[Senate Hearing 112-245]
[From the U.S. Government Publishing Office]
S. Hrg. 112-245
HOUSING FINANCE REFORM: ACCESS TO THE SECONDARY MARKET FOR SMALL
FINANCIAL INSTITUTIONS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING ACCESS TO THE SECONDARY MARKET FOR SMALL FINANCIAL
INSTITUTIONS
__________
JUNE 28, 2011
__________
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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
Charles Yi, Chief Counsel
Erin Barry, Professional Staff Member
Beth Cooper, Professional Staff Member
William Fields, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Chad Davis, Republican Professional Staff Member
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
----------
TUESDAY, JUNE 28, 2011
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Hagan................................................ 2
WITNESSES
Jack Hartings, President and Chief Executive Officer, The Peoples
Bank Company, on behalf of the Independent Community Bankers of
America........................................................ 3
Prepared statement........................................... 26
Edward J. Pinto, Resident Fellow, American Enterprise Institute.. 5
Prepared statement........................................... 31
Rod Staatz, President and Chief Executive Officer, SECU of
Maryland, on behalf of the Credit Union National Association... 7
Prepared statement........................................... 40
Responses to written questions of:
Senator Shelby........................................... 71
Senator Reed............................................. 72
Christopher R. Dunn, Executive Vice President, South Shore Saving
Bank, on behalf of the American Bankers Association............ 8
Prepared statement........................................... 62
Responses to written questions of:
Senator Shelby........................................... 73
Senator Reed............................................. 75
Peter Skillern, Executive Director, Community Reinvestment
Association of North Carolina.................................. 10
Prepared statement........................................... 68
Additional Material Supplied for the Record
Letter submitted by the National Association of Federal Credit
Unions......................................................... 77
(iii)
HOUSING FINANCE REFORM: ACCESS TO THE SECONDARY MARKET FOR SMALL
FINANCIAL INSTITUTIONS
----------
TUESDAY, JUNE 28, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 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.
The Committee meets today to continue our series of
hearings on housing finance reform. This hearing will examine
how small banks and credit unions currently sell mortgages on
the secondary market and how any potential changes to the
housing finance system would affect their access to that
market.
Community banks and credit unions play a crucial role in
local economies across the country, particularly in rural
areas, and as 90 percent of FDIC-insured institutions hold less
than $1 billion in assets, any action by Congress must not
ignore small institutions.
The current system is unsustainable and the need for reform
is clear, but I am concerned that proposals for the future of
the secondary market could lead to bank concentration and
unintentionally limit access for these institutions. This
hearing will help us better understand the possible
consequences of such proposals as well as their potential
impact on the rest of the housing market, local communities,
and the broader economy.
There are several questions we must consider. If small
institutions do not have access to the secondary market, will
they be able to offer mortgages to their customers and at what
cost? How would it affect those institutions and their
surrounding communities? Would some proposals provide more
equitable secondary market access than others?
I look forward to hearing from our panel and thank them for
their testimony and their time. I would also like to submit
testimony for the record on behalf of the National Association
of Federal Credit Unions.
With that, I will turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
Small and community banks play a unique and vital role in
our housing finance market. Historically, small banks were the
primary source of mortgage lending. If you wanted to buy a
home, you went to your local bank to get a mortgage. Today,
however, the financial landscape is quite different.
First, the banking industry has witnessed substantial
consolidation. In 1984, there were 15,000 banking and thrift
organizations in this country. Today there is less than half
that number. In addition, mortgage lending is concentrated in
just a few banks. Last year, three banks--yes, three banks--
originated 56 percent of all mortgages while 8 institutions
serviced 63 percent of all outstanding mortgages.
Another shift in the mortgage landscape is the dependence
on capital markets to finance mortgage lending. Before the
advent of securitization, the vast majority of single-family
residential mortgages were held by banks. In 1970, banks held
over 70 percent of single-family residential mortgages while 30
percent were held by the Government and other investors. By
2008, those numbers had flipped, with banks holding less than
30 percent of mortgages. The days when your local bank actually
owned your mortgage generally have long passed.
Despite these significant changes, small banks have proven
to be remarkably resilient and able to adapt to the new
environment. Because they are close to their communities, small
banks are often able to find profitable lending opportunities
overlooked by the big mortgage lenders. Therefore, there is no
economic reason why small institutions cannot compete with
large ones. I believe we just have to make sure here that we do
not create regulatory barriers that place small banks at an
unfair competitive disadvantage.
Accordingly, as we consider how to reform our housing
finance system, it is critical that we devise a system that
works for all banks, not just large institutions. Any reform
should recognize that small banks have very different business
models. Failing to account for the distinct needs of small
banks could needlessly accelerate the consolidation of our
banking industry to the detriment of consumers and taxpayers.
For generations, small banks have been the backbone of the
communities throughout our Nation, and as we undertake housing
finance reform, we must ensure that they remain so for
generations to come.
Chairman Johnson. Thank you, Senator Shelby.
Senator Hagan wants to say something briefly in that we
have a witness from North Carolina.
STATEMENT OF SENATOR KAY HAGAN
Senator Hagan. Thank you, Mr. Chairman, and thank you for
holding this hearing on the role of the secondary mortgage
market for small financial institutions.
As we look at ways to reform our housing finance system, it
will be critical to understand the issues faced by small
financial institutions and the communities that they serve. I
would also like to thank the Chairman for inviting Peter
Skillern, the executive director of Community Reinvestment
Association of North Carolina, to testify before the Committee
today. CRA-NC, as the association is known, is dedicated to
promoting and protecting the community wealth in underserved
areas. Since its creation in 1986, it has played a key role in
regional advocacy and development for underserved areas.
Mr. Skillern is a graduate of the Kenan-Flagler School of
Business at UNC-Chapel Hill, came to work at CRA-NC after
serving as the executive director of the Durham Affordable
Housing Coalition, and under his guidance CRA-NC has pioneered
innovative outlets to promote financial education to residents
in underserved areas, and this is something that I have
championed for many years, especially during my time in the
North Carolina General Assembly. I look forward to his
testimony and the deep knowledge he can bring to today's
discussion on access to the secondary market for small
financial institutions.
Thank you, Mr. Chairman.
Chairman Johnson. Before I introduce the witnesses, would
any of my colleagues like to make a brief opening statement?
[No response.]
Chairman Johnson. If not, then we will proceed.
Mr. Jack Hartings is the president and CEO of the People's
Bank headquartered in Coldwater, Ohio. Mr. Hartings is also the
treasurer of the Independence Community Bankers Association.
Mr. Edward Pinto is a resident fellow at the American
Enterprise Institute, a private, nonprofit institution
dedicated to the research and education of a host of different
policy issues.
Mr. Rod Staatz is the president and CEO of SECU, a North
Carolina-based credit union founded in 1937. Mr. Staatz is also
a member of the Board of Directors for the Credit Union
National Association.
Mr. Christopher R. Dunn is the executive vice president of
South Shore Savings Bank, a Massachusetts-based full-service
mutual savings bank.
Finally, we have Mr. Peter Skillern, executive director of
the Community Reinvestment Association of North Carolina, which
is a nonprofit community advocacy and development group.
We welcome all of you here today and thank you for your
time. Mr. Hartings, you may proceed.
STATEMENT OF JACK HARTINGS, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, THE PEOPLES BANK COMPANY, ON BEHALF OF THE INDEPENDENT
COMMUNITY BANKERS OF AMERICA
Mr. Hartings. Chairman Johnson, Ranking Member Shelby,
Members of the Committee, I am Jack Hartings, president and CEO
of The Peoples Bank Company and a member of the Executive
Committee of the Independent Community Bankers of America. The
Peoples Bank Company is a $350 million asset bank in Coldwater,
Ohio, and I am pleased to represent community bankers and the
ICBA's nearly 5,000 members at this important hearing.
Any broad-based recovery of the housing market must involve
community bank mortgage lending. Community banks represent
approximately 20 percent of the mortgage market, but more
importantly, our mortgage lending is often concentrated in
rural areas and small towns not effectively served by large
banks. For many borrowers in these areas, a community bank loan
option is the only option. The Peoples Bank Company serves a
community of about 5,000 people and has been in business for
105 years. We survived the Great Depression and numerous
recessions--as have many other ICBA member banks--by practicing
conservative, common-sense lending.
Today I would like to talk about my bank's mortgage lending
and the importance of the secondary market access. Mortgage
lending is about 80 percent of my business. About half the
mortgage loans I make are sold, mostly to Freddie Mac, with a
smaller portion going to the Federal Home Loan Bank of
Cincinnati. The secondary market allows me to meet customer
demand for fixed-rate mortgages without retaining the interest
rate risk these loans would carry. As a small bank, it is not
feasible for me to use derivatives to manage interest rate
risk. Selling into the secondary market frees up my balance
sheet to serve customers who prefer adjustable rate loans as
well as small businesses which play a vital role in our
community.
The mortgages I sell perform extremely well. None of my
mortgages that I originated for Freddie Mac have gone into
foreclosure. Currently, none of my loans in my $75 million
Freddie Mac portfolio have been 30 days or more delinquent in
the past 3 months. Although my bank's performance may be
exceptional, it is typical of community bank-originated
mortgages to perform well, and it shows in the data.
The key to the performance of community bank mortgages is
diligent, community-based underwriting and servicing. Again,
using my bank as an example, while Freddie Mac's automated
underwriting, Loan Prospector, provides a set of ratios and
statistics that are useful in the initial screening, our
underwriting is enhanced with the direct and personal knowledge
of the community and the lifestyle of the borrower. A grasp of
these intangibles is what makes the difference between
community-based relationship lending and remote transactional
lending done by the megabanks.
When it comes to servicing--and we service all of our loans
that we sell to Freddie Mac--again, our community connection
makes the difference. We know, for example, when an employer
closes in our community and how that may impact the income of
our borrowers. We intervene early and work out mutually
agreeable solutions with struggling borrowers.
My written testimony has a comprehensive list of features
that make the secondary market entity attractive to a community
bank. I will limit my discussion here to the essential ones.
First, equal access and equal pricing. A sustainable and
robust secondary market must be impartial and provide equitable
access and pricing to all lenders, regardless of size and
lending volume.
Second, originators must have the option to retain
servicing after the sale of the loan. While servicing is a low-
margin business, in fact I would make more by releasing
servicing rights. It is a crucial aspect to my relationship
lending business model, giving me the opportunity to meet
additional banking needs of my customers. What is more, when I
release servicing, I release proprietary consumer data that is
highly valuable for cross-selling products. Community banks
must be able to preserve customer relationships and franchises
after transferring loans.
As we listen to the debate over the secondary market
reform, community banks are particularly alarmed by proposals
that would transfer the functions of Fannie Mae and Freddie Mac
to a small group of megabanks, the very ones whose abusive loan
terms, slipshod underwriting, and exotic securitization
contributed to the most recent financial catastrophe. Such
proposals would intensify systemic risk and moral hazard
through concentration of assets. I urge this Committee to
reject any proposal that does not provide equal representation
for community banks and lenders of all sizes and does not
ensure that communities and customers of all varieties are
served.
Thank you again for holding this hearing and for the
opportunity to testify.
Chairman Johnson. Thank you, Mr. Hartings.
Mr. Pinto, you may proceed.
STATEMENT OF EDWARD J. PINTO, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Pinto. Chairman Johnson, Ranking Member Shelby, thank
you for the opportunity to testify today.
In mortgage lending, community financial institutions face
two continuing but related threats. While community financial
institutions did not cause the financial crisis, it appears now
that they will be subjected to regulatory overload. The 12
pages of statutory provisions related to qualified residential
mortgage and qualified mortgage have now ballooned to over 800
pages of proposed regulations. This adds insult to injury.
Fannie Mae and Freddie Mac, the GSEs, had a long history of
giving their largest and riskiest customers lower guarantee
fees. This denied community financial institutions fair and
equal access to the secondary market. It disadvantaged them
economically and in many cases resulted in handing over their
best customers to their large bank competitors.
As far back as 1995, Fannie Mae's top 25 customers, led by
Countrywide, benefited from substantially lower guarantee fees
than Fannie's 1,200 smallest customers. Large lenders like
Countrywide also benefited from looser underwriting standards,
many times undertaken to meet affordable housing goals. In 1995
Fannie Mae was frank about the risks and why it was willing to
take them. Countrywide liked to test the limits of investment
quality underwriting and had a major impact on Fannie Mae's
affordable housing goals.
In my written testimony is a chart that speaks volumes
about the risks posed by too-big-to-fail financial institutions
as compared to regional and community banks. There are over
6,000 banks in this country with less than $10 billion in
assets. Virtually all of them are community banks, and there
are virtually no community banks over $10 billion. They had a
current nonperforming loan rate of a little over 2.5 percent.
The four banks that are over $1 trillion have a rate of over 16
percent nonperforming loan rate, and all banks over $20 billion
have a rate of approximately 12 percent, about 5 times what
community banks experience.
The nonperforming loan rate is a delinquency in excess of
90 days, 90 days or more, or a loan that has already been moved
into foreclosure. You have heard similar statistics from Jack
Hartings on the sales to Fannie Mae.
A white paper I coauthored with Peter Wallison and Alex
Pollock has principles, many of them similar to those suggested
by Mr. Hartings' testimony.
First, a limited scope of conservatively underwritten
products available for securitization. We advise repealing QRM
and QM and replacing them with a statutory definition of prime
loan, and that is outlined in my written testimony. We have
already been beset with problems emanating from the broad
delegation in the original legislation to regulators, lobbying
by industry groups against the proposed regulations, and claims
by many Members of Congress that their intent was thwarted.
