[Senate Hearing 112-29]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 112-29

 
 THE ADMINISTRATION'S REPORT TO CONGRESS: REFORMING AMERICA'S HOUSING 
                             FINANCE MARKET

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

EXAMINING THE ADMINISTRATION'S REPORT TO CONGRESS: REFORMING AMERICA'S 
                         HOUSING FINANCE MARKET

                               __________

                             MARCH 15, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Catherine Galicia, Counsel

                Laura Swanson, Professional Staff Member

                 Erin Barry, Professional Staff Member

                 Beth Cooper, Professional Staff Member

             Andrew J. Olmem, Jr., Republican Chief Counsel

            Chad Davis, Republican Professional Staff Member

              Michael Piwowar, Republican Chief Economist

                       Dawn Ratliff, Chief Clerk

                      Brett Hewitt, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 15, 2011

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Reed.................................................     4
        Prepared statement.......................................    37
    Senator Brown................................................     4
    Senator Bennet
        Prepared statement.......................................    38
    Senator Moran
        Prepared statement.......................................    38

                               WITNESSES

Timothy Geithner, Secretary, Department of the Treasury..........     5
    Prepared statement...........................................    38
Shaun Donovan, Secretary, Department of Housing and Urban 
  Development....................................................     7
    Prepared statement...........................................    42

              Additional Material Supplied for the Record

Prepared Statement on behalf of the National Multi Housing 
  Council and the National Apartment Association.................    48
Letter submitted by Timothy Geithner.............................    51
Letter submitted by the National Association of Federal Credit 
  Unions.........................................................    52

                                 (iii)


 THE ADMINISTRATION'S REPORT TO CONGRESS: REFORMING AMERICA'S HOUSING 
                             FINANCE MARKET

                              ----------                              


                        TUESDAY, MARCH 15, 2011

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 9:58 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order.
    I would like to thank Secretary Geithner and Secretary 
Donovan for coming before the Committee to discuss the 
Administration's White Paper, Reforming America's Housing 
Finance Market.
    In February, I issued a Committee agenda which stated 
housing finance reform would be one of my top priorities. 
Today's hearing provides us an opportunity to start a long-term 
discussion with top Administration officials about the future 
of housing policy in America. We are here today to get down to 
the work of determining how our housing finance system should 
function.
    I want to emphasize that the purpose of this hearing is not 
to lay blame for the housing crisis, nor is it to revisit every 
vote taken in this Committee before and during the crisis. We 
are not here today to merely point fingers and score political 
points. There is plenty of blame to go around. Members of both 
parties, Republican and Democrat administrations, that shunned 
regulation and pushed home ownership. Loan originators, 
investors, regulators, and the GSEs themselves all contributed 
to the formation of the housing bubble and its collapse.
    Despite some persistent talking points to the contrary, the 
Financial Crisis Inquiry Report, including the dissenting views 
of Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas on 
page 437 concluded that Fannie Mae and Freddie Mac did not by 
themselves cause a crisis. In fact, others point out that they 
lagged well behind Wall Street. However, because Fannie Mae and 
Freddie Mac along with the FHA provided a backstop to the 
private market, mortgages continued to be available even as 
credit dried up in other sectors. According to Moody's Chief 
Economist, Mark Zandi, this Government backstop is one of the 
most important reasons why the economy suffered a great 
recession and not another Great Depression.
    Today, Fannie Mae, Freddie Mac, and the FHA account for 
more than 90 percent of the mortgages in the country. 
Determining the proper level of Government involvement in the 
mortgage market is just one of the questions before this 
Committee and it is one that we need to thoroughly and 
carefully examine. As we consider our options for reforming the 
housing finance system, there are other questions we must 
answer. Do we want to preserve the availability of affordable 
30-year fixed-rate prepayable mortgages? Should lenders have 
equal access to the secondary market? Will a new structure 
provide equal access for all qualified borrowers and market 
segments, including rural areas, to the mainstream housing 
finance system? Should we have stable, liquid, and official 
mortgage markets for single-family and multifamily housing? How 
will a new structure protect taxpayer dollars?
    We must find workable solutions that protect current 
homeowners and preserve the option of responsible home 
ownership for future borrowers. The report for us today is a 
valuable starting point for this discussion and I would like to 
thank Secretary Geithner, Secretary Donovan, and the staff at 
the Treasury Department and HUD for the work putting it 
together. I look forward to your testimony and to a 
constructive discussion of the challenges ahead of us.
    Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Thank you for 
calling this hearing.
    Last month, the Treasury Department and the Department of 
Housing and Urban Development presented a report to Congress on 
options for ending the conservatorships of Fannie Mae and 
Freddie Mac and improving our housing finance system.
    During the debate over Dodd-Frank, Republicans insisted on 
dealing with the failed housing enterprises. In response, the 
Democrats refused to even discuss the GSEs. Ultimately, they 
included a reporting requirement so that they could not be 
accused of completely ignoring the issue. It is that report 
that we will be discussing here today.
    The joint report contains several positive items. First, 
the report recognizes many of the failures of the existing 
structure of the GSEs. It notes that Fannie and Freddie were 
undercapitalized, were poorly regulated, and took on excessive 
risk to maximize profits for their shareholders. These views 
are in sharp contrast to the position of Fannie and Freddie's 
defenders, who for years denied that there was anything wrong 
and aggressively fought reform until it was too late. The 
consequences of their actions have cost the American people, 
taxpayers, more than $150 billion.
    I am pleased, however, to see that the Administration is 
beginning this debate by at least recognizing the serious 
structural flaws in GSEs. I believe that is a good place to 
start. The report also concludes that the housing finance 
system must be reformed and that the goal should be to scale 
back the Government's role in mortgage finance and promote the 
return of private capital to a healthier, more robust mortgage 
market. This is a goal I believe we must all embrace.
    The report, however, is not without its flaws. First, it is 
a mere 31 pages. Given the vast resources of Treasury and HUD 
and the importance of this issue, I believe the American people 
deserved a more thorough and detailed study.
    Second, the report is vague on exactly how the 
Administration thinks the housing finance system should be 
reformed. The report presents three options for long-term 
reform. However, subsequent statements by the Treasury 
Secretary suggest that the Administration really only sees its 
third option, which resembles the status quo, as a viable path 
forward. While I appreciate the willingness of the 
Administration to be flexible on the details of reform, it 
would have been helpful, I believe, to know which items the 
Administration believes should be included in a reform bill. 
For example, should there be any reform of housing goals, or 
should there be minimum down payments for any Government-backed 
mortgages?
    It is impossible to tell what the Administration's 
priorities are at the moment for reform. Accordingly, I hope to 
learn today exactly what the Administration believes is the 
best way to reform our housing finance system.
    Finally, the report is narrowly focused on reforming Fannie 
Mae, Freddie Mac, and the Home Loan Banks. It says nearly 
nothing about the numerous other housing programs operated by 
the Federal Government. Each year, the Federal Government 
spends billions of dollars on housing programs aimed at 
ensuring that every American has access to quality housing. 
From Section 8 to housing tax subsidies, these programs usually 
receive little scrutiny from Congress. However, they are an 
important part of our housing finance system. Accordingly, they 
should be included as part of the Committee's consideration on 
housing finance reform.
    So far, the majority has yet to lay out a plan on how the 
Committee will develop its reform proposal. I would encourage 
the Chairman to promptly set forth such a plan that provides 
for a comprehensive examination of housing finance and the 
Federal Government's role in housing.
    The Committee has before it a very difficult task. The vast 
subsidies the Federal Government presently provides to the 
housing industry, Wall Street, and special interest groups 
means that real reform will face an uphill battle. In 2005, 
when the Senate considered reforming our housing finance 
system, politics and special interests trumped. Millions were 
spent to lobby against reform. Ultimately, the antireform 
effort cost the American taxpayers, as I have said, billions in 
bailouts. For far too long, our housing system has been 
distorted to benefit special interests. Hopefully, the collapse 
of Fannie and Freddie means that Congress now has an 
opportunity to enact reforms that will correct our past 
mistakes. The question remains, however, will we seize the 
opportunity or will we squander it? We will see.
    Thank you, Mr. Chairman.
    Chairman Johnson. Before I introduce our witnesses, would 
other Members like to make a very brief opening statement?
    Senator Reed. Mr. Chairman?
    Chairman Johnson. Yes, Jack.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Just a very brief statement. I think it is 
important to note that there is bipartisan agreement that we 
need to restructure Fannie and Freddie, and how to do it is 
going to be terribly consequential, not just to these 
institutions, but to homeowners, taxpayers, the construction 
industry, you name it. Everybody, I think, has an interest in 
this issue of getting it right.
    I think it is also important to note that a lot of the 
issues that we are dealing with, we have seen before. The 
evolution of Fannie and Freddie began in the 1930s because of 
the liquidity crisis, huge foreclosures. There was no 
mechanism, and the Government stepped in and created a 
mechanism.
    Today, effectively, Fannie and Freddie, in many respects, 
is a liquidity mechanism for the entire market, and without its 
existence, we would have, I think, much more serious 
consequences in the financial markets and on Main Street, as 
well as the financial centers.
    So we are wrestling with an issue that has come up 
repeatedly throughout our history. How do we provide support 
for the housing market without risking unnecessarily taxpayers 
and risking the stability of our financial system? That is not 
an easy challenge. It is one we have to accept, and it is one 
over the course of the next several months and years, I hope 
working on a bipartisan basis, we can accomplish, as we did, I 
think, looking back, in many respects, with many of the aspects 
of the Dodd-Frank bill, where there was agreement and there was 
support and we have moved forward.
    Thank you.
    Chairman Johnson. Does anyone else like to make a very 
brief statement?
    Senator Brown. Mr. Chairman?
    Chairman Johnson. Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman. I appreciate very 
much our two witnesses. I am eager to talk about, as my 
colleagues are, how we stabilize housing finance and bring 
private capital into the market, but we have got to walk before 
we can run. As long as we continue to have more than a million 
foreclosures a year, that crisis must be our priority. 
Secretary Donovan, thank you for acknowledging that problem in 
your testimony.
    Policy Matters Ohio, a think tank in my State, in a recent 
report pointed out that 2010 was the first time in 15 years 
that we had not had more foreclosures than the year before. So 
until 2010, we had had an increased number of foreclosures 
every year for 14 years, and you know what that does to 
neighborhoods. You know what that does to an economy overall 
and the pain it inflicts on so many families. If several of the 
larger services had not temporarily suspended their foreclosure 
filings, that likely would have increased again in 2010. Four-
hundred-thousand Ohioans, more than one in four homeowners, are 
still underwater. You know what that means to a neighborhood 
and to an economy.
    I disagree with some of my colleagues who blame this crisis 
overwhelmingly on fair lending laws and irresponsible 
homeowners alone. Unlike some other States with similar 
foreclosure crises, the causes of Ohio's problems were not 
primarily limited to subprime loans and real estate 
speculation. Ohio families lost jobs because of Washington 
policies. That includes trade agreements. It includes a 
financial crisis brought on by financial deregulation. It 
includes a shift from an industrial to a service-based economy 
and, frankly, a bias that our Government had toward the 
financial industry in support of the financial industry and 
support of the financial industry and a bias against 
manufacturing in many ways.
    That is why Senator Reed from Rhode Island and I are 
introducing legislation to fix a servicing model that has 
caused foreclosure fraud and homeowner abuse in Ohio and across 
the Nation. It means funding foreclosure counseling and legal 
services. These are common sense and high-reward investments 
that will help our economy recover. And it means providing 
constructive suggestions, not to improve the Administration's 
HAMP program. I have done conference calls with housing 
advocates. HAMP has been disappointing, but to eliminate it is 
clearly not the answer. To improve it is. All of those things. 
And it means ensuring that Fannie and Freddie are helping, not 
hurting, taxpayers. All of those things, we need to look at.
    I appreciate the service of both of you at Treasury and 
Housing and thank you, Mr. Chairman.
    Chairman Johnson. Does anyone else like to make a brief 
statement?
    Senator Moran. Mr. Chairman, I would just ask unanimous 
consent to submit my opening statement for the record.
    Chairman Johnson. Everyone will have their statement 
included. I will remind my colleagues that we will keep the 
record open for 5 days for additional statements and questions.
    Neither one of the two witnesses that we have here today 
need any sort of extensive introductions. First, we have the 
75th United States Secretary of the Treasury, the Honorable 
Timothy Geithner. And finally, we have the 15th U.S. Secretary 
of Housing and Urban Development, the Honorable Shaun Donovan. 
We welcome both of you back to the Committee.
    You may proceed, Secretary Geithner.

  STATEMENT OF TIMOTHY GEITHNER, SECRETARY, DEPARTMENT OF THE 
                            TREASURY

    Secretary Geithner. Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee, thanks for giving us the 
chance to come testify before you today.
    Last month, the Administration released a report to 
Congress outlining our reforms, our proposed reforms to the 
housing finance market. Our plan, as you know, is designed to 
create a housing finance system in which the Government's role 
is limited to robust oversight and consumer protection, 
targeted assistance for low- and moderate-income homeowners and 
renters, and carefully designed support for market stability 
and crisis response.
    Now, under this plan, private markets, subject to strong 
oversight and standards for consumer and investor protection, 
would be the primary source of mortgage credit and bear the 
burden for losses. Banks and other financial institutions will 
be required to hold more capital to withstand future recessions 
or significant declines in house prices and to adhere to more 
conservative underwriting standards. Homeowners will hold more 
equity in their homes, and the securities markets, alongside 
credit from the banking system, will play a major role in 
housing finance, but subject to risk retention disclosure and 
other key reforms and requirements.
    We proposed a three-part plan. First, we proposed to wind 
down Fannie and Freddie and help bring private capital back to 
the mortgage market. As you know, in the wake of this crisis, 
private capital receded, retreated, and has not yet returned, 
leaving the Government to guarantee more than 9 out of 10 new 
mortgages today, and that assistance has been absolutely 
essential in helping bring a measure of stability to the 
housing market and to help ensure that Americans have continued 
access to mortgage credit, but it is not a long-term solution.
    Our report recommends using a combination of policy tools 
to wind down Fannie and Freddie over time, such as increasing 
guarantee fees, reducing conforming loan limits, gradually 
tightening underwriting standards. We also support a continued 
wind-down of Fannie and Freddie's investment portfolio, and 
these actions will help shrink the Government's footprint in 
the housing market and help bring private capital back.
    Now, we are not going to get private capital to come back 
and replace the Government's role unless we fix the very 
substantial remaining problems in the private mortgage market. 
So a second part of our plan is to make the necessary reforms 
to provide better protection for borrowers, for lenders and 
investors, and help restore confidence to that market. Again, 
this means helping consumers make informed decisions about 
mortgages and providing them better protection from unfair 
predatory deceptive practices. It means requiring participation 
in the securitization chain to retain risk, to improve access 
to information, increase accountability and transparency. It 
means requiring banks to hold more capital, including against, 
of course, high-risk mortgages so that they are in a better 
position to withstand future housing downturns. And it means 
addressing the chronic problems we still see in servicing and 
foreclosure processes by setting national servicing standards 
and improving industry incentives.
    Our third objective, which Secretary Donovan will speak to 
in more detail, is to more effectively target the Government's 
support for access to sustainable credit and to affordable 
rental housing options.
    Now, our report puts forward a limited number of options 
for structuring the Government's future role in the housing 
market for replacing Fannie and Freddie. Each of these three 
options would produce a market where the private sector plays 
the dominant role in providing mortgage credit and bears the 
burden for losses. Each has unique advantages and disadvantages 
that Congress must consider carefully.
    In the first option, the overwhelming majority of mortgages 
would be financed by lenders and investors and would not 
benefit from a Government guarantee. This would limit the 
Government's role to initiatives at the Federal agencies, 
principally FHA, but also VA and USDA, that provide targeted 
support for affordable housing and access to sustainable 
mortgage credit.
    In the second option, that function, the Government's role 
through the FHA, would be complemented by a Government backstop 
available only at times of mortgage stress, of crisis, to help 
to provide continued access to mortgage credit even in a very 
deep recession.
    In the third option, alongside the Government's role in 
FHA, for example, FHA and VA, USDA, the Government would 
provide a form of reinsurance for certain securities backed by 
high-quality mortgages. These securities would be guaranteed by 
carefully regulated private companies under strict capital 
standards and oversight so that private investors take the 
first loss on any mortgages reinsured by the Government.
    Now, we considered but opposed two alternative models. We 
did not recommend Congress embrace a complete privatization of 
the mortgage market with no role for the Government in 
providing access to affordable housing, nor did we recommend 
what some have called the full nationalization option in which 
the Government would provide an explicit guarantee and directly 
bear the cost of most of the credit risk in the housing finance 
system. The alternatives we propose that you consider lie 
between those two more extreme options.
    Now, a key criteria in evaluating these options--there are 
a number of criteria you have to use in evaluating these 
options and we encourage you to carefully consider their 
advantages and disadvantages. Our challenge is to strike the 
right balance between providing access to mortgages for 
American families and communities, limiting the ultimate risk 
to the taxpayer, maintaining more stable, healthy, mortgage and 
housing markets, and whatever path you choose will require some 
tough decisions and some tradeoffs.
    Although comprehensive reform will take time, we cannot put 
this process off indefinitely and leave the market with too 
much uncertainty about the ultimate solution. Delay will make 
it harder to get private capital to return and to replace the 
role the Government is playing today.
    Each of the options we considered would require legislation 
from the Congress, and, of course, we look forward to working 
with you, with this Committee, and with your colleagues in 
helping designing comprehensive legislation as quickly as we 
can, and we would like to try to do that within the next 2 
years.
    But we have to proceed with care. As all of you know, many 
of you emphasized, the housing market is still in crisis and we 
have to make sure that we proceed very carefully to avoid 
adding to the many burdens still on this market and with care 
not to disrupt the economy recovery now underway.
    Thank you.
    Chairman Johnson. Thank you, and you go ahead, Secretary 
Donovan.

