth a very interesting
    proposal for bringing the private market back to mortgage
    finance. I think it is very important for the long-term
    stability of housing that we have a robust private financing
    market.
        Mr. DeMarco, thanks for coming again. You have maybe what
    is one of the most difficult but most important jobs in our
    country right now. I guess the taxpayers and you got some bad
    news this morning. It looks like Freddie needs another infusion
    of about $6 billion.
        What I found troubling about that was that they lost $6
    billion in the previous quarter, but you are--if you go back a
    year ago, they only list $4.1 billion. And with the amount of
    origination that they have, you would have expected, I think,
    for the earnings to start showing some improvement. So I found
    that troubling. I would assume that you do as well.
        Mr. DeMarco. I certainly do, Congressman.
        I would say that a portion of these--so the breakdown
    briefly, there are three key contributors to this. One is, an
    additional increment of credit losses is continuing to reflect
    both the pre-conservatorship book of business and difficulty
    certain housing markets are having in stabilizing.
        It also reflects losses due to hedging in terms of a
    hedging of the financing risk of their retained portfolio, and
    then $1.6 billion of that is the dividend that is owed to the
    Treasury Department.
        Mr. Neugebauer. So recently, on September 30th, the loan
    limit temporary increase it was granted expired, and so the new
    loan limits are in place. Has anybody done an analysis of how
    much that would affect overall origination to the GSEs for that
    to move from the 729 down to the--what is it? The 625 number?
        Mr. DeMarco. I know we have how many mortgages, say, in the
    last year Fannie and Freddie had originated in that dollar
    range in the particular markets that were affected by the
    change in the loan limit. I am afraid I don't have that number
    with me, but I could easily provide it. It is really not a huge
    number, but we can get that for you.
        Mr. Neugebauer. In fact, it is a really small number. Would
    you agree with that--
        Mr. DeMarco. I would say certainly relative to their book,
    it is a very small number.
        Mr. Neugebauer. And so the question is--and Mr. Scott has a
    great proposal of bringing some certainty to the market--but
    what would be the incentive in the private market to originate
    anything in the current space that the GSEs are allowed to
    operate? What would be the incentive for the private market not
    to go ahead and let the Federal taxpayers guarantee that book
    of business long?
        Mr. DeMarco. It is pretty hard to compete with the Federal
    Government and the degree of support that is being provided
    right now.
        Mr. Neugebauer. So, if you are going to get the private
    sector back into the market, you are going to have to create
    some space for them to operate, because, really, there is no
    incentive below whether 625 for the private sector to originate
    anything that is not sent through the GSEs.
        Mr. DeMarco. Right. It is hard to compete with a government
    guarantee, and so as long as there is a wide footprint for
    that, that is going to be a wide space in the market that would
    be hard for private participants to compete in, in terms of
    their financing.
        Mr. Neugebauer. Do you think, though, that the fact that we
    did kind of create a little bit more space in the jumbo market
    by letting those limits expire gives us an opportunity to see;
    because, in fact, the private sector is operating in the jumbo
    space now. Isn't that a good opportunity, though, to create a
    little additional space without really giving up a lot of
    origination, because, as you just said, it is a very small
    amount of origination?
        Mr. DeMarco. It certainly is an opportunity to provide a
    modest amount of additional running room, if you will, for the
    jumbo market to be able to reestablish itself.
        Mr. Neugebauer. And so you would support that?
        Mr. DeMarco. I have remained faithfully agnostic on the
    question of what the loan limits should be, viewing that very
    much as a decision of lawmakers. But to your premise that, by
    having this well-announced in advance, gradual decline in loan
    limits in just certain areas, does that create greater
    opportunity for the private sector to reestablish itself, the
    answer, I would say, is certainly yes.
        Mr. Neugebauer. And so, here is a final question. I think
    recently we wrote you, and we would be anxious to hear your
    response, but with the fact that Freddie and Fannie, in certain
    spaces, basically have a monopoly on that origination space,
    what would be the reason to give certain originators different
    fees than others? Why would you have a spectrum there? You are
    not competing for the business; you are getting all of the
    business.
        Mr. DeMarco. Right. That is a very fair question. And I
    would say two things: one, in fact, those gaps have been
    declining; and two, I said publicly back in September that what
    remains in that space is something that I am looking to
    eliminate.
        Mr. Neugebauer. Thank you very much for your time.
        Mr. DeMarco. Thank you, sir.
        Chairman Garrett. The gentleman yields back.
        And the gentlelady is recognized for 5 minutes.
        Ms. Moore. Thank you so much, Mr. Chairman.
        And I do want to thank our guest for taking this time.
        I just first want to mention that I am really happy to see
    that you have filed lawsuits against these 18 financial
    institutions to recover the losses suffered by Freddie and
    Fannie and to seek compensatory damages for the losses that the
    Enterprises have suffered.
        There has been a lot of talk about the malfeasance, I
    guess, of Freddie and Fannie. But I think we too often forget
    that they were victims themselves of criminal activity. How
    much do you think you could recover from this, as compared to
    the exposure that Freddie and Fannie have?
        Mr. DeMarco. I appreciate the question, but I am afraid
    that is something, given that I am in litigation, that is
    really impossible for me to answer--
        Ms. Moore. Okay, thank you.
        Mr. DeMarco. We are seeking to recover appropriate--
        Ms. Moore. Okay, thank you. Right now, the FHFA is funded
    through the fees that the GSEs receive. You indicated earlier
    in your testimony that you need a considerable staffing-up in
    order to fill that TBA space. How would you--under this bill,
    how would you fund the GSEs?
        Mr. DeMarco. I am not sure that there would be GSEs, but in
    terms of the funding for FHFA, I believe it is--
        Ms. Moore. Right.
        Mr. DeMarco. --something that is not determined by--in this
    bill, and so that would be something that would have to be
    figured out.
        Ms. Moore. What--
        Mr. DeMarco. It is a gap right now.
        Ms. Moore. Is it a gap or a cavern? Is it a small gap, or
    is it a significant thing--
        Mr. DeMarco. For me, it is in fact--to manage this budget,
    it is a significant thing, since I want to know where the funds
    are coming from. But--
        Ms. Moore. How much does it cost right now to run it
    under--
        Mr. DeMarco. Our budget today is on the order of $180
    million. So I am being told it is probably less than that.
        Ms. Moore. Okay.
        Mr. DeMarco. We are funded through assessments on Fannie
    and Freddie, but also assessments on the 12 Federal Home Loan
    Banks, because we have supervisory responsibility for them.
        Ms. Moore. Okay, thank you. Right now, the investors in
    Fannie and Freddie securities are basically rate investors. But
    under this bill, they would have to add credit risk as well as
    the rate. Is there any indication that we would be able to
    attract these kind of investors in a totally privatized market
    without the GSEs?
        Mr. DeMarco. That is quite right. We are in a rate market
    today because of the guarantees associated with Fannie and
    Freddie securities. What the pricing of this credit risk would
    be is going to depend on market appetite for credit risk, and
    then also with--it is also going to depend upon the clarity and
    resiliency of the standards and structures that are put in
    place.
        Ms. Moore. And so, what would a borrower, a mortgage
    borrower, have to look like? It would be totally risk adverse
    to these investors? What is the risk tolerance in order to be
    able to raise the appropriate amount of funds? If we want our
    mortgager market to come back, we have to be able to fund
    mortgage-backed securities.
        What is your assessment of the tolerance for this credit
    risk in the private market only without a GSE?
        Mr. DeMarco. I believe that there is certainly tolerance to
    sort of the private capital to fund this risk. But they are
    going to want to know: ``What are the rules of the road, and do
    I have pretty good clarity into how to assess the amount of
    risk that I would be undertaking?''
        Ms. Moore. Not NINJA loans, but what would be standard use,
    do you suspect?
        Mr. DeMarco. The standards in terms of the underwriting
    standards?
        Ms. Moore. Yes.
        Mr. DeMarco. Yes. Actually, as--the discussion draft would
    require us to--
        Ms. Moore. Would it be like 20 percent down?
        Mr. DeMarco. No, I don't understand the bill to require
    that sort of thing at all. I think the bill requires us to
    establish risk buckets, buckets of mortgages that are defined
    by their risk characteristics, and I would certainly--
        Ms. Moore. Okay. My time is about to expire, and you are
    not going to answer this question.
        The largest mortgage insurer, the Mortgage Guarantee
    Insurance Corporation, is located in my district, the 4th
    Congressional District of Wisconsin. What impact do you think
    that this legislation would have on the mortgage insurance
    industry?
        Mr. DeMarco. I think that is an interesting question,
    because I believe that there are some investors who may well
    look to having various forms of credit enhancement either on
    mortgages or on pools of mortgages, and I think it certainly
    creates a market opportunity for private guarantors to replace
    what is currently a Federal guarantor.
        Ms. Moore. Thank you so much. My time has expired.
        I yield back, Mr. Chairman.
        Chairman Garrett. The gentlelady yields back, and I
    appreciate the gentleman's answer.
        And of course, the gentlelady knows that is one of the
    variables that may be considered by the FHFA as well.
        Mr. McCotter is recognized for 5 minutes.
        Mr. McCotter. Thank you, Mr. Chairman. I would like to
    start by yielding 30 seconds to my colleague from New Mexico,
    Steven Pearce.
        Mr. Pearce. Thank you, gentleman, for yielding. Just in
    response to my good friend from the other side of the aisle who
    is talking about the negative impact of drilling on properties,
    if that was really the case, then you wouldn't have any
    properties in my hometown--we have gas wells in back yards, in
    the front yards; we have them on the school grounds. In fact,
    it positively impacts the values of homes in our town.
        So when you are going to create a Fannie Mae dead zone if
    you limit loans to private residences in areas where they
    drill, so be careful in New Mexico. We don't mind out there.
    Thank you.
        Mr. McCotter. I am reclaiming my time. I have a question on
    economics and then a question about the past. The question is
    one our colleagues who talked about how the subsidizing of the
    Federal Government into the housing realm has helped to keep
    interest rates low, and that if all of a sudden, it went away,
    interest rates would climb back through the roof.
        My question is, having a rudimentary understanding of the
    law of supply and demand, wouldn't it work that if the
    government subsidized the housing market purchases, that would
    mean they would be more available to more people? And the more
    people that there are for the limited number of houses, the
    higher the prices would go for those houses, which would then
    reduce the availability. Isn't that pretty much how that would
    work?
        Mr. DeMarco. In posing that sort of system in the short
    run, yes. And in the long run, you would see a change in the
    supply of housing.
        Mr. McCotter. And you would see the prices come down, which
    would upset the homeowners but not necessarily the people
    purchasing them, which would then make the actual
    downpayments--because 3 percent of the asking price of the
    house would be lower than it would be at the governmentally-
    inflated rate. I just wanted to make sure that I actually had
    read the book in college that some might have skipped through.
        A practical question about the past would be, as you have
    stated, and I think everyone can see that in the operating of
    these entities, there were mistakes made by these boards and
    the people in charge of operating them. Is that a fair
    statement?
        Mr. DeMarco. Yes, sir.