Second, adequate private capital would insulate taxpayers.
Risk-based pricing needs to be adequate for long-term cycles,
and that would help assure equal access regardless of loan
volume. Any replacement structure must avoid re-creating the
moral hazard represented by Fannie and Freddie by not replacing
them with a few too-big-to-fail banks.
We need strong supervision. Relying on a regulatory
structure that incorporates countercyclical capital
accumulation and other self-implementing features rather than
expecting regulators to be all knowing and all seeing, with
somehow having the ability to reset capital levels on the fly
based on market conditions or put brakes on at just the right
time is not reasonable of feasible.
And, last, accommodate a joint venture structure that will
aggregate the mortgages produced by community financial
institutions.
There is one area that we think special caution should be
taken. Many industry participants call for the Government to
guarantee mortgage loans for catastrophic loss. History
suggests that that guarantee will end up costing the taxpayer
dearly. Why? Because the reserves necessary will not be
accumulated, the Government will not be able to successfully
price the risk, and you will have distortion of prices,
resource allocation, and competition, and there will be
political interference, which leads to weakened credit
standards.
The private market that would develop under a more
privatized approach would be entirely different from the
distorted market created by the GSEs. A high preponderance of
the mortgage would be prime loans, loans of the kind that
community financial institutions usually originate. These loans
will be highly sought after because not only are they good
investments, but the type of mortgages that can be securitized.
Thank you and I would be happy to answer questions at the
appropriate time.
Chairman Johnson. Thank you, Mr. Pinto.
Mr. Staatz, you may proceed.
STATEMENT OF ROD STAATZ, PRESIDENT AND CHIEF EXECUTIVE OFFICER,
SECU OF MARYLAND, ON BEHALF OF THE CREDIT UNION NATIONAL
ASSOCIATION
Mr. Staatz. Mr. Chairman, Ranking Member Shelby, Members of
the Committee, thank you very much for the opportunity to
testify at today's hearing.
A healthy, efficient, and accessible secondary market is
vital to credit unions and the millions of consumers we serve.
The problems that led to the conservatorships of the Fannie and
Freddie need to be addressed in a comprehensive and meaningful
manner. However, as Congress and the Administration undertake
this effort, it is critical that a widespread availability of
mortgage credit, housing affordability, consumer protection,
financial stability, and strong regulation are maintained. We
urge Congress to take reasonable time to complete GSE reform
and to ensure that an effective foundation will be responsive
to the needs of borrowers and lenders.
Credit unions are increasingly important players in the
residential mortgage market. Since 2007, we have originated
over a quarter of a trillion dollars in mortgages. I will focus
my testimony on our principles of housing finance reform and
our concerns with the proposed definition of a qualified
residential mortgage.
Quite frankly, many credit unions fear a world in which the
secondary market is occupied by a handful of very large banks.
Concerns about access to and pricing in such a market are
frequently expressed. We believe that it is very important that
there be a neutral third party whose sole role would be as a
secondary market conduit.
The Federal Government has a very important role to ensure
that the secondary market operates efficiently, effectively,
and fairly for all borrowers and lenders alike. We believe that
there are seven principles that are essential to consider as
you develop comprehensive housing finance reform:
Number one, equal access. The paramount concern for credit
unions is equitable access to the secondary market. It is
essential that the Federal Government's regulation ensure that
terms, rates, and conditions for selling loans are affordable
and fair to all lenders, regardless of their size or charter
type.
Number two, strong oversight and supervision. Secondary
market services must be subject to appropriate oversight to
ensure safety and soundness, including strong capital
requirements.
Number three, durability.
The new system must ensure mortgage loans will continue to
be made to qualified borrowers even in troubled economic times.
Four, financial education. Credit unions are leaders in
providing quality financial education to their members, which
may help account for credit unions' low loss rates. If other
lenders did the same, borrowers could make better decisions.
Preservation of the 30-year fixed-rate mortgage. This
product is the centerpiece of the mortgage lending market, and
the new system should facilitate its availability to qualified
borrowers. Federal support should remain to preserve this
product, and the costs should be borne by the financial
mortgage finance system, not by the taxpayers.
Affordable housing, number six. The important role of
Government support for affordable housing should be a function
separate from the responsibilities of the secondary market
entities. Programs to stimulate the supply of credit to lower-
income borrowers are not the same as those for the broader
mortgage market. Combining both goals in a single vehicle can
frustrate the achievement of each goal individually.
And, number seven, transition. Changes to the housing
finance system must be reasonable and orderly to avoid further
disrupting a housing market that is in a fragile State of
recovery.
I would also like to briefly address our concerns with the
proposed definition of QRM. This definition is narrower than
what was contemplated under Dodd-Frank, which requires a credit
risk retention rule. We are concerned that the stringent
definition of QRM could not only shut out an entire class of
qualified borrowers from the market, but could also drive up
mortgage liquidity for small lenders. Further, QRM could be a
template that regulators will impose on all home mortgage
loans, whether they are securitized or not. We urge Congress to
insist that the regulators go back to the drawing board and
issue a new proposed QRM definition for public comments.
Mr. Chairman, reform of the housing finance system has
already proven to be a very difficult challenge, but failing to
make necessary changes to improve the system will result in
even greater challenges for the economy, lenders, and
borrowers.
Thank you for taking credit unions' concerns into
consideration. I appreciate the opportunity to testify, and I
am happy to answer any questions the Committee may have.
Chairman Johnson. Thank you, Mr. Staatz.
Mr. Dunn, you may proceed.
STATEMENT OF CHRISTOPHER R. DUNN, EXECUTIVE VICE PRESIDENT,
SOUTH SHORE SAVING BANK, ON BEHALF OF THE AMERICAN BANKERS
ASSOCIATION
Mr. Dunn. Chairman Johnson, Ranking Member Shelby, and
Members of the Committee, my name is Christopher Dunn. I am
executive vice president and chief operating officer of South
Shore Savings Bank in South Weymouth, Massachusetts. I
appreciate the opportunity to testify on behalf of the ABA.
The issue of GSE reform is a critical one for banks,
particularly for community banks like mine, which use the GSEs
as the primary mode of access to the secondary markets. I have
been in the mortgage lending business since 1972 and sold my
first loans to Fannie Mae in 1974, so I know the importance of
secondary market access for smaller banks. Without that access,
my bank could not be an active player in the mortgage market
because our balance sheet could not support the demand.
Further, we would not be able to offer long-term fixed-rate
loans due to the increased interest rate risk that this would
create for our portfolios.
The ABA believes that a private market for the vast
majority of housing finance should be encouraged with a much
smaller Government role. To distinguish our position from
others, we define a private market as one without a Government
guarantee of any sort, not private ownership of companies that
operate with a Government backstop. Therefore, the role of
Fannie Mae and Freddie Mac should be reduced and transformed.
We believe that the Government's role in housing finance should
be to ensure stability and accessibility of the capital markets
in the event of a market failure. In addition, FHA should
return to its traditional role of servicing first-time
homebuyers and borrowers who may not qualify for conventional
financing.
The overarching principle is to ensure that banks of all
sizes have access to the secondary market financing. The ABA
has not endorsed a specific structure for the GSEs and the
private secondary market, and finding the right system will be
challenging. In the meantime, there are steps that can be taken
and should be taken to reduce governmental involvement, foster
private sector financing, and still assure equitable access to
all secondary markets for the banks. These steps are essential
to begin an orderly transition from the failed market
structure.
First, the compensation being paid for what amounts to full
Government backing is simply not priced correctly in the
market. These G-fees, as they are called, should be dialed up
in an orderly manner so that eventually the private market will
be able to price for risk in a fashion that allows for safe and
sound lending at comparable and eventually better rates than
the GSEs. The increased G-fees will also help to offset losses
and repay the Government for its investment in Fannie Mae and
Freddie Mac.
The second mechanism for a transition to a private market
is to set more reasonable loan limits for GSE purchases. The
current maximum loan limits are dramatically higher than
necessary for the purchase of a moderately priced home,
especially in light of housing price declines nationwide.
Underpinning all of this must be workable and clear
underwriting standards for all mortgage loans. We must get the
underwriting standards correct today if we hope to transition
to a stable system for secondary market instruments.
The current regulatory proposals for risk retention define
a narrow qualified residential mortgage exemption. As a result,
many high-quality loans posing little risk will end up being
excluded. This will inevitably mean fewer borrowers will
qualify for loans to purchase or to refinance a home. Moreover,
should this proposal be adopted as proposed, it will drive many
banks out of mortgage lending. ABA strongly believes that this
rule should be substantially rewritten and reproposed.
Specifically, we recommend that most mortgage loans with lower
risk characteristics, which include most of the loans being
made today by community banks, should be exempted from the risk
retention requirements regardless of whether they are sold to
Fannie Mae and Freddie Mac or private securitizers. The
imposition of risk retention requirements is a significant
change to the operation of the mortgage markets and must not be
undertaken lightly. Driving community banks from the mortgage
marketplace and shutting out many borrowers from the credit
market entirely is completely counter to having a vibrant
mortgage market. ABA urges Congress to exercise its oversight
authority to assure that logical, consistent rules are adopted.
Thank you for the opportunity to testify, and I would be
pleased to answer any questions.
Chairman Johnson. Thank you, Mr. Dunn.
Mr. Skillern, you may proceed.
STATEMENT OF PETER SKILLERN, EXECUTIVE DIRECTOR, COMMUNITY
REINVESTMENT ASSOCIATION OF NORTH CAROLINA
Mr. Skillern. Thank you. Thank you very much, Chairman
Johnson and other Members, for allowing me to speak today on
reforms in the secondary market.
On September 6, 2000, I testified before the House
Financial Institutions Subcommittee on Government Sponsored
Enterprises and I stated, quote, ``For the record, these high-
cost loans will become a significant problem in the coming
years. In the future, this Committee will return to discuss how
the financial markets played a role in spurring high default
rates and the decline of our neighborhoods.'' That proved to be
true. Subprime lending was bad for our neighborhoods and for
our economy, and the purchase of those high-cost subprime loans
was the primary cause for the GSEs' failure.
Today, I am concerned that reform proposals that eliminate
the GSEs and convert to a solely private capital market will
also be harmful for our communities and housing sector as a
whole. We support reforms to increase private mortgage capital
with adequate oversight. However, the GSEs are needed as public
purpose agencies that provide stability for our Nation's
housing and financial markets.
We are concerned that megabanks will dominate the mortgage
market from origination to securitization, to the detriment of
consumers and small banks. In the rural areas of Alabama, North
Carolina, Oregon, Ohio, and South Dakota, megabanks originated
75 percent of conventional loans and 88 percent of FHA loans.
By comparison, small institutions, under $10 billion,
originated 16 percent of conventional loans.
Small lenders shop their loans among the secondary buyers
of GSEs and financial banks. Loans are underwritten to a
standard established by the GSEs and sold as commodities to
those who are offering the best price and services. If the GSE
is eliminated, the secondary capital markets will become
dominated by megabanks, which will further concentrate capital
in a vertical integration of the mortgage market. This will
disadvantage small lenders' access to capital, underwriting,
and technology that is controlled by their competitors. If
megabanks are too big to fail now, imagine their size, power,
and vulnerability as they become guarantors and holders of the
mortgage-backed security market.
Capital is greedy and scared. Its volatility adds to swings
during booms and busts. Private capital is the primary source
of liquidity, will not act countercyclically to provide credit
in a recession or to slow things in a boom.
By analogy, mortgage credit is like water. We are concerned
about the quality of water that comes out of our tap, but we
also want to know who controls the water's availability and its
price. Who owns the plumbing from the water source of the
glaciers to the spigot at home? Mortgage credit, like water, is
too critical and should not be entirely controlled by private
interests.
But if we should not privatize the secondary market, what
should be done? We believe that the GSEs should be converted
into public purpose entities that are accountable to Congress
but are not a department of the Government, such as the Federal
Housing Administration. The agency would provide liquidity for
30-year mortgages that are explicitly guaranteed or price
adequately for reserves. The agency would provide liquidity for
multifamily financing. The agency would act as a provider of
underwriting standards and technology for the benefit of the
whole market. It would balance private influence by providing
choice on the secondary market.
As an example, the North Carolina Housing Finance Agency is
not a Government department. It is independent, but yet it
serves a public purpose of financing affordable housing and
rental. While appointed by the Governor and State legislature,
the board is independent, self-supporting, and operates without
appropriations. Likewise, the GSEs can serve the public purpose
in the secondary market for rental and home ownership
financing.
We concur that the status quo is not acceptable in the long
term for a healthy secondary market. We support reforms that
include reducing the portfolio of GSE loans and liabilities.
They have grown too large and the sale of assets can help to
strengthen the capital base of the institutions. Pricing for
explicit Government guarantees on 30-year mortgages is needed.
Reforming FHA to provide adequate infrastructure and oversight
to its portfolios is part of a broad reform.
We oppose the GSEs' current loan level pricing program and
recommend that it be amended to better utilize private mortgage
insurance. This will lower FHA volume, yet increase lending to
creditworthy households who have low downpayments.
The financial meltdown was caused in large part by private
label mortgage-backed securities. Private institutions should
be involved in mortgage securities, but on the condition they
are recognized as systemic risks and have adequate oversight
for safety and soundness.
Let me state for the record, if the proposal to eliminate
the GSEs succeeds, this Committee will meet in the future to
address new problems. We will have more volatile capital
markets, greater inequality in the access to mortgages, and
disinvestment from low- and moderate-income communities. The
real estate market will struggle as it becomes more difficult
for renters to become first-time homebuyers. Small lenders will
be less competitive with megabanks. We will lack financing for
affordable rental housing for our workforce.