 STATEMENT OF SHAUN DONOVAN, SECRETARY, DEPARTMENT OF HOUSING 
                     AND URBAN DEVELOPMENT

    Secretary Donovan. Thank you, Chairman Johnson, Ranking 
Member Shelby, and Members of the Committee, for this 
opportunity to testify before you today on the Obama 
administration's report to Congress on reforming America's 
system of housing finance.
    Mr. Chairman, today, I would like to focus on the 
Administration's commitment to housing affordability and access 
to mortgage credit, the critical role the Administration 
proposes for the FHA going forward, and how the Administration 
and Congress must work together to ensure housing finance 
advances opportunity in every community.
    Since taking office, the Obama administration has acted to 
help stabilize the housing market and provide critical support 
for struggling homeowners. Working with Congress, we helped 
avert a deeper economic collapse and a more severe housing 
crisis. Our efforts preserved access to our mortgage markets at 
a moment they were threatening to seize up entirely.
    Since April 2009, more than 9.5 million homeowners have 
been able to refinance their mortgages to benefit from lower 
interest rates, collectively saving $18.1 billion annually. 
More than 4.2 million distressed borrowers have received 
modifications since April 2009, more than twice the number of 
foreclosures completed during that time.
    Looking forward, the President believes that an integral 
part of reforming the housing finance system must be ensuring 
that Americans have access to quality housing they can afford. 
This involves supporting a range of affordable options. We are 
committed to promoting sustainable home ownership, predicated 
on safe mortgages, a process significantly strengthened under 
the Dodd-Frank law.
    Every American who has the credit history, the financial 
capacity, and the desire to own a home should have the 
opportunity to take that step with fairly priced access to 
mortgages in all communities. For the millions of Americans who 
rent, affordable options means a system that can consistently 
provide the financing needed to maintain those rental 
properties and support development of affordable housing in 
communities with decent jobs and good schools. The question 
today is how we provide those options.
    In our report, the Administration lays out four key 
principles for access to mortgage market and housing 
affordability that will form the foundation of a reform system. 
First, reforming and strengthening the FHA. Mr. Chairman, in 
all three options for long-term reform the Administration 
identifies, a reformed and strengthened FHA remains an 
important participant in the market. That is why we will 
continue to ensure that creditworthy low- and moderate-income 
borrowers have access to affordable mortgages. And as we have 
done over the past 2 years, we will do so in a way that is 
healthy for FHA's long-term finances. Indeed, because of the 
reforms we have implemented with the help of this Committee 
these last 2 years, FHA is projected to generate approximately 
$9.8 billion in receipts for the taxpayer this fiscal year.
    Further, thanks to the Committee's work, FHA received 
additional authority to raise premiums, and we look forward to 
working with both chambers of Congress to enact broader FHA 
reforms that protect the taxpayer. While FHA has already 
changed policy to require that borrowers with lower FICO scores 
make larger down payments, FHA will consider other options, as 
well, such as lowering the maximum loan- to-value ratio for 
qualifying mortgages more broadly.
    In considering any changes, FHA will continue to balance 
the need to manage the risk to the taxpayer and the borrower 
with the need to ensure access to affordable loans for lower- 
and middle-income Americans, including providing access to 
credit for first-time homebuyers and underserved markets.
    Second, we must provide targeted, transparent support for 
affordable rental housing. Right now, half of renters spend 
more than a third of their income on housing and a quarter 
spend more than half. With the 2007 to 2009 period showing the 
largest increase in worst-case housing needs in a quarter 
century, the need to express strong support for affordable 
housing has never been clearer.
    Historically, private credit markets have not served 
affordable multifamily rental properties terribly well, 
preferring to invest in high-end developments. However, the 
GSEs were able to assist this market segment without the losses 
that occurred on the single-family side. As we move forward, we 
must ensure that the infrastructure and capacity they built in 
this critical area remains. One option could be to share risk 
with private lenders to expand FHA's capacity to support 
lending to the multifamily market. We could also develop 
dedicated programs that ensure we capture hard-to-reach 
segments, like smaller properties, particularly in rural areas.
    Third, the plan commits us to helping ensure that capital 
is available to creditworthy borrowers in all communities, 
including rural areas, economically distressed regions, and 
low-income communities. The plan calls for greater transparency 
by requiring securitizers to disclose information on the 
credit, geographic, and demographic characteristics of the 
loans they package into securities. A key lesson we have drawn 
from this crisis is that decisions made in the secondary market 
very clearly drive lending practices in the primary market, and 
the potential for disparate impact in the availability and 
quality of mortgages in underserved communities is very real. 
To that end, the Administration is fully committed to exploring 
other measures to make sure that secondary market participants 
are providing capital to all communities in ways that reflect 
activity in the private market, consistent with their 
obligations of safety and soundness.
    Last, support for affordable housing requires consistent, 
flexible, and transparent funding. That was the goal of the 
National Housing Trust Fund that was authorized by Congress in 
2008 but has yet to receive funding. That is why the 
Administration will work with Congress on developing a new 
dedicated financing mechanism to support affordable home 
ownership and rental housing that current policies cannot 
adequately address.
    I have described this Administration's bedrock commitment 
to affordable and accessibility, and Secretary Geithner has 
just described the three options that the report presents. As 
we considered these options, one element I would like to 
highlight that impacts affordability, not just when consumers 
buy but over the long term, is the question of the availability 
and pricing of long-term fixed-rate loans. For decades, the 30-
year fixed-rate mortgage has allowed families to safely build 
wealth and climb the ladder to the middle class. As such, I 
believe we should carefully consider the implications for 
availability and pricing of those mortgages.
    Ultimately, this plan is about bringing private capital 
back to pave the way toward the balanced national housing 
policy that ensures Americans have access to credit for those 
in a position for sustainable home ownership, rental options 
near good schools and good jobs, assistance for those who feel 
the strain of high housing costs, and above all, choices in 
housing that make sense for them and for their families. The 
more the American people can participate in this debate to 
expand beyond necessary discussions of capital markets, G-fees, 
risk-based capital, and mortgage-backed securities and consider 
how essential the system is to the futures of their own 
families and communities, the better system we will build, the 
stronger our country will be, and the more opportunity we will 
be able to provide to every American.
    Thank you, and we look forward to taking your questions.
    Chairman Johnson. Thank you.
    For both Secretaries, there have been reports that large 
financial institutions are closing branches in historically 
underserved communities. How would each of the Administration's 
options ensure that mortgages would continue to be available to 
Americans in rural underserved areas and that small community 
banks and credit unions would have access to an independent 
secondary market?
    Secretary Donovan. Mr. Chairman, this is a very important 
question and it is one of the elements that we highlight as 
important to focus on as we are looking at the three options. 
We have seen with the effects of the crisis a significant 
consolidation in mortgage originations to the point where the 
top five lenders today account for about 60 percent of all new 
mortgages. It is important that we consider the ability of 
community-based lenders, community banks, and others to be able 
to originate mortgages.
    First of all, through FHA, we would continue to provide 
that option, but it is important to recognize that the 
potential for the lack of any guarantee outside of FHA, the VA, 
and USDA to further increase consolidation in the market 
because of the requirements for substantially more capital to 
originate those mortgages under a system. So that is an 
important element that we should consider as we consider these 
three options.
    Chairman Johnson. For both Secretaries, looking at the 
Administration's GSE housing finance reform report, it states 
that we need to have a plan to address multifamily mortgage 
finance, but does not provide much detail. What are your 
recommendations to provide for stable, liquid, and affordable 
financing for multifamily housing, including affordable 
multifamily housing and housing in rural areas?
    Secretary Donovan. As I mentioned in my testimony, one of, 
I think, the often forgotten aspects of this crisis is that we 
have not seen multifamily finance, and particularly multifamily 
finance at the GSEs, contribute substantially to their failure. 
And, in fact, they have been able to continue to originate 
multifamily mortgages profitably through this crisis.
    I think it points, first of all, to the need to look 
carefully at multifamily financing distinctly from single-
family financing, and, in fact, to recognize that often for 
multifamily financing, because of the broader mix of products, 
the broader range of housing types, the broader range of 
communities, from rural to urban, that have different types of 
multifamily properties, that the need for standardization is 
more significant and can contribute more to giving us lower 
interest rates and making multifamily housing more affordable.
    And so, therefore, having a targeted guarantee as we do 
through FHA to multifamily housing has been a significant 
contributor to improving the provision and the building of 
multifamily housing, but also the affordability of that housing 
over time. And so there are a number of ways that we suggest we 
ought to keep that strong commitment to multifamily housing.
    One of the lessons I think we have learned is that we 
should be looking in FHA, for example, at risk sharing or other 
forms of insurance that would put more private capital in front 
of the guarantee that we provide. That is an option that we 
suggest in the report and it is one that we would look forward 
to looking at with the Committee as we consider potential 
legislation.
    Chairman Johnson. Quickly, the report says that the 
Administration believes that the securitization market should 
continue to play a key role in housing finance, and they agree. 
In the rulemaking to define the qualified residential mortgage, 
what appears to be the most challenging issues to address? Will 
the agencies take sufficient time and care to make sure you get 
it right and to avoid unintended consequences that might 
restrict credit? Either of you.
    Secretary Geithner. Mr. Chairman, yes, we will--the 
entities responsible will take care in designing this to make 
sure they get it right, and, of course, one of the great 
strengths of our system is they will put out a draft for 
comment so that all affected parties will have a chance to 
provide advice directly in the shaping of the final rule.
    Among the many challenges we have to confront in this 
context is not just how to get all the agencies that are part 
of this on the same page with a reasonably integrated approach, 
but fundamentally, this comes down to the question about, for 
example, how much equity you think homeowners should hold in 
their homes. How do you get the incentives better between the 
originator of a mortgage, the servicers, and the investors? It 
is a whole range of complicated problems, but we are getting 
close to a consensus and I suspect we will be able to put out a 
draft for public comment reasonably quickly. And, of course, 
that is just a draft.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Secretary Donovan, would you describe your involvement in 
the well-publicized negotiations on a global mortgage service 
settlement currently underway between mortgage servicers, 
Federal agencies, and States Attorneys General. Have you been 
involved in establishing a settlement figure, which has been 
reported as high as $30 billion?
    Secretary Donovan. Senator Shelby, we are one of the 
Federal regulators that has been involved in the discussions. 
That is because FHA, obviously, and ultimately the American 
taxpayer, has a significant stake in the performance of 
servicing by the lenders that originate and service FHA loans.
    Senator Shelby. Secretary Geithner, has Elizabeth Warren 
been participating in these discussions that Secretary Donovan 
referenced as your Special Advisor on the BCFP or as Assistant 
to the President, in either of those roles?
    Secretary Geithner. Senator Shelby, I sent you a copy of a 
letter this morning that I sent to Chairman Bachus in the House 
on this basic question and I thought maybe it would be helpful 
if I just quote directly from this letter. I think it will be 
responsive to your question.
    Senator Shelby. And who is the letter from?
    Secretary Geithner. It is from me.
    Senator Shelby. OK. Can we make the letter part of the 
record?
    Secretary Geithner. Absolutely.
    But I will read you briefly these three sentences.
    Senator Shelby. OK.
    Secretary Geithner. Under the Dodd-Frank Wall Street Reform 
and Consumer Protection Act, the CFPB, the Consumer Financial 
Protection Bureau, does not currently have authority to 
administer penalties and will, therefore, not be a party to any 
formal settlement with mortgage servicers. Under that same law, 
though, the CFPB will obtain significant authority to set 
standards for the mortgage servicing industry on July 21, 2011, 
the date when the consumer finance protections of other 
agencies transfer to the Bureau. For this reason--and this is 
very important--for this reason, the CFPB has been invited to, 
and I personally invited Elizabeth Warren to advise the other 
agencies that are part of this process on how to design 
appropriate servicing standards for the mortgage servicing 
industry.
    Senator Shelby. So she has been involved in the process?
    Secretary Geithner. We invited her to advise on this 
because, again, that agency----
    Senator Shelby. You invited her, but my question is, has 
she been involved in the process?
    Secretary Geithner. Yes, she has. She has been involved in 
helping to advise on the design of servicing centers because 
that is part of the formal authority of the Bureau under the 
law that Congress passed last year.
    Senator Shelby. OK. Secretary Geithner, the recently 
released draft of the proposed global servicer settlement would 
force financial institutions to submit to third-party 
monitoring of their compliance with the agreement. These third 
parties, I believe, would be selected at the discretion of the 
Attorneys General and the BCFP. As Secretary of the Treasury, 
do you believe it is appropriate for Federal financial 
regulators to outsource compliance monitoring to third parties, 
and does this raise any safety and soundness concerns, and if 
not, why not?
    Secretary Geithner. Senator Shelby, that is an excellent 
question and I want to be a little careful in how I respond to 
this. This is an enforcement proceeding. It is a very 
complicated set of questions and I am not going to comment on 
any of the detailed provisions in that draft or have been 
discussed in the press. What we are trying to do is to get all 
parties together, State AGs and all the Federal agencies with 
direct regulatory authority, enforcement authority in this area 
to come together and bring about a set of reforms that will 
help improve what is still broken in the mortgage servicing 
process, and a lot is still broken, and I think all parties 
have a really strong interest in trying to resolve this quickly 
so we can bring more certainty to the mortgage market and help 
encourage the process of repair, make sure that people who are 
still vulnerable get some assistance, and that is what we are 
trying to do.
    Senator Shelby. With respect to the housing financial 
reform which we are all interested in, what role do you believe 
third parties, such as community activist groups, for example, 
like the former ACORN, should play here, or should play at all?
    Secretary Geithner. In the debate?
    Senator Shelby. Yes, in the recommendations and so forth.
    Secretary Geithner. Well----
    Senator Shelby. Should they play a role at all?
    Secretary Geithner. Well, again, Congress will get to 
decide who they hear from, and you will want to hear from a 
broad range of people, and I would expect you want to hear from 
people who spend their days every day trying to help people 
caught up in this mess, housing counselors, et cetera. But you 
will have the chance to consult with anybody you choose to 
consult with.
    Senator Shelby. Going back to housing, reform of the 
finance system, I would like for you to clarify your position 
on a few key issues. Do you believe that the formerly implicit, 
now explicit, Government guarantees of the GSE's mortgage-
backed securities should cease or merely be modified?
    Secretary Geithner. Well, Senator Shelby, in the report, 
the three options we suggested Congress focus on all involve 
some form of Government guarantee, either just through the FHA 
and USDA and VA, or potentially through one of two other 
options. One is a backstop only available in crisis, or a much 
more limited, carefully designed guarantee, as in what we 
called option three.
    Now, as you know, guarantees are perilous. Governments are 
not very good at doing them, not very good at designing them, 
not very good at pricing them, not very good at limiting the 
moral hazard risk that comes with them. And as we saw in this 
crisis, when you make those mistakes, you can leave the 
taxpayers with huge losses in this context, and, of course, we 
are committed to avoiding that.
    Fundamental to design of any guarantee that works is trying 
to take the politics out of setting the standards and the 
eligibility requirements and the pricing, and that is why we 
have been very careful to say that any of these options, they 
have advantages and disadvantages, but whether they work or not 
will depend a lot on how they are designed, and in particular 
in this case, whether you can keep the politics out of the 
design of the guarantee itself.
    Senator Shelby. If we do not keep the politics out of it, 
we are going to repeat where we are today down the road, are we 
not?
    Secretary Geithner. That is right. Well, I would say, even 
if you keep the politics out of it, it is a challenge to get 
right, and humans are not perfect in this stuff. As you know, 
banks and credit rating agencies, insurance companies 
themselves made lots of mistakes in this area, too. So it is a 
hard thing to do even without the politics, but if you do not 
keep the politics out of it, you have got no chance for getting 
it right.
    Secretary Donovan. Let me, if I could just add on this, as 
well----
    Senator Shelby. Sure.
    Secretary Donovan. It is not just the implicit or explicit 
nature of the guarantee. It is the pricing of that guarantee 
that is critical, as well. One of the key failures that the 
report points to is that the guarantees at Fannie and Freddie, 
in significant part because they were implicit, were not set at 
the right pricing levels and that contributed to their lack of 
adequate reserves to withstand the crisis.
    I would point out, though, that in the case of FHA, while 
the crisis has substantially challenged those reserves, we have 
remained able to operate through the crisis without our 
reserves dropping below zero. And because of our work----
    Senator Shelby. They have dropped a lot, though, have they 
not?
    Secretary Donovan. They have dropped significantly----
    Senator Shelby. Yes.
    Secretary Donovan. ----and because of our work with this 
Committee, we have been able to gain more flexibility to price 
those guarantees. We have been able to raise our pricing 25 
basis points just recently, thanks to that flexibility. And 
that has allowed us, because we have an explicit, fully paid 
for guarantee at FHA, to be able to thus far operate 
effectively through this crisis.
    Senator Shelby. Secretary Geithner, do you believe that 
conforming loan limits should be reduced beyond HERA levels, 
and if so, what figure would you target and what timeframe?
    Secretary Geithner. As we proposed in the report, Senator 
Shelby, we think that they should be allowed to revert, as 
current law would suggest, on the current schedule. Beyond 
that, we have not made a judgment yet. I think, again, that we 
want to make sure that you design a carefully phased-in set of 
tools to reduce the Government's role, allow the private market 
to come in. The pace at which we do that, how we do that will 
depend a little bit on the evolution of the market.
    Senator Shelby. Mr. Secretary, one last question and I will 
move on. Secretary Geithner, do you have any confidence that 
the new European bank stress test will provide any meaningful 
results? It seems like they might have a credibility problem 
getting off to a second start.
    Secretary Geithner. Senator, a very important question, and 
I would say that, as our question implies, it is very important 
that for these things to work, they have got to be tough, they 
have got to be transparent and disclosed, and they have to 
provide a--they have to come with a clear commitment to provide 
the capital banks need if the stress test reveals a shortage of 
capital. But I am not in a position--not close enough to the 
details right now to know whether it will meet that test, and 
ultimately, the market will judge whether----
    Senator Shelby. Absolutely.
    Secretary Geithner. ----the design is strong enough.
    Senator Shelby. Transparency helps the market judge, does 
it not?
    Secretary Geithner. It is essential. Now, markets do not 