        Mr. McCotter. And let me just say thank you very much for
    trying to go in there and fix it and working so well with us to
    do it. So this is not directed at you in any way. But just as a
    matter of curiosity, as well as public record, is there
    anywhere we can go and find just a very succinct list of who
    was on the boards and what bad decisions these boards made;
    because these people made a whole lot of money to screw this
    thing up?
        And I think that under the concept of credit where credit
    is due, I know a lot of people who would like to thank them
    personally for their efforts.
        Mr. DeMarco. Since these were public companies, certainly
    in their annual disclosures and annual reports, the leadership
    of the companies is a matter of public record.
        Mr. McCotter. That is heartening. That is very heartening.
    I was also curious, since they are public companies, in those
    reports, is there anywhere we can find out how they managed to
    get these new jobs? These are important jobs.
        These aren't just something that you would want to see go
    to a political crony who might not have the best of motivations
    or the best business acumen in terms of dealing with these
    things. So are those in there too? So you can say not only are
    these the people who should be credited with these decisions,
    this is also their compensation package, and here is how they
    were chosen to be on this board.
        Mr. DeMarco. I believe that is available information.
        Mr. McCotter. Can you send me the link and give me a nice
    little concise sheet of that so that I can share that with all
    the people in my district who are wondering why this thing got
    so bad so quickly, and people were compensated so much for so
    little?
        Mr. DeMarco. We can provide you information from the public
    record.
        Mr. McCotter. Thank you. I yield back.
        Chairman Garrett. The gentleman yields back. I appreciate
    the gentleman's question, and also learning about the book that
    he read in college, as well. But I used the footnotes. So I do
    appreciate, Mr. DeMarco, your being here today, and your candid
    and insightful answers to all of the questions.
        And I believe that is the extent of the questions, although
    the record, as I always say at the end of the hearing, is open
    for an additional 30 days for additional questions. And as we
    go through this, I am sure there will be additional questions.
    Again, I thank you for your testimony and time today, and also
    your work as well. Thank you.
        Mr. DeMarco. Thank you so much, Mr. Chairman.
        [Brief recess].
        Chairman Garrett. Greetings, and still good morning. We
    actually were able to complete the first panel while still in
    the morning before 12 o'clock, so we are glad that we have
    ample time now for hearing the testimony from the second panel.
    And we welcome all of you. I know we are going to get our last
    panelist here before he comes up to testify.
        And so, we will begin with Mr. Deutsche from the American
    Securitization Forum. Welcome. Obviously, you are recognized
    for 5 minutes. Your full written statement will be made a part
    of the record, and we look forward to your testimony this
    morning.

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

        Mr. Deutsch. Thank you. Thank you very much, Chairman
    Garrett. My name is Tom Deutsch, and as the executive director
    of the American Securitization Forum, I very much appreciate
    the opportunity to testify here on behalf of the 330 ASF
    institutions which originate, structure, trade, service,
    invest, and serve as trustee for the preponderance of
    residential mortgage-backed securities created in the United
    States, including those backed entirely by private capital, as
    well as those guaranteed by public entities such as Fannie Mae,
    Freddie Mac, and Ginnie Mae.
        Let me begin my remarks with what I believe to be a very
    clear consensus proposition. There is very strong political and
    economic will in the United States today to decrease the
    overall level of Federal Government involvement in housing
    finance, and to have more private capital eventually replace
    many of the risks and rewards of that involvement.
        Given that 90-plus percent of mortgage loans made in
    America in the first half of 2011 were guaranteed by the GSEs,
    there certainly isn't a shortage of opportunity to achieve that
    goal. To date though, Fannie Mae and Freddie Mac have drawn
    $169 billion in direct support from the American taxpayer
    through the Department of the Treasury since they were placed
    under conservatorship, and are predicted by the FHFA to draw a
    total ranging from $220 billion to $311 billion by the end of
    2014.
        Given the substantial losses and the outsized role of the
    GSEs in today's U.S. mortgage finance system, the ASF's
    membership is strongly supportive of reducing the Federal
    Government and role in the mortgage finance system in America.
        While there is little opportunity for an overnight
    transition, there is a strong need to begin that transition
    over time and work as soon as possible to restore the long-term
    health of both the U.S. mortgage finance system, the U.S.
    economy, and the U.S. housing market. Reducing dependence on
    the public guarantees for new mortgage origination necessarily
    implies that private capital has to flow again into the
    mortgage market.
        Securitization is an absolutely essential funding mechanism
    for this to occur because bank portfolio lending will not be
    sufficient to meet overall consumer demand and reinvigorate the
    housing markets, particularly with the process of bank
    deleveraging and balance sheet reductions still under way, and
    with increased bank capital requirements on the horizon until
    Basel III.
        This then begs the question of whether the U.S. mortgage
    market--that has grown up for nearly a century now around the
    presence of a government guarantee--can be broken down and
    rebuilt with investor demand without the backing of the
    American taxpayer.
        Our recommendation is that Congress must begin incremental
    steps over a period of years to substantially reduce the
    government's role in mortgage finance. And we commend you,
    Chairman Garrett, for proposing today's legislation that works
    towards that goal.
        Other key areas that may also help incrementally reduce the
    government involvement is Congressman Neugebauer's H.R. 1222,
    which will eventually, and over time, increase the guarantee
    fee, which will equilibrate the GSE competition with private
    market competition. The recent lowering of loan limits also
    creates more ability for the private sector to begin to
    reinvigorate and creates more opportunity for the market to
    return.
        Finally, reducing or eliminating regulatory competitive
    advantages of the GSEs compared to the private label markets
    will also allow the private markets to better and on equal
    footing compete with the GSEs.
        But before turning to efforts that may be helpful in
    resuscitating the private mortgage market, let me first
    highlight that the securitization industry is experiencing what
    our professionals may colloquially describe as a death by 1,000
    cuts. If you look on the last page of my written testimony, it
    is attachment A--or I believe it is up on the monitor here--you
    will see a bit of a dizzying chart that briefly sums up the
    myriad of regulatory efforts that are currently under way
    impacting securitization.
        Any one of these efforts may be appropriately benign in its
    own right, but when combined together in this great whole, they
    serve as an effective poison that will keep private mortgage
    securitization transactions from occurring in sufficient scale
    over time.
        I think this is extremely deadly to the mortgage
    securitization market, particularly in an effort to try to
    reduce the public guarantees on mortgage transactions.
        But because the GSEs are exempt from many of these rules,
    in particular such as the proposal to explicitly count the
    government guarantee as the 5 percent risk retention, these
    myriad new rules will further entrench the GSEs' artificial
    advantages over the markets rather than ratcheting it away.
        Additional details on those issues may be found in our
    written testimony and various comment letters linked to in that
    testimony.
        But turning back to your proposals, Chairman Garrett, the
    key area you attempt to replicate in the private market--the
    TBA market--certainly additional efforts to create
    standardization in this market will go a long way in creating
    more private market capital flowing into the mortgage finance
    market.
        And particularly, as we have seen in the loan declines over
    the past month or so, we have seen private mortgage market
    originations replace what was formerly government guarantee.
        And, in fact, if you evaluate the numbers on that, you
    evaluate Senator Menendez's proposal that came through the
    Senate, you will see that only approximately a $40-per-month
    increase in a $700,000 loan would occur because of those
    changes.
        Ultimately, I don't think that is a massive or substantial
    increase in a private mortgage market over the government-
    guaranteed rate. So, ultimately, I do believe the private
    mortgage markets can substantially replace those roles. And
    over time, we look forward to working with the committee
    chairman to ultimately help that goal be achieved. Thank you.
        [The prepared statement of Mr. Deutsch can be found on page
    77 of the appendix.]
        Chairman Garrett. Thank you.
        Mr. Hughes is recognized for 5 minutes.

     STATEMENT OF MARTIN S. HUGHES, PRESIDENT AND CHIEF EXECUTIVE
                      OFFICER, REDWOOD TRUST, INC.

        Mr. Hughes. Good afternoon, Chairman Garrett, and members
    of the subcommittee.
        I am Marty Hughes, CEO of Redwood Trust, and I am honored
    to be here to testify today. Redwood has a long history as a
    sponsor and investor in private-label prime mortgage-backed
    securitizations, and we have done the only three newly issued
    private securitizations since the crisis began.
        We hope to do a fourth securitization in the next couple of
    months. I thought, just as an interesting frame of reference,
    Redwood Trust has 75 employees and only 25 are dedicated to
    this effort. So it can be done.
        My testimony is focused on the Private Mortgage Investment
    Act. But before I move to the main part of my testimony, I
    would like to address the ongoing government subsidies for the
    mortgage market.
        As I discussed in my previous testimony, government
    subsidies must be scaled back on a safe and measured basis to
    reduce and create a level playing field for the private markets
    to flourish. Despite the warning sounds from some, mortgages
    did not become instantly unaffordable to thousands of
    prospective home buyers when the limits were reduced on October
    1st.
        We saw a smooth transition in the market to the new low
    conforming loan limits and, in fact, through the month of
    October, the difference in interest rates was less than half a
    point between the non-conforming and the conforming rate.
        I urge the committee to reject the attempts to raise the
    loan limits back up, as some have suggested, and give the
    private market additional opportunity to return to a
    sustainable state.
        Directing my attention specifically to the proposed
    legislation, we are just going to highlight a few things. And,
    overall, I would like to thank you for addressing the overall
    topic. It is the first omnibus bill that is going in to address
    all the different elements from servicing that are really
    investor concerns.
        My first comment is about second liens, which is one of
    Redwood's major concerns, and a big concern of the investors in
    our securitizations. And we believe the steps taken in the bill
    are a good first step, but we think you need an additional
    step.
        The most important part of skin in the game is at the
    borrower level. If the borrower can remove their skin in the
    game after the first mortgage is given out, the likelihood of
    default on the first goes up significantly.
        This was a significant event in the crisis that led to
    losses. And it continues to be a significant event that keeps
    investors out of the market. They can do their loan-to-value
    analysis on day one, knowing what the amount of the first
    mortgage is. They can't do analysis later on and catch up if
    all of a sudden, the credit profile of that borrower has
    changed.
        In terms of representations and warranties, incorporating
    mandatory arbitration, we think is great. We have incorporated
    it in all three of our deals. We haven't had to use it yet.
        One other thought that we have in terms of the proposed
    legislation is the concept of having a third party identify all
    claims, and let them be the one independent party to push
    through reps and warranties.
        In our deals, we are the credit risk manager, as holding
    the lower tranches of securities.
        So maybe the best protection for the higher tranches of
    securities is that the people on the bottom who were first in
    line to absorb losses are the ones to fight claims. Because our
    concern is, with an independent third party, there is not
    nearly as much incentive as there is for somebody at Redwood to
    fight claims for the protection of the senior lenders.
        If we turn our attention to servicers, prospective
    surveillance standards should be developed to govern when a
    trustee must investigate a servicer's performance. There need
    to be defined events that require when actions need to be
    taken, whether it is excessive loan losses, modifications, or
    early-pay defaults.
        While we fully agree that servicers need to be accountable,
    we think the removal of the servicer and the transfer of the
    servicing is a difficult and time-consuming process; and
    probably very difficult for borrowers if they are in the middle
    of some type of loss mitigation.
        Really, what we think would make sense is to have the
    servicers have a ``hot backup,'' a special servicer that would
    work behind them, that is already in place. They would have the
    systems, the contact points, and it would be an easy transition
    to go from the primary servicer to the special servicer.