If mortgage financing is not inclusive of low- and middle-
income families, we will have a system that works very well for
some, but not for too many others, and ultimately not for the
greater good. Our agency affirms the vision of an inclusive and
healthy housing market.
Thank you very much.
Chairman Johnson. Thank you, Mr. Skillern.
For Mr. Hartings, Mr. Staatz, and Mr. Dunn, an article in
the HousingWire last week stated in its headline, ``Big Four
Top Contenders to Replace Fannie and Freddie,'' and went on to
name Bank of America, Citigroup, JPMorgan Chase, and Wells
Fargo as the likely replacements. Can you discuss the
challenges or benefits this might present to small
institutions? Mr. Hartings.
Mr. Hartings. To answer that, I guess I cannot see any
benefit to moving it from a Fannie and Freddie and just moving
it to the four or five largest megabanks. It just moves that
risk. I think the key to at least our success in underwriting
loans has been being able to be close to our customer base,
some common-sense lending, and whatever program would be
improved on, I guess for Freddie and Fannie, would have to have
those same guidelines to have that equal access and fair access
and fair pricing. That is part of it. You know, you can have--
you can be able to sell to a larger institution, but you could
be priced out of the market, either because you charge more for
servicing or a higher rate to sell that loan to those larger
institutions.
Chairman Johnson. Mr. Staatz.
Mr. Staatz. First of all, one of our principles was that we
want--we would like to see equal access, and I am just not sure
that if those four very large banks are the conduit or are the
ones that are participating in this, do you really think that
we will have equal access? In other words, do we believe that
pricing would not be affected and it would be different for
them versus us smaller institutions?
So, again, would we have equal access? I am not sure that
we would. And would the pricing be different? I am almost
positive, because you are putting in the hands of for-profit
institutions control of the marketplace and I am not sure that
is a wise idea. We need an independent third party.
Chairman Johnson. Mr. Dunn.
Mr. Dunn. There is no question that large banks have a
decided advantage, and that is why one of the principles that
we have had, as the other speakers have stated, is that
replacement of the GSEs needs to provide for access by all
lenders. The mortgage markets nationally have been well served
by community banks and other lenders other than the big four
over the years and we think that is a very important ingredient
for a successful, stable mortgage market going forward.
Chairman Johnson. Mr. Skillern, in your written testimony,
you raise a concern that phasing out the GSEs will disadvantage
smaller institutions, making them less competitive and less
independent from large institutions while creating even greater
concerns about institutions being too big to fail. Would you
elaborate on those concerns.
Mr. Skillern. Yes, sir. Access to capital is not only about
the money, it is about access to the technology and the
business services that allow you to sell on the secondary
market. One can imagine large lenders saying, if you would like
to have capital access through our channel, you will need to
adopt our business operations to do so and our underwriting,
trapping small institutions into one channel or the other and,
therefore, becoming less competitive, unable to shop their loan
among different players. So that is one of our primary concerns
about its impact on the local institutions.
Chairman Johnson. Mr. Hartings, Mr. Staatz, and Mr. Dunn,
we have heard from previous witnesses that without a Government
guarantee, the 30-year fixed-rate mortgage would not exist, but
that adjustable-rate mortgages or rollover mortgages would
develop. Would limiting access to the secondary market create a
similar reduction in the availability of the 30-year fixed-rate
mortgage? Mr. Hartings.
Mr. Hartings. It is hard for me to answer that theoretical
question. I can tell you from my customer base, we are in the
secondary fixed-rate mortgage market because that is what the
customers are demanding out there. It stabilizes their budgets.
They do not have to worry about interest rate fluctuations. So
whatever is done going forward, I think providing a secondary
market for a 30-year fixed-rate mortgage is of the utmost
importance.
Chairman Johnson. Mr. Staatz.
Mr. Staatz. Like my colleague here, we do quite a business
in 30-year mortgages because that is what our members want, and
for the very same reasons, and it avoids future issues. Now,
does it need to be priced differently in the future? That is a
possibility. But I also tell you that with our 30-year
mortgages, again, the ones that we have sold to Freddie, there
have been no losses whatsoever. So from a credit standpoint,
they have been fine. Only interest rate risk has been an issue
for us. But there ought to be a way to price that in the
future.
Chairman Johnson. Mr. Dunn.
Mr. Dunn. Tying the fixed-rate mortgage, the elimination of
that to the changes in the secondary market, I do not think
they necessarily go hand in hand. I think that the key
determinant long-term of the existence of the 30-year mortgage
is really the correct risk pricing of that loan. I think that
increasing the G-fees as presently discussed in our testimony
is really the key. Without a proper risk premium in a 30-year
fixed-rate, I think you do see a possibility of the 30-year
fixed-rate going away.
Chairman Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, thank you, and let me start
out by saying to all the members of the panel, thanks for being
here. Your testimony and your comments have been very, very
interesting.
Let me, if I might, come at this from a little bit
different direction. One of the things I hear from our bankers
back in Nebraska--and I am not talking about the big four or
five, obviously, I am talking about bankers like a couple of
you represented at the table--is that you have a small bank out
there, limited ability to respond to the requirements of Dodd-
Frank, et cetera, et cetera, stacks of paperwork to understand,
the potential liability that occurs in making a real estate
loan, and on and on, and they are saying to me that they are
kind of getting to a point where they are saying, why are we
doing this? It does not make any sense for us to be in the
mortgage business.
Mr. Dunn, I would like to hear your thoughts about those
comments from Nebraska bankers. Are they overreacting, or are
they pretty much hitting the nail on the head?
Mr. Dunn. It has crossed our mind.
Senator Johanns. I think you are being diplomatic. You do
not have to be here.
[Laughter.]
Mr. Dunn. The regulatory burden is significant. I think
that probably the most important issue that we see before our
bank right now in terms of determining whether or not we are
going to be in the mortgage business or not is this whole
discussion circulating around the Qualified Residential
Mortgage. If that stays as currently proposed, we have--we have
talked to a number of our fellow community bankers and we have
no doubt that the move toward a safe harbor protection will be
there, and quite frankly, a lot of loans that otherwise are
being made today to qualified borrowers will not be made in the
future.
The regulatory burden itself overall has become pretty
significant, and quite honestly, it is hard to keep them
straight and many of the bills overlap, or many of the
regulations overlap and contradict and it is a challenge.
Senator Johanns. Mr. Hartings, do you have some thoughts
about that?
Mr. Hartings. Well, I would agree with the comments of Mr.
Dunn. I think, you know, as a banker, as a community banker, we
are very good at understanding credit and qualifying credit,
and I always tell everybody, there are two documents I need on
every loan. I need a note and a mortgage. The rest of the items
are just disclosures and slows down the process.
Now, a lot of those are very well intended, but one of the
interesting emails I have received, or several of the
interesting emails were from bankers, actually, one from your
State, that said, tell them about the regulatory overload. A
lot of the smaller institutions are just not able to stay up
with the paperwork and are leaving the market just simply
because it is too cumbersome to close a real estate mortgage,
and it seems sad to me, because that is really the heart of our
business as community lenders is to take care of our
communities.
Senator Johanns. Now let me add another feature to this, if
I could. Everybody, I think, wants a robust mortgage industry.
We have got a struggling housing market. We can only benefit by
having community bankers involved in the process, and the more
the better for a guy like me, you know. I go to these local
banks. These are community leaders. These are the people that
are asked first to contribute to new uniforms for the high
school football team, whatever it is that is going on, and they
are always the first to say yes. I mean, they lead the effort.
What I see happening, and I would like you to react to
this, too, is that the smaller banks who have limited ability
to respond to the burden of additional regulations and
requirements and oftentimes have a difficult time getting the
expertise to come to a small town to live, et cetera, are just
starting to look around and say, you know what? I know we have
been around 100, 125 years, but quite honestly, it is time to
sell. Are you seeing that in your States? Let me start again
with Mr. Dunn.
Mr. Dunn. We are not a publicly owned institution, first of
all, but there is no question that it has been more difficult
for us to compete, but I think we are a little bit more
optimistic about our ability to do that, particularly now
that--one of the reasons we lost a lot of market share over the
course of the last several years is the playing field is not
level and a lot of that had to do with lack of enforcement of
regulations that were already in place. And we were
disadvantaged in the marketplace to a great extent by people
who did not play by the same rules that the community banks
play by.
We, as a bank, and I think most community banks, are
comfortable with the whole concept of ability to pay. In fact,
we like to have people pay us back when we lend them money. And
the standards of ability to repay are good. What we do not like
is regulations that come down and they are ``check the box''
underwriting that removes all discretion and does, in fact,
challenge our ability to perform in the marketplace the way we
have done.
Senator Johanns. Mr. Hartings, do you have a thought on
that?
Mr. Hartings. In our State, I know a lot of community
bankers getting up in age a little bit, looking for succession
planning, and are having a difficult time being able to find a
qualified individual to bring into that bank to continue. I do
not know that they have made that decision to sell out, but,
you know, we look at regulations as kind of a pile-on.
Sometimes we are asked, what regulation would you like to see
eliminated? It is not one regulation. It is every regulation
and it continues to pile on, and that is really the difficulty
that we have.
When I have examiners come in, they look at my institution
and I will occasionally ask them a question and they will say,
well, we are not the expert of that. We will get back to you.
Well, I have to be the expert of all of those regulations and
every community bank has to be. So size is not a determining
factor. So that is definitely pushing some individuals to
reconsider their franchise.
Senator Johanns. Thank you, Mr. Chairman.
Chairman Johnson. Senator Tester.
Senator Tester. Yes, thank you, Mr. Chairman. I also want
to echo those remarks. Thank you all for being here. I very
much appreciate all your testimony and thank you for your
perspective on this issue.
You all talked about access, all talked about equal access
to the secondary market, and it is something that is very, very
important in rural America, as I think it is important across
the country. As we look at the secondary market and Fannie Mae
and Freddie Mac in particular, what can we do to ensure that
you have that access? I will start with Mr. Hartings and then
Mr. Staatz and then Mr. Dunn--on equal access.
Mr. Hartings. I think that is the biggest concern that I
have about going from a GSE market to a private market. You
have to have some kind of a system in place, and I do not have
the answer for you for that today. I know ICBA has talked about
a co-op, and that is an idea, to own part of that company. But
that concerns me very much, Senator.
Senator Tester. OK. Go ahead, Mr. Staatz.
Mr. Staatz. I cannot tell you exactly how it should be
structured, but I can tell you that it should not--should not
be structured where it is just in the hands of the largest
institutions.
Senator Tester. Amen.
Mr. Dunn. ABA does not have, nor do I, a silver bullet
solution to this, and it is why we also believe that the
direction of a private market is the way to go, but maybe some
governmental role in that process.
Senator Tester. I have got you, and I thank you all for
your comments. It is not an easy situation, but the fact is
that with input from folks like you all, I think that we can
get around it.
You know, we all want a stable, liquid market. I think we
all want more private investment in that market. Can a 30-year
note--30-year fixed-rate, let me put it that way--can it exist
without a Federal Government backing? And the same three, and
we will start in reverse order, go with Mr. Dunn first.
Mr. Dunn. I believe I tied the future of the 30-year fixed-
rate really to the pricing of the 30-year fixed-rate. I believe
that, properly priced, there is probably a market out there for
the 30-year fixed-rate without a guarantee.
Senator Tester. OK.
Mr. Staatz. I think that is a possibility. I think it is a
possibility, but there may need to be some sort of guarantee,
certainly not what we have been used to in the past.
Senator Tester. OK. Mr. Hartings.
Mr. Hartings. I think it is also possible to do without
some type of guarantee. It is really the equal access I would
be more concerned about. Is that 30-year fixed-rate mortgage
offered in small towns and rural areas if you let it controlled
by the four or five largest banks.
Senator Tester. And let us go back down the line again. Is
the 30-year note something that is important, 30-year fixed-
rate?
Mr. Dunn. The consumer pretty much decides that, and right
now, it is very important to them. But I know the models have
worked differently in other countries, so--and in terms of not
having 30-year fixed rates.
Mr. Staatz. It is----
Senator Tester. Go ahead.
Mr. Staatz. It is what our members want, the majority of
our members.
Senator Tester. OK.
Mr. Hartings. Fifteen years ago, I sold no mortgages to the
GSEs. I started about 15 years ago. We were all adjustable-rate
products. Today, I have $75 million in that portfolio. That
tells me that my residential borrowers want the 30-year fixed.
Senator Tester. OK. Mr. Dunn, on a previous question that
was asked, you talked about lack of regulatory consistency and
I very much appreciate those comments. I think they are
critically important. I think we all want to have a level
playing field for everybody, and I think the consolidation of
the banking industry that we have seen over, as the Vice
Chairman talked about, over the last 25 years or so, has not
been healthy for the industry as a whole and is certainly not
healthy for the consumer.
As we--the percentages are there. I mean, we talked about
the percentages. Four percent of the largest banks currently
have 70 percent of the originations. That is up. Is there
anything we can do, and I do not mean to pick on the same three
guys all the time, and I apologize to the two I have not
asked--is there anything we can do to have you play a bigger
role, because I, quite frankly, feel the same way you guys do.
The role you play in rural America is critically important, and
I think I should not just say rural America, the role you play
in America is critically important. Are there ways that we can
make it so you can have a bigger piece of the pie?
Mr. Dunn. Well, I think that if you look at the replacement
or whatever is going to replace the GSEs----
Senator Tester. Yes.
Mr. Dunn. ----we really do need some type of vehicle to
allow the community bank access. We cannot just let it be
through the big four lenders. I think that is one of the
principles that we have talked about in approaching the whole
subject. Again, it is not an easy solution. I think we are all
pretty cognizant of the fragile state of the housing market. So
any kind of a quick solution is not going to be there. The co-
op structure may be a way to go, and I think that--I know the
ABA is very open to looking at all sorts of different
possibilities in helping shape that.