always get these things right, but they have no chance to get 
it right without better disclosure.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Reed [presiding]. Thank you, Senator Shelby.
    Secretary Geithner, in the context of this ongoing 
discussion about a global settlement, which has, frankly, been 
dragging on many, many months, and I think personally should 
come to an appropriate conclusion, if it does not, there is the 
potential for numerous suits by Attorneys General in 25, 30 
States, both in terms of consumer protection laws and other 
statutes, including criminal statutes. There is potential for 
the bond holders with, I am guessing, billions of dollars of 
notional value at risk, of suing, based on potential breaches 
of representations and warranties. There are individual suits 
by homeowners who claim they were unfairly foreclosed. This 
would have, I would presume, a very deleterious effect on the 
marketplace and on the standing of the companies that you are 
talking to right now. Is that accurate?
    Secretary Geithner. Yes, Senator Reed. It is very 
important, and I think all parties have a stake in bringing 
this to resolution as quickly as possible, and it would help 
resolve the remaining legal uncertainty around the broader 
mortgage servicing foreclosure process that itself is very 
important, and it would give us a better chance to move beyond 
this and focus more directly on the remaining things we have to 
do to help repair the damage in this market as a whole.
    It is very important that we try to bring this to bed as 
quickly as we can. I think all parties in this, not just the 
servicers, but the State AGs and the Federal agencies, have a 
strong stake in doing that.
    Senator Reed. Just a follow-on point is that many of 
these--these are allegations, in many respects, but a legal 
process that would take several years to determine multiple 
cases about liability, responsibility, that itself could have a 
very significant impact on the market, both the value of these 
companies and their ability, frankly, to move forward and to 
more robustly contribute to the recovery, is that right?
    Secretary Geithner. That is right, and a comprehensive 
settlement like what is being discussed cannot solve all these 
problems, but it will help provide at least a measure of 
certainty with respect to the Government and the servicers and 
I think that is an important thing to do.
    Senator Reed. Thank you----
    Secretary Donovan. Senator, if I could just add on that, as 
well----
    Senator Reed. Secretary Donovan.
    Secretary Donovan. One of the issues that would potentially 
result, as well, we have made very clear, Secretary Geithner in 
his testimony, that ensuring we have clear, consistent 
standards for servicing mortgages is an important element of 
our recommendations. One of the clear reasons we ended up in 
this crisis is that there were no consistent strong standards 
for servicing those mortgages, how first mortgages interacted 
with seconds, and a result which had a fragmented set of 
standards that might come from individual settlements with 
various States or various agencies would be a real negative 
result.
    But I would also point to the fact that for many homeowners 
waiting, who have not been offered the options that they 
should, that have ended up in foreclosure because early on in 
the process they were not contacted as they were required to, 
for example, by FHA requirements, means that we have not only 
hurt them, but lengthened potentially the foreclosure process, 
and a significant part of what we are aiming for here is to 
speed up the process, to make it better and to get resolution, 
therefore, not just for the homeowners but for the market, as 
well. When a homeowner has to contact a bank three or four 
times, when paperwork is lost, when these types of things 
happen, it is good for no one in the process. And so it is 
important that these standards get established in a single 
concerted way as much as possible rather than in a fragmented 
way.
    Senator Reed. Thank you, Mr. Secretary.
    Secretary Donovan, just let me follow up. One of the, I 
think, insights of the report you submitted--in looking back, 
it should have been more obvious to us--is that we, I think, 
the Nation, Congress, regulators, were obsessed with home 
ownership in terms of that as the primary housing policy, and 
rental property, affordable rental property, multifamily, was 
sort of a distant second, a far distant second. And I think 
this report says we really have to have a balance.
    Many people, the best form of housing for them is 
affordable, decent rental housing, and that should be--our goal 
should be providing people the options that they can choose the 
best form of housing for their family, their proximity to work, 
their lifestyle.
    Now, one of the things that--and I am glad you commented 
upon this--is the National Housing Trust Fund, which is devoted 
to trying to build and construct affordable housing for 
relatively low-income Americans, to make it affordable to them 
and affordable to all of us, and I wonder if you might comment 
upon this aspect of the report.
    Secretary Donovan. Very important, Senator, and thank you 
for raising it. One of the things I think many people miss in 
terms of what has happened, as we have seen, gone through this 
housing crisis, we have, in fact, seen rents come down at the 
top end of the market, vacancies increase. But at the same 
time, at the lower end of the market, for those lowest-income 
and even some moderate-income renters, rents have actually 
increased and to the point where between 2007 and 2009, we saw 
the single greatest increase in worst-case housing needs that 
we have ever measured in the study that we do every 2 years.
    And so, clearly, the range of options that we are providing 
to focus on affordable rental housing has not been strong 
enough to meet those needs, and so the need for some kind of 
targeted, focused effort that improves on many of the 
shortcomings that we had in the affordable housing goals that 
the GSEs had, a much more targeted, transparent way of meeting 
those needs, we think would help to significantly reverse the 
declines in affordability that we have seen through the crisis 
while at the same time protecting against some of the negative 
impacts that the goals had at the GSEs.
    Senator Reed. Thank you very much, Mr. Secretary and Mr. 
Secretary.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman.
    Thank you both for being here. It is always good to hear 
from you. I know that the Administration has laid out three 
options, and I am one of those folks that believes the 
Administration--we work best when the Administration lays out 
something clear and then we offer editorial comment here. I 
think we have made a lot of mistakes over the last several 
years where 535 folks try to craft something on their own with 
no supervision and we end up with major problems.
    Secretary Geithner, you have laid out three options, I 
know. Which one of the three do you like the most?
    Secretary Geithner. I am going to disappoint you and not 
answer that question directly at this stage because, as I said 
before, they each----
    Senator Corker. But we would like some adult supervision.
    Secretary Geithner. But I will say this. I do believe 
that--and I think it is likely that we will do this, but we 
have to consult with your colleagues on how to do this--I do 
think that after a period of debate and discussion and further 
exploration of these options, then I think it makes sense for 
us to tell you what we think makes sense, what is the best mix 
of them, what is the best alternative. And we will reflect and 
consult with you and your colleagues about whether we should do 
that in the form of legislation or not. But I expect we will 
take that step.
    Senator Corker. And I understand that is kind of a punt. I 
mean, there are three options. I guess you are sort of letting 
those lay out there for a while and people will comment on 
them. But they all--the second and third options involve 
pricing risk. The first option, to a limited degree, does 
because you keep three programs in place for low to moderate 
targeting, as you talked about.
    But if we can price risk effectively, is there any need for 
Government involvement? I mean, it is kind of self-predicting, 
is it not? I mean, if you can actually price risk for option 
two and option three appropriately, there would never need to 
be involvement by the Government in the first place, would 
there?
    Secretary Geithner. Well, I am not sure you are making the 
case for and against, but I would say the two classic arguments 
people make for a Government role in the form of something like 
a guarantee are, first, the affordable access argument, and 
second, in terms of how an economy can best weather recessions 
and house price collapses. They are slightly different 
arguments.
    In option one, we are suggesting the Government limit its 
role fundamentally to the affordability option. Now, of course, 
even in that option, you could have the FHA dramatically expand 
what it does in a crisis, providing some protection against a 
deep recession even in a crisis. But in that option, the 
Government would be left with a lot of exposure to risk, 
because as you know, the FHA provides guarantees for mortgages 
with very little down payment. The Government has a lot of 
exposure to risk.
    So I guess my suggestion, Senator, is that, again, look 
very carefully at the impact you have on concentration in the 
industry on small community banks. Look very carefully about 
what the ultimate exposure to the taxpayer is. Look carefully 
at how much flexibility you have to protect the economy, 
protect the innocent from the kind of mistakes you see that you 
might see in a future crisis. And look at the moral hazard 
risk. And remember that, as you said, in any guarantee, you 
need to make sure you separate it from political influence, 
from banks, from the real estate community, from other people, 
however noble their objectives are, so that you can price it 
and design is so the taxpayer is not too exposed to risk of 
loss.
    Secretary Donovan. If I----
    Senator Corker. Again, I would just say one more time--I am 
running out of time--if you have the ability to price risk 
appropriately, again, which we do not because you do not know 
when----
    Secretary Geithner. Right.
    Senator Corker. ----that 100-year issue is going to occur, 
then you do not need the Federal Government in the first place.
    But let me go to Fannie and Freddie. I think all of your 
options say that Fannie and Freddie end.
    Secretary Geithner. That is right.
    Senator Corker. And right now, they are under 
conservatorship. What technically occurs to cause Fannie and 
Freddie to end? I mean, who really owns Fannie and Freddie 
today?
    Secretary Geithner. Well, under the law that Congress 
passed, the conservator, in which case is FHFA, owns those 
responsibilities and judgments, and without legislation, 
without new legislation to allow us to wind them down 
definitively, there is a substantial risk, and that is really 
the only option created under the legislation, is that they be 
re-created in a somewhat different form, recapitalized and 
privatized. And we do not believe that will be a sensible path 
for the Government to take and that is why it is important to 
recognize that we need to legislate in this. If we do not 
legislate, the risk is we are more likely to face a system 
where they get re-created in a different form.
    Senator Corker. And over what timeframe should they end?
    Secretary Geithner. Well, it depends a lot on how quickly 
the mortgage market heals, how successful we are in bringing 
private capital back in. But I think our sense is that a 
realistic expectation is this is a 5- to 7-year period of time. 
It could be somewhat longer. It is possible it could be a 
little shorter----
    Senator Corker. And how do we benefit from the--inside 
Fannie and Freddie, there are numbers of databases and other 
kinds of things that have value. There are also the newer 
legacy loans that have value. So how do we make sure that the 
Federal Government benefits from that value?
    Secretary Geithner. Excellent question. It is not just 
there are a lot of very talented people with experience there, 
but a lot of systems with a lot of intellectual property in 
them, a lot of value in those systems, and we have a variety of 
ways we could try to make sure that the Government maximizes 
the benefit and the housing market can benefit from the talent 
in terms of people and the talent in terms of systems and 
resources. But a very important question.
    Senator Corker. I know my time is up, and I notice we 
talked about maybe giving more time to people who do not give 
opening comments, so I might ask one more question, then, 
because he nodded.
    On the debit issue--this is sort of off-subject, but I know 
we have had numbers of regulators in on the Durbin Amendment, 
talking about how it was such a narrow situation, narrow 
definition that it really did not price the interchange rate 
appropriately. Do you have any comments on that?
    Secretary Geithner. I do not, Senator, because you did not 
give me the authority under the law to resolve this. I know 
that the Fed has got a lot of advice on how to deal with these 
challenges and they are thinking through carefully how to do 
that, but it is not my authority.
    Senator Corker. And on the qualified residential mortgages, 
where they did set a 20 percent, is that something you support 
or----
    Secretary Geithner. Well, have not yet, but there is a 
draft working its way through the system now and I will say 
that I do believe that there is a very strong case as we build 
this new system that we have a system in which most homeowners 
hold more equity against the value of their house, and we 
should look at a way to do that, achieve that, in a sensible, 
careful balanced way, and that would be one tool for doing 
that.
    Senator Corker. What is the timeframe upon which we should 
pass reform for housing?
    Secretary Geithner. As I said in a response to an earlier 
question, I think you should, as an objective, try to do it 
within the next 2 years. Again, if you do not give the markets 
clarity about the end game, it is going to be harder to get 
people to come in and take risk in the interim. Banks and 
investors, it would be a hard time trying to figure out what 
are the economics of housing finance. And so I would try and do 
it in the next 2 years.
    Senator Corker. Thank you both. Thank you, Mr. Chairman.
    Chairman Johnson [presiding]. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    I have a few questions. I just want to say a brief thing--I 
did not make an opening statement, either--about Fannie and 
Freddie. There are some people who try to lay the entire blame 
of the financial crisis at Fannie and Freddie's feet. I think 
it is ideological as opposed to looking at the facts. When you 
look at the facts, it is hard to pin exclusively or even 
predominately the blame on Fannie or Freddie, because here are 
some facts that cannot be explained away by Fannie and Freddie, 
and I wish my colleagues who think that Fannie and Freddie are 
the center of the crisis would explain these.
    First, the housing bubble was international. There were 
housing bubbles in Ireland, Spain, Eastern Europe, and 
elsewhere. There were no Fannies and Freddies there.
    Second, the peak of the housing bubble was in 2004, 2005, 
and 2006, when Fannie and Freddie were losing market share to 
private label securitizations.
    Third, there was a bubble and a bust in commercial real 
estate as well as residential. No Fannie and Freddie loans in 
commercial.
    So I think certainly Fannie and Freddie need reform, but 
this idea that they are at the center of the crisis, as I say, 
I believe is ideologically driven as opposed to fact-based 
driven. They deserve some of the blame, as do banks, as do 
regulators, as do even consumers. I will leave it at that.
    I want to ask you questions about, first, about covered 
bonds, which is something I care about. Whatever we do with 
Fannie and Freddie, we are going to need to get private capital 
back into housing finance sooner rather than later. Covered 
bonds work in Europe, have not caught on in the U.S. because we 
do not have a statutory framework that provides certainty 
regarding their treatment in the event of insolvency. There has 
been a bill introduced just recently in the House that I am 
considering introducing in the Senate by Representatives 
Garrett and Maloney on covered bonds.
    So, Secretary Geithner, you mentioned in your written 
testimony you are willing to work with Congress to explore 
creating a legislative framework for covered bonds, so here are 
my questions. What do you think of the legislation that Garrett 
and Maloney put in? The FDIC has argued that covered bonds 
could potentially put the Deposit Insurance Fund at some 
increased risk, but I cannot see how covered bonds are any 
different than any other secured obligations. Banks always have 
secured obligations that put those at a higher thing. And 
finally, do covered bonds put the taxpayer at risk? Secretary 
Geithner, let me ask you first and then ask Secretary Donovan 
to----
    Secretary Geithner. Yes, we would support legislation that 
would help create better conditions for a covered bond market. 
It is important to recognize that we do have a covered bond 
market in the United States today in the form of the Federal 
Home Bank financing structure that is essentially the 
functional equivalent.
    The questions you raised about the FDIC are very legitimate 
concerns. We have to work through those.
    Again, for this to work, you would be putting the taxpayer, 
in some sense, behind private investors and that has its own 
consequences. But that is something we can work through and I 
think it could play a better role, a greater role in our 
system----
    Senator Schumer. How are they different than any other 
secured obligation?
    Secretary Geithner. Well, it depends how the law defines 
it.
    Senator Schumer. Do not have to be----
    Secretary Geithner. I do not think this is rocket science, 
Senator. I think it is something we can work through. But it 
is----
    Senator Schumer. Yes, that is why I want to get involved. 
It is not rocket science, so I can probably deal with it.
    [Laughter.]
    Senator Schumer. Secretary Donovan.
    Secretary Donovan. I would just add to Secretary Geithner's 
point, it is important that we create the conditions for more 
innovation in the system. I do think, though, it is important 
to point out, as well, given that GSE obligations are the 
second-largest securities market in the world, there really is 
no precedent for covered bonds operating in a market as broad 
and deep as the U.S. market. And so I think it is an important 
element, but I do not think, as some have suggested, that it is 
a sort of silver bullet, if you will, in terms of----
    Senator Schumer. Or a total replacement----
    Secretary Donovan. ----or a replacement for----
    Senator Schumer. I agree----
    Secretary Donovan. ----for whatever system might----
    Senator Schumer. ----and I see Secretary Geithner agreeing. 
But you, too, support the basic concept and think we ought to 
explore it?
    Secretary Donovan. Absolutely.
    Senator Schumer. OK. A final question for Secretary 
Geithner on a topical issue. It is about Japan. They are our 
second largest creditor after China, an issue you and I have 
talked a lot about--not Japan, but China. Do you think there is 
any risk that in order to respond to the disaster and support 
their economy in the aftermath, that the Japanese will have to 
resort to selling some of their Treasury holdings to raise 
cash? Do you see this having any impact on Treasury prices and 
U.S. interest rates?
    Secretary Geithner. I do not.
    Senator Schumer. Could you explain why?
    Secretary Geithner. Japan is a--I should say, Senator, that 
I extend and we should all extend our thoughts and concerns to 
what Japan is going through.
    Senator Schumer. Absolutely.
    Secretary Geithner. I think it is an extraordinary 
challenge for them and I think--but Japan is a very rich 
country, very high savings rate, and it has the capacity to 
help deal with not just the humanitarian challenge, but the 
reconstruction challenge they face ahead.
    Senator Schumer. Thank you, and thank you, Mr. Chairman.
    Chairman Johnson. Senator Moran.
    Senator Moran. Mr. Chairman, thank you very much. Thank 
you, both Secretaries, for joining us today.
    Short of overall GSE reform, what steps could we take today 
short of that 2-year period that Secretary Geithner mentions 
that would encourage capital formation, the return of the 
private sector into the housing market?
    Secretary Geithner. Well, Senator, we begin in our report 
by highlighting the fact that there are some things we can do 
to help gradually phaseout the Government's role, and we have 
to get these rules in place for banks and investors and the 
securitization market so there is clarity about the rules of 
the game in this context, you know, better underwriting 
standards, clearer capital requirements, better disclosure 
requirements, better servicing standards, things like that. So 
those two conditions are very important for getting private 
capital to come in and we think we can begin that process right 
now.
    Senator Moran. In the instances that you describe, that 
would be an administrative action as compared to a 
Congressional action?
    Secretary Geithner. Those sets of reforms we laid out to 
wind down the Government's role and to put in place clearer 
rules of the game for the private markets, most of those things 
we can do within authority Congress has already given the 
executive branch.
    Senator Moran. Secretary----
    Secretary Donovan. There is also, I would add, a number of 
levers that we point to in the report that we have already 
begun to take action on, as well. FHA has grown from its 
historic share of the market of 10 to 15 percent to close to 30 
percent, in the purchase markets, over 50 percent. And with 
authority that this Committee worked to give us last year, we 
just announced an increase in our premiums of 25 basis points, 
that in addition to helping to rebuild our reserves can help to 
begin to step back our role.
    I would also point to the loan limits, which we advocate 
Congress allowing to step back to the HERA limits on October 1, 
and we would want to engage in further conversations, 
particularly around FHA, about what lower loan limits we might 
want to pursue for FHA, as well as the GSEs going forward. So 
those are a number of other steps we have begun to take.
    Senator Moran. Thank you both. Hometown Kansas bankers 