        So, in conclusion, I thank you for putting this bill
    forward. This bill is really important. There are a lot of
    facets to it. We do have some questions about some aspects, but
    we really applaud the efforts in moving it ahead. And thank you
    for beginning the process.
        [The prepared statement of Mr. Hughes can be found on page
    116 of the appendix.]
        Chairman Garrett. And thanks for your testimony. It raises
    more questions, but that is what we are here for.
        Ms. Ratcliffe is recognized for 5 minutes.

       STATEMENT OF JANNEKE RATCLIFFE, SENIOR FELLOW, CENTER FOR
     AMERICAN PROGRESS ACTION FUND; AND EXECUTIVE DIRECTOR, CENTER
     FOR COMMUNITY CAPITAL, UNIVERSITY OF NORTH CAROLINA AT CHAPEL
                                  HILL

        Ms. Ratcliffe. Good afternoon, Chairman Garrett, and
    members of the subcommittee.
        I am Janneke Ratcliffe, senior fellow at the Center for
    American Progress Action Fund and executive director of the UNC
    Center for Community Capital. Thank you for the opportunity to
    comment on the draft Private Mortgage Market Investment Act,
    which addresses several challenges that must be overcome to
    restore a well-functioning system of housing finance in
    America.
        I am also a member of the Mortgage Finance Working Group,
    authors of a plan for responsible housing mortgage market
    reform. And though I speak only for myself today, my testimony
    does draw on our plan.
        Our proposal calls for private capital at risk to play a
    much greater role in the market than it does today. For that to
    happen, investor confidence in non-guaranteed securities must
    be restored. And this bill lays out several steps that will be
    helpful to that end.
        Importantly, the bill recognizes that the Federal
    Government is critical to a well-functioning market, even the
    purely private part. Thoughtful oversight, implemented a decade
    ago, could have staved off much of the bubble and bust of the
    mid-2000s. And I am pleased to see the regulation of private
    mortgage-backed securities getting the congressional attention
    it deserves.
        Issues detailed in my written testimony that I will
    highlight are as follows: first, Congress should take steps to
    restore investor confidence so GSEs can stop serving borrowers
    who don't need them.
        But some government role in ensuring liquidity and access
    remains absolutely critical for the bulk of the $11 trillion
    mortgage market. It would be unwise to pull the rug out from
    under the market by scaling back this support too quickly.
        As the draft bill suggests, standardization of products,
    terms and conditions is critical, and I particularly commend
    the proposal for demarking the 30-year fixed-rate mortgage
    category, which has been the building block of middle-class
    economic security in this country for more than 70 years.
        And I concur with Mr. Peters' prior comments on the need to
    take additional steps to ensure it continues to be broadly
    available. Classifications of mortgage loans as called for in
    this bill should consider loan and channel factors that have
    been proven to affect risk. And though it is unclear how the
    categories will be set, is clear it will be a challenge to get
    it right.
        There is real risk that if the classification system is
    based on borrower factors, it could duplicate problems raised
    by the recent regulatory proposed QRM definition. Moreover, we
    must avoid repeating the mistake of consigning qualified
    borrowers with fewer resources to higher risks, higher costs,
    products, and channels.
        To Mr. Posey's earlier point, my written testimony provides
    evidence of additional sustainable high loan-to-value lending
    to moderate-income families that has proven successful, even
    during this time of market turmoil, and I would be glad to
    provide more details during discussion.
        The bill's transparency requirements and loan level
    disclosures are welcome changes to the PLS market. One open
    question is whether those standardization measures will go far
    enough to foster a private label TBA market.
        In the proposed private market, multiple loan classes,
    multiple issuers, and a lack of government guarantee may likely
    inhibit a TBA market, making this regime a useful complement,
    but necessarily a viable substitute to serve the entire
    conforming loan market.
        The bill's measures to reduce conflicts of interest related
    to second liens are also welcomed. However, any provisions that
    limit the use of second liens should be constructed to favor
    legitimate downpayment assistance programs, which are so vital
    in so many communities' economic recovery at this time, and
    allow households to make productive use of their accumulated
    housing wealth.
        There are certain provisions of the draft that should be
    reconsidered altogether. These include striking risk retention
    requirements, standing government principal reduction
    initiatives, and easing qualifying mortgage rules.
        Other fundamental questions to be addressed include
    choosing the best regulator to fill the mandate, how the bill
    fits in with active GSE reform proposals, and other critical
    next steps toward a more responsible and comprehensive system
    of housing finance. Standardization and transparency as
    promoted by this draft bill are essential, but are not enough.
        A well-functioning mortgage market also requires broad and
    constant liquidity, stability, affordability, and consumer
    protection. In closing, I would like to commend the chairman
    and the other members of the committee for holding this
    hearing.
        As Congress and the Administration work to design a better
    system of housing finance, it is important to make sure the
    rules of the game are laid out clearly and fairly before anyone
    can be expected to start playing.
        I believe the Private Mortgage Market Investment Act as
    drafted is a helpful starting point for negotiating those
    rules. But it must be seen as only a first step towards
    comprehensive reform. And I look forward to your questions.
        [The prepared statement of Ms. Ratcliffe can be found on
    page 124 of the appendix.]
        Chairman Garrett. Thank you.
        Mr. Wallison, welcome back. You are recognized for 5
    minutes.

       STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN
     FINANCIAL POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE (AEI)

        Mr. Wallison. Thank you, Mr. Chairman.
        My name is Peter Wallison. I am a senior fellow at the
    American Enterprise Institute, and I would like to make the
    following oral statement. I have also submitted a detailed
    written statement. There are three serious problems facing this
    country: unemployment; the Nation's enormous debt; and the
    deplorable state of the housing market.
        All three are directly involved in the subject of today's
    hearing. The proponents of a government role in the housing
    finance system don't mention it, but continuing the
    government's role in housing finance increases the Nation's
    debt. There are $7.5 trillion of government agency debt, most
    of it Fannie's and Freddie's that is off budget, but still a
    burden to the taxpayers.
        We can reduce it by eliminating the GSEs over time and
    turning over housing finance to the private sector, like every
    other part of our economy. Securitization, which has worked
    well for 30 years and is almost universally used for credit
    cards and auto loans quite effectively, is a necessary source
    of funds for mortgages. This is because there are insufficient
    funds in the banking system to meet the housing sector's needs.
        And banks have to raise capital levels, which causes them
    now to reduce their lending. Securitization also accesses a
    huge, currently untapped source of funds. Fixed-income
    investors, such as insurance companies and pension funds, have
    at least $13 trillion to invest and almost all of it now goes
    to corporates, some of it to junk bonds. Institutional
    investors used to be major buyers of mortgages, but not after
    the GSEs came to dominate the field.
        The yields on GSE securities are just too low for the needs
    of these investors. Mortgages would diversify their risks,
    making them much more stable. It also provides funds for U.S.
    homeowners, a win-win situation if there ever was. A robust
    securitization market will bring in these institutional
    investors, and of course, if the housing market revives with
    more funding, unemployment will decline.
        Since the financial crisis of 2008, private mortgage
    securitization has almost been moribund. One of the major
    reasons is uncertainty about the government's future role in
    the housing market, for example, whether Fannie and Freddie
    will continue to exist or some other government program will
    replace them. Few if any firms are going to invest in a
    securitization program if they understand or believe that they
    will be competing ultimately with the government.
        Beyond that, however, various provisions of the Dodd-Frank
    Act add substantially to the risks faced by securitizers. These
    are detailed in my prepared testimony, but I will name a few
    now. The 5 percent risk retention idea gives a huge financial
    advantage to FHA and the GSEs. They can securitize any mortgage
    that is not a QRM without paying the large capital costs of
    holding a 5 percent risk slice indefinitely.
        Private mortgage securitizers simply can't compete with
    this. Anyway, the whole 5 percent retention idea doesn't work
    to reduce risk-taking, only a vertical slice through the pool
    will qualify for true sale treatment under accounting rules,
    and the vertical slice does not provide much incentive to avoid
    risk taking.
        Fortunately, the Garrett bill will repeal the risk
    retention provisions of the Dodd-Frank Act and substitute a
    more effective means for preventing deterioration of
    underwriting standards. By providing for minimum mortgage
    standards and securitization, it reassures investors and
    prevents the kind of mortgage meltdown that caused the
    financial crisis in 2008.
        The bill also goes some distance toward eliminating the
    nuclear bomb lodged in the QM provisions of Dodd-Frank. This
    creates a defense to foreclosure if a borrower claims that he
    received a mortgage he could not afford. The bill exempts prime
    mortgages from this provision and also provides for an
    exemption from the Securities Act for qualified securities
    based on prime loans. Other provisions require the
    standardization of documentation used in securitizations,
    including trust and servicing agreements, mandatory
    arbitration, and appointment of an independent trustee when a
    servicer has a conflict of interest with investors.
        All these provisions will encourage firms to enter the
    securitization business and institutional investors to buy and
    hold the resulting securities. There are many more reforms that
    I haven't mentioned. Many of them are necessary, but not
    included in the bill. This legislation is an important start on
    the process of reviving the private mortgage market,
    controlling the U.S. debt, creating a growing housing market,
    and reducing unemployment.
        That concludes my testimony. Thank you.
        [The prepared statement of Mr. Wallison can be found on
    page 142 of the appendix.]
        Chairman Garrett. I thank the entire panel for all their
    testimony. I will now recognize myself for 5 minutes for some
    questions. Mr. Wallison, I think if I heard him right at the
    very beginning, the ranking member said that legislation would
    create a significant intrusion by the Federal Government into
    the housing mortgage finance market. As if we haven't been a
    significant intrusion into the housing finance market for the
    last few years, i.e., the diagram that we just saw up on the
    screen. So, maybe we have gone too far even in this legislation
    and perhaps--and Mr. Wallison you sort of say that in your--at
    least at one point with regard to--we set out standards for the
    sponsors.
        Can you comment as to why you think we are going
    essentially then an overreach when we try to do that? Is that
    a--
        Mr. Wallison. Mr. Chairman, I don't think you are going too
    far. I think it is a good idea.
        Chairman Garrett. Okay.
        Mr. Wallison. I think it is a responsibility of Congress
    after what we experienced in 2008, to do something about the
    problem of gradual mortgage quality deterioration as a housing
    bubble grows. The proposal that was made in the Dodd-Frank Act
    and adopted there, the 5 percent retention, will not work.
        What will work is providing certain basic prime mortgage
    standards that would be available for securitizations. That
    will prevent the private market from going out of control, as
    it occasionally does, when bubbles begin to grow.
        Chairman Garrett. I appreciate that. You are going down a
    slightly different road--maybe I didn't ask my question clearly
    enough. We set also, besides the standards there for that,
    standards for the securitization; and then with the standards
    or certification, if you will, in the bill for the sponsors--
    for the issuers as well.
        I thought I read in your testimony that you said if we do
    that, we create impediments to folks coming in and being that.
        Mr. Wallison. I am sorry. I didn't understand your
    question. I am concerned about setting standards for
    securitizers because I don't think they are necessary. I think
    especially if you are setting standards for the financial
    capabilities of securitizers, it adds cost for them, makes it
    less likely that more organizations will become securitizers,
    and thus reduces competition and the efficiency and innovation
    that will occur in that market.