Senator Tester. OK. Anything you would like to add, Mr.
Staatz?
Mr. Staatz. No, just equal access. I cannot stress that
enough.
Senator Tester. Same thing, Mr. Hartings.
Mr. Hartings. I would say, you know, it is a little bit
like regulation. I do not want a bigger piece of the pie. I
just want to keep my piece of the pie----
Senator Tester. I have got you.
Mr. Hartings. ----and it is starting to leave, the way it
looks to me. Thank you.
Senator Tester. I, once again, want to thank you all for
being here. I very much appreciate your testimony. I apologize
to Mr. Pinto and Mr. Skillern for not asking you guys
questions, but maybe next time. Thank you.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you, Mr. Chair, and thank you all
for addressing this issue because it is really a key one.
I thought I would try to concentrate on this concept of the
lender-owned cooperative. Mr. Hartings, in your written
testimony, you elaborated a bit on how covered bonds would
consolidate the market among, really, to the advantage of just
a few large financial institutions. So I wanted to get a better
sense of how you picture the lender-owned cooperatives. Do you
picture this being essentially a cooperative in which it is all
financial institutions, or primarily the smaller banks, the
community banks, the credit unions, et cetera? What would be
the--who would own them? What lenders are we talking about
here?
Mr. Hartings. I do not know that I can answer that by going
into quite that detail, but the idea of the cooperative is a
little bit the way that I think we are successful today in the
Freddie and Fannie market. We rep and warrant what we sell to
Fannie and Freddie. That means that if Fannie and Freddie looks
at our applications and they are incorrect or we falsified or
we did not cross every ``t'' and dot every ``I'', it comes back
to us. We have capital to back that up.
That is the idea of the cooperative a little bit. The other
point of the cooperative is equal voices, having one vote per
bank. So I am not sure that you limit it or not. Again, I do
not know that we have gone into that detail. It is one proposal
and it is the proposal that I think we have out on the table
today.
Senator Merkley. OK. And in your written testimony, you
talk about strategy for insulating taxpayers and note, and I
quote, ``Government catastrophic loss protection would be paid
for by an appropriately priced co-cop premium.'' So it sounds
like you are expecting the Government to stand behind the co-op
as the insurer of last resort, essentially, but I want to make
sure I understood that structure.
Mr. Hartings. I am not--I really would not like to comment
on that. I mean, I am not sure that is exactly our theory. I
think the idea would be--again, at this point in time, our
proposal out there. I think when you get into the details, I
think that is when you have to look at that a little bit more
seriously, how you would take care of that backstop.
Senator Merkley. OK. So I wanted to invite other folks to
weigh in on this. This is part of the challenge we are all
trying to figure out here, is how do we create a functional
secondary market in which the taxpayers are not on the hook or
are on the hook in a very defined and responsible manner of
some sort. But I think it makes me a little nervous to see the
Government being the insurer, because how do you know that you
have an appropriately priced co-op premium? If the premium is
completely appropriately priced, you would not need that
insurer to begin with. You could just put it into a fund to the
side. So a little expansion on this role would be helpful. Mr.
Pinto.
Mr. Pinto. Yes, Senator. I think that is a good point. If
you could price it properly, you would not need it. I think the
problem with real estate financing is it is cyclical and there
are boom-bust periods and there are the normal losses, and
those losses can be actuarially calculated based on the normal
risk factors. And then there are the imponderables, which occur
as a result of some economic event. This past one was very
unusual because it was led by very weak mortgage lending.
Normally, it is led by some type of other economic event, like
unemployment, and then that impacts the weaker loans. We had
the reverse this time.
But what you can be sure of is that there will be these
catastrophes periodically. When, is the problem. We do not
know. All we know is they will occur and you need to accumulate
enough capital to deal with the largest event you can
anticipate. It is kind of like the 100-year flood, and you
accumulate that capital.
The problem with a Government guarantee is the history of
accumulating that level of capital is not very good. Pricing
it, the impacts on, as I said, the impacts on the marketplace
that are unintended, the political pressures to reduce the
amount of capital. Oh, we have not had any claims in three or 4
years. Therefore, we should not do anything. That happened with
the FDIC. They did not charge any premiums for 96 or 97 percent
of the banks in this country for about 10 years because it was
thought that they had accumulated enough capital. Those are the
risks that really put the taxpayer in the cross-hairs.
Senator Merkley. One thing about that FDIC model, though,
is that it does allow them to go back out and increase their
rates to recoup it and, therefore, not have the Government as
the ultimate backstop, but I am running out of time and I
wanted to go on.
Mr. Skillern, you talk about something modeled more or less
on the North Carolina Housing Finance Agency, that is, a public
purpose entity, and you note in your written testimony that you
get rid of the conflicting private profit motive which may have
driven some of the practices in the GSEs that came back to
haunt us. Does the idea of a lender co-op perhaps fit into
that, or is this kind of a different, completely different
structure?
Mr. Skillern. I think it would be a different structure. In
addition to my concern about access to capital for small
financial institutions, I also have it for low- to moderate-
income households and communities of color, and that the
pricing of that risk and how we define the boundaries could be
very narrow or more expansive as long as they are more
responsible and sustainable. So I also think that the Housing
Finance Agency model would be a smaller role to play, if you
look at the total, what is really happening in North Carolina.
It fits a particular range where there is an appropriate role
for Government to help facilitate home ownership and rental
housing.
So there is a--we really embrace this concept of both
private and public participation, but that public has to be
intentional. And I guess my concern about the cooperative model
is that that is not intentional enough to assure us that we are
going to have enough access to a range of communities across
the country.
Senator Merkley. Do you see the Government standing behind
such a public purpose entity, an independent nonprofit, if you
will, that is playing this secondary market role?
Mr. Skillern. Yes, sir, I do. You know, I believe that,
while as much as we want to put taxpayer money behind private
money, that we want to assign risk to the decision maker so
that we are not putting taxpayers to insure someone else's
moral hazard, the reality is is that our Government and our
taxpayers stand behind our society as far as the risk that we
take and our cost. So there is a role for that and I think we
should be up front about it, but also then be clear about
defining what those limits are, and I think that this finance
agency model allows us to define that more clearly, to say who
pays once private dollars are taken.
Senator Merkley. Thank you. Thank you, Mr. Chair. I am
going to continue for a moment here.
Mr. Pinto, you observed that the community banks and credit
unions were producing better loans but paying higher guarantee
fees, and I am trying to picture how this unfolded and I assume
it was volume discounts and the competition between Fannie and
Freddie, but can you elaborate a little bit on how it is that a
better product had to pay a higher insurance fee?
Mr. Pinto. Yes, I would be happy to. Back--I actually went
back into the late 1980s and the guarantee fees were level
regardless of lender, and then starting in about--I had data
from 1993, 1994, 1995, the guarantee fee started diverging, and
I mentioned--that is in my written testimony. What was going on
was this competition with Fannie and Freddie for customers and
also for affordable housing loans. I found credit policy
meeting minutes that talked about the fact that the credit
variances were being approved. I also found evidence that there
were lower guarantee fees being offered to the larger
customers.
Over time, those widely diverged, and so Mr. Hartings'
testimony is correct. The losses on the community bank loans
were much lower at much higher guarantee fees than experienced
the other way around. Countrywide and the other large lenders
were paying much lower guarantee fees but had much higher
default rates. Again, it was driven by a combination of
competition and the goals that were looking for the kinds of
loans that were most easily gotten from the large lenders.
Senator Merkley. Were those fees denominated in terms of
percentage rates for the size of the loan? Is that how it was
done?
Mr. Pinto. Yes. It is termed in basis points, so it was
called a guarantee fee, and normally guarantee fees would range
from, you know, 20 to 25 basis points, and things got down as
low in the mid-aught years around 10 basis points, 11 basis
points, somewhere in there for the largest lenders as their
base fee. So you can see the disadvantage. That does not sound
like a lot, ten basis points, but when you multiply it every
year, it ends up being something on the order of close to half-
a-percent. Well, given the profit margin that one has on a
loan, a half-a-percent looms large.
Senator Merkley. So if I am an investor, would I not want
to pay a higher price, if you will, for loans originated by
community banks and credit unions where they have a tradition
of kind of honest underwriting, if you will?
Mr. Pinto. One would think so. I actually had conversations
with Freddie Mac on this precise topic about 5 years ago and
asked that question from the head of marketing and I was told,
well, we already have their business. Why would we pay up for
it? And I made the exact point that the quality was better, and
there were lots of different reasons why it was better, and the
answer was, we already have that business. Why would we pay up
for it?
Senator Merkley. Well, and in essence, the investor was
looking at pools that mixed the loans from many sources, so
they did not have really a choice of discriminating as far as I
am aware.
Mr. Pinto. Well, when you said investor, I was talking
about Fannie Mae or Freddie Mac.
Senator Merkley. Yes.
Mr. Pinto. But as far as the investor, the end investor's
concern, everything got, as you said, put together and the
investor had the implicit guarantee of Fannie and Freddie. So
they really did not look below to see what was going on below
that guarantee by Fannie and Freddie.
Senator Merkley. Thank you all. Thank you very much.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman.
Mr. Skillern, in your testimony, you mentioned that the GSE
loan level pricing adjustment policy impacts on low- to
moderate-income borrowers. This appears to be similar to what
is being proposed in the Qualified Residential Mortgage
proposed rule. Loans with low downpayments become less
affordable as conventional loans and are forced into FHA. Can
you explain this program to me and what lessons can be learned
from it in regards to pricing loans according to the size of
the downpayment rather than the ability to pay?
Mr. Skillern. To echo the comments of the bankers who feel
like they have the ability to understand risk because they know
their customer and to do the loan file review, the ability to
repay is really the primary underwriting that we should have in
approving loans.
The loan level pricing program of GSEs is essentially
pricing much higher for loans that have downpayments less than
10 percent and credit scores less than 720. And while we
certainly applaud stringent underwriting, safe underwriting,
the result, though, is that as you start to add price to
anything outside that narrow band, you push folks over to FHA,
which has a bigger impact of more credit being direct--more
risk directly on the taxpayer as the Government guarantees FHA
loans, or you start to price people completely out of the home
ownership market and deny them. And it starts to shrink who is
able to purchase a home, particularly on the first-time
homebuyer.
The QRM is similar in that it is even a greater definition.
It starts to--it is setting the benchmark at 20 percent
downpayment, further narrowing who the eligible, creditworthy
borrowers are, and as my fellow bankers have said, there are a
lot of good borrowers out there who do not necessarily have ten
or 20 percent down. And when you look at who in that category
does not, it often tends to be low- and moderate-income
households or communities of color who do not have that
downpayment or wealth to be able to meet that criteria.
So part of our housing policy has to be based on sound
economics, sound underwriting, protecting the taxpayer. It also
should be done with some sense about how do we have social
inclusion that allows credit across the spectrum of our
communities. That is the intentionality that I referred to
earlier.
So we are opposed to the QRM because it draws that band of
what is prime much too narrow and is not good for the housing
market as a whole, nor for the local communities.
Senator Hagan. When I look at the average income in North
Carolina and I think about a 20 percent downpayment, it appears
that people would have to save upwards of 15 years plus in
order to be able to afford a 20 percent downpayment on an
average house in North Carolina, and I just think that is
definitely pricing people out of the market----
Mr. Skillern. Yes----
Senator Hagan. ----and unreasonable.
Mr. Pinto, the FDIC before the passage of Dodd-Frank put in
place its own risk retention regulation. Has the FDIC risk
retention provision that predates Dodd-Frank ignited mortgage
securitization, and how important is the return of a vibrant
mortgage securitization market for the return of private
capital?
Mr. Pinto. Senator, you are referring to the one that was
passed in 2001?
Senator Hagan. No, I was referring to the most recent Dodd-
Frank.
Mr. Pinto. No, the FDIC----
Senator Hagan. Yes.
Mr. Pinto. ----pre-Dodd-Frank----
Senator Hagan. Right.
Mr. Pinto. Was that in 2001, that securitization? They had
a rule that changed the weighting----
Senator Hagan. I presume so.
Mr. Pinto. OK. If that is the one, the regulators, and it
was not just the FDIC, I think, banking regulators changed the
weighting for AAA private mortgage-backed securities. The
research I have done has shown that that did not have any
immediate impact on what was going on in the mortgage-backed
securities market. Whatever happened, happened with about a 3-
year lag. So I could not tie the two together.
Regarding your second question, yes, I believe it is
necessary for the financial markets to have a vibrant mortgage-
backed securities market because the banking system is not
large enough to handle it, number one, and number two, the too-
big-to-fail problems in the banking system, we do not want to
end up just moving mortgage risk from Fannie and Freddie, where
it was not very well managed, to, as has been talked here today
quite a bit, three or four large banks.
Senator Hagan. Thank you. And, Mr. Hartings, how reliant
are small community bankers on the ability to originate, to
sell a mortgage, and how problematic is the proposed rule for
the risk retention language in Section 941 if the regulators do
not get the QRM right?
Mr. Hartings. Well, we look at our balance sheet when we
have risk retention. We have interest rate risk in our--we are
rated as banks under CAMEL. They added CAMELs a couple of years
ago, which was sensitivity, risk rate sensitivity. If we have
to retain some of that mortgage on our books, then we have a
whole another issue with capital. So, yes, I think that would
be devastating to community banks.