continue to talk to me about the regulatory environment in 
which they operate, and particularly small community banks. I 
have had conversations with bankers who say they no longer are 
making real estate loans as a result of the concern about the 
regulatory examination environment. I think it would be a very 
sad day for particularly rural America, but for America in 
general when your hometown banker is not willing or capable of 
making home loans. Are both of you aware of those concerns and 
are there steps being taken to either dissuade the bankers from 
having that concern or to reduce the reason that they do have 
the concern?
    Secretary Geithner. Senator, you are absolutely right, and, 
of course, we hear the same thing from banks across the 
country. Part of this, of course, is, in some sense, the 
natural consequence of the natural response of regulators who, 
in some sense, were a little too--how should I say--too loose 
in the boom and they tend to overcorrect----
    Senator Moran. Overreact?
    Secretary Geithner. ----in the crash. And so I think that 
you are still seeing banks report a lot of concern about the 
change in the basic environment from examiners.
    The bank supervisors in the country with responsibility for 
this are aware of this concern. They have issued a series of 
guidance to examiners and clarifications about treatment of 
commercial real estate loans, for example, to try to respond to 
this concern, and I know that Chairman Bernanke and Chairman 
Bair and the Acting Comptroller of the Currency, John Walsh, 
are aware of this and are continuing to try to look for ways 
they can try to make sure their examiners bring the appropriate 
degree of balance to these judgments and do not overcorrect.
    Senator Moran. Another point I would make, though, Senator, 
is well, is one of the consequences that we have seen in the--
through this crisis has been an increasing concentration of 
lending. Today, the top five banks account for about 60 percent 
of all originations, and we have heard--I have heard very 
directly from FHA-approved lenders in many communities, 
particularly rural communities, that FHA's presence, along with 
VA and USDA, is absolutely critical to ensuring that they can 
continue to be a source of safe, affordable home loans in their 
communities. And, in fact, one of the points that we make in 
the report is that a risk of option one, in particular, could 
be that we would have less--more concentration and less----
    Senator Moran. In the origination.
    Secretary Geithner. ----availability for community banks in 
others to be able to continue lending in those communities.
    Senator Moran. Before I lose my last 9 seconds, let me ask 
a broad question. I think there is a--as you all are aware, the 
topic of conversation, the discussion, the point that Congress 
and the Administration are in deals with the fiscal house of 
the United States. In my view, we are bankrupt or nearly 
bankrupt fiscally, and I think there is a tendency in this 
country to see this as a typical Republican versus Democrat, 
liberal, conservative, whatever the labels are, something that 
is an academic or philosophical battle going on in Washington, 
DC.
    In my view, there are significant consequences to everyday 
Americans' standard of living, interest rates, and I would 
think that if we continue to have a goal in this country of 
having home ownership, I hope that you would agree with me that 
there is a significant consequence to the failure of Congress 
in addressing the fiscal issues that we face today with rising 
interest rates. I would like your reaction as to tell Americans 
that what we are discussing here are the outcome of the debate 
and the votes that occur in the House and Senate, approved by 
the President, have direct consequences upon our country's and 
its citizens' ability to enjoy a higher standard of living and 
to enjoy home ownership. Am I missing something in the 
magnitude of what we face today?
    Secretary Geithner. No, I agree completely. It is a 
bipartisan imperative that we find a way to put in place long-
term reforms to reduce our long-term deficits. Of course, we 
have to do that in a way that does not hurt the recovery or 
leave us without the capacity to finance things that are 
critical to our capacity to grow as a country going forward. 
But our growth prospects will be in jeopardy, short-term and 
long-term, if we cannot find a way on a bipartisan basis to 
lock in reforms that will bring those deficits down over time, 
not least because of the potential risk you see higher interest 
rates in the future, higher interest rates that would be bad 
for the economy generally, not just make home ownership more 
expensive.
    Secretary Donovan. I would also add that within the direct 
area of housing finance, important steps have been taken by the 
conservator of the GSEs to improve their lending. Their current 
lending has begun not only to improve the housing crisis more 
broadly, but also to allow them to make good on their 
commitments to repay the American taxpayer through the 
agreements they have with Treasury.
    And on the FHA side, we have taken a broad set of steps to 
improve our finances to the point where we will actually 
contribute to the taxpayer in the range of $10 billion this 
year because of the improvements that we have made in risk 
management and a range of other areas.
    So these are critical areas where we can get our own fiscal 
house in order by responsibly managing, again, on a bipartisan 
basis, just as you have said, to improve Government in the way 
that the President laid out in his State of the Union Address 
and has consistently said. We have to improve the performance 
of Government, and that means an important part of getting our 
fiscal house in order.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman.
    Secretary Geithner, the Administration's report to Congress 
refers to Basel III, and Basel III will require banks to hold 
more capital--[inaudible]--and this should improve the ability 
of banks to withstand downturns and home price declines, and 
importantly, it would increase the stability of our financial 
system and create incentives to, obviously, underwrite good 
mortgages, and I would expect that, as the guarantees provided 
by Fannie Mae and Freddie Mac are wound down----
    Chairman Johnson. Could the Senator turn on her microphone?
    Senator Hagan. Sorry about that. Is it on now? Thank you.
    I would expect as the guarantees provided by Fannie Mae and 
Freddie Mac are wound down and the Government involvement in 
the mortgage market is removed, that mortgages will be viewed 
as riskier for purposes of capital standards.
    How would you expect mortgages and mortgage-related 
securities to be viewed for risk weighting and capital adequacy 
standards under Basel in each of the three options outlined in 
the Administration's report?
    Secretary Geithner. I think my own view is that the capital 
you ask, you require banks to hold against risk should be the 
same under all those three options. I would not alter them 
based on the options that Congress ultimately comes to. And 
again, that is because of the simple proposition that whatever 
risks banks hold, in mortgages or elsewhere, you want to make 
sure they are required to hold more capital against those 
risks. So those standards should apply regardless of the 
options Congress chooses.
    Senator Hagan. Well, with the higher capital requirements 
in place, what do you believe the comparative cost to consumers 
will be for a 30-year fixed-rate mortgage under these plans?
    Secretary Geithner. I think under any of these plans, it is 
important to recognize that the cost of mortgages will rise for 
the American people. It will rise modestly, we believe, but 
they would be different under those three options, and I think 
any reasonable person looking at those options would conclude 
that the cost of mortgage finance and particularly for a 30-
year fixed mortgage would be higher in option one and in option 
two than in option three.
    Senator Hagan. Higher in option one?
    Secretary Geithner. Highest in one----
    Senator Hagan. OK.
    Secretary Geithner. ----less high in two, and less high in 
three.
    Secretary Donovan. Also, Senator, obviously, the 
interaction of the qualified residential mortgage, as you know, 
as one of the sponsors of that provision, will be critical 
here, as well. And so how we set those standards, as Secretary 
Geithner said, not changing the risk weighting, but obviously 
QRM will be a critical part of how we set those standards more 
broadly, and as we release that rule for comment, we should 
continue to have that discussion about how we set those 
standards to ensure adequate capital, but also not pricing that 
would put fixed-rate financing out of reach for most consumers.
    Senator Hagan. That is what I am very concerned about. What 
would the impact be on U.S. banks that hold mortgage-related 
securities relative to their competitors abroad, and would our 
banks be required to hold comparatively more capital?
    Secretary Geithner. Under the framework of capital reforms 
that we have supported, there would be a level playing field 
across global markets and institutions. So the design of these 
standards are--the objective is to make sure that banks in the 
United States are required to hold the same level against risk 
as would be banks in the United Kingdom or in Canada or in 
Germany, and that is for obvious reasons, because you want 
there to be a level playing field across institutions. Now, of 
course, that is a challenge to achieve in practice, but it is 
very important we try to do that.
    Senator Hagan. Well, as we have been talking about, there 
have been calls for down payment requirements of as much as 20 
percent, and just some examples right now. Middle-class 
families in the U.S., I do not think are able to always satisfy 
that high down payment requirement. Median single-family homes 
cost, on average, about $170,000 in 2009, and median household 
income was approximately $55,000. So it would seem that under 
such circumstances, if the family earned that median income, it 
would take them a great deal of time to save $34,000 to put 
toward a home, and when you consider instances where the same 
family has, for instance, unreimbursed medical expenses or is 
saving college education for several children, how do we help 
and ensure that families that fit this middle class definition 
and this profile could ultimately obtain a home?
    Secretary Donovan. So I think, first of all, as a bedrock 
principle, this is one of the reasons we focus on having FHA 
continue to be a source of affordable, safe mortgages for low- 
and some moderate-income borrowers. So that is an important 
bedrock to ensure that that continues.
    Second of all, a clear commitment through a dedicated, 
transparent stream of funding that would allow us to continue 
to support, for example, down payment assistance that would 
allow homeowners who can achieve home ownership to be able to 
buy a home that they can afford and to remain a homeowner in a 
sustainable way.
    But I do think that there are implications beyond those two 
bedrock principles that we lay out in any of the three options 
that we need to look at the differences between the various 
options, particularly around the availability--and the pricing, 
as Secretary Geithner said earlier--of the 30-year mortgage in 
those different options. It would be different and there 
clearly would be less availability of a fixed-rate 30-year 
mortgage and higher pricing on that in option one relative to 
option three.
    Secretary Geithner. I agree with what the Secretary said, 
and I want to underscore how important it is, the point you 
made. And again, it is not just the impact on the homeowner, 
but we have a great tradition in this country of thousands of 
small businesses started because people were able to borrow 
against the value of their home. So we want to make sure we get 
this balance right.
    So we do not know exactly where the right balance is, but I 
do think it is important to recognize that whatever we do, it 
is important that we get the incentives better for people to 
hold more equity in their house over time. Not all Americans, 
necessarily, but we do want to save for the bulk of the 
mortgage market. You want the system to rely on a thicker 
equity cushion, not just greater capital requirements by banks 
but by homeowners. I think that is very important, and we have 
lots of ways, not just through FHA, but we propose in the 
report a number of other ways to try to make sure that we give 
people some help to buy that first home, to be able to afford 
that first home, and I think we can get a better balance than 
we have in our current system.
    Senator Hagan. And then the financing structure, the actual 
cost, the interest rates, too, I think, is that----
    Secretary Geithner. Exactly right, and----
    Senator Hagan. ----impact that greatly.
    Secretary Geithner. And that is one reason why we have 
emphasized so--and this is very important, that as we proceed, 
we have to proceed with a lot of care because it would be 
irresponsible for the Government of the United States to 
embrace policies today that would raise the cost of mortgage 
financing significantly and add to the still very substantial 
burdens, fragility of the current housing finance system. So we 
want to proceed carefully, but, of course, in terms of the 
ultimate end state, we also want to be careful that we do not 
go too far the other direction.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman, and thank you both 
for being here and for your work.
    I want to go back to Senator Moran's concerns about the 
overall fiscal situation. Do you think Congress and the 
President can put off to beyond the next election some major 
approach to get us on a different long-term fiscal path without 
the risk of serious negative consequences in the meantime.
    Secretary Geithner. Well, I would say it this way. It would 
be better for the country for Congress and the Administration 
to come together sooner and agree on a set of reforms you can 
lock in today that would restore gravity to our fiscal 
position. If you do it now, with a multiyear set of reforms, 
you give people more time to adjust. You give individuals and 
investors more time to adjust, businesses more time to adjust, 
and you leave the world more confident that we are not going to 
put this off forever, and it is easier to solve if you start 
these kinds of things early. Better to move now if you can and 
you can find a way to do it sensibly.
    Secretary Donovan. And just to add to that, Senator, I 
would say critical steps that we are taking, the freeze that 
the President proposed over 5 years, reductions we are 
proposing for 2012, I would say, in our own budget at HUD, 
almost a 3-percent reduction relative to 2010, all of those 
steps would bring domestic discretionary spending to the lowest 
level since President Eisenhower. So those are critical steps. 
As I think we have recognized, Secretary Geithner has 
recognized, we need to move beyond just domestic discretionary 
spending, but we clearly have proposed a budget that puts us on 
that course.
    Senator Vitter. Well, at least my next question, because I 
guess I just fundamentally disagree with that, my next question 
was going to be when will the President and the Administration 
lead on changing our fiscal course, because I truly believe 
what has been announced so far has gotten completely panned in 
terms of the markets, which are ultimately the most important 
and most objective judge, and that is going to impact what 
consequences we face down the line.
    Secretary Geithner. Well, Senator, of course, you do not 
expect me to agree with that, and I do not agree with that. 
What the President proposed in his budget is a series of 
detailed changes to our resources and our commitments that 
would reduce our deficits from 10 percent of GDP to around 3 
percent of GDP, which is primary balance. That is the level at 
which you stop our overall debt burden from growing as a share 
of our economy. That is a necessary condition for fiscal 
sustainability. It does not solve the problem for the 
succeeding decades, but it is the minimum thing we need to do, 
and when we frame this, we frame this as proposed, is we frame 
it as a first step, as a down payment. And if Congress were to 
legislate constraints on itself that was consistent with that 
deficit reduction path, that would be enormously helpful to 
sustaining the confidence in the United States and around the 
world that we are going to go back to living within our means.
    Now, we will still--even if we achieve that, we will still 
have to figure out how to come together and make deeper reforms 
in health care spending over time, because ultimately, over the 
succeeding decades, that is what drives our long-term deficits. 
But we have to find a way to get from 10 percent of GDP, which 
is an unsustainable near-term fiscal position, to at least 
primary balance in a 3- to 5-year period so that we can stop 
the overall debt burden from growing as a share of the economy, 
and that is what we propose.
    Now, under our Constitution, the President proposes but 
Congress has to legislate in that context, and I actually would 
be more encouraging than I think you were in the sense that I 
think if you listen carefully to what is happening across the 
Congress today, there is a lot of interest across the aisle, 
Democrats and Republicans, to try to come together now in a 
bipartisan framework that will lock in some long-term reforms.
    Senator Vitter. I agree with the last statement and I 
encourage everyone, including the Administration, to latch on 
to that and to lead in that.
    My second main topic is about risk retention. There are 
proposals to exempt GSE loans from risk retention. Do either of 
you support that?
    Secretary Donovan. I actually do not think that there are 
discussions about exemptions. I think that the key question is 
if we are setting standards for risk retention, that should 
cover the market broadly, and the question is how do we ensure, 
whether it is the GSEs or any other kind of financial 
institution, that they are holding adequate capital? I think 
everything that we have said in the discussion today about 
reform of the GSEs would suggest that we are very much in 
favor, the Administration is, of ensuring that the GSEs are 
holding adequate capital against their commitments, and that 
is, I think, what you will see not only when the draft rule for 
QRM gets released, but also in the further discussions that we 
have about the future of the GSEs.
    Secretary Geithner. Well, one quick thing, Senator.
    Senator Vitter. Sure.
    Secretary Geithner. Again, our overall objective, and this 
has to be our shared objective, is to have the private markets, 
banks and investors, bear more of the risk in housing finance, 
not less of the risk. So absolutely, we want to make sure as we 
design these draft regulations that we are meeting that basic 
objective. We do not want to be working against that basic 
objective. And as I said, we expect to go out with a draft rule 
reasonably soon and that will be just a draft rule. We will 
have a chance for people to comment on that so we can adjust 
it, if necessary, to make sure we are consistent with that 
objective.
    Senator Vitter. So under the framework you are describing, 
would GSE loans in terms of down payments, risk retention, et 
cetera, be treated like other loans?
    Secretary Geithner. Senator, I do not think it is 
appropriate for either of us to comment on the details of these 
proposals yet because, again, we want to make sure that the 
people responsible do that carefully and they will come out for 
public comment soon in draft form. But again, our overall 
objective should be to make sure that we create a system where 
private investors, private banks, private individuals are 
holding more of the risk in housing finance, not less of the 
risk relative to the Government agencies in this context.
    Senator Vitter. OK. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you both for testifying and working on this very important 
challenge.
    I wanted to focus on option three and get a little better 
sense of some of the pieces. Perhaps those have not been laid 
out in detail, but at least a little bit of a sense of what you 
are thinking are thinking.
    In terms of a piece of the guarantee fund fee being pulled 
off for the Government's catastrophic guarantee fund, first, 
would that portion that would go to the Government's 
catastrophic guarantee, would that be adjustable in kind of an 
FDIC style, where it could be set and changed from year to year 
as the size of the fund grew and the risks seemed higher or 
lower?
    Secretary Donovan. Senator, I think that is something, 
obviously, that could be designed in the details. But I think 
one of the principles that we have as we laid out these options 
was that providing the ability to respond to market conditions, 
particularly as you enter a financial or a housing crisis, 
there is a need to ensure that that pricing can be adjusted, 
whether it is to grow those reserves more rapidly or to ensure 
that there is adequate capital available, adequate liquidity 
during that crisis. So I think some form of flexibility would 
be important.
    Senator Merkley. And my impression is, this catastrophic 
guarantee fund is designed as a last resort after private 
mortgage guarantee companies, I assume, fail, if you will. And 
so would that kick in after the stockholders have lost their 
value? Would it kick in after the bond holders have lost the 
value of their investment?
    Secretary Donovan. I think one of the primary areas that we 
focused on the report is to ensure that we are creating a 
system where there is real private capital at risk ahead of any 
guarantee. Were there to be that system, we would want to 
ensure that equity would be at risk and therefore would be 
wiped out, if you will, before there would be access to a 
guarantee in that----
    Senator Merkley. Including bond holders as well as stock?
    Secretary Donovan. Well, it depends who--if you are talking 
about the bond holders on securities, obviously, the protection 
would be for the bond holders on the securities. If those are 
bond holders to capital that goes to that institution, then 
yes, that would be at risk.
    Senator Merkley. I was speaking to the latter. So next, one 
of the concerns about Fannie and Freddie is they became so 
large, so systemically significant. Would there be a limit on 
the size of these private mortgage guarantee companies?
    Secretary Geithner. I think the most important thing to do 
would be to make sure that you regulate them for capital and 
that they are required to be subject to a set of comprehensive 