        The really good thing about securitization is that the
    purchasers of mortgage-backed securities in securitizations are
    protected by the subordinated pieces in those securitizations,
    not by the quality--the financial ability to respond--of the
    sponsor or the securitizer. Now, I understand that some people
    may be concerned about whether they are financially
    responsible, but we have to create a balance here.
        What I am always afraid of is that government regulation,
    which always imposes costs, will keep many people out of the
    securitization business who could otherwise profitably engage
    in it.
        Chairman Garrett. Okay, I have to think all these through.
        Mr. Hughes, you started to--and maybe I just didn't hear
    the next step with regard to the second lien provision? And you
    sort of said, ``Okay, what we have in here is good,'' but then
    you said, ``But, hey, there is a next step.''
        Mr. Hughes. The second lien provision, I think there should
    be some limitation on a borrower's ability to take out the
    second mortgage, all the way up front so that there would be a
    test. And it would be a test that the combined loan to value of
    a first mortgage combined with a second mortgage couldn't be
    over 80 percent.
        Chairman Garrett. Okay.
        Mr. Hughes. There would be an approval by the first
    mortgage lender. So the first is not disadvantaged as a result
    of someone taking out a second mortgage.
        Chairman Garrett. But can you walk me through in a real-
    world experience how that actually works?
        Mr. Hughes. It requires an amendment to the Garn-St.
    Germain Act.
        Chairman Garrett. It is hard.
        Mr. Hughes. I know you mentioned--and everybody says it is
    impossible to amend it, but therein lies the problem. So I
    think there are ways to get there. But just being able to allow
    a borrower or another lender to hand out and give out another
    mortgage after the fact is very, very problematic for AAA
    investors.
        Chairman Garrett. Mr. Wallison, on that point?
        Mr. Wallison. In commercial lending, Mr. Chairman, the
    first lienor always has the right to approve whether there will
    be a second lien on the same property. In this case, if the
    first has the approval right and a second lien is proposed, the
    first always has the choice whether to decide to allow a second
    lien or not. If he decides not to, he runs the risk that the
    mortgage will be refinanced away from him. So there is a choice
    that is given to--
        Chairman Garrett. Right. And I know what we have here but
    one of the tricks is the notice requirement, I guess, on how
    you do all this. And I guess you have to work faster; we have
    language here. I am out of time, but Ms. Ratcliffe, did you
    want to chime in on that point? No? Well, then, I thank the
    panel for the answers.
        Mr. Green is recognized.
        Mr. Green. Mr. Chairman, I know you are a stickler for
    time, but given that we don't have a really long line today--
        Chairman Garrett. I will give you an extra 15 seconds.
        Mr. Green. No, not for me.
        Chairman Garrett. Oh.
        Mr. Green. My suggestion is that you be a little bit more
    liberal with yourself, and I am not going to object. So by
    unanimous consent, I would agree that you should finish your
    question.
        Chairman Garrett. I very much appreciate that. I will yield
    to the gentleman if he has questions. We can go around again
    for another round.
        Mr. Green. All right.
        Chairman Garrett. But that was very nice of you to offer.
        Mr. Green. Thank you, Mr. Chairman, and I thank the
    witnesses for appearing.
        Let me start with Mr. Deutsch. It is good to see you; it
    has been a while.
        Mr. Deutsch. Yes.
        Mr. Green. And I would like to start because you mentioned
    that there would be an increase in the product, but that
    increase was not going to be exponential. Is this correct?
        Mr. Deutsch. An increase in the product of private mortgage
    securities?
        Mr. Green. Yes, sir.
        Mr. Deutsch. Yes.
        Mr. Green. And I am just curious as to how you arrived at,
    I think it was $40 for a loan at a value of, what was that
    value again, please?
        Mr. Deutsch. $700,000. A $700,000 loan, so--
        Mr. Green. A $40 increase.
        Mr. Deutsch. I will run through the quick math of how the
    conforming jumbo market has changed. On September 30th,
    obviously the loan limits went down from $729,000 to $625,000,
    approximately. If you were to look at yesterday's mortgage
    rates, a jumbo conforming is about 4.5 percent; a loan that is
    a jumbo loan that is not conforming--that is the GSEs wouldn't
    be willing to buy it--was about 4.5 percent.
        So it is about 25 basis points difference. Senator Mendez's
    amendment would say that the rate on the conform launch should
    go up 15 basis points, that there should be an extra fee on it.
        So the difference you are looking at for conforming loans--
    conforming jumbo versus a nonconforming jumbo would be about
    4.4 percent with a government guarantee and 4.5 percent for the
    non-government guarantee, which on a $700,000 loan, works out
    to be about $40 a month.
        Mr. Green. Let me ask you this, we don't find a lot of
    these loans being accorded in the market currently, do we?
        Mr. Deutsch. It is about 3 percent of all mortgages
    nationwide were in the $625 to $700--
        Mr. Green. My point is if there is some concern about the
    loan itself in terms of--cost doesn't appear to be a factor.
    What would be the factor that causes these loans not to be a
    product that consumers are eager to purchase?
        Mr. Deutsch. I think consumers are eager to get loans in
    that band, if that is the price of the house that you are
    looking for. Obviously, there are not that many million-dollar
    homes out there that people are looking to purchase, but there
    are a substantial amount.
        Mr. Green. All right, let me move on and ask--let us see.
        I believe Mr. Wallison--is that correct, sir?
        Mr. Wallison. Yes, sir.
        Mr. Green. Thank you. You have indicated that this would
    repeal the risk retention provision in Dodd-Frank and you
    indicate that would be a standard set for securities and, of
    course, there will be no Federal backstop any place in this
    process. Is that correct?
        Mr. Wallison. Yes, that is correct.
        Mr. Green. Okay, let us start with the notion that there
    won't be a Federal backstop. Is it your opinion that there will
    be a great demand for the products absent a Federal backstop?
        Mr. Wallison. Absolutely. My discussion with people in the
    private sector, and also just simply thinking about it, would
    indicate that once the Federal Government is out and there is
    no risk-taking by the Federal Government and no subsidy of
    government risk-taking by the taxpayers, the private sector
    would be very happy to take mortgages and mortgage-backed
    securities that produce market-based yields.
        As I mentioned in my testimony, the fixed-income buyers of
    securities like insurance companies and pension funds really
    need market rate securities like mortgage-backed securities.
    They don't have them to invest in now because of the domination
    of the market by the GSEs.
        When these mortgages become available through a private
    market, these buyers will step in and be major supporters of
    the mortgage market, which will help housing buyers, the
    housing market, and of course, give the buyers the
    diversification that they need.
        Mr. Green. I don't know that I am going to adamantly differ
    with you, but I talked to a lot of people and--but most of the
    people that I talked to have a different opinion, so perhaps
    you and I should talk more and perhaps you can enlighten me to
    a greater extent--
        Mr. Wallison. I would be happy to do that.
        Mr. Green. --but I just don't find that is the case.
        One more thing, you do agree that part of the reason we are
    in the trouble that we are in now is because the originators
    were not concerned about whether persons were able to pay; they
    were just originating loans that they could pass on.
        Well, if we eliminate the risk retention, how will the
    standards prevent this from occurring again--just standards
    alone--because we had standards before? And this will be my
    last question, but I would like to hear your answer, given that
    we had standards before, and we had the risk passed on to
    others, even with standards.
        Mr. Wallison. This is a much more complicated question than
    simply those transactions.
        What happened was that the government was interested in
    buying mortgages or having Fannie and Freddie buy mortgages
    irrespective of the quality of those mortgages, because Fannie
    and Freddie were required to reach certain quotas in the
    purchase of mortgages for people who were at or below the
    median income in the areas where they live. That created what
    would always happen when the government says, ``We will buy
    whatever you can produce; we are not worried about the
    quality.'' Those things are produced and that is how we got to
    the situation we are in. That is one of the reasons why I am
    very much afraid of returning to a market in which people are
    no longer interested in the quality of the mortgages that are
    being produced.
        That can also happen when a bubble develops in the housing
    market, because the tendency of a bubble is to suppress
    delinquencies and defaults, so mortgages and mortgage-backed
    securities look safer than they actually are. That also
    produces excessive demand for low-quality mortgages, which have
    high yields.
        What this bill would do, as I understand it, is set minimum
    standards for mortgages that can be securitized. They would be
    called prime mortgages. And if it is possible that can be
    done--and I gather that Mr. Demarco believes it is--we could
    avoid many of these problems of deterioration in mortgage--
        Mr. Green. Would it surprise you to know that Dodd-Frank
    sets some minimal standards?
        Mr. Wallison. I don't know that I have seen in Dodd-Frank
    anything that requires a certain minimum standard. What Dodd-
    Frank is trying to do is to penalize people who do not
    securitize a Qualified Residential Mortgage (QRM). But a QRM,
    as now defined, at least by the regulators, is a mortgage that
    is far more of a prime mortgage than it needs to be. It is a
    much more difficult mortgage to obtain.
        There would be many, many mortgages that are not as high
    quality as the QRM has proposed, which could be securitized by
    the private sector or the--
        Mr. Green. So this bill lowers the standard?
        Mr. Wallison. I don't know that it would lower the
    standard, we haven't seen what those standards would be, but it
    would probably involve less than a 20 percent downpayment.
        Mr. Green. Thank you, Mr. Chairman. You have been generous.
    I will wait for the second round.
        Thank you.
        Chairman Garrett. Sure. Thanks.
        The gentleman from Arizona?
        Mr. Schweikert. Thank you, Mr. Chairman.
        Mr. Hughes, you are literally one of the only folks, I
    think in the market over the last couple of years, who has
    actually done an MBS securitization.
        What do you think the appetite is out there right now for
    mortgage-backed debt?
        Mr. Hughes. I think the appetite out there is very high;
    having said that, it is going to require that you meet their
    standards.
        A lot of those standards are what are built into this bill
    and what we have put into the existing bills that are out
    there. We are not going back to the days where they are going
    to buy subprime securities. Where I really think there is the
    biggest securitization market is for prime--so to the extent
    that loans that look a lot like the Fannie and Freddie loans, I
    believe investors would buy on the private side, to the extent
    that you meet the criteria for transparency disclosures,
    fairness of collateral protection.
        Mr. Schweikert. Of properly packaged.
        Mr. Hughes. Properly packaged.
        Mr. Schweikert. Okay.
        On the previous panel, Mr. Demarco talked about holding,
    what, almost a trillion dollars in mortgage debt. I am assuming
    that was both performing and nonperforming.
        If he were to come to you and say, ``Here is $100 billion
    of performing GSE debt, but we would like to strip the Federal
    guarantee,'' is there a hunger for that? Is that something
    someone like yourself would package in one securitization and
    sell?
        Mr. Hughes. That is something that we would be interested
    in to the extent it is from current production. I don't know
    that we would want to jump into the older loans.
        Mr. Schweikert. Okay, so 2009 and later?
        Mr. Hughes. To the extent that there was a billion dollar
    pool, and the credit enhance point was five points on that
    pool, Redwood would absolutely consider--to the extent that it
    met the criteria and if you look at the average criteria for
    the Fannie/Freddie pool, they look a lot like the Redwood-type
    pools except the loan size is more.