Senator Hagan. I do, too. And, Mr. Hartings, currently,
small lenders are able to participate in the mortgage market by
selling loans to Fannie Mae and Freddie Mac without having to
go through one of the big banks to accumulate enough loans, as
we were talking about, to create a securitization pool. What
would the Administration's proposals do to the ability of
smaller lenders, such as community banks, to compete in the
mortgage market and what would this do to the concentration of
the market?
Mr. Hartings. You know, my belief would be it would
concentrate it to the, certainly the larger megabanks, again,
without equal access, and it is equal pricing. Mr. Pinto
touched on it a little bit. Every day, we go out to Freddie and
Fannie and we price our loans accordingly. They give us--we
sell at a par or par plus a half-a-percent. If that pricing
gets raised, how often does my customer want to come to me if I
have to charge him a half-a-percent higher or a full 1 percent
higher? We would lose it either immediately or as a slow burn,
as we call it.
Senator Hagan. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman, and
thank you, gentlemen, for your excellent testimony.
Mr. Pinto, I want to follow up on something that you
commented upon in your testimony, and that is the need for both
strong supervision and adequate capital. You know, we have a
debate right now about adequate capital. I think you also
suggest that it has to be countercyclical, that capital has to
be built up. So if you could elaborate on those points, I would
appreciate it.
Mr. Pinto. Thank you, Senator. I would be happy to. As I
said, the mortgage business is countercyclical, has these two
components of risk, the second of which is this catastrophic
risk that occurs because of, generally, some external event.
And back in the early 1980s, it was the collapse of oil prices
which then led to high unemployment in Texas and elsewhere. So
you do not know what it is going to be. You just know you have
to be prepared for it.
And the problem, and Fannie Mae is the perfect example.
Fannie Mae had a static capital requirement that was 45 basis
points on--less than half-a-percent on its guaranteed loans.
That stayed pretty constant. They were accumulating very little
in the way of loss reserves because of the way the accounting
works for that. And so as the risk was building up in the
system--but it did not look like risk was building up in the
system because delinquency rates looked very low. Well, that
was being fed by the boom that was keeping them down and
everybody was thinking everything was fine.
What happened was they were not accumulating any additional
capital, and then when the boom ended and they collapsed, A,
they were very thinly capitalized. The mortgage-backed
securities were 220-to-one. And their actual capital was very
weak. Half of their capital was tax advantaged. Well, again, if
you are a financial guarantee entity, to invest your money in
something that you need to make money in order to have your
capital be worth something, it seems, is backwards. So those
are the kinds of----
Senator Reed. Right. But in the context today, when we are
talking about capital rules for these large megabanks and for--
particularly large megabanks, my sense is that you would
suggest that there needs to be more than less capital.
Mr. Pinto. In general, more, and in general, if the
entities are too big to fail, they should be smaller.
Senator Reed. Thank you very much.
Mr. Hartings, one of the issues here on the Qualified
Residential Mortgages, what is the downpayment and what is the
sort of percentage of your income that you are devoting to
housing. And I think one of the reactions across America, not
on Wall Street but on Main Street, was as this housing crisis
evolved was people were shocked, saying, they did not put any
money down and 45 percent of their income was a mortgage
payment?
So now, looking at this proposed regulation--and it is a
proposed regulation--we were very general in our description of
what the QRM should be. There seems to be--there has got to be
some notion of a, I think in the minds of people on the street,
of a minimum downpayment to make this a safe loan, a
traditional loan. So just what is the average downpayment that
you would insist upon in your very well-run community bank? Is
it 10 percent? Is it 15 percent?
Mr. Hartings. We have a couple of different programs.
Certainly, most of everything we sell to Freddie Mac has got
the 20 percent down, the Federal Home Loans, and we actually
have a program we do internally in our bank called Homebuyers
Assistance that we have five, ten, or 15 percent down.
What you really find out is it is not the downpayment. It
is other things, like payment-to-income ratio. It is, did you
come up with your own downpayment? What is your credit card
debt? It is not one silver bullet that decides if that is going
to be a good loan or not. Our concern would be if you just look
at downpayment, you do not want to be an asset lender, and that
is the way you are going to get paid back. You really want to
look at the probability of payment from your customer through a
regular source.
Senator Reed. Can I presume that you would think
appropriate that when this regulation is finally approved, it
would have some combination, as you suggest, of minimum
downpayment--in fact, my sense is most people are still shocked
that people were getting--I grew up in the 1950s, 1960s, 1970s,
where you had to put money down--some combination of
downpayment and also some percentage of your housing per income
and also other expenses per income. Are we just arguing about
what the proper sort of numbers are----
Mr. Hartings. My concern----
Senator Reed. ----because you----
Mr. Hartings. My concern is this. I saw the market a couple
years ago when we did not participate in the subprime, and what
I would see happen is I would see someone selling a home for
$100,000. They would increase the price to $110,000 or
$115,000. That person, that seller, would give the buyer the
downpayment and he had the downpayment. So they gamed the
system----
Senator Reed. No, I----
Mr. Hartings. ----so that is what I am concerned about when
you put some hard ratios in there----
Senator Reed. Of course, the other concern is if you do not
have any of these rules of the road, you get exactly what we
had, which was gaming, no money down, great products, et
cetera. So I think, you know, the challenge we gave to
regulators was come up with an appropriate balanced mechanism
that exempts certain loans from the requirement to hold, and
you would not have to hold a loan. You could sell anything you
want to the securitizer. They would have to hold 5 percent. And
we thought, and I think, again, the logic we can examine, is
that if they had to hold some of these, they would not be quite
as willing to buy terrible products that were emanating from
many different sources. So I am just trying to get a sense from
a community banker of what you are doing and what we have to
do.
Mr. Hartings. Well, I think what we are doing is when we
see less of a downpayment, we have somewhat of different
standards, maybe a little higher standards in some of these
other areas, and we hold them a little firmer to those, because
it is all risk and we do not want our customer not to be able
to make their payment. We do not want them to have to leave
their home and have it foreclosed or sell it out from
underneath them. So I think prudence says that if you have less
of a downpayment, Senator, you probably have to have a little
bit more stringent underwriting with those lesser downpayments.
Senator Reed. Thank you.
Chairman Johnson. Thanks again to all of our witnesses for
being here with us today. Steady access to the secondary market
for small financial institutions is a necessary component to
any proposal for reforming the housing financial system. Your
testimony today will, without a doubt, serve as a resource to
this Committee as we continue to work toward creating a stable
and sustainable housing market for American families.
The hearing record will remain open for 7 days for
additional statements and questions.
This hearing is adjourned.
[Whereupon, at 11:22 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF JACK HARTINGS
President and Chief Executive Officer, The Peoples Bank Company, on
behalf of the Independent Community Bankers of America
June 28, 2011
Chairman Johnson, Ranking Member Shelby, Members of the Committee,
I am Jack Hartings, President and CEO of The Peoples Bank Company and a
member of the Executive Committee of the Independent Community Bankers
of America. The Peoples Bank Company is a $350 million asset bank in
Coldwater, Ohio. I am pleased to represent community bankers and ICBA's
nearly 5,000 members at this important hearing on ``Housing Finance
Reform: Access to the Secondary Market for Small Financial
Institutions.'' Community bank mortgage lenders have a great deal at
stake in the future of housing finance in this country. Any proposal
for reform must support fair and robust access to the secondary market
for community banks.
Community Banks Strengthen the Mortgage Market
Any broad based recovery of the housing market must involve
community bank mortgage lending. Community banks represent
approximately 20 percent of the mortgage market, but more importantly,
our mortgage lending is often concentrated in the rural areas and small
towns of this country, which are not effectively served by large banks.
For many rural and small town borrowers, a community bank loan is the
only mortgage option.
A vibrant community banking sector makes mortgage markets
everywhere more competitive, and fosters competitive interest rates and
fees, better customer service, and more product choice. The housing
market is best served by a large and geographically dispersed number of
lenders. We all witnessed the danger and devastating fallout that
resulted when mortgage lending became concentrated in a few major
market players. We must promote beneficial competition and avoid
further consolidation and concentration of the mortgage lending
industry.
Quality Community Bank Mortgage Lending
The Peoples Bank Company has been in business for 105 years. We
survived the Great Depression and numerous recessions before and
since--as have many other ICBA member banks--by practicing
conservative, common-sense lending. We make sure loans are affordable
for our customers and they have the ability to repay. Loans are
underwritten based on personal knowledge of the borrower and their
circumstances--not based on statistical modeling done in another part
of the country. Community banks generally did not make subprime loans
with the characteristics that have led to recent problems, such as
``teaser'' rates and lack of appropriate documentation. As responsible
community-based lenders, community banks require appropriate
documentation of borrower income and do not make loans that compel
borrowers to refinance or sell in order to remain solvent. As a result,
our borrowers are less likely to default.
When community banks sell their well-underwritten loans into the
secondary market, they help to stabilize and support that market.
Community bank loans sold to Fannie Mae, Freddie Mac, and the Federal
Home Loan Banks (the GSEs) are underwritten as though they were to be
held in portfolio. We often go beyond the ratios and statistics used by
the GSE automated programs and underwrite based on direct and personal
knowledge of the community and the lifestyle of the borrower him or
herself. This relationship underwriting makes a striking impact on the
performance data. In a typical year, before the GSEs accelerated their
purchases of riskier loans, community bank-originated loans became
``seriously delinquent'' (i.e., more than 3 months delinquent) at about
one-third the rate of all GSE loans. In the most frenzied, exuberant
years of mortgage lending, 2005 through 2007, the general pool of GSE
loans was seriously delinquent at a rate four or five times higher than
loans originated by community banks and sold to GSEs. In the wake of
the financial crisis, with the general tightening in underwriting
standards, community bank loans have continued to perform better--with
a delinquency rate one-third to one-half that of other loans. Community
bank loans perform better in all market conditions and contribute to
the safety and soundness of the secondary markets. Our role must be
preserved in any reform.
Better underwriting is complemented by better servicing--the two
sides of the lending equation. Community bank servicing, which is also
based on our close ties to customers and communities, is more effective
at keeping mortgages out of default. We know, for example, when an
employer closes in our community and how that closure impacts the
income of our borrowers. A servicer based 1,000 miles away won't have
such knowledge. Smaller servicing portfolios and better control of
mortgage documents also provide an advantage over the large servicers.
For these reasons, community banks have generally been able to identify
repayment problems at the first signs of distress and work out mutually
agreeable solutions with struggling borrowers.
As Congress and the agencies consider how to address the abusive
servicing standards of some large lenders, they must recognize
community banks have fundamentally different standards, practices, and
risks. Overly prescriptive servicing requirements should not be applied
across the board. For example, if the State attorneys general
foreclosure settlement term sheet were applied to all banks, regardless
of size, it would cause many community banks to exit the mortgage
servicing business and accelerate consolidation of the servicing
industry, leaving it to the largest too-big-to-fail lenders.
Fair Access to the Secondary Market
While community banks choose to hold many of their loans in
portfolio, it is critical for community banks to have robust secondary
market access in order to support lending demand with their balance
sheets. My bank's access to Freddie Mac, for example--I have a $75
million servicing portfolio of loans we originated and sold to Freddie
Mac--allows me to support the broad lending needs in my community,
fixed-rate lending in particular. As a community bank, it is not
feasible for me to use derivatives to offset the interest rate risk
that comes with fixed-rate lending. Secondary market sales eliminate
this risk. In addition, I have the assurance that Freddie Mac won't
appropriate data from loans sold to solicit my customers with other
banking products.
While many community banks remain well-capitalized following the
financial crisis, others are being forced by their regulators to raise
new capital, even above minimum levels. With the private capital
markets still largely frozen for small- and mid-sized banks, some are
being forced to contract their lending in order to raise their capital
ratios. In this environment, the capital option provided by the
secondary markets is especially important. Selling my mortgage loans
into the secondary market frees up capital for other types of lending,
such as commercial and small business, which is critical to our
communities.
In addition to selling mortgage loans to Freddie Mac, for the past
2 years my bank has participated in the Mortgage Purchase Program (MPP)
through the Federal Home Loan Bank of Cincinnati. While our sales to
the MPP are only a fraction of our sales to Freddie Mac, we're pleased
to have this alternative secondary market access. The Federal Home Loan
Banks (FHLBs) are an important source of liquidity to support community
bank mortgage lending. The FHLBs were particularly important during the
financial crisis when they continued to provide advances to their
members without disruption while other segments of the capital markets
ceased to function. The FHLBs must remain a healthy, reliable source of
funding.
Key Features of a Successful Secondary Market
The stakes involved in getting housing-finance market policies
right have never been higher. Given the fragile state of the housing
market across America, there is no room for policy missteps and no
luxury for experimentation. Housing and household operations make up 20
percent of our economy and thousands of jobs are at stake. Proven,
practical solutions must take precedence over the theoretical.
With regard to the secondary market, the critical questions of
corporate structure, governance, and mission will determine whether,
and to what extent, community banks are able to participate. If the
terms are not right, the secondary market could be an impractical or
unattractive option for community banks. Below are some of the key
features community banks seek in a first-rate secondary market.
Equal access. To be sustainable and robust a secondary market must
be impartial and provide equitable access and pricing to all lenders
regardless of their size or lending volume. Without the appropriate
structure, a secondary market entity will have a strong incentive to
offer favorable terms to only the largest lenders. Such an outcome
would drive further industry consolidation, increase systemic risk and
disadvantage the millions of customers served by small lenders.
Financial strength and reliability. A secondary market must be
financially strong and reliable enough to effectively serve mortgage
originators and their customers even in challenging economic
circumstances. Strong regulatory oversight is needed to ensure the
secondary market is operating in a safe and sound manner.