oversight supervision with capital requirements to do that. 
That would be the necessary test for this. I think the only way 
to limit the real risk to the system ultimately and the risk to 
the taxpayer in this context, beyond just requiring them to 
hold enough capital, is to make sure that if the Government is 
exposed to any risk of loss, there is, as Secretary Donovan 
said, there is a lot of capital ahead of the Government in that 
context.
    Secretary Donovan. I think the other important point here, 
as well, would be that independent of the size of the 
individual institutions, a fundamental premise of option three 
was that the footprint overall of that guarantee be limited 
relative to, as Secretary Geithner referred to it, the sort of 
nationalization option or continuing the current place where we 
are, where over 90 percent of new mortgages are guaranteed.
    So it is not just the individual size of the institutions 
but the overall size of any guarantee being limited to ensure 
that the primary risk in the market is borne by the private 
sector.
    Senator Merkley. You know, one of the things that we talked 
about under the Volcker Rule structure--actually, it was 
outside the Volcker Rule but was in Merkley-Levin--was that the 
companies that were private investment banks, as they became 
larger and more systemically significant, that the regulators 
could raise the capital requirements so as to recognize that 
additional risk of a particular single house going down. Could 
something like that be used in this incident to not necessarily 
completely put an upper limit on the size of companies, but to 
kind of encourage multiple smaller companies?
    Secretary Geithner. I think that perhaps I could start on 
that, Senator. I think it is very important generally, as you 
look across the system, that we recognize there is a level of 
concentration or consolidation that would be against our broad 
interests in this context, and we very much want to create a 
set of incentives in the system where we are preserving the 
very strong role played in that today by regional banks, by 
small community banks in this context. And one important thing 
to do in looking at these options is to make sure that we do 
not alter that balance in a way that would work against the 
objective of a very diversified, rich mix of institutions, 
small and large, in our current banking system.
    Now, in terms of capital requirements, I am personally very 
supportive of, and I welcome very much the recognition in 
legislation of this, of trying to make sure that for the 
largest institutions in the country that create the greatest 
potential risk in the context of stress, that they be held to 
higher capital standards than other banks, and that is the 
approach we have brought to these broad capital reforms around 
the world.
    Again, the basic principle should be not just that banks 
hold enough capital against risks, they could absorb a shock 
without having to turn to the Government or taxpayer, but for 
large institutions whose failure or whose mistakes would cause 
broader damage to the innocent or to the more prudent, you want 
to make sure that they are held to higher standards, as a 
whole. So I very much welcome that basic principle.
    Senator Merkley. And finally, under the description of 
option three, the Government would set standards for mortgages 
that could be in the pools, guaranteed by the private guarantee 
companies. Would those be different than the QRM standards, and 
what would guide those standards?
    Secretary Geithner. I hope not, just on the grounds that I 
think we would want to have a simple, uniform, tougher, more 
conservative set of standards for these things. You would want 
to try to improve the odds that you have got one framework for 
differentiating. But that depends a little bit on how these 
options are designed.
    Secretary Donovan. Just to echo Secretary Geithner's point, 
one of the clear problems that led us into this crisis in the 
first place was sort of a patchwork of various standards, or 
lack of standards, that applied across different types of 
mortgages. One of the important elements of the QRM is that it 
would hopefully level that playing field rather than continuing 
the patchwork that we saw before.
    Senator Merkley. Thank you.
    Chairman Johnson. Senator Kirk.
    Senator Kirk. Thank you, Mr. Chairman.
    Just picking up on everyone else's thought, and even the 
Secretary talking about increased risk retained by the private 
sector, I think one of the key problems is for the American 
people to best understand it the way I think about it is the 
movie, ``It's A Wonderful Life.'' The Bailey Building and Loan 
retained its mortgages and, therefore, expects to be repaid. I 
think it was Long Beach Savings which pioneered becoming just a 
loan origination house and they never expected to be repaid. 
And so they just skimmed the percentage and off-loaded loans 
onto the Government. So the Government actually was the problem 
because it turned banks and savings and loans into loan 
origination houses that never expected to be repaid, and, 
therefore, quality was not retained.
    What about a rule, if we look at other than option one, 
which required the originating bank to re-own out of 100 loans 
it made the bottom ten? And so if the Government found that out 
of 100 loans, these bottom ten were not performing, you have to 
re-own them. And so the garbage that you passed on to the 
Government needs to be recaptured by the loan, therefore 
sinking the bank that originated this terrible paper.
    Secretary Geithner. Senator, you have got the challenge 
exactly right and the problem exactly right and that may be one 
way to do that. Again, for this to work, you have to do two 
things, or maybe many more than two things. You need to make 
sure that you get the underwriting standards right and people 
who originate are required to be exposed to some of the risk in 
that judgment. But you also have to require that they hold 
capital against the risk, because as you said, in our system, 
we let people not just originate these things and well them----
    Senator Kirk. Right.
    Secretary Geithner. ----and they have legal liability 
there, but if they did not have capital, you did not have that 
protection in that context, and the people who bought those 
have no recourse against them, so----
    Senator Kirk. Right. Yes.
    Secretary Donovan. Senator, I would just add, and this 
connects back to the discussion we just had with Senator 
Merkley, by the nature of the design that we discussed for 
option three, they would be at risk not just for the ten worst 
mortgages, but, in fact, all 100 of those mortgages in the pool 
to the extent of the capital they are holding as well as the 
equity, whatever assets were held at that institution. And so I 
think we fundamentally agree with the nature of your comment.
    Senator Kirk. Right. A totally separate subject, because it 
is a hot issue. We now see Japanese equities have fallen 17 
percent, Chinese equities 1.4, Hong Kong 2.9, Taiwan 3.4, and 
Australia 2.1. Do you see a systemic risk forming here, because 
the assumption, you know, housing in general will always rise 
was a fundamental assumption that created a systemic risk in 
our system. Another problem may be Asia is strong, and 
therefore, actually, that assumption is incorrect, creating a 
systemic risk. I would guess that you could probably give me a 
better--that U.S. pensions and other holdings are probably, 
what, 1 to 3 percent held in Asian equities, which are now 
falling fairly rapidly. Could you describe if you see a 
systemic risk in the fall of Asian equities?
    Secretary Geithner. I do not, Senator, in this context. 
Again, I would focus much more on just the basic humanitarian 
reconstruction challenge and containing the risks and repairing 
the damage caused by the catastrophe there, and I think that is 
something that Japan, with assistance from the world community, 
can do, can achieve.
    Now, I do think it is important to recognize that we come 
into this period of challenge in the world economy in a much 
stronger position than we have been and you see much more 
confidence--and I think it is justified--here and around the 
world in the resilience of the process of repair and expansion 
you see underway. Now, of course, we want to make sure that we 
do everything we can to help sustain that. We do not want to 
jeopardize that. And I think that should be our focus and 
attention.
    Senator Kirk. I am concerned, though, because we see 
Toshiba and Toyota stopping production and it looks like we 
have a systemic shortage of power in Japan that will cripple 
large publicly traded companies in being able to maintain 
production.
    Secretary Geithner. Well, Senator, again, there are a lot 
of things to be concerned about in the world and I think that 
it is very important that we watch this carefully, and it is 
very hard to judge at this stage, again, what is going to be 
the magnitude of the short-term cost of production and output 
there. Again, our focus and attention is going to be on trying 
to help them make sure they can help meet the humanitarian 
challenge and the reconstruction challenge and I think we can 
be reasonably confident they are going to be able to do that.
    Senator Kirk. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. Thank you, 
Secretaries, for being here today.
    I actually want to go all the way back to the very 
beginning and the Ranking Member's conversation with you, 
Secretary Geithner, about taking the politics out of this, 
which I am all for. And one of the things that worries me in 
reading the three options and all the discussions that have 
been had is that even though we will not make an explicit 
guarantee, even though we will do everything that we are going 
to try to do to mitigate the private actors from believing that 
the Government is going to show up and rescue the markets, 
there is a nagging concern that they will always believe that 
we will be because of the sheer scale of housing, the 
importance of it to our economy, and I wonder if you could talk 
a little bit more about whether you see that as a risk and what 
it is we could do to try to mitigate it, that moral hazard.
    Secretary Geithner. I do see it as a risk, and I think you 
are right to highlight it, but I do not think it is beyond our 
capacity to make a substantial improvement in mitigating that 
risk. The options we proposed, in each of those options, any 
guarantee the Government provided would be explicit, carefully 
qualified, priced to the extent we can cover any risk or loss 
to the taxpayer, and a very important principle.
    Now, you could say, even if we achieve that, would we still 
be left as in all financial system with some risk that banks 
operate with the hope and expectation, or investors operate 
with the hope and expectation the Government would step in in 
the future, as we have in the past. That is a very important 
concern, and I think that the only way credibly we know to 
reduce that risk is to make sure we deliver the reforms that 
were put in place in legislation last year. And again, what 
those reforms do is require banks to hold much more capital--
not just banks, but entities that operate as banks hold much 
more capital against losses, that the Government cannot step in 
to save them from their mistakes.
    The only thing the Government can do is step in to 
dismember them safely with less risk of collateral damage to 
the innocent, and if we do those two things along with 
improving the incentives in the mortgage market so that not 
just banks but homeowners have more equity in their homes as a 
whole, I think we can make a very substantial difference in 
creating a system that is less vulnerable to crisis and less 
vulnerable to the moral hazard risk that pervades all financial 
systems.
    Secretary Donovan. Let me go back to sort of the premise of 
your question, which I think is important, as well, that part 
of this debate is to look at other countries around the world 
that have different housing finance systems and to say, well, 
they do not have mechanisms that protect against crisis in the 
same way that we do. But I think, in fact, if you look closely 
at those systems, there are--in almost every case, there is a 
recognition, exactly as you have said, that in the midst of a 
major financial crisis, the impacts on housing, on household 
savings, on a whole range of problems--labor mobility, for 
example--are so deep that, in fact, there is a system, whether 
explicit or not, that would step in, whether it is banking 
guarantees or some other form that exists, and a broad 
recognition that there needs to be a system that exists.
    And so we try, I think, in the report to be very explicit 
about that and to lay out options. And in each case, whether it 
is FHA alone or FHA plus some other form of backstop in crisis, 
in options two and three, recognize that we will need to step 
in. In fact, if you look at Mark Zandi's recent analysis of 
this, he says that had we not stepped in, the crisis would have 
been much deeper on the housing front.
    But I think as Secretary Geithner has laid out, designing 
that in the most clear, transparent way possible, putting 
private capital at risk in front of it as much as possible so 
that we minimize the chances, which are always there, of 
mispricing the guarantee or of having moral hazard, other 
effects, are minimized.
    Senator Bennet. And I was going to actually ask you to talk 
a little bit about the differences between what we saw with 
FHA, what we saw with Fannie and Freddie, but in the interest 
of--and I think it is important for people to focus on that--in 
the interest of time, I am going to skip that, because I do not 
want to get in trouble with the Chairman, and ask you another 
question.
    The White Paper notes that, quote, ``Fannie Mae and Freddie 
Mac were allowed to behave like Government-backed hedge funds, 
managing large investment portfolios for the profit of their 
shareholders with the risk ultimately falling largely on 
taxpayers.'' If we create something like the Administration's 
third option, should the private successors to Fannie and 
Freddie be allowed to maintain investment portfolios or should 
they be allowed to maintain them with certain restrictions on 
the investments?
    Secretary Donovan. I think there is no question that any 
portfolio activities should be dramatically different from what 
was there before. I think there are some minimal functions 
that, for example, if you are talking about multifamily housing 
in rural communities or in other underserved communities where 
there might be some need to accumulate loans for some short 
period of time prior to securitization, there are some 
relatively small activities that we might consider. But 
fundamentally, the scale of the portfolios, the lack of 
restrictions on the portfolios were fundamental problems. And, 
I think perhaps most importantly, ensuring that any guarantee 
that was provided did not backstop those portfolios, I think, 
are critical pieces of what we are proposing, fundamentally 
different from what was true at Fannie Mae and Freddie Mac.
    Senator Bennet. Thank you, Mr. Chairman.
    Chairman Johnson. Thank you.
    Senator Bennet. Thank you for your testimony.
    Chairman Johnson. We will have a second round of very brief 
questioning.
    Secretary Donovan, the Administration's report cautions 
against a hasty transition from Fannie Mae and Freddie Mac in 
the current economy, but it also recommends increasing the 
enterprise guarantee fees. Last week, we heard from the 
realtors and home builders that increasing these fees 
discourages potential home buyers. Some industry groups argue 
that these fees may drive borrowers to FHA-insured loans. By 
increasing these fees, are we moving more mortgages away from 
the private market and toward FHA?
    Secretary Donovan. Senator, first of all, I would say, and 
I want to echo Secretary Geithner's comments earlier, that we 
do, under any of the options, have to recognize that there will 
be some increased cost for mortgages. I think if you look back 
at the system that we had, there is no question that we 
underpriced risk and took on risks at the interest rates we 
provided that we were not prepared for. And so I think that is 
one recognition we have to make in the system going forward.
    I also think it is important that as we take steps with the 
GSEs, we also within FHA take prudent steps to ensure that we 
are not expanding risk through FHA and increasing our portfolio 
beyond its current footprint. And, in fact, our recent 
announcement of a 25-basis point increase in our premiums will 
help to do that, and I think sets the stage for private capital 
to begin to return. So I do think we are taking steps 
recognizing that through FHA.
    And one important point I would make, FHA's guarantees are 
100 percent guarantees, and so we take that risk very seriously 
and we have to ensure as we look at Fannie Mae and Freddie Mac 
that we are also doing things, whether it is looking at options 
like risk sharing or other legislative changes to FHA, that 
would ensure FHA is better prepared in the future to step in in 
this kind of role.
    Chairman Johnson. Would this be more likely in one of the 
options in the report rather than others?
    Secretary Donovan. I do think that if FHA is the sole 
guarantor, with VA and USDA playing a somewhat smaller role, 
but if the Federal Government in total through those three 
entities are the sole guarantors, particularly in the wake of a 
crisis, then I think there is certainly a risk that we take on 
a much larger footprint, if you will, in the market than would 
happen under options two or three.
    So clearly, that is something as we consider the various 
options we need to be aware of, and I think to work 
collaboratively with the Committee to ensure that FHA is 
prepared and that we continue to make changes for FHA to take 
on a larger footprint in crisis, as we have done in this one. 
There are many issues, systems issues around procurement and 
other things where ensuring we have the ability to operate 
effectively and efficiently as we step up in a crisis, those 
are things that I think ought to be a central part of what we 
are looking at as we consider reform to the GSEs.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Secretary Donovan, to quote in your words, the 
Administration is fully committed to exploring other measures 
to make sure that secondary market participants are providing 
capital to all communities. Then Secretary Geithner said, 
Government-supported incentives for housing that distorted the 
market. On the one hand, you say the Administration is fully 
committed to exploring Government incentives that will distort 
the market and are good to distort the market. What are some of 
the ways that the Administration is considering meeting these 
seemingly contradictory goals? Are you considering Government-
mandated lending quotas or an expansion of the CRA, Community 
Reinvestment Act, and how do you achieve some of these goals 
without politicizing lending decisions?
    Secretary Donovan. I think we have, Senator, talking about 
the risks of the politicization of any of these issues----
    Senator Shelby. And there are big risks there, are there 
not?
    Secretary Donovan. No question there are risks, but I would 
go back to something you said earlier in the hearing, which is 
that transparency can be a powerful tool to ensure that markets 
are working effectively----
    Senator Shelby. Absolutely.
    Secretary Donovan. ----and one of the things that we have 
seen is as we have provided transparency in the primary market 
through mechanisms like the Home Mortgage Disclosure Act, for 
example, we have seen that transparency be a powerful force to 
ensure that where you have homeowners that can be successful 
homeowners, that have the capacity to take on loans, that 
credit is provided in those communities.
    So I think there is a lot that we can do with transparency 
as well as making sure that we do not have an unlevel playing 
field between primary market and secondary market factors. So 
those are a couple of ideas I would point out.
    Senator Shelby. Secretary Geithner, your joint report 
states that the Obama administration's reform plan is designed, 
quote, ``to target the Government's vital support for 
affordable housing in a more effective manner.'' Numerous 
studies, including those conducted by the Congressional Budget 
Office and the Federal Reserve, have concluded that the Federal 
Government's implicit guarantee of Fannie and Freddie 
securities yielded a small benefit to borrowers. Most of the 
benefit went to Fannie and Freddie's shareholders and 
executives. Do you agree with the results of those studies?
    Secretary Geithner. I do.
    Senator Shelby. So has the value of Government guarantees 
for mortgage-backed securities been overstated by some, and 
probably me here, trying to push home ownership?
    Secretary Geithner. I think that in the context of Fannie 
and Freddie and the support the Government provided implicitly 
to those institutions for housing finance, you are right to say 
that most of the benefits of those guarantees did not go to the 
purported beneficiaries, and that would be something that you 
would want to make sure you avoided in the future if you were 
going to preserve any role for a guarantee, and again, I think 
there are ways to do that, Senator, that are not beyond our 
capacity to get right.
    Senator Shelby. I hope we can, because if you are 
socializing the risk, putting it on the taxpayer, and 
privatizing the profits to the shareholders, we have got a bad 
situation.
    Secretary Geithner. Exactly. And I would--we would not 
support, even if this Committee were inclined to, we would not 
support re-creating a system in which private shareholders were 
able to benefit from a guarantee designed to help make sure 
that homeowners have access to more affordable housing, and 
that an economy like ours is able to withstand shocks like this 
with less collateral damage.
    Senator Shelby. Would it be the position of both of you not 
to replicate another Fannie Mae and Freddie Mac?
    Secretary Geithner. Absolutely.
    Secretary Donovan. Absolutely.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Thanks again to Secretary Geithner and 
Secretary Donovan for being here today.
    It is essential that we create a stable, sustainable 
housing market for American families. The Administration's 
White Paper is a good starting point for our discussions about 
how to do that. I look forward to continuing those discussions 
as we further explore the options presented today.
    This hearing is adjourned.
    [Whereupon, at 11:51 a.m., the hearing was 
adjourned.]&I21[Prepared statements and additional material 
supplied for the record follow:]