        Yes, we would buy them, and I think there is a pretty deep
    market to do that.
        Mr. Schweikert. And that is sort of an open question for
    anyone on the panel because I have been trying to get my head
    around the appetite for fixed-income mortgage-backed loans that
    would be lineage from really the last 3 years. So we know it is
    written at a readjusted real estate value, probably with a much
    tighter underwriting standard, and how much of that debt would
    be consumed even without a Federal guarantee. But at the same
    time, if it was consumed in different types of securitization,
    would that also help us build exactly what Chairman Garret is
    doing here is the flow in the system and the pipeline?
        Am I making a mistake somewhere?
        Mr. Hughes. No.
        Mr. Deutsch. To jump in, I think there is a degree with Mr.
    Hughes, there is a significant appetite from investors for
    mortgage-backed securities. Ultimately, the question every
    investor will ask is, what is the price? And many if not any
    investor will buy the appropriate price or the price that they
    would be willing to purchase at.
        One of the key challenges of the last few years is sort of
    the price and sort of the supply/demand equilibrium has been
    off and that investors are demanding higher prices and want to
    see higher prices where they and where as issuers want to issue
    them at lower prices or lower yields and those are just
    starting to come into the equilibrium and you are seeing some
    transactions like Redwood come out into the marketplace.
        Mr. Schweikert. In my last minute-and-a-half, Mr. Demarco
    calls one of your members and says, ``Hey, I have $100 billion
    of performing mortgage debt, I want to strip the Federal
    Government guarantee off of this,'' what would be the barriers
    that you would see within the securitization world right now?
    Is there a reps and warrants issue? Where do I have an Achilles
    heel?
        Mr. Deutsch. The first question, as I indicated, would be
    the price. What is the price you are trying to sell me those
    at, and what do I value that as?
        In terms of the other barriers, reps and warrants, assuming
    that Fannie and Freddie have bought these, they have pretty
    stringent reps and warranty requirements in place so most
    investors would take those as appropriate reps and warranties
    there in place. Some may want some more repurchase requirements
    similar to what has been promulgated out into the market, but I
    think those loans would be able to be sold out into the
    secondary market again, just depending on what the price was.
        Mr. Schweikert. Ms. Ratcliffe, would you have any objection
    to seeing the GSEs right now at least offer some of their debt
    and see if they could literally go out in private places?
        Ms. Ratcliffe. I think there would be a lot of benefits in
    at least getting price discovery. I think the questions you
    have to find out are--I don't think there is an $11 trillion
    appetite. I think the questions that will come up are, ``What
    price?'' and ``Using what products?'' and ``For whom?'' And so,
    I think that price discovery would help show what the real gap
    is.
        A lot of people refer to this 40 to 60 basis points
    difference facing jumbo borrowers in the fixed-rate market
    versus GSE execution. I think that is a little misleading
    because it is exactly the jumbo borrowers who can access that
    kind of product efficiently without any government support. So
    it is not surprising--
        Mr. Schweikert. Mr. Chairman, with respect to--actually,
    the price discovery is one of the things I have great interest
    in, because, in a weird way, this is also debt that has some
    performance history. So actually, it may carry somewhat of a
    premium on my credit risk side. But I have also been trying to
    do some quick calculations, saying, ``Okay, if this debt from
    the last couple of years,'' and with the Federal Reserve trying
    to move us out from the WAM, my 30-year interest rate is here
    today--there may be a premium to the GSEs right now on that
    debt from just a yield standpoint.
        All right.
        And thank you, Mr. Chairman. I am sorry I went over my
    time.
        Chairman Garrett. It will be remembered.
        The gentleman from California?
        Mr. Campbell. Thank you, Mr. Chairman, and thank you,
    panel.
        Mr. Hughes, your re-securitizations were often held up by a
    lot of people as an example of what could occur if there were
    no government guarantee in any segment of the market. I have a
    report from Business Wire here dated September 27, 2011. It
    talks about your last securitization.
        And it says, ``The weighted average original combined loan-
    to-value ratio is 64.2,'' meaning an average 36 percent
    downpayment, ``and a weighted-average original FICO credit
    score of 773,'' which, last I checked, I don't have. So that is
    a very high down, very high-credit type of issuance you are
    making, correct?
        Mr. Hughes. Correct. A couple of observations: If you were
    to go look at where Fannie's and Freddie's executions are, you
    would see 750 FICO scores, and you would see a probably a 70
    percent loan-to-value.
        So they are not that dissimilar. And then probably the
    bigger comment is, with everything getting sold to the
    government or on a bank's balance sheet, they are the only
    loans available for us to buy and securitize.
        If we had access to more loans, but there are no loans to
    buy. With 95 percent of them going to the government, we are
    constrained in what we can buy.
        Mr. Campbell. Mr. Hughes, I find that also another from
    this is that the average balance is $793,000; so these are, as
    we say, not conforming loans. These are in the jumbo market.
        I come from the Newport Beach/Irvine area of Orange County,
    where my average house price is higher than this. So I can tell
    you there are plenty of people who are trying to buy houses and
    trying in the jumbo market without any government support,
    trying to buy houses with 20 percent down, trying to buy them
    sometimes with 40 percent and 50 percent down, and with FICO
    scores of 740 and 715, and they can't get a loan.
        So I would suggest that--to say that you can't find those
    loans--there have to be plenty of loans out there with lower
    FICO scores and lower downpayments than this.
        Mr. Hughes. Redwood Trust is not an originator or a
    servicer. So what we do is align ourselves with banks, large
    mortgage companies, and then draw from their distribution
    network. So we can only draw in--
        Mr. Campbell. Okay, but doesn't that mean that somebody
    along the line, maybe because of the risk retention
    requirements, maybe because of your ability to sell into the
    secondary market, once these kinds of downs and these kinds of
    credit scores without a government guarantee, they are not--I
    have a Dow Jones report on the same thing from September 20,
    2011, which says, ``Redwood and lead manager Credit Suisse
    raised the coupon to 3.9 from the expected 3.6 set for
    investors. One of the speculators said investors are concerned
    about low yields they are being asked to accept to take the
    credit risk,'' which, obviously, when there is a government
    guarantee, that credit risk is out of the equation.
        So that means that somewhere along the line--
        Mr. Hughes. I would disagree with the conclusion for the
    reason that we went from 360 to 390, and I would point to the
    disruption in the financial markets and widening of credit
    spreads across the board.
        Mr. Campbell. Okay, but back to my original point, there
    are plenty of people who would love to buy a house in the
    nonconforming market with 10 percent down or 20 percent down
    who don't have this kind of credit score. Somebody along the
    line won't make them loans.
        Somebody along, in the--or else you could package them and
    send them out, because there is no government competition
    there, or somebody else would do it. It just seems unreasonable
    for me when, in this area of the market, where there is no
    government competition, to say that the loan demand out--if you
    are the only one doing it, why isn't somebody else doing 10
    percent loans or 20 percent loans down?
        Mr. Hughes. I don't know.
        Mr. Campbell. Okay. Mr. Deutsch, I spoke to the American
    Securitization Forum, to your group, back in June. And I asked
    the group--there were 200 or so people there--whether they
    would transact in the TBA market without a government guarantee
    on the securitization. And I asked people to raise their hands.
    Not a single hand in the room went up. I then said, ``Let me
    repeat it. Make sure you all understand: Will anybody in this
    room do it?'' Not a single hand in the room went up, and I then
    said, ``Let the record show that no hands went up.''
        Was that a totally nonrepresentative part of the American
    Securitization Forum, or how can we--if that is correct, how
    can we have a robust securitization market without a government
    guarantee if nobody is going to go into the TBA market with it?
        Mr. Deutsch. We certainly appreciate your participation at
    our annual meeting, Congressman Campbell.
        I would say the one key factor that was omitted from asking
    that question is what the price would be. As I indicated
    before, I don't think you will get any investor to say they
    would be willing to transact without knowing what the price is,
    what the yields would be, and I think that is where, if I was
    sitting in that audience, I wouldn't raise my hand, because I
    would want to know and negotiate that price.
        Mr. Campbell. Okay, then the question is: What is that
    premium? And I realize my time has expired. So I have lots more
    questions, but I think we are doing a second round.
        Chairman Garrett. Sure.
        The gentleman from New York is recognized for 5 minutes.
        Mr. Grimm. Thank you, Mr. Chairman, and thank you to our
    panelists.
        I appreciate you coming in and giving us your testimony
    today.
        Mr. Deutsch, can you just go into a little bit about how
    the GSEs underprice credit risk?
        Mr. Deutsch. I think what you see in the current market
    right now is the GSEs have what they have a guarantee fee that
    they charge to people selling into their securitizations
    effectively. You can look at various ways.
        I think FHFA has a good report out on how that guarantee
    fee is effectively underpriced so that if you sell a loan to
    Fannie and Freddie, and they will sell it out to mortgage-
    backed investors, when there are a higher delinquencies or
    defaults, particularly over the last few years.
        Over time, those aggregate to be more in terms of losses
    than their guarantee fees that they are charging, which is one
    explanation of why you had $169 billion flow to Fannie and
    Freddie from the U.S. taxpayer.
        Mr. Grimm. Thank you. And one other question to you as
    well, I think it was you who mentioned, ``Death by 1,000
    regulatory cuts,'' and, as you know, a lack of private
    securitizations. Can you just describe that a little bit,
    please?
        Mr. Deutsch. Sure. I think what we have seen over the
    course of the past couple of years, there is no question in our
    minds, in our membership's minds, that additional reforms to
    securitization have been necessary, and we have been very
    supportive of things, even such as a basic risk retention
    requirement, as well as it doesn't have bells and whistles like
    a premium capture cash reserve account and other items that
    aren't called for in the Dodd-Frank Act.
        But those 1,000 cuts, when you add up so many different
    regulatory initiatives, it makes it very hard for private
    sector capital to flow back into this market, because if you
    are--think about if you are running your own business, you have
    10, 20, 30 regulatory initiatives coming at you, you don't know
    how they are going to come out--it is very hard to go to your
    boss and say, ``Hey, we need to build up some infrastructure
    here. We need to build up and hire more staff, but we don't
    know what is going to happen with Fannie and Freddie. We don't
    know what is going to happen with these QRM rules. We don't
    know what is going to happen exactly with Basel III.''
        It makes it very challenging to be able to build and run a
    business, and proud folks like Mr. Hughes, who have been able
    to come out in the market, get some transactions going, and be
    prepared for when the market does turn.
        But I think most of our market participants would say that
    may be years down the road, particularly given the uncertainty
    around what will happen to Fannie and Freddie.
        Mr. Grimm. Thank you.
        Mr. Hughes, I think you have been critical of QRM, and if
    you could, just very briefly describe to me what is wrong with
    the proposed QRM.
        Mr. Hughes. We haven't been that critical of QRM. Actually,
    for the whole risk retention, we are probably one of the few
    people who were in favor of the risk retention rules.
        But I would say, generally, where risk retention has come
    out in the proposals, and with premium capture and where it is
    going, it is just too cumbersome to actually make work. So I
    would say, from a Redwood standpoint, we would agree with the
    proposal, rely on representation to warranties rather than a
    narrow definition of QRMs.