No appropriation of customer data for cross-selling of financial
products. When a community bank sells a mortgage to a secondary market
entity, it transfers proprietary consumer data that would be highly
valuable for the purposes of cross-selling financial products. Without
large advertising budgets to draw in new customers, community banks
seek to deepen and extend their relationships with their current
customer base. Secondary market entities must not be allowed to use or
sell this data. Community banks must be able to preserve our customer
relationships and our franchises after transferring loans.
Originators must have option to retain servicing and servicing fees
must be reasonable. Originators must have the option to retain
servicing after the sale of a loan. In today's market, the large
aggregators insist the lender release servicing rights along with the
loan. Transfer of servicing entails transfer of data for cross-selling,
the concern identified above. While servicing is a low margin
business--in fact I would make more by releasing servicing rights--it
is a crucial aspect of my relationship-lending business model, giving
me the opportunity to meet the additional banking needs of my
customers.
Because the income provided by servicing is only enough to cover
costs, ICBA is very concerned about a recent Federal Housing Finance
Agency (FHFA) proposal to significantly reduce servicing fees and, by
rewarding servicers of nonperforming loans, remove the incentive for
diligent servicing that keeps loans current. This would be unfair to
community banks that predominantly service performing loans.
Additionally, some of the proposed fees do not reflect the cost of loan
servicing at a community bank.
Limited purpose and activities. The resources of any secondary
market entities must be focused on supporting residential and
multifamily housing. They must not be allowed to compete with
originators at the retail level where they would enjoy an unfair
advantage. The conflicting requirements of a public mission and private
ownership must be eliminated.
Private capital must protect taxpayers. Securities issued by the
secondary market entities must be backed by private capital and third
party guarantors. Any Government catastrophic loss protection must be
fully and explicitly priced into the guarantee fee and the loan level
price. This guarantee would not only provide credit assurances to
investors, sustaining robust liquidity even during periods of market
stress.
The Future of the Secondary Markets
For decades the housing GSEs worked well and supported high-quality
mortgage lending by banks of all sizes. However, conflicting demands of
investor expectations and arbitrary affordable housing goals, combined
with weak oversight and inadequate risk management, sent the GSEs off
track, ending a long and successful run. The steep and sudden drop in
the value of GSE preferred shares had staggering consequences for many
community banks that purchased these shares with the support of their
regulators. My bank held Freddie Mac preferred shares, so I speak from
first-hand experience. This injustice must be corrected by restoring
the dividend payments on the preferred shares and paying injured
holders the amount of suspended dividends.
There is widespread agreement that this troubled model must be
reformed. Any reform cannot simply reestablish the GSEs or recreate
them under a different name with the same scale and risks. An
aggressive role for Government in housing is no longer a viable option.
The private sector should and will take the lead in supporting mortgage
finance. ICBA welcomes this new reality as an appropriate response to
the moral hazard and taxpayer liability of the old system. Community
banks are prepared to adapt and thrive in this environment. But however
different are the successors to Fannie Mae and Freddie Mac are from the
legacy of those institutions, we believe they must retain the key
features and principles that allowed community banks to thrive as
mortgage lenders and to serve their communities.
The worst outcome in GSE reform would be to allow a small number of
megafirms to mimic the size and scale of Fannie and Freddie under the
pretense of creating a private sector solution strong enough to assure
the markets in all economic conditions. This would create a new moral
hazard, just as pernicious as the one it replaced. The concentration of
assets would make them too big to fail. The market would know full well
that the Government would bail them out (as it did in 2008) rather than
let the housing market and the economy collapse. These lenders would in
effect become privatized ``Fannies'' and ``Freddies,'' with all the
benefits and the risks that come with TBTF status. Moral hazard derives
from the concentration of risk, and especially risk in the housing
market because it occupies a central place in our economy. Any solution
that fuels this consolidation is only setting up the financial system
for an even bigger collapse than the one we've just been through.
The GSEs must not be turned over to the Wall Street firms that
fueled the financial crisis with sloppy underwriting, abusive loan
terms, and an endless stream of complex securitization products that
disguised the true risk to investors while generating enormous profits
for the issuers. These firms have exploited the trust of investors and
brought the economy to the brink of collapse. Lack of trust in these
firms has hindered private investment in the mortgage market and
prolonged Government dominance of it. They must not be allowed to
reclaim a central role in our financial system.
A Note on Covered Bonds
While covered bonds have been advanced as an alternative to the
secondary markets in providing liquidity to loan originators, they
have, to date, enjoyed little investor interest. Also, these bonds are
capital intensive which makes them infeasible for all but the largest
banks. Banks like mine would have to sell their loans to larger banks
thus fueling further concentration and consolidation.
With the conservatorship of Fannie Mae and Freddie Mac, there is
some legislative interest in making covered bonds more attractive to
investors by enhancing investor claims over the pool of assets that
secures (or ``covers'') a covered bond. ICBA continues to analyze the
legislative proposals that have been put forward. We are concerned the
covered bond system may provide covered bond investors superior rights
in receivership that aren't provided to other secured creditors. We
have expressed our concerns with how this ``super priority'' status for
the covered bond investor could affect the Deposit Insurance Fund (DIF)
in the event an FDIC institution that held these covered bonds failed.
Therefore, like all secondary market proposals, more analysis and
rigorous debate is warranted to avoid unintended consequences.
ICBA Concept for Secondary Mortgage Market Reform\1\
One option for reform, which would address the criteria outlined
above, would replace Fannie Mae and Freddie Mac with lender-owned
cooperatives.
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\1\ ICBA's cooperative model is similar to a proposal favorably
analyzed by the New York Federal Reserve and the Government
Accountability Office.
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We believe this proposal would protect taxpayers from another
bailout, ensure equal access and pricing for lenders of all sizes,
deter further consolidation, ensure liquidity during periods of market
stress, preserve the significant benefits of the ``to-be-announced''
(TBA) market, and minimize disruption in the market by providing for
the direct transfer of Fannie Mae's and Freddie Mac's infrastructure to
the new co-ops. While ICBA is prepared to advance the co-op option,
other options that address our principles may be equally appealing to
community banks.
Cooperative governance would ensure broad access and deter excessive
risk taking
The key securitization role of Fannie and Freddie could be done by
cooperative entities owned by mortgage originators who purchase stock
commensurate with their loan sales to the co-ops. This is similar to
the capitalization of the Federal Home Loan Banks (FHLBs) and provides
a capitalization source that can be adjusted based on market conditions
and risk profile and performance of the co-ops' book of business.
Members would have an incentive to transfer only soundly underwritten
loans to the co-ops because any losses would adversely affect their own
capital investment.
The co-ops would be governed on a one-company-one-vote basis. Big
banks would not be allowed to dominate the new co-ops. Further,
directors would be appointed to represent various sizes and classes of
members, while a minority number of seats would be reserved for outside
independent directors with financial expertise.
The advantage of this form of governance is that all co-op members
would enjoy open and equal access and benefits in terms and pricing,
regardless of their origination volume. This would prevent industry
consolidation and preserve access to credit for the millions of small
town and rural borrowers served by community banks. The co-ops would be
required to provide liquidity to all home mortgage markets on a
continuing and equitable basis. Guarantee fees and reinsurance fees
would be set by the co-op boards and would be the same for all members.
However, any mortgage originators with substandard loan performance
would be subject to additional surcharges and restricted access until
their loan performance improved.
The co-ops would guarantee a limited range of conservatively
underwritten products: 15- and 30-year fully amortizing mortgage loans.
The co-ops would only be engaged in the secondary market and would
be barred from operating in the primary market. They would not unfairly
compete with mortgage originators.
A privately capitalized guarantee fund would insulate taxpayers
Mortgage-backed securities issued by the co-ops would be guaranteed
by a fund capitalized by co-op members as well as 3rd party guarantors.
Resources would be mandatorily set aside in good times to prepare for
challenging times. Any Government catastrophic loss protection would be
paid for by an appropriately priced co-op premium. Any guarantee, must
be fully and explicitly priced into the guarantee fee and loan level
price, and would not only provide credit assurances to investors,
sustaining robust liquidity even during periods of market stress, but--
a point less often noted--it would enable the co-op securities to be
exempt from SEC registration and trade in the ``to-be-announced'' (TBA)
forward market. \2\ Without the TBA market, which allows lenders to
sell loans forward before they are even originated and to hedge their
interest rate risk during the rate ``lock'' period, the typical 30-year
fixed-rate loan as we know it and on 8 8 which our housing market is
based will become a rarity. Again, private capital from members,
mortgage insurers, and private reinsurers would absorb all but
catastrophic losses to ensure taxpayer would be well insulated.
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\2\ In a TBA trade, participants agree to exchange a given volume
of mortgage-backed securities at a specified date and at an agreed-upon
price. This allows lenders to sell mortgages forward before they are
even originated. Because it facilitates hedging of interest rate risk,
the TBA market also allows lenders to offer borrowers an interest rate
``lock'' for as long as 90 days. TBA trades are based on an assumption
of homogeneity among the securities that will actually be included in
the MBS. This assumption is facilitated by standardization in the
underwriting of mortgages and by a Government guarantee, implied or
explicit.
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The infrastructure of Fannie and Freddie--including their
personnel, patents, systems, automated underwriting engines--could be
transfer to the new co-ops. This is an important and essential feature
of the proposal as it would minimize disruption in the market and
reduce the cost of the transition to the new system.
The outstanding debt and securitizations of Fannie and Freddie
would maintain the current guarantee.
Strong Supervision
The Federal Housing Finance Agency (FHFA) would regulate and
supervise the co-ops. FHFA would be responsible for setting and
monitoring capital levels based on market conditions, portfolio
performance and overall safety and soundness. FHFA would approve all
new mortgage products purchased by the co-ops.
Closing
Private entities must play a more robust role in the mortgage
securitization market. That much is all but settled. Still to be
determined is what form those entities will take--instruments of Wall
Street or those in which community banks and lenders of all sizes are
equally represented and communities and customers of all varieties are
served.
The co-op proposal is one option that encompasses our principles
for a successful secondary market. ICBA looks forward to working with
this Committee, the Administration, and our industry partners to
examine proposals that can support quality, competitive mortgage
lending and are in the best interest of the communities we serve.
Thank you for holding this hearing and for the opportunity to
testify.
PREPARED STATEMENT OF EDWARD J. PINTO
Resident Fellow, American Enterprise Institute
June 28, 2011
PREPARED STATEMENT OF ROD STAATZ
President and Chief Executive Officer, SECU of Maryland, on behalf of
the Credit Union National Association
June 28, 2011
PREPARED STATEMENT OF CHRISTOPHER R. DUNN
Executive Vice President, South Shore Saving Bank, on behalf of the
American Bankers Association
June 28, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, my name is Christopher Dunn, Executive Vice President and
Chief Operating Officer of South Shore Savings Bank, South Weymouth,
MA. I appreciate the opportunity to present the views of the American
Bankers Association (ABA) on the future of Government-sponsored
enterprises (GSE) and particularly the access to the secondary market
by community banks. ABA represents banks of all sizes and charters and
is the voice of the Nation's $13 trillion banking industry and its two
million employees.
The issue of GSE reform is a critical one for banks, particularly
for community banks like mine, which use GSEs as the primary mode of
access to the secondary markets. At South Shore Savings Bank, we have a
proud heritage of commitment to the communities on the South Shore
since 1833, with 13 branches and 187 employees. From a personal
perspective, my entire career since 1972 has been in the mortgage
lending business within the community bank world. I sold my first loans
to Fannie Mae in 1974, so I know well the importance of secondary
market access for smaller banks. Without that access, my bank could not
be an active player in our primary mortgage market because our balance
sheet could not support the demand in the market. Further, we would not
be able to offer long-term fixed-rate loans due to the increased
interest rate risk that this would create in the bank loan portfolio.
Over the course of the last year, ABA has gathered bankers like me
to discuss the future of Fannie Mae and Freddie Mac and to consider an
outline for a path forward. ABA has also engaged in discussions with
regulators, which have helped us refine our views. In that process, ABA
developed eleven principles to guide reform of the GSEs, which are
attached to my testimony as an appendix. As Congress begins the next
phase in shaping the future of the mortgage markets and the
Government's role in them, I hope these principles, and the
recommendations I will discuss below, will provide a base to build on.
ABA believes that the role of Fannie Mae and Freddie Mac should be
reduced and transformed, enabling the private sector to shoulder more
of the responsibility to assure an effective and efficient secondary
mortgage market. In addition, the Federal Housing Administration (FHA)
should return to its traditional role of serving first time homebuyers
and other borrowers who may not qualify for conventional financing. The
end goal we envision is a housing finance market in which more than
half of mortgage finance occurs without Federal secondary market
guarantees of any type. An ideal goal might be to have 10 percent of
loans in direct Government guarantees like FHA and VA, 30 percent in
well-regulated and mission-directed businesses that are privately owned
and operated with a Government backstop, and 60 percent with no
Government aid.
The overarching principle is to ensure that banks of all sizes have
access to secondary market financing. The ABA has not endorsed a
specific structure for the GSEs and the private secondary market to
achieve this going forward; finding the right mechanism will be
challenging. In the meantime, however, there are significant actions
that can provide a transition vehicle to reduce governmental
involvement, foster private sector financing, and still assure
equitable access to secondary markets for all banks.
Possible transitional structures for the GSEs or their successors
include a well-regulated and controlled cooperative structure owned by
the financing entities or a similarly controlled secondary market
utility that is publicly owned. Whatever structure is chosen will
require significant control and direction of guarantee fees, mission,
investor returns, and potential taxpayer liability. Activities under
that portion of the structure with Government support or backstop will
need to be confined to a controlled mission that is intended, among
other things, to foster and accommodate development and expansion of
purely private sector mortgage financing alternatives.