                PREPARED STATEMENT OF SENATOR JACK REED

    I want to welcome both of our distinguished witnesses.
    We are here this morning to discuss the Administration's report to 
Congress on several possible pathways forward for reforming the housing 
finance market.
    To start off, let me say I am particularly pleased that the report 
focuses on achieving a better balance in the U.S. housing market to 
provide for a wider range of housing choices. This includes access to 
home ownership for those in a position to take on mortgages and a more 
robust and affordable rental housing sector, which would include 
something similar to a national Housing Trust Fund, which I created to 
support and develop affordable rental housing for more Americans.
    There is bipartisan agreement that we need to restructure Fannie 
and Freddie and limit the Government's role in the mortgage market. But 
we have to be careful and get this right, and not rush towards a 
solution that might not be the right one just for the sake of acting 
quickly.
    Changing the home financing landscape is going to have a major 
impact on consumers, construction workers, and taxpayers.
    If we act precipitously, as some have suggested, the already 
fragile housing market and the overall economy could be severely 
affected. The solution, at the end of the day, must be right and 
actually solve problems, instead of creating more problems.
    The proposals we will discuss today outline options to properly 
target and limit the Government's involvement in the mortgage business.
    However, we need to clearly remember that the Federal Government 
became involved in the housing finance system because of a series of 
major failures in this sector.
    In the 1930s, liquidity risk was born by the borrowers. Back then, 
a borrower took out a 5-year interest only loan and put 50 percent of 
the value of the home down as a down payment. At the end of the loan, 
the outstanding balance had to be paid or the loan had to be 
renegotiated, or rolled over.
    During the Great Depression, so many banks went under and borrowers 
lost so much value in their homes that these loans could not be 
refinanced or rolled over. As a result, we had a liquidity crisis, and 
there were massive numbers of foreclosures.
    In response, the Federal Government created the Federal Housing 
Administration, Fannie Mae, and the Federal Home Loan Banks to help 
provide liquidity for housing loans.
    FHA also standardized a new concept at the time--20-year mortgages 
where the loan would be repaid in full at the end with the FHA insuring 
lender repayment. Eventually, over time, this lead to the 
standardization of the 30-year mortgage.
    The next housing crisis requiring Government intervention was the 
savings and loan (S&L) crisis.
    As interest rates went up to 15 percent, S&Ls found themselves 
paying 15 percent in financing costs, but were only receiving 7 percent 
on home loans. This severe mismatch caused many to fail, and the S&L 
crisis was really an interest rate crisis, which also precipitated a 
Government response.
    Fast forward to 2008, to our most recent housing crisis--which many 
believe was caused by the failure to properly underwrite loans. In 
other words it was caused by underwriting risk. Lenders improperly 
believed they had found a way to sufficiently diversify risk through 
the securitization process that they no longer had to focus as much on 
the basic and fundamental tasks of ensuring that borrowers could repay 
the loan at the end of the day. We addressed some of these underwriting 
issues in Dodd-Frank by, for example, requiring lenders to ensure a 
borrower's ability to repay and requiring lenders to disclose the 
maximum a consumer could pay on a variable rate mortgage, with a 
warning that payments will vary based on interest rate changes.
    So, some key questions I will have for our witnesses this morning 
are: What have we learned from these various housing sector crises? And 
how can we preserve some of the strengths of our existing system--such 
as the 30-year fixed rate mortgage, a deep and liquid national mortgage 
market, and the standardization of mortgage products that has made them 
attractive for private sector investment--while making our system less 
subject to such crises in the future?
    I am pleased that Chairman Johnson is planning on holding a robust 
set of hearings on these issues in the months ahead, as we work towards 
how to best reform our housing finance system and provide access to 
decent, safe, and affordable housing for all Americans.
                                 ______
                                 
            PREPARED STATEMENT OF SENATOR MICHAEL F. BENNET

    Mr. Chairman, thank you for holding this important hearing.
    With this hearing, we start the difficult process of reforming our 
housing finance system and reducing the Government's role in the 
secondary mortgage market.
    As we start our work, it's critical that we remember that families 
across the country continue to struggle in this difficult economy. In 
Colorado, one property out of forty had some form of a foreclosure 
filing making the State 10th in the Nation when it comes to foreclosure 
problems. Between foreclosure sales and vacant homes, there are 
reminders across Colorado of how the failure in our housing market has 
fundamentally changed our lives.
    Problems with Fannie Mae and Freddie Mac are emblematic of a 
financial system that had spun completely out of control. As the 
subprime lending boom escalated, Fannie and Freddie sought to maximize 
their profits by entering this unstable market. By doing so, they 
undermined their financial integrity and exposed taxpayers to billions 
of dollars in risk.
    Moving forward, we need to ensure that the American taxpayer will 
not be subject to such exposure again. We also need to reduce the 
Government's involvement in the secondary mortgage market. Finally, 
these reforms must ensure that middle-income families can still attain 
the American dream of home ownership.
    I look forward to this challenge. Thank you Mr. Chairman.
                                 ______
                                 
               PREPARED STATEMENT OF SENATOR JERRY MORAN

    Thank you Chairman Johnson and thank you Secretary Geithner and 
Secretary Donovan for appearing before the Committee to discuss the 
critical need for reform of our Nation's housing market. The white 
paper submitted to Congress by your Administration is a foundation to 
the discussions we will be having over the coming months. It is lacking 
in specific detail and in recommendations, but does give my colleagues 
and me some food for thought.
    There is no doubt that our housing markets are fragile and will 
likely remain so for some time. Nine out of every ten mortgages being 
made today are supported by the Federal Government. Any fundamental 
reform of Fannie Mae, Freddie Mac, and FHA must take this current 
fragility into account. That being said, the housing market's heavy 
reliance on the GSEs must not serve as an excuse to delay the debate. 
Taxpayers have pumped tens of billions into the failed giants Fannie 
Mae and Freddie Mac and it is highly unlikely that they will be made 
whole.
    However we choose to reform the system, whether it is one of the 
three options that the Administration has presented or something else 
entirely, we must make sure that taxpayers are protected and that the 
private markets are not disadvantaged. There are some who may believe 
that we have time on our side and that this is a discussion that can 
begin somewhere down the road. I am not one who is willing to postpone 
this debate. I stand willing to begin the necessary work with my 
colleagues and with the Administration so that we can reach a point 
where taxpayers are protected and responsible home ownership remains an 
option for Kansans.
    Thank you both for appearing before us today and I look forward to 
your testimony.
                                 ______
                                 
                 PREPARED STATEMENT OF TIMOTHY GEITHNER
                 Secretary, Department of the Treasury
                             March 15, 2011

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify this morning.
    Last month, we released a report outlining our vision of the next 
steps for reforming the housing finance market. My testimony today 
summarizes the content of that report.
    There is little dispute that the financial crisis was partly the 
result of fundamental flaws in the housing finance market. The 
consequences of those flaws, and the losses Fannie Mae and Freddie Mac 
have inflicted on taxpayers, make clear that we must build a healthier, 
more stable market that will work better for American families and our 
Nation's economy.
    For decades, the Government supported incentives for housing that 
distorted the market, created significant moral hazard, and ultimately 
left taxpayers responsible for much of the risk incurred by a poorly 
supervised housing finance market. In more recent years, we allowed an 
enormous amount of the mortgage market to shift to where there was 
little regulation and oversight. We allowed underwriting standards to 
erode and left consumers vulnerable to predatory practices. We allowed 
the market to increasingly rely on a securitization chain that lacked 
transparency and accountability. And we allowed the financial system as 
a whole to take on too much risk and leverage.
    These were avoidable mistakes. Their convergence, as we all know, 
resulted in a financial system vulnerable to bubbles, panic, and 
failure. Reforming our country's housing finance market is an essential 
part of our broader efforts to help ensure Americans will never again 
suffer the consequences of a preventable economic crisis.
    Our proposal for reform breaks sharply from the past to 
fundamentally transform the role of Government in the housing market.
    We believe the Government's primary role should be limited to 
several key responsibilities: consumer protection and robust oversight; 
targeted assistance for low- and moderate-income homeowners and 
renters; and a targeted capacity to support market stability and crisis 
response.
    The Administration is committed to a system in which the private 
market--subject to strong oversight and strong consumer and investor 
protections--is the primary source of mortgage credit.
    We are committed to a system in which the private market--not 
American taxpayers--bears the burden for losses.
    And while we believe that all Americans should have access to 
affordable, quality housing, our goal is not for every American to 
become a homeowner. We should provide targeted and effective support to 
families who have the financial capacity to own a home but are 
underserved by the private market, as well as a range of options for 
Americans who rent.
    As the housing market recovers and the economy heals, 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.

Reducing the Government's Role in the Mortgage Market
    In the wake of the financial crisis, private capital has not 
sufficiently returned to the mortgage market, leaving Fannie Mae, 
Freddie Mac, FHA, and Ginnie Mae to insure or guarantee more than nine 
out of every ten new mortgages. Under normal market conditions, the 
essential components of housing finance--buying houses, lending money, 
determining how best to invest capital, and bearing credit risk--should 
be private sector activities.
    We will work closely with the Federal Housing Finance Agency to 
determine the best way to responsibly reduce Fannie Mae and Freddie 
Mac's role in the market and ultimately wind down both institutions. 
This objective can be accomplished by gradually increasing guarantee 
pricing at Fannie Mae and Freddie Mac, as if they were held to the same 
capital standards as private institutions; reducing conforming loan 
limits by allowing the temporary increases enacted in 2008 to expire as 
scheduled on October 1, 2011; and gradually increasing the amount of 
private capital that risks loss ahead of taxpayers through credit loss 
protections from private entities and gradually increased down payment 
requirements. We also support the continued wind down of Fannie Mae and 
Freddie Mac's investment portfolios at a rate of no less than 10 
percent annually.
    I want to emphasize that it is very important that we wind down 
Fannie Mae and Freddie Mac at a careful and deliberate pace. Closing 
the doors at Fannie Mae and Freddie Mac without consideration for the 
pace of economic recovery could shock an already-fragile housing 
market, severely constrain mortgage credit for American families, and 
expose taxpayers to unnecessary losses on loans the institutions 
already guarantee. It is ultimately in the best interest of the economy 
and the country to wind down Fannie Mae and Freddie Mac in a 
responsible and prudent manner.
    Treasury estimates show that the net cost of our support for Fannie 
and Freddie will total approximately $73 billion through 2021, 44 
percent lower than the $134 billion in net investments requested or 
drawn to date. This estimate is consistent with the FHFA's stress 
tests, which have proven to be appropriately conservative. Costs have 
already begun to decline; in the third and fourth quarter of 2010, the 
combined net costs to the taxpayers of Fannie Mae and Freddie Mac 
decreased by approximately $2 billion largely as a result of the 
recovering housing market and reforms instituted by FHFA as 
conservator. Minimizing loss to the taxpayer will continue to be a 
priority during the reform process, and many of the steps we lay out in 
our plan are likely to help us further reduce the ultimate cost.
    The Administration is fully committed to ensuring Fannie Mae and 
Freddie Mac have sufficient capital to perform under any guarantees 
issued now or in the future, as well as the ability to meet any of 
their debt obligations. Ensuring these institutions have the financial 
capacity to meet their obligations is essential to maintaining 
stability in the housing finance market and the broader economy. During 
the transition, it is also important that the operations of Fannie Mae 
and Freddie Mac continue to serve the market and the American people, 
including retaining the human capital necessary to effectively run both 
institutions.
    As we decrease Fannie Mae and Freddie Mac's presence in the market, 
we will also scale back FHA to its more traditionally targeted role. We 
support decreasing the maximum loan size that qualifies for FHA 
insurance--first by allowing the present increase in those limits to 
expire as scheduled on October 1, 2011, and then by reviewing whether 
those limits should be further decreased going forward.
    We will also increase the pricing of FHA mortgage insurance. FHA 
has already raised premiums twice since the beginning of this 
Administration, and an additional 25 basis point increase in the annual 
mortgage insurance premium is included in the President's 2012 Budget 
and will be levied on all new loans insured by FHA as of mid-April 
2011. This will continue ongoing efforts to strengthen the capital 
reserve account of FHA and align its pricing structure in a more 
appropriate relationship with the private sector, putting the program 
in a better position to gradually return to its traditional and more 
targeted role in the market.
    The Administration also supports reforms at the Federal Home Loan 
Banks (FHLBs) to strengthen the FHLB system, which provides an 
important source of liquidity for small- and medium-sized financial 
institutions. These reforms include instituting single district 
membership, capping the level of advances for any institution, and 
reducing the FHLBs' investment portfolios.
    We also believe it is appropriate to consider additional means of 
advance funding for mortgage credit as a part of the broader reform 
process, including potentially developing a legislative framework for a 
covered bond market. We will work with Congress to explore 
opportunities in this area.

