[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








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