Rather than develop a single ``silver bullet'' solution to housing
finance, it may be desirable to develop several sources which aid in
the reestablishment of a private market. Multiple sources of liquidity
for private market (including portfolio) lenders will lead to a more
diverse and ultimately safer housing financing system. Thus, in
addition to the creation of a successor entity or entities to the GSEs,
policy makers may want to consider the creation of a well-regulated
covered bond market, as well as enhancements to the Federal Home Loan
Banks which would better help them continue to meet their mission of
providing advances to private market portfolio lenders with minimal
taxpayer exposure. It is also important to ensure that any actions
taken with regard to Fannie Mae and Freddie Mac do not harm or
destabilize the Federal Home Loan Banks, which provide a key source of
liquidity to our Nation's banks, especially community banks.
Further, we would note that to fully protect taxpayers from
additional losses, it will be necessary to impose similar reforms on
the Farm Credit System, which continues to follow the discredited model
of privatized gains and public losses which failed so badly in the
housing sector. Without similar reforms to the Farm Credit System, it
is only a matter of time until taxpayers again are put at risk.
That vision of transforming the GSEs and enhancing the role of the
private sector may take years to attain, and goals can be better
calibrated as we proceed. However, it is essential that we start taking
incremental steps toward these goals, and trust in our ability to make
midcourse corrections as we progress.
Underpinning all of this must be workable and clear underwriting
standards for all mortgage loans. We must get the underwriting
standards correct today if we have any hope of transitioning to a
stable system for secondary mortgage instruments. The current proposals
defining a narrow Qualified Residential Mortgage (QRM) exemption from
risk retention requirements fly in the face of workable and clear
standards. In fact, should this proposal be adopted as proposed, it
will surely drive many banks from mortgage lending and shut many
borrowers out of the credit market entirely. ABA strongly believes that
this rule should be substantially rewritten and reproposed in a new
form.
Not only is the proposal ill-conceived and will have long-term
negative impacts on mortgage lending, but it comes at a particularly
bad time with the housing market still struggling to recover. Since it
is also the stated goal of both the Congress and the Administration to
end the conservatorship of Fannie and Freddie, it is important that
risk retention requirements be rational and nondisruptive when they are
applied broadly to the market. The rule as proposed does not meet those
tests.
In the remainder of my testimony, I want to focus on three key
things:
The role of the Government in housing finance should be
dramatically reduced from its current level. Guarantee fees
should be used to encourage private sector involvement.
The transition to a private market should be carefully
managed to protect taxpayers and ensure continued credit
availability.
New proposed mortgage rules on risk-retention are likely to
drive many community banks out of mortgage lending and cut off
mortgages to some borrowers.
I will discuss all three of these points in turn.
I. Government's Role in Housing Finance Should Be Dramatically Reduced
A private market for the vast majority of housing finance should be
fostered and encouraged with an ultimate goal of a much smaller
governmental role. Therefore, ABA proposes that the Government's role
in housing finance should be focused primarily on ensuring stability
and accessibility of the capital markets in the event of market
failure.
Direct Government involvement may be necessary and desirable for
the creation of affordable rental housing and to assist first-time
borrowers or others who may not readily qualify for conventional
financing. A well-regulated private market should be the desired
financing source for the bulk of borrowers whose income and credit
rating qualify them for conventional financing. We do strongly urge the
continued Federal guarantee of existing GSE debt and securities to
ensure stability as the process moves forward.
Because of the trauma suffered by the financial markets and the
borrowers they served during the recent financial crisis, it will be
necessary to move toward a substantially private market in a cautious
and well-considered fashion. A transition period taking a number of
years will be necessary.
Guarantee Fees Should Be Used to Encourage Private Sector Involvement
ABA recommends that the primary mechanism for reducing Government
involvement (and for compensating the Government for its ongoing
support) is through adjustments to the guarantee fees (G-fees) paid to
the GSEs (or their successors). The current G-fees are too low--the
compensation being paid for what amounts to full Government backing is
simply not priced correctly. Raising the G-fee can do much to encourage
development of the private market and to begin to repay the Government
for its current support. By ``dialing up'' the G-fees in an orderly and
well-detailed manner, eventually the private market will find itself in
a position where it is better able to compete with the GSEs for
business.
With a high enough G-fee, the private market will be able to price
for risk in a fashion that allows for safe and sound investment and
lending at a rate that is comparable (and eventually better) than the
rate charged by the GSEs. In the meantime, the increased rates for G-
fees will help to offset losses and assist in the repayment of the
Government's investment in Fannie Mae and Freddie Mac. This approach
also allows for flexibility in the setting of guarantee fees, thereby
ensuring a safety valve for housing finance in the event of private
market disruptions.
The other key mechanism for transition to a private market will be
setting more reasonable loan limits for GSE purchases. The current
maximum loan limit of $729,750 in high cost areas and $417,000 in all
other regions is dramatically higher than necessary for the purchase of
a moderately priced home, especially in light of housing price declines
nationwide. While some high-cost areas persist--and a recovery of the
housing market will entail a hoped-for stabilization and recovery in
home values--the conforming loan limits for most of the Nation can be
reduced. This will assist the development of a private market for loans
outside of the conforming loan limits as a step to a more fully private
market for all loans.
Underwriting will also be an important mechanism, but given the
significant new underwriting requirements required by the banking
regulators and by the Dodd-Frank Act, it would seem that the most
important role played by the GSEs in this area for the foreseeable
future is to ensure that uniform underwriting requirements are followed
by all market participants selling to the GSEs or their successors.
Under the Dodd-Frank Act, the current GSE regulator, the Federal
Housing Finance Authority, will be among the regulators establishing
underwriting standards and ``safe harbors,'' so they will remain
heavily involved with setting underwriting standards. As I mentioned in
the introduction, getting the underwriting standards correct and
consistent is the first and most important step toward any transition
of the GSEs. I will cover this in detail in my third point below.
II. The Transition to a Private Market Should Be Carefully Managed To
Protect Taxpayers and Ensure Continued Credit Availability
The critical question in creating a private market is how to
mitigate costs as the transition is made. Any successor entity to the
housing GSEs must provide market stability and liquidity, and be
adequately capitalized. It is reasonable to expect that the users of
that entity will contribute to capital or at least pay the full value
and cost of any Government guarantee, explicit or implicit. Similarly,
any assumption of the hard resources of the existing GSEs by a private
entity must occur in a manner in which the Government recovers fair
value for the assets acquired. In other words, the taxpayer should not
subsidize the formation of privately owned successors.
It is not realistic to imagine that there is capacity within the
financial services industry to fully capitalize a new entity in the
near term, or to take on the debt of the existing GSEs. It is our
recommendation that income from increased G-fees be used to begin
building capital, to repay the Treasury, and to better protect
taxpayers.
This could be facilitated by cordoning off the troubled assets of
Fannie Mae and Freddie Mac into a segment of the enterprises which
would remain in need of Federal support while being wound down.
Ultimately, the troubled assets of the GSEs may have to be separated
into a ``bad bank'' structure and the remaining losses realized.
However, as the economy recovers some troubled assets may yet be
salvaged and losses recovered. The new book of G-fee business, which
would consist of guarantees for securitized pools of high quality
mortgages--with higher G-fees going forward--should provide healthy
returns that support Government payments and absorb some or all of the
potential bad asset losses.
The resulting healthy guarantee businesses should be managed and
regulated in a manner intended to dramatically shrink their market
share, and also to establish incentives for growth of purely private
mortgage finance alternatives to fill that market share. This most
likely will require that the successors initially be managed under a
public utility model under Government control. Subsequently, the
Government can exit its controlling interest by spinning the successors
to private ownership as cooperatives or through public offerings,
further recouping its investment. If these smaller private successors
retain some form of Government guarantee, which we believe likely, a
continuation of the public utility regulatory model will be necessary
to ensure capital requirements and G-fee pricing necessary to
compensate the Government, protect taxpayers, and prevent leveraging of
the Government guarantee in a manner that discourages growth of private
sector, nonguaranteed mortgage markets. To be clear, this is not the
only possible approach, but we believe this offers a path from the
current environment of Federal support for the mortgage markets to a
more realistic and sustainable private sector driven mortgage market.
III. Proposed Mortgage Rules Will Harm Creditworthy Borrowers and Drive
Community Banks From the Market and Must Be Revised
ABA has grave concerns that the risk retention proposal issued by
the regulators will drive many banks from mortgage lending and shut
many borrowers out of the credit market entirely. Responding to
widespread objections from consumer groups, banks, and Senators and
Congressman, the regulators extended the comment period from June 10th
to August 1st. While more time for commenting on such a far-reaching
regulatory proposal is welcome, what is really necessary is for the
rule to be substantially reconsidered and reproposed.
It is true that the proposal's immediate impact is muted by the
fact that loans sold to Fannie Mae and Freddie Mac, while they are in
conservatorship, escape risk retention. However, once the rule's
requirements are imposed broadly on the market--should they be
adopted--they would likely shut out many borrowers entirely and act to
destabilize the housing market once again. Since it is also the stated
goal of both the Congress and the Administration to end the
conservatorship of Fannie and Freddie, and since ending the
conservatorships and the related GSE exemption would expand the
proposal's negative impact, it is important that risk retention
requirements be rational and nondisruptive when they are applied
broadly to the market. The rule as proposed does not meet those tests.
Therefore, ABA urges Congress to ensure that the regulators revise
the risk retention regulation before it is imposed on the mortgage
market broadly. Specifically we recommend:
A. Exemption from risk retention provisions must reflect changes in
the market already imposed through other legislative and
regulatory change, and
B. Risk retention requirements should be conformed to GSE
underwriting standards.
I will explain each of these recommendations in more detail:
A. Exemption From Risk Retention Provisions Must Reflect Changes in the
Market Already Imposed Through Other Legislative and Regulatory
Change
In the Dodd-Frank Act, Congress determined that some form of
additional risk retention was desirable under certain circumstances to
ensure that participants in a mortgage securitization transaction had
adequate ``skin in the game.'' The goal was to create incentives for
originators to ensure proper underwriting (e.g., ability to repay) and
incentives to control default risk for participants beyond the
origination stage. There have already been dramatic changes to the
regulations governing mortgages and more are pending with new ``ability
to pay'' rules. The result is that mortgage loans with lower risk
characteristics--which include most mortgage loans being made by
community banks today--should be exempted from the risk retention
requirements, regardless of whether sold to Fannie Mae and Freddie Mac
or to private securitizers.
Exempting such ``qualified residential mortgage'' loans (QRM) is
important to ensure the stability and recovery of the mortgage market
and also to avoid capital requirements not necessary to address
systemic issues. However, the QRM as proposed is very narrow and many
high-quality loans posing little risk will end up being excluded. This
will inevitably mean that fewer borrowers will qualify for loans to
purchase or refinance a home. Instead, the QRM definition should
closely align with the proposed ``Qualified Mortgage'' (QM) definition
promulgated by the Federal Reserve Board. The QM definition (as
proposed) focuses on a borrower's ability to repay and allows
originators to measure that ability with traditional underwriting
tools. The proposed QRM rule, in contrast, takes most underwriting
decisions away from originators in favor of rigid loan-to-value and
other targets.
For example, for the loan to qualify for QRM status, borrowers must
make at least a 20 percent down payment--and at least 25 percent if the
mortgage is a refinancing (and 30 percent if it is a cash-out
refinance). Certainly, loans with lower loan-to-value (LTV) ratios are
likely to have lower losses if in default, and we agree that this is
one of a number of characteristics to be considered. However, the LTV
should not be the only characteristic for eligibility as a ``Qualified
Residential Mortgage,'' and it should not be considered in isolation.
Setting the QRM cutoff at a specific LTV without regard to other loan
characteristics or features, including credit enhancements such as
private mortgage insurance, will lead to an unnecessary restriction of
credit. To illustrate the severity of the proposal, even with private
mortgage insurance, loans with less than 20 percent down will not
qualify for the QRM.
ABA strongly believes that creating a narrow definition of QRM is
an inappropriate method for achieving the desired underwriting reforms
intended by Dodd-Frank.
B. Risk Retention Requirements Should Be Conformed to GSE Underwriting
Standards
The proposal presented by the regulators will make it vastly more
difficult to end the conservatorship of Fannie and Freddie and to
shrink FHA back to a more rational portion of the mortgage market. As
noted above, under the proposed rule, loans with a Federal guarantee
are exempt from risk retention--which includes loans sold to Fannie Mae
and Freddie Mac while they are in conservatorship and backed by the
Federal Government. FHA loans (as well as other federally insured and
guaranteed loan programs) are also exempt. Since almost 100 percent of
new loans today being sold are bought by Fannie and Freddie or insured
by FHA--and as long as these GSEs can buy loans without risk
retention--it will be dramatically more difficult for private
securitizers to compete. In fact, the economic incentives of the
proposed risk retention strongly favor sales of mortgages to the GSEs
in conservatorship and not to private securitizers. Thus, this proposal
does not foster the growth of private label securitizations that would
reduce the role of Government in backing loans.
Equally important is the fact that the conservatorship situation is
unsustainable over the long term. Eventually, these narrow and
restrictive rules would apply to a much, much larger segment of the
mortgage market. After the conservatorships end, even fewer borrowers
will qualify for QRM mortgage loans, and the risk retention rules make
it less likely that community banks will underwrite non-QRM--but
prudent and safe--loans. Some community banks may stop providing
mortgages altogether as the requirements and compliance costs make such
a service unreasonable without considerable volume. Driving community
banks from the mortgage marketplace would be counterproductive as they
have proven to be responsible underwriters that have served their
borrowers and communities well.