        Mr. Grimm. Okay. Thank you.
        I am going to throw this out to the panel. I have often
    said that the economy won't fully recover and turn around and
    grow until we get the housing market turned around. I just
    think it is too big a sector. And if you could pick two things
    that you think that Congress should make paramount, maybe we
    will get those who haven't spoken yet, what would they be?
        Ms. Ratcliffe. I have one.
        Mr. Grimm. Okay.
        Ms. Ratcliffe. And it is a little theoretical here, but
    actually, a colleague, Phillip Swagel at AEI, I would sort of
    paraphrase what he has said, that we should recognize that
    whether there is an explicit or an implicit or an unstated
    government guarantee, the government is always going to step in
    to preserve markets.
        And so if you all could come around to making a
    confirmatory statement that you do see a role for some kind of
    limited government guarantee, at least in the foreseeable
    future, for supporting the middle of the market, or the sort of
    the conforming space that it is today, I think that would send
    a tremendous signal to the marketplace to begin planning ahead
    and moving forward with a comprehensive understanding of what
    the market is going to be like. Just sending that signal along
    and moving forward with figuring out how to structure that
    guarantee.
        Mr. Grimm. Thank you.
        Go ahead, sir.
        Mr. Wallison. I am glad to be able to point out that
    everyone at AEI does not agree. My view is the opposite, and
    that is, to the extent that we have any government involvement
    in the market, we will rekindle the kinds of problems that
    caused the financial crisis in 2008.
        What we ought to be sure that we do have is market
    discipline, with firms being able to fail, and firms that
    market poor quality mortgages bearing the costs of that, and/or
    the investors bear the costs of that. So I would strongly
    oppose any system where we introduce the government to support
    the housing market in any way. I think it can be done perfectly
    well by the private sector.
        Mr. Grimm. My time has expired.
        Thank you.
        Chairman Garrett. The gentleman yields back.
        And without objection, we will do a second round. I would
    like to do it just for the dedicated people who are remaining
    here, but I am told I am not allowed to exclude other Members
    from coming in by sealing the doors, or what-have-you. But be
    that as it may, I will start the second round and then go
    through it.
        So from the testimony, what we hear is in one respect, and
    we have heard this before, that part of the issue is that it is
    a supply problem, and not a demand problem; that there is a
    demand out there. And there is a supply problem as far as the
    security from the underlying--from the lack of mortgages
    underneath them.
        But to the gentleman from California's question, I think it
    was a good question. I think, ``Why isn't this happening above
    the conforming loan limits right now?''
        And Mr. Hughes, could it partly be in fact that with the
    bank balance sheets as they are, that the banks--and I see Ms.
    Ratcliffe is nodding her head--that the banks are just picking
    these things up, since these are the million dollar homes. And
    these are the ones--I will let either one of them--Ms.
    Ratcliffe, is that what is happening, do you think?
        Mr. Hughes. That is, in fact, what is happening.
        Chairman Garrett. And Ms. Ratcliffe agrees? Yes?
        So I guess that answers that piece of it. I can't,
    obviously, explain what the particulars are in any anecdotal
    story as to why in certain cases, people aren't getting the
    loans that they are looking for. I know I personally have a
    good credit rating score and I have a job, but I would not be
    able to, right now, much as I would like to, go and get a loan
    for $700,000, because I am on a fixed income.
        But to Ms. Ratcliffe, and anybody else on the panel as
    well, the issue here is--and I think what we are trying to do
    here is to change the focus from the focus by investors to
    being on from the credit rating of the United States, which is
    having problems by itself, to the credit ability of the
    borrower. Isn't that really what we should be trying to do?
        Ms. Ratcliffe. Peter and I can continue to have our debate
    forever, but it is not going to advance the market. And I think
    if we can say we are going to find a minimum appropriate role
    for government--
        Chairman Garrett. Okay.
        Ms. Ratcliffe. --as well as the responsibility for
    borrowers, and start moving towards structuring that--
        Chairman Garrett. Right.
        Ms. Ratcliffe. --that is what I am calling for here. Our
    plan at the Mortgage Finance Working Group foresees using
    mostly private capital in this sector with an FDIC-like model,
    where exhausting the balance sheets of the securitizers, the
    issuers, you would then have a pooled fund that you could go to
    and only super-catastrophic government guarantee.
        Chairman Garrett. Yes.
        No one is suggesting that we would not--I think someone
    else testified to this--no one is suggesting that we are not
    having a government involvement in the housing sector, because
    even with this, if this was to happen tomorrow--and no one is
    suggesting that this is happening tomorrow--is that you would
    still have--who said it? You would still have the FHA; you
    would still have the EVA; you would have Ginnie Mae; you would
    have the Federal Home Loan Banks; you would have the mortgage-
    interest-deduction aspect. I know that plays into how things
    finance in the sense that we support borrowing that way; right?
        And of course, there are probably a myriad of other Federal
    programs, I think some of which I guess Ms. Ratcliffe is
    referring to as far as supporting--supporting people as far as
    community programs and the like; so all of those would remain
    out there.
        So I guess that--and maybe to the point that Ms. Ratcliffe
    raised--to the extent that what would happen if you did
    something to send a signal to the marketplace, if you did
    something on top of that--and I guess, Mr. Wallison and I will
    open it to anybody else--what signal would it be if you say,
    well, we are going to continue to have a backstop to the
    marketplace?
        Would you get the same response then from your investors,
    Mr. Deutsch, as far as they are saying, well, we are going to
    wait and see then, until--
        Mr. Deutsch. I think if you are selling out securities to
    investors--
        Chairman Garrett. Yes?
        Mr. Deutsch. --and you tell them that there is an implicit
    backstop, or they get the sense that there is an implicit
    backstop to those securitizations, that will make it more
    desirable to them. And the fact that they will be able to go
    back to the government if the government--
        Chairman Garrett. So they will go there, as opposed to go
    over here? That they will go over to the government--
        Mr. Deutsch. Right. If you have a choice, if you are sold a
    private security and you are sold a public security, and they
    are at the same yield, you will choose the public security
    every day, because you have the U.S. Government as a backstop.
    Then, it becomes a quality covered bond by the U.S. Government.
        Chairman Garrett. Right.
        Mr. Deutsch. But if you have just a private securitization
    out there, they will demand a little bit more yield, because
    they don't have that backstop behind it.
        Chairman Garrett. And Mr. Wallison?
        Mr. Hughes. And to the credit backstop, there is a
    difference in liquidity as well.
        Chairman Garrett. Right.
        Mr. Hughes. So it is something they could readily borrow
    against to the extent that it is an agency security.
        Chairman Garrett. Right, and that is what we are trying to
    do here is trying to get the liquidity up so that you can get
    all of the markets to give it to the market.
        Mr. Wallison, do you have a comment?
        Mr. Wallison. I think that as soon as people believe that
    the government is going to remain in the market in some way
    through a guarantee, they are not going to put any
    investments--or put in the activity--to become securitizers, or
    work themselves into that field. It just doesn't make sense if
    you think you are going to be competing against the government.
        A government backstop will have exactly the same effect as
    the government actually guaranteeing, because it will just mean
    that the value of the government backstop is included in the
    risk profile and reduce the return.
        And because it reduces the return, private investors will
    not be particularly interested in it. So you have to really
    give the investors a signal, not only the securitizers, but
    also the investor market, that the government is getting out.
    And one way to do that, of course, is first to provide for the
    gradual winding down of Fannie Mae and Freddie Mac--
        Chairman Garrett. Yes.
        Mr. Wallison. --and then, give them assurance that no other
    government activities similar to Fannie and Freddie, whether
    implicit or explicit, is going to be put into place to replace
    them.
        Ms. Ratcliffe. And with all due respect, if I could
    disagree with Mr. Wallison, I think staying stuck on this point
    is supporting the status quo with 90 percent of the market
    being supported by 100 government guarantee. And the challenge
    is to figure how to limit the government guarantee so that
    there is a viable private sector, and so that the taxpayers are
    protected. And I think we can do that.
        Chairman Garrett. All right. So just since you gave me
    the--so what is happening right now, there is an issue as far
    as that guarantee with regard to the conforming loan limit. You
    saw what happened in the Senate.
        The last question is for Ms. Ratcliffe: Should we be
    propping up the conforming loan limit, or should that be coming
    down?
        Ms. Ratcliffe. If you read our plan, which you know, in the
    long run, we certainly see that the--
        Chairman Garrett. But what about right now, because we
    have--as you said before--to get going.
        Ms. Ratcliffe. No, I agree. And I think the difficulty here
    is exactly what I am talking about. Some of these incremental
    steps are very hard to execute without a clear idea of where we
    are headed.
        Chairman Garrett. Right.
        Ms. Ratcliffe. And where we are headed, the government
    should not be guaranteeing those high-end jumbo lines.
        Chairman Garrett. So I will introduce for the record
    without objection the statement from the National Community
    Reinvestment Coalition, who on that point take the view that we
    need that direction to the marketplace, and we need for the
    conforming loans to start the trajectory down, as was put into
    law.
        Without objection, it is so ordered.
        Mr. Green is recognized.
        Mr. Green. Thank you.
        To make sure I understand where each witness is on this
    question--if you are of the opinion that there is no role for
    the Federal Government in this market, would you kindly extend
    a hand into the air? I think it will help me to see.
        No role at all for the Federal Government? All right.
        Let the record--
        Chairman Garrett. Clarify in what market, when you are
    asking this? The Federal home loan housing market?
        Mr. Green. No, not the Federal home loan housing market.
        Chairman Garrett. I meant the Federal housing market, or
    just in guarantees?
        Mr. Green. In the market that currently allows for the
    government to have it--it was implicit, but we have made it
    explicit now with the GSEs.
        Chairman Garrett. Okay.
        Mr. Green. Because FHFA owns the GSEs, so that is we are
    talking about. So, is it fair to say that the record will
    reflect that one person, and that would be Mr. Wallison, you--
        Mr. Wallison. I am talking only about no government
    guarantees for middle-class prime borrowers.
        Mr. Green. Yes.
        Mr. Wallison. There has to be a government program for low-
    income borrowers.
        Mr. Green. Exactly.
        Mr. Wallison. --and so, we don't need the government in
    that.
        Mr. Green. And in your opinion, but you are the only one? I
    just want the record to reflect this is the case.
        Now, having that in the record, let me just say this. And I
    will get to you, Mr. Hughes, in just a second if I may, because
    my time is limited.
        I want to go to you, Ms. Ratcliffe. Let us talk about this.
    And I hate to use this term, ``apples and oranges,'' because it
    has become sort of a term that is not in good standing right
    now after some recent events and debates. But is it fair to
    compare the non-conforming with the conforming if we come to
    some conclusion about jumbos? Is it fair to use that for the
    entire market?
        Ms. Ratcliffe. I think your point is perhaps the same, that
    the benefits of having a government guarantee are able to be
    quantified or modified by looking at the spread between what
    does the jumbo pay for a 30-year fixed-rate mortgage, and what
    does somebody getting a government-backed or government-
    supported GSE loan pay for a similar mortgage product. And that
    spread doesn't look very big, and so people say there is really
    not that much value there.