Addressing Fundamental Flaws in the Mortgage Market
    Winding down Fannie Mae and Freddie Mac and implementing reforms at 
FHA and the FHLBs, however, is only one side of the coin. These steps 
alone will not give rise to a housing finance market that meets the 
needs of families and communities, nor will it guarantee that private 
markets can effectively play a predominant role. We must also pursue 
reforms that restore confidence in the mortgage market among borrowers, 
lenders, and investors.
    The Administration supports the strong implementation of reforms to 
help address precrisis flaws and rebuild trust and integrity in the 
mortgage market. Taken together, these reforms will improve consumer 
protection, support the creation of safe, high-quality mortgage 
products with strong underwriting standards, restore the integrity of 
the securitization market, restructure the servicing industry, and 
establish clear and consolidated regulatory oversight. The Dodd-Frank 
Act laid the groundwork for many of these reforms. We will implement 
its provisions in a thoughtful manner to protect borrowers and promote 
stability across the housing finance markets.
    Treasury is currently coordinating critical reforms to the 
securitization market that will require originators and securitizers to 
retain risk, including coordinating an interagency process to determine 
the parameters for Qualified Residential Mortgages (QRM) under the 
Dodd-Frank Act. This summer, the Consumer Financial Protection Bureau 
will assume authority to set new rules to curb abusive practices, 
promote choice and clarity for consumers, and set stronger underwriting 
standards. Federal regulators will require banks to increase capital 
standards, including maintaining larger capital buffers against higher-
risk mortgages that have a greater risk of default.
    Treasury is also actively participating in interagency efforts to 
design and implement near-term reforms that will help correct chronic 
problems in the servicing industry, which has proven especially ill-
equipped to deal fairly and efficiently with the sharp increase in the 
number of families facing foreclosure. Right now, we are working 
together to design national servicing standards that better align 
incentives and provide clarity and consistency to borrowers and 
investors regarding their treatment by servicers, especially in the 
event of delinquency. Our work includes identifying ways to reduce 
conflicts of interest between holders of first and second mortgages and 
improving incentives for servicers to work with troubled borrowers to 
avoid foreclosure.
    Alongside these efforts, Treasury, the Department of Housing and 
Urban Development, and the Department of Justice are coordinating the 
Administration's interagency foreclosure task force, which is comprised 
of eleven Federal agencies and also works closely with the State 
Attorneys General. In light of reports of misconduct in the servicing 
industry, the task force is currently reviewing foreclosure processing, 
loss mitigation, and disclosure requirements at the country's largest 
mortgage servicers. Those that have acted improperly will be held 
accountable.

Providing Targeted and Transparent Support for Access and Affordability
    Low-and moderate-income families and communities account for a 
large proportion of all home purchase mortgages, and 100 million 
Americans are renters. The Administration stands strongly behind our 
obligation to support an adequate range of affordable housing options 
and access to fairly priced, sustainable mortgage credit for all 
communities and families--including those in rural and economically 
distressed areas, and those with low- or moderate-incomes.
    Although home ownership is not the best option for everyone, 
affordable opportunities should be available to Americans with the 
financial capacity to own a home. Part of our efforts to reform the 
housing finance system will focus on helping ensure FHA is a 
sustainable, efficient resource for creditworthy first-time homebuyers 
and families of modest incomes. We are working expeditiously with the 
FHA to plan and carry out reforms so its programs are more efficient 
and responsive to changing market conditions. To improve and streamline 
other Government initiatives, the Departments of Housing and Urban 
Development, Agriculture, and Veterans Affairs--which all operate 
targeted housing finance programs--will establish a task force to 
explore ways to better coordinate or consolidate their efforts.
    We will also consider measures to help ensure secondary market 
participants--securitizers and mortgage guarantors--provide capital to 
all communities in ways that reflect activity in the primary market 
consistent with safety and soundness. In addition, we will focus on 
making sure all mortgage market participants comply with 
antidiscrimination laws, and work with Congress to require greater 
transparency for data that tracks where and to whom mortgage credit is 
flowing.
    Our approach should also encourage greater balance between home 
ownership and rental opportunities. That means improving support to the 
one-third of Americans who rent their homes, and especially to low- and 
moderate-income families. In the near term, the Administration will 
begin work to strengthen and expand FHA's capacity to support both 
lending to the multifamily market and adequate financing for affordable 
properties that private credit markets generally underserve. As part of 
our efforts, we will explore innovative ways to finance smaller 
multifamily properties, which contain a third of all multifamily rental 
units but the housing finance system has not adequately served.
    Addressing long-standing problems in housing finance, like rental 
supply shortages for the lowest income families, will require a 
dedicated commitment, but it is one that can be made in a budget 
neutral way. We look forward to working with Congress and other 
stakeholders to discuss this and other avenues for improving access and 
affordability in a targeted, transparent way.

Options for the Long-Term Structure of Housing Finance
    In the paper the Administration released last month, we laid out 
three potential ways to structure Government support in a housing 
finance market where the private sector is the predominant provider of 
mortgage credit.
    In each option, Government support would be transparent, explicit, 
and limited. Each would make private markets the primary source of 
mortgage credit and the primary bearer of mortgage losses. Each would 
preserve FHA assistance and similar Government initiatives that assist 
targeted groups, such as low- and moderate-income families, farmers, 
and veterans.
    The first option would limit the Government's role almost 
exclusively to these targeted assistance initiatives. The overwhelming 
majority of mortgages would be financed by lenders and investors and 
would not benefit from a Government guarantee.
    In the second option, targeted assistance through FHA and other 
initiatives would be complemented by a Government backstop designed 
only to promote stability and access to mortgage credit in times of 
market stress. The Government backstop would have a minimal presence in 
the market under normal economic conditions, but would scale up to help 
fund mortgages if private capital became unavailable in times of 
crisis.
    The third option broadens access for creditworthy Americans and 
helps ensure stability in times of market stress. Alongside the FHA and 
targeted assistance initiatives, the Government would provide 
reinsurance for certain securities that would be backed by high-quality 
mortgages. These securities would be guaranteed by closely regulated 
private companies under stringent capital standards and strict 
oversight, and reinsured by the Government. The Government would charge 
a premium to cover future claims and would not pay claims until private 
guarantors are wiped out.
    The report we released last month discusses the advantages and 
disadvantages of each approach in additional detail, and also 
encourages Congress and the public to evaluate each option in light of 
four common criteria: access to mortgage credit, including the future 
role of the 30-year fixed-rate mortgage; incentives for private 
investment in the housing sector; taxpayer protection; and financial 
and economic stability.
    Part of our intention in providing this narrow set of options and 
key criteria by which they should be judged is to encourage an honest 
conversation about the merits and drawbacks of each approach among the 
Administration, Congress, and stakeholders. We are faced with difficult 
choices that will involve real trade-offs. The challenge before us is 
to strike the right balance between providing access to mortgages for 
American families and communities, managing the risk to taxpayers, and 
maintaining a stable and healthy mortgage market.
    In choosing among these options, care must be given to designing a 
system that maximizes the benefits we are seeking from Government 
involvement in the mortgage market, while minimizing the costs. We 
should also be sure to consider how to utilize the existing systems and 
assets in our housing finance system, including those at Fannie Mae and 
Freddie Mac, as best as possible for the benefit of the taxpayer and 
the American people.
    Each of the longer-term reform options we have outlined will 
require legislation from Congress, and we hope to work together with 
you and your colleagues to pass comprehensive legislation within the 
next 2 years. Failing to act would exacerbate market uncertainty and 
risk leaving many of the flaws in the market that brought us to this 
point in the first place unaddressed. We look forward to continuing the 
dialogue with consumer and community organizations, market 
participants, and academic experts as we work together to build a 
housing finance market that is stronger and more stable than it was in 
the past.
    I want to conclude with one important point. Housing is a critical 
part of our economy and we will proceed with our plan for reform with 
great care. Our objective, after all, is a healthier, more stable 
housing finance system. While we are confident that the steps we have 
laid out follow the right path, haste would be counterproductive--
possibly destabilizing the housing finance market or even disrupting 
the broader recovery.
    I'd be happy to take your questions now and, again, thank you for 
the opportunity to be here today.
                                 ______
                                 
                  PREPARED STATEMENT OF SHAUN DONOVAN
         Secretary, Department of Housing and Urban Development
                             March 15, 2011

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify today on behalf of 
the Obama administration's efforts to reform and strengthen America's 
system of housing finance.
    I appear before you today at a time when our housing market and 
underlying economy continue to recover from the worst crisis since the 
Great Depression, while still mindful that this recovery remains 
fragile. We have made remarkable progress these past 2 years, which I 
will describe in greater detail below. But we must also look to the 
future to ensure that such a crisis never happens again--and our recent 
proposal for reform, Reforming America's Housing Finance Market, sets 
the stage for a robust public discussion of how we can do that. At the 
end of the day, the housing finance system must work for all American 
families, whether they are high or low income, owners or renters.
    Before discussing the report itself, I would like to say a few 
words about the steps that we have taken to stabilize a fragile housing 
market. I will then focus on three key elements in the report. First 
and foremost is the Administration's commitment to housing 
affordability and access to mortgage credit. Second is the critical 
role the Administration proposes for the FHA going forward, and third 
is how the Administration and Congress must work together to ensure 
housing finance advances opportunity in every community.
Administration Efforts To Stabilize the Housing Market
    Mr. Chairman, immediately upon taking office, President Obama and 
this Administration quickly took several steps to confront the economic 
crisis, including steps to stabilize a housing market that was 
declining rapidly with seemingly no bottom. House prices were in 
freefall--having fallen every month for 30 straight months before the 
inauguration. Home equity had been slashed in half--losing $6 trillion 
total--which wiped out wealth for many families. And we were losing an 
average of 753,000 jobs every month and were in the middle of 22 
consecutive months of job losses.
    With the housing market continuing to collapse and private capital 
in full retreat, the Administration had no choice but to take action.
    Federal Reserve and Treasury Department mortgage-backed securities 
purchase programs helped keep mortgage interest rates at record lows, 
enabling many American families with equity in their homes to refinance 
into sustainable mortgage products at significant monthly savings. 
Indeed, refinancing a mortgage amortized over 30 years from 6 percent 
down to 4 percent cuts monthly payments by 20 percent. These savings 
can then be applied to other household budget needs or put away for a 
rainy day, a college fund, to start a new business, or for retirement.
    To ensure mortgages were available at those low rates, the 
Administration provided critical support for Fannie Mae and Freddie 
Mac, which had been put into conservatorship under the Administration 
of George W. Bush, and FHA and Ginnie Mae stepped in to play a larger 
role in the home purchase and refinancing markets. As reported in the 
Obama Administration's February Housing Scorecard, since April 2009, 
more than 9.5 million homeowners have been able to refinance their 
mortgages to benefit from lower interest rates, saving each household 
an average of $140 per month or, collectively, $18.1 billion annually.
    It should be noted moreover that the vast majority of losses the 
GSEs have incurred are from loans made prior to conservatorship. 
Indeed, since Fannie Mae and Freddie Mac were placed into 
conservatorship by the previous Administration, the FHFA has 
strengthened underwriting standards and adjusted pricing to better 
reflect risk, and key indicators show that the quality of loans they 
are making has improved substantially--allowing the GSEs to play an 
important role supporting our housing market over the last 2 years.
    And collectively, the FHA's loss mitigation policies and the 
Administration's Home Affordable Modification Program (HAMP) set an 
example for mortgage modification efforts that the private market took 
too long to adopt but has finally begun to incorporate into their 
servicing practices. More than 4.2 million distressed borrowers have 
received mortgage assistance since April 2009--including HAMP 
modifications, FHA loss mitigation activities, and voluntary private 
efforts as part of the HOPE NOW alliance--more than twice the number of 
foreclosures completed during that time. Monthly foreclosure starts are 
down more than 25,000 per month from this same time 1 year ago. While 
some of this decline may be attributed to servicer process reviews that 
are taking place in response to the recent discovery of widespread 
foreclosure processing issues, we are seeing encouraging signs that 
fewer families are entering delinquency.
    In short, our efforts are helping struggling families, their 
communities, and the economy. Foreclosure starts are down, and, most 
importantly, we have seen 12 straight months of job growth in the 
private sector.

The Need for Reform
    For all of the efforts to date, though, there is much more to do. 
We must continue to take steps to facilitate the return of private 
capital to the housing finance system in a responsible way. Last 
summer, Congress passed, and the President signed, sweeping financial 
reform legislation. Crucially, the Dodd-Frank Wall Street and Consumer 
Protection Act, provides vital protections for consumers and investors 
that will help end abusive practices in the mortgage market and improve 
the stability of the overall housing finance market.
    In keeping with our obligations under Dodd-Frank, the Obama 
Administration recently delivered a report to Congress, Reforming 
America's Housing Finance Market, which provides a path forward for 
reforming our Nation's housing finance system. The report outlines 
steps that will be taken to wind down Fannie Mae and Freddie Mac and 
help bring private capital back to the market in a first loss position. 
Moreover, it describes how to fix fundamental flaws in the mortgage 
markets and better target the Government's support for a full range of 
housing that is affordable for its occupants, and lays out choices for 
longer-term reforms.
    The President believes that an integral part of reforming the 
housing finance system must be ensuring that Americans have access to 
quality housing they can afford. This involves supporting a range of 
affordable options. For the millions of Americans who rent, this means 
designing a system that can consistently provide necessary financing to 
appropriately maintain those rental properties and support development 
of affordable housing opportunities in communities that provide access 
to decent jobs and good schools. For current and aspiring homeowners, 
we reaffirm our commitment to promoting sustainable home ownership 
predicated on safe mortgages. We continue to believe that every 
American who has the credit history, the financial capacity and the 
desire to own a home should have the opportunity to take that step--and 
that the private sector will continue to play a crucial role in 
providing fairly priced access to mortgages in all communities.
    Although some have suggested Fannie and Freddie's affordability 
goals were solely responsible for their failure, they were not. Indeed, 
the vast majority of mistakes that were made--poor underwriting 
standards, underpriced risk, and insufficient capital with inadequate 
regulatory or investor oversight--mirrored those made in the private 
label securities market where affordability goals were simply not a 
factor. It was these flaws that drove the GSEs and the broader market 
to failure, not the affordability goals.
    Nevertheless, we must recognize that the GSEs' affordable housing 
goals, while well intended, were not well designed. They didn't respond 
effectively to the needs of underserved communities and they were 
decidedly misaligned with mortgage origination by primary market 
actors. Worst of all, they failed to prevent the kind of high-cost, 
predatory loans which devastated countless communities and were one of 
the roots of the crisis.
    In reforming the housing finance system, we have before us an 
opportunity to ensure that our efforts to provide access to mortgage 
credit and promote housing affordability are more effective than in the 
past. Those efforts must be better targeted, more transparent, and more 
focused on providing support that is financially sustainable for 
families and communities alike. We must remain cognizant that secondary 
market activities are a significant driver of liquidity in the primary 
market and variations in access to mortgage finance across communities 
is substantively impacted by them.

The Importance of a Robust and Responsible Private Mortgage Market
    FHA and the GSEs have stepped into the void left when private 
capital for mortgage finance dried up early in the housing crisis. They 
have played, and continue to play, this critical countercyclical role. 
But as we return to normal market function, we are committed to 
shrinking Government's oversized footprint in the mortgage market. The 
Government-backed share of the current mortgage market is well in 
excess of 90 percent, which is far higher than we would like in normal 
times.
    Similarly, FHA alone accounts for more than 20 percent of the 
market--almost twice its historical norms and about seven times bigger 
than its share leading up to the crisis, when typical FHA borrowers 
were frequently convinced to take on unsustainable and often predatory 
products flowing through effectively unregulated channels. FHA's 
countercyclical activities have been critical in providing mortgage 
financing during the crisis. By facilitating the availability of vital 
liquidity through a variety of approved community banks, credit unions, 
and national lenders, FHA has helped over 2 million families buy a home 
since President Obama took office--80 percent of whom were first-time 
buyers. FHA has also helped nearly 1.5 million existing homeowners 
refinance into stable, affordable products, with monthly savings 
exceeding $100 on average.
    FHA, along with VA and USDA, are not alone in providing liquidity 
for mortgages during this crisis. Nearly all non-Ginnie Mae residential 
mortgage-backed securities issued since the crisis began have come from 
the GSEs. Without them playing this role, the availability of credit 
for families purchasing homes during these times of economic stress 
would have been dramatically restricted, leading to an even more strain 
on the housing market.
    But this level of Government exposure isn't sustainable--and the 
time has come to begin to bring private capital back. The options we 
laid out in the report help us get there.

Towards a New System of Housing Finance
    Bringing private capital back into the housing finance system does 
not mean eliminating all Government involvement in housing finance. We 
believe that a Government role, targeted correctly, and with the right 
protections for taxpayers, should remain an important component of any 
future system. That is why all three of the reform options we lay out 
in the white paper include a strong, resilient FHA and solid consumer 
and investor protections.
    To that end, reforming and strengthening FHA is the first of four 
primary areas of reform to achieve broader mortgage access and housing 
affordability. The other crucial components of reform are a commitment 
to affordable rental housing, a flexible and transparent funding source 
for access and affordability initiatives, and strong measures to ensure 
that ensure that capital is available to creditworthy borrowers in all 
communities, including rural areas, economically distressed regions, 
and low-income communities.