        And my point would be that, again, it is true that
    borrowers with big downpayments and good incomes should be able
    to tap into that kind of credit at very efficient rates without
    a government backing. We need to find out where that line is,
    and not have the government supporting that part of the market.
        However, if you went deeper into the market, you would see,
    I think that these spreads seem much wider. And it is hard to
    know what that would be, because there is no real place to
    determine that. I also think that it is very unlikely that such
    a private market would provide the volume of 30-year fixed-rate
    mortgage finance that we are used to in this country.
        And so, that is a factor that is not necessarily covered in
    price, but certainly in the risk that the borrower is taking
    on. That is a higher cost to them, because they are talking on
    great risk. And we have seen the consequences of that.
        Mr. Green. Now, we haven't always had the government
    involved in the market. At one time, in the absence of the
    government, we had these loans that would have big balloons--
    short payment periods. People were not exactly eager to have
    their money on the line for 30 years.
        It was after Fannie and Freddie got into this market that
    we found that product, especially for middle-class people and
    working people. They were able to afford homes.
        Would you comment on this, Ms. Ratcliffe?
        Ms. Ratcliffe. Yes, it is true that before FHA was
    introduced, there was a basically non-existent market for
    fixed-rate mortgages and there was more volatility. And some of
    the things we saw sort of repeated in the private market in the
    2000s.
        But the nice thing about the 30-year fixed-rate mortgage is
    that the borrower knows what their payment is going to be over
    time, effectively, and what happens is, with even modest
    increases in their income, their debt-to-income improved and
    with even modest appreciation, their LTV automatically
    improves. And it creates an excellent source saving vehicle,
    right? Home equity is still a big portion of the retirement
    wealth in households retiring today, and that is largely thanks
    to the 30-year fixed-rate mortgage.
        So that product in and of itself makes it possible for more
    households to be able to get into homeownership and do so
    sustainably. We studied a portfolio of 50,000 mortgages made in
    the decade prior to the crisis. These mortgages were made by
    30-some banks around the country. And generally, the median
    income of these borrowers was $30,000, and most of them put
    down less than 5 percent.
        About half of the credit scores at origination were below
    680, and yet we have seen the default foreclosure rate on this
    program staying below 6 percent, even through this terrible
    crisis, which is much lower than you would see, for example, in
    the subprime market. And this is just one example that I have
    put forward where these borrowers all had 30-year fixed-rate
    mortgages that were prime priced and underwritten for ability
    to repay.
        When we looked at those sort of identical borrowers who
    were given different kinds of loan products, we see that those
    identical borrowers with different products had default rates
    that were 3 to 5 times higher than those having the 30-year
    fixed-rate mortgages. So, that is the evidence about the
    additional stability of that product for--
        Mr. Green. And Mr. Hughes, onto you now. Thank you for
    being patient, but I do have a question, and of course, you may
    have an additional answer. But my question to you is, with
    reference to the QRM, are you of the opinion that it cannot be
    adjusted such that it would be suitable?
        Mr. Hughes. I think with the QRM tied in with risk
    retention, tied in with premium capture, it would be very
    difficult to try and unbundle it in a way where you could
    really get something that is actionable for people who would be
    originating loans and then securitizing them.
        Mr. Green. My time has expired. Thank you.
        And thank you, Mr. Chairman.
        Chairman Garrett. The gentleman from Arizona for 5 minutes.
        Mr. Schweikert. Mr. Chairman, with your permission, can we
    do a lightning round? Actually, you are the victims of the
    lightning round.
        I would love to actually just throw out a couple of the
    mechanics within my understanding of trying to get to a
    securitization of MDS and all the things I hear about and just
    your quick comment. How much more definition has to be in
    regards to servicing standards, particularly on the impairment
    side?
        Mr. Deutsch. I think that there will be within private-
    label securities a lot more additional work that has to be done
    to pull in the servicing agreement to clarify the servicing
    standards. But a lot of that is going to be done through
    private market mechanisms for investors to get comfortable with
    how servicing will work on a go-forward basis.
        Mr. Schweikert. Okay, on impairment?
        Mr. Deutsch. On impaired loans.
        Mr. Hughes. Same question?
        I would agree with Mr. Deutsch.
        Ms. Ratcliffe. Nothing to add.
        Mr. Wallison. Nothing to add.
        Mr. Schweikert. Okay. How about on the TBA market?
        From a quick standpoint, how do you see it working under
    Chairman Garrett's bill?
        Mr. Deutsch. For servicing standards?
        Mr. Schweikert. No, TBA, to be announced.
        Mr. Deutsch. I think for any private label security and
    private originations can replicate being able to rate lock
    borrowers. The price of replication will be a bit higher and
    doing it through the private markets. But it can replicate
    being able to lock borrowers in.
        The price of replication will be a bit higher doing it
    through the private markets. But it can replicate being able to
    lock borrowers in. But I think the real question for secondary
    market buyers is the liquidity of the securities without a
    government guarantee, is being able to move--you can call
    things homogeneous. Then they could be relatively homogenous
    mortgage loans.
        But once you start creating loan-level data in a secondary
    market for what would be TBA-type loans, without that
    government guarantee, then they start making differentiation
    between those loans, and that does impair liquidity, to an
    extent.
        Mr. Hughes. I would say one of the things that we need to
    think through is: What is the proper subordination level? In
    addition, do you need these securities to be rated? I know we
    have tried to accomplish securitizations without ratings to
    just see if we can get investors together. It is very, very
    difficult.
        So I would say, in getting a liquid TBA market, we need to
    think subordination levels, and we need to figure out whether
    or not a rating will ultimately be attached to the security.
        Mr. Schweikert. Yes.
        Mr. Chairman, would you need that to be able to produce a
    30-day forward or what would create that distribution--
        Mr. Hughes. One of the things, as I tried to start out in
    my testimony that we are a little fuzzy on, is some of the
    ideas and thinking it through, and I think probably what we
    need to do is, from our side, is vet it more with investors, to
    just begin to socialize it and take it--
        Mr. Schweikert. Yes, we would love that input, because I
    know that is something we are all talking about, asking, are we
    giving enough guidance to make sure that the private market is
    able to cover that need?
        Ms. Ratcliffe. I totally appreciate the emphasis on the TBA
    market in this bill, and the emphasis on standards and
    granularity and categories and loan level data. The problem is
    there is a tension between these two things.
        If we do get to category ST, XYZ of loans, and you spread
    that across multiple issuers and with different subordination
    levels, and also the different--the nice thing about the
    Fannie/Freddie product is also 30-year fixed-rate mortgages,
    whereas, in the private-labeled sector, you see a little more
    complexity of instrument and cash flow. So I think it has sort
    of met its challenge.
        All of that said, I agree with Mr. Hughes that it is time
    to start exploring these things and trying some things out and
    see how they could be made to work.
        Mr. Wallison. My understanding is there was a TBA market
    before there were Fannie and Freddie securities, and one will
    be created again by the private sector. The real issue in TBA
    market is simply liquidity. And that is why, to the extent that
    there are different classifications produced by FHFA here, that
    there not be too many. We would have relatively few
    classifications of prime mortgages that are securitized, which
    would allow some depth in that market. All you need is
    liquidity, and then it works. It has nothing to do, really, in
    my view, with a government credit.
        Mr. Schweikert. In our last 30 seconds, give me one or two
    changes you think need to be out there for the M.I. markets.
        Mr. Deutsch. For the which?
        Mr. Schweikert. Mortgage insurance.
        Mr. Deutsch. We don't have any strong views on the changes
    in the M.I. market.
        Mr. Schweikert. Mr. Hughes?
        Mr. Hughes. For the market that we are working with,
    private investors really the--there is very little M.I. that is
    applied to jumbo loans. So we don't really have opinions on
    that.
        Mr. Schweikert. Ms. Ratcliffe?
        Ms. Ratcliffe. I am not sure what I would do to change the
    M.I. market. I guess it is worth recognizing that--and we
    haven't touched on this in the discussions of the bill, because
    it is really not in there.
        But another approach to improving the functioning of the
    market is not only to improve the pricing of risk, but to
    improve the levels of capital across the industry sectors that
    are decked against the kinds of risks people are taking and
    rationalize that to avoid adverse selection.
        And the mortgage insurance companies actually have a very
    interesting model for capitalization that requires them, if
    their stockpilers are--during good times and sort of
    countercyclical, and then they draw down those reserves during
    like this as we are seeing they are.
        They have paid some $27 billion or so in claims to Fannie
    and Freddie, saving their taxpayers that money. And actually,
    they are allowed to fail. They are not too-big-to-fail. But
    that capital is being drawn down on. I think it is a model
    worth considering if they--
        Mr. Wallison. Okay. I think mortgage insurance is extremely
    important if we want to bring in institutional investors, for
    example, because mortgage insurers will do their own
    underwriting.
        Mr. Schweikert. Are there a couple of changes you would
    make in today's M.I. world?
        Mr. Wallison. That I would make? No. M.I., of course, is
    regulated at the State level, and in most cases, it has worked
    pretty well. They have survived, with few exceptions, during
    this terrible financial crisis.
        So it is a regulatory system that has worked well so far,
    and we ought to make more use of it--especially when we have a
    situation where the rating agencies no longer have public
    confidence. Mortgage insurers can provide that confidence.
        Mr. Schweikert. Forgive me. I am way over my time. Mr.
    Chairman, thank you for your tolerance.
        Chairman Garrett. Not at all.
        The gentleman from California?
        Mr. Campbell. Thank you, Mr. Chairman. I guess I am the
    cleanup hitter here. And I am first going to make a couple of
    comments myself and then get to a few more questions.
        The chairman asked a question relative to a question I had
    posed before about, perhaps why in this jumbo market there
    weren't a lot of lower down or lower credit loans. And by the
    way, I bring that up not because $800,000 loans are a norm by
    any means, but just that is completely unaffected by Fannie and
    Freddie and by a government market.
        But the answer that everybody gave was that the reason for
    this was bank balance sheets and so forth and so on, which, for
    those of us like myself and Ms. Ratcliffe, who believe there
    ought to be a limited government guarantee, explicit but
    limited, with lots of private capital up front, in order to
    provide the fungibility that you are looking for, Mr. Deutsch,
    and the liquidity that you are looking for, Mr. Hughes, those
    of us who believe that.
        The bank balance--that is exactly the point. That is
    exactly the point. The housing market is such a huge part of
    the economy. It is such a gigantic part of each individual's,
    as was all discussed here, personal net worth, and in fact,
    their retirement savings. Banks are cyclical. Everything is
    cyclical. And when they want to loan to everybody, as we have
    seen, they will loan to anybody. And then, you probably don't
    need government guarantee.
        But when they go off like they are, then what? Then, nobody
    can get a loan. Then, nobody can sell a house. And then, all
    kinds of problems happen. And it will be procyclical. It will
    make recessions into depressions and it will make booms into
    bigger booms.
        And that is why this kind of stability that I think Ms.
    Ratcliffe and I are seeking, which also provides that
    fungibility and that liquidity that Mr. Hughes and Mr. Deutsch
    are looking for, is the sort of thing that we ought to be
    adding here.
        But Mr. Wallison, let me just--because I had to bring up--
    you mentioned private mortgage insurance, and we haven't
    mentioned at all the failure of PMI organization based in Mr.
    Schweikert's State, and I know you believe governments can't
    properly price insurance. Isn't there an argument to say that
    PMI didn't properly price private insurance either?
        Mr. Wallison. One of the reasons government doesn't
    properly price is that it doesn't have the incentive to price
    properly. It has an incentive not to price risk, because that
    works better politically. But the--
        Mr. Campbell. Whoa, whoa, whoa. Okay, well, there are a lot
    of things that government does that can work different
    politically than--
        Mr. Wallison. Yes.
        Mr. Campbell. --that is why you have to try and take that
    pricing out of our hands, because you are right; we will price
    it politically. That is not the right thing to do. But go on.
        Mr. Wallison. I am just suggesting why it is that the FDIC
    and many other agencies that are supposed to be risk pricing
    their insurance don't do it properly. But in the case of
    insurance companies, they have the incentive to do it. They do
    it by creating a reserve fund. The fund gets larger and larger
    over time, and that is what--
        Mr. Campbell. But private mortgage insurance right now is
    under huge stress, right?
        Mr. Wallison. Yes, but--
        Mr. Campbell. --for the failure of PMI in the swaps market,
    it is under huge stress. And understand; I believe there ought
    to be private insurance. I am not saying there shouldn't be. In
    fact, I think it is an important part of the market. But they
    have mispriced it.
        Mr. Wallison. Well, yes. They mispriced it, but they are--
        Mr. Campbell. Okay. Thank you.
        Mr. Wallison. No, let me finish because I think it is
    important--
        Mr. Campbell. I will get cut off, so let me.
        Ms. Ratcliffe, did you have a--
        What is that? All right.
        Chairman Garrett. It is your time. We will allow it.
        Mr. Campbell. If you want to give me more time, I will let
    him finish.
        Chairman Garrett. Yes, I will give you--we are over time
    anyway, but I will give you the additional time so Mr.
    Wallison--
        Mr. Campbell. Okay. Go ahead, then.
        Chairman Garrett. Yes.
        Mr. Wallison. The way that the insurance companies work is
    they create reserve funds, which they allow to grow over time.
    They are pricing for catastrophic circumstances by creating
    these funds. And by and large, that is how the mortgage
    insurance industry has worked.
        There are two or three which have been in trouble. But the
    rest of them are paying their claims right now, and will
    continue to pay their claims in the future. So they are the one
    area where we can be quite sure that mortgage risks are
    covered.
        Mr. Campbell. You know that a lot of the loss before the
    Fannie and Freddie--we were just talking about it earlier--at
    least according to their press release, they are blaming on the
    fact that because PMI failed, they now have to step in and
    cover a lot of the private insurance.
        Ms. Ratcliffe, you looked like you wanted to say something
    about the private insurance?
        Ms. Ratcliffe. I did want to say that, as we have talked
    about, the M.I.s are a sort of force to hold capital by
    regulatory requirements. So that does kind of prevent them from
    pursuing the race to the bottom.
        And I think there was probably more of that, for example,
    in the main competitor to PMI, which was the purchase money
    second, those lenders really underpriced risk. And we have
    already talked today about the way that the private-label risk
    takers, mortgage-backed securities market really acted
    procyclically and failed to adequately price risk.
        So I think those might be better examples of those
    procyclical tendencies than M.I., which is like government-
    required to reserve countercyclical.
        Mr. Campbell. Okay. Good point.
        And then, Ms. Ratcliffe, my last question will be to you,
    relative to--if there is no guarantee--so we have something
    like the bill that is before us and we go forward--we have
    talked about various things that may happen, the 30-year fixed-
    rate mortgage could disappear.
        There could be a big premium interest--the interest rates
    that people pay up could go up, the number of people who have
    the ability to get a loan could go down. There are any number
    of circumstances, and it could be all of those to some degree
    or whatever, if there were no government.
        If we have no Fannie and Freddie, there is no government
    support for the mortgage market, it is now just this bill in
    place, what do you see as that doing to housing prices, to the
    housing market, to whatever you think it might affect?
        Ms. Ratcliffe. No, as a result of fewer mortgages being
    available, fewer fixed-rate mortgages being available, and
    costs necessarily increasing, it would obviously have a strong
    negative effect on the economy and on household wealth. And
    those obviously need to be taken into account. Moreover, I
    don't think that those things are necessary. I think we can--
        Mr. Campbell. I agree with you completely. And the other
    thing that all that will result in is a loss of lots and lots
    and lots of jobs. And when we are all debating about how to
    create jobs, the last thing we should be doing is putting in
    policies that will, without question, lose jobs. And I yield
    back.
        Chairman Garrett. You answered a whole bunch of different
    criteria as to what would happen. Did you say what would happen
    if, under that scenario, the government does provide the
    guarantee and the government prices the risk wrong? What
    happens then?
        Ms. Ratcliffe. I would hope we would not price the risk
    wrong. We have good benchmarks now for what that risk pricing
    should look like, and there are a number of things--government
    doesn't have it--always the incentive to make a profit in
    pricing risk.
        They also don't have the same incentive to chase profits
    and take less risk. And we saw the FHA basically pull away from
    the market rather than chase it during the peak of the bubble.
    And so, I think there are elements about government risk-
    taking.
        Chairman Garrett. Just briefly, where are examples,
    historically, of where the government priced risks well? Is
    that like with blood or with the pension fund or--?
        Ms. Ratcliffe. In some of those cases, government takes
    risks that the private sector is not willing to take on.
        Chairman Garrett. Right, but the--
        Ms. Ratcliffe. It takes those risks in order to facilitate
    the functioning of some other private sector. So if you really
    want to look at the whole cost-benefit equation, you have to
    take some of those other benefits and externalities into
    account.
        Chairman Garrett. Yes. But at the end of the day, if they
    don't price the risk, who pays?
        Ms. Ratcliffe. The taxpayer. But, again, we do have pretty
    good markers now on what--
        Chairman Garrett. Yes.
        Ms. Ratcliffe. --crisis--what levels of capital you need to
    have, and what kind of pricing you would have. And that would
    definitely have to change from the old Fannie/Freddie.
        Chairman Garrett. I am--
        Mr. Campbell. Mr. Chairman, the existing bill would have
    the government setting underwriting standards. They might do
    that wrong, too. Anything the government does could potentially
    go wrong.
        Chairman Garrett. Right. But if that happened, who would
    bear the burden, then, the taxpayer or the investor?
        Mr. Campbell. The American economy, depending on where they
    set it--
        Chairman Garrett. Yes.
        The gentleman from California has come back for the second
    round.
        And the gentleman is recognized.
        Mr. Sherman. I want to commend my colleague from California
    for pointing out the importance of not allowing the conforming
    loan limit to go down in high-cost areas. As to pricing risks,
    I point out that the FHA has done a good job.
        CBO does a pretty good job, whether it is in the
    international sphere with loans to foreign countries or OPEC
    insurance. And the idea that the Federal Government can't price
    risk, CBO is a tough taskmaster, but they predict things that
    are just as hard to predict as downside risk. And, of course,
    they price risk as well.
        Now, Ms. Ratcliffe, if we didn't have Fannie and Freddie,
    and you are the average homebuyer looking to buy a $400,000
    home, how many more basis points are you going to pay? I know
    kind of what that answer was in 2006, back when mortgage-backed
    securities were very popular with the market. What are you
    going to pay now; any idea? And I have seen estimates of about
    75 basis points. Do you have anything that would counteract
    that or contradict it?
        Ms. Ratcliffe. I think there is no way to know in today's
    marketplace what the average homebuyer would pay, if there was
    no form of government support in forming market at this time,
    maybe.
        Mr. Sherman. Could it be more than 75 basis points?
        Ms. Ratcliffe. Certainly, depending on the borrower's
    characteristics, the loan amount being sought, and other--
        Mr. Sherman. So even people who are qualifying under
    today's Fannie and Freddie tougher standards for a particular
    loan might be paying 100 to 125 basis points for that same
    loan?
        I see the person next to you nodding his head.
        Sir, do you have--?
        Mr. Hughes. I think making the argument in the extreme,
    that Fannie Mae drops off the face of the earth the next day,
    and then what are the markets going to be like is not a
    rational--
        Mr. Sherman. I didn't put it forward--the extremes as if
    there wouldn't be a transition period and everybody would
    expect Fannie to exist and then the next--but let me go on with
    my limited time.
        So what happens to home prices in this country, Ms.
    Ratcliffe, if--I have seen estimates that we are talking about
    a 15 percent to 20 percent additional decline in home prices.
    Do you know of anything that contradicts that?
        Ms. Ratcliffe. No, sir.
        Mr. Sherman. And this is maybe a little outside your
    expertise, but it is something that Mr. Campbell and I face all
    the time.
        What happens to the economy, particularly in places where
    people have so much of their life tied up in the value of their
    home, if we see another 15 percent or 20 percent decline? Are
    you aware of any studies on that?
        Ms. Ratcliffe. I am not aware of any studies. I think we
    have discussed some of the impacts on, obviously, jobs and
    household wealth.
        I think one thing we haven't talked about but is worth
    always keeping in mind is that today we are seeing a
    substantial loss of wealth in housing that is going to
    translate, especially as people draw down on their retirement
    accounts and other assets to keep paying mortgages that may be
    underwater, that at the--this is sort of kicking the can on
    down the road, to make it a retirement-savings problem--
        Mr. Sherman. And I point out, a lot of people think this
    only relates to folks who are looking to buy a home or looking
    to sell a home or looking to refinance a home.
        But what I point out to people in my area is if you are
    just planning to continue to live in my area, and you hear that
    the home down the street sold for $100,000 less than everybody
    expected, you are not going out to dinner after that unless the
    restaurant has golden arches on the front of it.
        So the effect on the overall economy in the San Fernando
    Valley of a decline in the home prices is something that
    affects the 90 percent of the people who aren't buying, selling
    or refinancing.
        As to the bill, as I commented earlier today, I don't know
    whether this bill is just designed to assist what might remain
    a niche market, and that is the non-government-involved
    mortgage-backed securities, or whether it is the first step in
    taking a radical step of pushing government completely out.
        So if this is just going to make the niche market more
    efficient, it would be hard to have any of us oppose it. But if
    it is the first step toward the calamity that I have discussed
    with Ms. Ratcliffe and others, you won't find a lot of support
    on this side of the aisle.
        Not a whole lot of--there will be some non-supporters on
    your side of the aisle, too, so with that, I yield back.
        Chairman Garrett. The gentleman yields back, recognizing
    the calamity that we are in right now, because of the status
    quo of the GSEs, and the government backstop that has been
    provided to them.
        Without objection, I will enter into the record a letter
    from the National Association of Federal Credit Unions; seeing
    none, it is so ordered.
        I would like to very much thank this entire panel for all
    of your expert testimony and input and dialogue that we had
    going back, as with the first panel.
        The Chair notes that some Members may have additional
    questions for the panel which they may wish to submit in
    writing. Without objection, the hearing record will remain open
    for 30 days for Members to submit written questions to these
    witnesses and to place their response in the record.
        And, again, I thank the panel very much. The hearing is
    adjourned.
        [Whereupon, at 1:23 p.m., the hearing was adjourned.]

                                A P P E N D I X

                                November 3, 2011