A Reformed and Strengthened FHA
    Within the existing authorities granted to us by Congress, we have 
already begun the necessary process of making changes to FHA to ensure 
that it will be able continue its mission. FHA has already made the 
most sweeping combination of reforms to credit policy, risk management, 
lender enforcement, and consumer protection in its history. These 
reforms have strengthened our financial condition and minimized risk to 
taxpayers, while allowing us to continue fulfilling our mission of 
providing responsible access to home ownership for first-time 
homebuyers and in underserved markets.
    In the near term, we look to Congress to pass FHA reform 
legislation that enhances FHA's lender enforcement capabilities and 
risk management efforts critical to our ability to monitor lender 
performance and ensure compliance, among other things. Indeed, last 
year the House of Representatives passed an FHA reform bill, H.R. 5072, 
containing an array of changes along these lines, and, while similar 
legislation was introduced in the Senate, action on the bill was not 
completed. We look forward to working with both chambers of Congress to 
enact these proposals into law.
    Longer term, we also hope to work with Congress to give FHA 
additional flexibility to respond to stress in the housing market and 
to manage its risk more effectively. This will mean giving FHA 
flexibility to adjust fees and programmatic parameters more nimbly than 
it can today. FHA should also have the technology and talent needed to 
run a world-class financial institution.
    Strengthening and reforming FHA in a way that is healthy for its 
long term finances and ensures that FHA is able to continue its mission 
of providing access to mortgages for low- and moderate-income families 
is a central component of broader systemic reforms. While FHA has 
already changed policy to require that borrowers with lower FICO scores 
make larger down payments, FHA will consider other options, such as 
lowering the maximum loan-to-value ratio for qualifying mortgages more 
broadly. In considering how to apply such options, FHA will continue to 
balance the need to manage prudently the risk to FHA and the borrower 
with its efforts to ensure access to affordable loans for lower- and 
middle-income Americans, including providing access to home ownership 
for first-time homebuyers and underserved markets.
    And similar to the Administration's broader reform of the U.S. 
housing finance system, FHA will take any steps for reform carefully to 
ensure that they do not undermine the broader recovery of the housing 
market. Similarly, as we consider changes in such areas as down 
payments and LTV ratios, we will make sure to retain the flexibility to 
respond to changing market conditions, so that we are able to manage 
risk, and maintain access, as effectively as possible.
    Some have expressed concerns that the increases to the monthly 
premium set to go into effect next month--on the order of $30 per month 
for the average borrower--and any increase in down payment requirements 
have the potential to excessively restrict access to credit or 
perpetuate a dual credit market. We believe that the benefit to the 
financial health of FHA of the relatively modest premium increase is 
appropriately balanced with the need to maintain access, as the change 
remains affordable for almost all homebuyers who would qualify for a 
new loan. Similarly, we will only pursue increases in down payment 
where the impact on access is not prohibitive.

A Commitment to Affordable Rental Housing
    With half of all renters spending more than a third of their income 
on housing--and a quarter spending more than half their income--this 
Administration believes that as part of a balanced housing policy there 
should be a range of affordable options for the millions of Americans 
who rent. Reducing Government's role in the single family market makes 
this commitment even more critical.
    Private credit markets have generally underserved multifamily 
rental properties that offer affordable rents, preferring to invest in 
high-end developments. By contrast, Fannie Mae and Freddie Mac 
developed expertise in profitably providing financing to the middle of 
the rental market, where housing is generally affordable to moderate-
income families. As we wind down Fannie Mae and Freddie Mac, it will be 
critical to find ways to maintain funding to this segment of the 
market.
    One option would be to expand FHA's capacity to support lending to 
the multifamily market. Utilizing existing multifamily expertise so 
that FHA and other entities continue the industry's current best 
practices and retain valuable human capital would help achieve this 
objective.
    We will also consider a range of reforms, such as risk-sharing with 
private lenders to reduce the risk to FHA and the taxpayer, and 
developing programs dedicated to hard to reach property segments, 
including the smaller properties that contain one-third of all rental 
apartments.

Dedicated Funds for Targeted Home Ownership and Rental Affordability
    Support for affordable housing requires consistent, flexible, and 
transparent funding. Although FHA and other Federal affordable housing 
policies do a great deal to provide access and affordability, we 
recognize that a more balanced system will require additional resources 
to address clear gaps. That was the goal of the National Housing Trust 
Fund, which was authorized by Congress in 2008, but which has yet to 
receive funding. And with the largest increase in worst case housing 
needs in the quarter-century history of the survey--the necessity for 
strong support of affordable housing has never been more clear.
    That is why the Administration will work with Congress on 
developing a new dedicated financing mechanism to support affordable 
home ownership and rental housing that current policies cannot 
adequately address. This funding stream would support the development 
and preservation of more affordable rental housing for the lowest-
income families to address serious supply shortages. On the ownership 
side, it would support down payment assistance, counseling, or other 
mechanisms to help qualified low and moderate-income homebuyers, in a 
form that does not expose them or financial institutions to excessive 
risk or cost.
    The funds could be used to scale up support for proven nonprofit 
partnerships for affordable housing production and preservation that 
can attract much larger amounts of private capital. This is the purpose 
of the Capital Magnet Fund, also enacted in 2008 and funded in FY2010 
as a pilot demonstration administered by the Treasury Department's 
Community Development Financial Institutions Fund. And funding would 
help to overcome market failures that make it hard to develop a 
secondary market for targeted affordable housing mortgages, such as 
that for small rental properties.
    These components target specific needs in flexible ways that can 
engage a range of partners and respond to local priorities and 
opportunities. We will work with Congress to ensure that funding will 
be transparent and targeted to clearly defined objectives and programs.

Ensuring That Capital Is Available to Creditworthy Borrowers in All 
        Communities
    Last, housing finance reform must include measures to ensure that 
capital is available to creditworthy borrowers in all communities, 
including rural areas, economically distressed regions, and low-income 
communities. Our plan calls for greater transparency that requires 
secondary market actors to disclose information on the credit, 
geographic, and demographic characteristics of the loans they package 
into securities. In addition to benefits for investors, greater 
transparency allows us know who is abiding by fair lending and equal 
credit obligations--and who's not.
    A key lesson from this crisis is that decisions made in the 
secondary market very clearly drive lending practices in the primary 
market--and the potential for disparate impact in the availability and 
quality of mortgages in underserved communities is very real.
    To that end the Administration is fully committed to exploring 
other measures to make sure that secondary market participants are 
providing capital to all communities in ways that reflect activity in 
the private market, consistent with their obligations of safety and 
soundness.

Long-term Options
    Beyond the key foundations of a new, reformed housing finance 
system based on the principles discussed above, the extent of any 
Government guarantee in the system has yet to be determined--and our 
report presents three options. While I would refer the Committee to the 
report itself for a detailed discussion of the advantages and drawbacks 
of each, I would note that the issue most likely to impact American 
families is the question of the availability and pricing of long-term, 
fixed-rate financing under each of the options. For decades, the 30-
year, fixed rate mortgage has allowed families to safely build wealth 
and climb the ladder to the middle-class. So as we consider the options 
for a future housing finance system, I believe we should consider 
carefully the implications of these choices on the availability and 
pricing of those mortgages.
    In all of these options, however, a reformed and strengthened FHA 
remains an important participant in the market. This Administration 
believes there continues to be an important role for Government in 
ensuring access to mortgage credit and housing affordability--one that 
incorporates lessons learned from the past. We will continue to ensure 
that creditworthy low- and moderate-income borrowers have access to 
affordable mortgages.

Winning the Future Starts at Home
    Ultimately, Mr. Chairman, this plan is about bringing private 
capital back into a healthier housing finance system and providing a 
balanced national housing policy that offers all Americans the choices 
in housing that make sense for them and for their families. Whether it 
is rental options near good schools and good jobs, access to credit for 
those in a position for sustainable home ownership, or assistance for 
those who feel the strain of high housing costs, the housing finance 
system must meet their needs, and we look forward to working with 
Congress to make it happen.
    The more the American people can participate in this debate, 
expanding beyond necessary discussions of capital markets, G-fees, 
risk-based capital, and mortgage-backed securities to express equally 
necessary consideration of how essential the system is to the futures 
of their own families and communities--the better system we'll build, 
the stronger our country will be, and the more opportunity we'll be 
able to provide every American. Thank you.
              Additional Material Supplied for the Record

PREPARED STATEMENT ON BEHALF OF THE NATIONAL MULTI HOUSING COUNCIL AND 
                   THE NATIONAL APARTMENT ASSOCIATION

    Chairman Johnson, Ranking Member Shelby, and distinguished Members 
of the Committee, the National Multi Housing Council (NMHC) and the 
National Apartment Association (NAA) support housing finance reform to 
ensure appropriate Government oversight to meet the mortgage finance 
needs of the multifamily rental housing industry. We commend 
Congressional efforts to address the future of the housing finance 
system and respectfully submit this statement regarding the reform of 
the Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie 
Mac.
    NMHC and NAA represent the Nation's leading firms participating in 
the multifamily rental housing industry. Our combined memberships are 
engaged in all aspects of the apartment industry, including ownership, 
development, management, and finance. The National Multi Housing 
Council represents the principal officers of the apartment industry's 
largest and most prominent firms. The National Apartment Association is 
the largest national federation of State and local apartment 
associations. NAA is a federation of 170 State and local affiliates 
comprised of more than 50,000 multifamily housing companies 
representing more than 5.9 million apartment homes.
    The bursting of the housing bubble exposed serious flaws in our 
Nation's housing finance system. As policy makers craft solutions to 
fix the single-family housing problems, they should be mindful not to 
do so at the expense of the much smaller and less understood, but 
vital, multifamily sector.
    Apartments are a critical component of the Nation's housing market, 
but history has made it clear repeatedly that the private market simply 
cannot meet a majority of the industry's capital needs. A federally 
backed secondary market is absolutely critical to the sector's health 
and our ability to continue to meet the Nation's growing demand for 
rental housing.
    Fortunately, to date meeting that need has posed little to no risk 
to the taxpayer. In stark contrast to the single-family sector, the 
apartment industry did not overbuild during the housing boom. Even more 
importantly for the issue at hand, the GSEs' multifamily programs did 
not contribute to the housing meltdown.
    Overall loan performance in the $2 trillion multifamily sector 
remains relatively healthy, and the strongest performance has been 
recorded by the debt provided by the GSEs. Their multifamily 
delinquency and default rates remain below 1 percent--a tenth of the 
size of the delinquency/default rates plaguing single-family.
    Through careful underwriting, the GSEs' multifamily models have met 
the test. They have attracted enormous amounts of private capital; 
helped finance millions of units of market-rate workforce housing 
without Federal appropriations; sustained liquidity in all economic 
climates; and ensured safety and soundness in their multifamily 
business. As a result of the liquidity provided by the GSEs, the United 
States has the best and most stable rental housing sector in the world.
    As you consider policy to alter the Government's role in mortgage 
financing for our housing system we ask that you consider the following 
factors affecting the financing needs for multifamily housing.
Private Capital Is Necessary, But Not Sufficient
    We are encouraged by the thawing in the private capital markets and 
support a return to a marketplace dominated by private capital. But 
lawmakers need to understand that even in healthy economic times, 
history has made it clear that the private market simply cannot meet a 
majority of the rental housing industry's capital needs.
    Banks are limited by capital requirements and have never been a 
source of long-term financing. Life insurance companies have typically 
been less than 10 percent of the market, lend primarily only to newer, 
luxury high-end properties and enter and leave the multifamily market 
based on their investment needs and economic conditions. The private-
label CMBS market is unlikely to return to the volume and market share 
it reached a few years ago, and the FHA has exceeded its capacity to 
meet the sector's capital demands. While covered bonds might provide 
some additional liquidity to apartment borrowers, they are unlikely to 
provide the capacity, flexibility, and pricing superiority necessary to 
adequately replace traditional sources of multifamily mortgage credit, 
including the GSEs.

Growing Importance of Rental Housing, Experts Forecast Supply Shortage
    The United States is on the cusp of a fundamental change in our 
housing dynamics. Changing demographics are causing a surge in rental 
demand that will continue long after the economic recovery. This 
includes 78 million echo boomers entering the housing market, baby 
boomers downsizing, and a dramatic decrease in the number of married 
couples with children to less than 22 percent of households.
    Between 2008 and 2015, nearly two-thirds of new households formed 
will be renters. That's six million new renter households. University 
of Utah Professor Arthur C. Nelson predicts that half of all new homes 
built between 2005 and 2030 will have to be rental units. Yet, private 
capital for new apartment construction all but disappeared during the 
crisis, virtually halting new development activity for nearly 2 years.
    New multifamily construction set an all-time post-1963 low in 2010 
at 97,000 new starts. We need to be building an estimated 300,000 units 
a year to meet expected demand. Yet most forecasts suggest we'll start 
fewer than half that many in 2011. That's not even enough to replace 
the units lost every year to demolition, obsolescence and other losses.
    Without Government credit support of multifamily mortgages or 
mortgage-backed securities to ensure a steady and sufficient source of 
capital going forward, the apartment industry will not be able to meet 
the Nation's housing needs and Americans will pay more for workforce 
housing. A federally backed secondary market is critical not only for 
the long-term health of the industry but also to help refinance the 
estimated $300-$400 billion in multifamily mortgages that will mature 
by 2015.

Workforce Housing Without Federal Subsidies
    Policy makers should understand that nearly ALL of the multifamily 
funding provided by the existing GSEs helped create workforce housing 
(not just the capital they provided to properties designated 
``affordable''). Fully 90 percent of the apartment units financed by 
Fannie Mae and Freddie Mac over the past 15 years--more than 10 million 
units--were affordable to families at or below the median income for 
their community. This includes an overwhelming number of market-rate 
apartments with no Federal appropriations, produced with virtually no 
risk to the taxpayer.

Key Principles for GSE Reform
    The apartment industry urges you to consider the following key 
points for inclusion in any reform measure:

1. Do No Harm: Preserve Multifamily Lending Programs
    The multifamily sector produces the vast majority of this Nation's 
affordable, workforce housing. Therefore there is an appropriate public 
mission for the Government to provide an effective financing system to 
ensure the Nation's housing needs are met. In addition, the multifamily 
sector, and more specifically the GSEs' multifamily programs, did not 
contribute to the housing meltdown. Therefore, as policy makers ``fix'' 
the problems in the single-family sector, they should not do so at the 
detriment of the multifamily industry.

2. Protect the Taxpayer: Look to Proven Multifamily Models
    The taxpayer is footing the bill for the breakdown of the single-
family housing sector and that should never happen again. The GSEs' 
multifamily programs can serve as a model for a reformed housing 
finance system. They have performed extraordinarily well and have less 
than a 1-percent delinquency rate. Historically, they have been well 
capitalized, have covered all their losses through the loss reserves 
they collected and have earned a profit. Even during conservatorship, 
the GSEs' multifamily programs have earned net revenues of $2 billion. 
\1\ Their success is the result of strong business models that use 
retained risk and stringent underwriting criteria.
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     \1\ Source: GSE SEC filings. This does not include writedowns of 
Low-Income Housing Tax Credit holdings that the firms have been 
prohibited from selling and liquidating.
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    To protect the taxpayer going forward, these models should be 
carefully studied for a broader application within the larger housing 
finance system. Specifically, the Government must ensure strong 
regulatory oversight. It should consider implementing some level of 
retained risk by mortgage originators and servicers and adequate 
capital standards to fund loan-loss reserves. These steps would 
preserve the strong mortgage loan performance and track record seen in 
the multifamily sector and protect the taxpayer.

3. Federal Government Involvement Necessary and Should Be Appropriately 
        Priced
    Even after we transition to a new housing finance system, there 
will be an ongoing need for an explicit Federal Government guarantee on 
multifamily mortgage securities and portfolio-held loans. Over the past 
40 years, there have been numerous occasions when the private sector 
has been unable or unwilling to finance multifamily loans. There is a 
legitimate concern that the private sector cannot be counted on, from 
both reliability and capacity stand-points, to consistently finance the 
majority of multifamily borrowers' needs. Hence it is hard to envision 
a reformed housing finance system without some form of Federal credit 
enhancement. However, that credit should be priced at an appropriate 
level that reflects the mortgage risk and the value of the Government's 
credit enhancement and in such a way that it complements, but does not 
unfairly compete with, private debt capital.

4. Liquidity Support Should Be Broad and Available at All Times, Not 
        Just ``Stop-Gap'' or Emergency
    Any Federal credit facility should be available to the entire 
apartment sector and not be restricted to specific housing types or 
specific renter populations. Narrowing any future credit source would 
remove a tremendously important source of capital to a large portion of 
our industry, namely market-rate developers who actually provide a 
large volume of unsubsidized workforce housing. Such a facility should 
also be available at all times to ensure constancy in the U.S. housing 
market throughout all business cycles. It would be impossible to turn 
on and off a government-backed facility without seriously jeopardizing 
capital flows.

5. Mission Should Focus on Liquidity, Not Mandates
    The public mission of a federally supported secondary market should 
be clearly defined and focused primarily on using a Government 
guarantee to provide liquidity and not specific affordable housing 
mandates. Such mandates create conflicts within the secondary market 
and are partially responsible for the housing crisis because of the 
distortions the mandates introduced into the GSEs' business practices. 
Instead of mandates, the new housing finance system should provide 
incentives to support the production and preservation of affordable 
multifamily housing. Absent incentives, the Government should redirect 
the affordability mission to HUD/FHA and the Low-Income Housing Tax 
Credit program.

6. Retain Portfolio Lending While Expanding Securitization
    Securitization must be used to attract private capital for 
multifamily mortgage capital. However, unlike single-family loans, 
multifamily loans are not easily ``commoditized.'' Without the ability 
to hold some loans in portfolio, multifamily lending activities will be 
significantly curtailed. In addition, securitizing multifamily loans is 
not always the best way to manage credit risk. Portfolio capacity is 
also required to aggregate mortgages for a structured securities sale.

7. Create Certainty and Retain Existing Resources/Capacity During the 
        Transition
    To avoid market disruption, it is important that policy makers 
clearly define the role of the Government in a reformed system and the 
timeline for transition. Without that certainty, private capital 
providers (e.g., warehouse lenders and institutional investors) are 
likely to limit their exposure to the market, which could cause a 
serious capital shortfall to rental housing. In addition, during the 
transition years, we believe it is critical to retain many of the 
resources and capacity of the existing GSEs. The two firms have 
extensive personnel and technology expertise as well as established 
third-party relationships with lenders, mortgage servicers, appraisers, 
engineers and other service providers that are critical to a well-
functioning secondary market.
    We appreciate the opportunity to present the views of the apartment 
industry and look forward to working with you to build a world-class 
housing finance system that meets the Nation's changing housing needs 
while also protecting the taxpayers.











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