Instead of exempting the GSEs from risk retention, the QRM should
instead encompass most if not all of the low risk loans being
underwritten today and purchased by the GSEs. If a loan meets those
requirements (which we anticipate will evolve to conform with any new
QM definition) and is thus eligible for purchase by the GSEs, it should
also be exempt from risk retention requirements. Conforming the QM,
QRM, and GSE standards will set the foundation for a coherent and
sustainable secondary mortgage market.
The imposition of risk retention requirements to improve
underwriting of mortgage loans is a significant change to the operation
of the mortgage markets and must not be undertaken lightly. ABA urges
Congress to exercise its oversight authority to assure that rules
adopted are consistent with the intent of the statute and will not have
adverse consequences for the housing market and mortgage credit
availability. Setting logical, consistent, and workable underwriting
standards is the foundation upon which GSE reform must be built.
Conclusion
The task ahead will not be easy. Fannie Mae, Freddie Mac, and the
Federal Housing Administration currently constitute the vast bulk of
available financing for the American mortgage market. It is imperative
that reform be cautious, in order to avoid inflicting further harm on
an already fragile housing economy, but deliberate, in order to move
away from the current situation of full Federal support for the long-
term. We must not wait, but start the process now. I hope that these
recommendations and the eleven Principles for Reform which are appended
to this statement are helpful to you in this process. The American
Bankers Association stands ready to assist in any way possible.
PREPARED STATEMENT OF PETER SKILLERN
Executive Director, Community Reinvestment Association of North
Carolina
June 28, 2011
Greetings, I am Peter Skillern, Executive Director of the Community
Reinvestment Association of North Carolina, a nonprofit advocacy and
community development agency working at the local, regional, and
national levels. Thank you for the opportunity to speak on reforms in
the secondary mortgage market.
On September 6, 2000, I testified in the House of Representatives
Subcommittee on Government Sponsored Enterprises to warn against Fannie
Mae and Freddie Mac purchasing high cost subprime loans. I said ``For
the record . . . these high-cost loans will become a significant
problem in the coming years. In the future, this Committee will return
to the issue of how the financial markets played a role in spurring
high default rates and the decline of our neighborhoods.''
That proved to be true. Subprime lending was bad for neighborhoods
and the economy. The GSEs purchase of subprime securities was a primary
cause of their failure.
Today I am concerned that reform proposals that eliminate the GSEs
and convert to a solely private capital market will also be harmful for
communities and our housing market as a whole. Reforms are needed to
increase the private market role with adequate oversight and to reduce
risk to tax payers. However the GSEs are needed as public purpose
agencies for the stability of our Nation's housing and finance markets.
GSEs Role in the Mortgage Markets
Megabanks have accelerated their market dominance and size since
the financial crisis. Nationally, in 2008, 56 percent of mortgage
originations were made by the top five banks; today 70 percent of
originations are made by the top four banks. In the rural areas of
Alabama, North Carolina, Oregon, Ohio, and South Dakota, megabanks
originated 75 percent of the loans and 88 percent of FHA loans. By
comparison small institutions under $10 billion originated 16 percent
of conventional loans (Federal Financial Institutions Examination
Council, 2009). Concentration of capital and mortgage origination
market share of big banks will continue.
Megabanks do not have dominance in the secondary market. There are
three primary sectors that loans are sold to: (1) Private commercial
entities like commercial banks, insurance companies, and their
affiliates (2) Fannie Mae and Freddie Mac, and (3) Ginnie Mae, which
deals exclusively with FHA.
Smaller financial institutions shop their loans among these
secondary buyers. Loans are underwritten to a standard established by
the GSEs and sold as a commodity that can to those offering the best
price and services. This practice should be preserved.
If the GSEs are eliminated, the secondary capital markets may
become dominated by megabanks, which will further concentrate capital
in a vertical integration of the mortgage market. This will
disadvantage small lenders access to capital, underwriting, and
technology controlled by their competitors.
If megabanks are too big to fail now, imagine their size, power,
and vulnerability, as they become guarantors and holders of the
mortgage-backed security market.
Capital is scared and its volatility adds to swings during booms
and busts. Private capital as the primary source of secondary markets
will not act countercyclically to provide credit in a recession or to
slow liquidity in a boom.
By analogy, mortgage credit is like water. We are concerned not
only with the quality of water that comes that comes out of our tap,
but who owns and controls the water and the plumbing from the water
source of the glaciers to the spigot at home. Mortgage credit like
water is critical and should not be entirely controlled by private
interests.
If we should not privatize the secondary market, what should be
done? We believe that the GSEs should be converted into public purpose
entities that are accountable to Congress, but are not a department of
the Government such as the Federal Housing Administration. The agency
would provide liquidity for 30-year mortgages that are explicitly
guaranteed, but priced for adequate reserves. The agency would provide
liquidity for multifamily rentals. It would act as a provider of
underwriting standards and technology for the benefit of the market. It
would balance private-market influence by providing choice on the
secondary market.
As an example, the North Carolina Housing Finance Agency is not a
Government department, yet serves a public purpose of financing
affordable home ownership and rental housing. While appointed by the
governor and State legislature, the board is independent and operates
without appropriations. It does not have a conflicting private profit
motive with its public mission. Its staff is paid competitively, but
not excessively. Likewise, the GSEs can serve the public purpose in the
secondary market for rental and home ownership financing as an
essential element to our national housing and financial policy.
Other Reforms
The status quo is not acceptable in the long term for a healthy
secondary market and its risk to taxpayers. We support reforms that
include:
Reducing the portfolio of GSE loans and liabilities. They
have grown too large and the sell of assets can help to
strengthen the capital base of the institutions.
Pricing for explicit Government guarantees on 30-year
mortgages, which are placed in reserves.
Reforming FHA to provide adequate infrastructure and
oversight to its portfolio.
The financial meltdown was caused in large part by private
label mortgage backed securities. Private institutions should
provide mortgage securities, but on the condition they are
recognized as systemic risks to the market and have adequate
oversight for safety and soundness.
Reform GSE Loan Level Pricing
The Community Reinvestment Association advocates for the reform of
the GSE loan level pricing policy in order to reduce FHA volume and
engage private capital in the mortgage market.
Federal Housing Administration loans are playing a significant role
in the mortgage market. In 2005 FHA represented 6 percent of purchase
mortgages, but grew to almost 40 percent by 2011, placing greater risk
on the taxpayer (FHA, 2011). This is in part a result of the credit
contraction by the private sector and the role of FHA in providing
needed countercyclical liquidity.
It is also a direct result of current GSE Loan Level Pricing
Adjustments LLPA. LLPA charges higher rates and fees for loans with
downpayments lower than 10 percent, credit scores below 720 and homes
in a declining market. The GSEs are taking the creme of the mortgage
market with new GSE loans having high credit scores and low loan to
value ratios.
This has not lowered risk for taxpayers. LLPA prices loans away
from the GSE portfolio and into FHA. If these loans did not have higher
LLPA pricing, they would be insured by the private sector with private
mortgage insurance (PMI). PMI premiums layered on top of higher GSE
LLPA rates are not competitive with FHA loans with low downpayments.
PMI originations have dropped by two-thirds over 3 years.
The LLPA program also demonstrates the impact of requiring high
downpayments as a condition of the best pricing for loans. With higher
downpayments used as a proxy for underwriting, rather than ability to
pay, creditworthy borrowers who can pay their mortgage are denied
because of downpayment requirements that will take years to save for.
The result is fewer people can buy their first home and owners have
greater difficulty in selling. The people most affected are low- to
moderate-income households and communities of color. For a more
thorough analysis of the LLPA program please read The New Hurdle to
Homeownership (Adam Rust, Community Reinvestment Association of North
Carolina June 2011).
We oppose the GSE loan level pricing program and recommend that it
be amended to better utilize PMI. This will lower FHA volume and
increase lending to creditworthy households with low downpayments.
Conclusion
The proposals being discussed in reforming the secondary market
potentially throw the good out with the bad in eliminating the GSE. The
catastrophic failure of the GSEs in chasing the private label subprime
mortgage markets is not a justification for eliminating the successful
elements of the institutions' public purpose. A conversion to a
completely private market delivery system will not serve the Nation's
economic or social interests.
Let me state for the record, if the proposal to eliminate the GSEs
succeeds, this Committee will meet in the future to address new
problems. We will have more volatile capital markets; greater
inequality in the access to mortgage credit; and disinvestment and
decline of low- and moderate-income communities. The real estate market
will struggle as it becomes more difficult for renters to become first
time homebuyers reducing household mobility. Small financial
institutions will be less independent and competitive with megabanks.
If we phase out the GSEs completely, we will lack financing for
affordable rental housing for our workforce. If the approach is not
inclusive of low- and middle-income households, we will have a system
that works very well for some, but not for many others and ultimately
not for the greater good. The Community Reinvestment Association
affirms the vision of an inclusive and healthy housing market.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM ROD STAATZ
Q.1. Mr. Staatz, Fannie and Freddie were responsible both for
supporting the secondary mortgage market by guaranteeing
mortgage-backed securities and for providing affordable housing
by meeting Government-mandated housing goals. In your
testimony, however, you state that ``[t]he important role of
Government support for affordable housing should be a function
separate from the responsibilities of the secondary market
entities.''
Why do you believe that it is important for affordable
housing goals to be separated from any entity that supports the
secondary market?
Should affordable housing mandates be on the Government's
budget?
A.1. The requirements of a program to stimulate the supply of
credit to lower income borrowers are not the same as those for
the more general mortgage market. Combining both goals in a
single vehicle can frustrate the achievement of both goals.
In principle, it would be better for the Government's
support for affordable housing to be explicitly funded rather
than being subsumed in the mission of some entity such as a GSE
with a broader mission, or imposed on lenders. However, it
might be reasonable for the source of that funding to derive at
least in part from borrowers and financial institutions that
might benefit from the Government's support for the mainstream
secondary mortgage market. For example, if the Government were
to provide some sort of back-up guarantee to the qualifying
mortgage-backed securities made of up mainstream mortgages, the
fee charged for that guarantee could include both a risk-
premium and a small fee to fund affordable housing goals. But
in any event, using the same mechanisms to support both the
broader secondary market and affordable housing is likely to
frustrate the achievement of both goals.
Q.2. Mr. Staatz, in your testimony you warn that Dodd-Frank
will increase costs for small financial institutions. In fact,
you argue that the requirements of Dodd-Frank are one factor
that ``will likely require small financial institutions to
retain additional employees . . . stretch small financial
institutional monetary resources to untenable levels, or worse,
force more of these institutions, including credit unions, to
cease to exist altogether.''
What aspects of Dodd-Frank are most costly to small
financial institutions?
A.2. It is probably too early to tell which provision of the
Dodd-Frank Act will ultimately be the most costly for credit
unions. However, over the last several years, there has been an
accumulation of regulatory burden which has combined with the
enactment of this legislation and the pending implementation of
the rules it requires to create a crisis of creeping
complexity. Every time a rule is changed--whether it increases
regulatory burden or not--costs to credit unions are increased.
So it's not any one regulation, but the cumulative effect of
many, many recent regulatory changes that is adding to the cost
burden. Because of the credit union ownership structure, under
which each member is an owner in equal standing, every dollar
that a credit union spends to comply with regulation is a
dollar that is not used to the benefit of the credit union's
membership.
Q.3. Mr. Hartings and Mr. Staatz, you both have advocated that
the Federal Government, and by extension the American taxpayer,
provide some level of guarantee to the secondary mortgage
market. Secretary Geithner, however, has warned this Committee
about the difficulty in having the Government guarantee
mortgage-backed securities. He cautioned: ``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.''
Do you agree with Secretary Geithner?
If not, on what basis do you believe that the Government
can accurately price risk?
A.3. Secretary Geithner raises very valid points. It would
indeed be difficult to design a system of Government support to
the secondary mortgage market that does not ultimately impose
undue risk to the taxpayer. But difficult is not the same as
impossible. We can learn from the lessons of the recent
financial crisis. We do not expect a free, no-questions-asked
Government guarantee. We would expect to see significant
underwriting requirements, and also a substantial guarantee fee
to cover the risk. Perhaps the most difficult aspect of such a
program would be maintaining discipline after a period of
several years of low losses.
Q.4. There has been discussion lately about various approaches
to housing finance reform. However, until we identify the most
important objectives of any new entity, speculating on the
structure of that entity or its products is premature.
Setting aside any characteristics of a future structure and
its products, please list and describe the most important,
specific priorities that community banks have in the reform of
our Nation's housing finance system.
A.4. In the context of the reform of our Nation's housing
finance system, the most important priorities for credit unions
are: (1) access to the secondary market; (2) strong oversight
and supervision of entities operating in the secondary market;
and (3) that the secondary market is durable enough to continue
to function during financial crisis. We also believe it is
critical that there be a reasonable and orderly transition from
the current system to any new system.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM ROD STAATZ
Q.1. Recently, the Wall Street Journal reported that the
percentage of mortgage applications being rejected by the
largest lenders increased last year to more than 1 in every
four 4 (and increasing in every State except Delaware). Has
there been a similar increase in rejections by community banks?
If so, what is driving the increase? How has demand changed?
(Community bank lending appears to have increased.) How have
borrowers changed their behavior, if at all?
A.1. We do not yet have recent data on rejection rates on
credit union mortgages, although they have historically been
much lower than rejections at other lenders across all types of
borrowers. We do know however that the credit union share or
first mortgage originations has risen dramatically since the
beginning of the financial crisis. Before the crisis, credit
unions would typically originate less than 2 percent of total
first mortgage loans. Last year, that proportion had doubled to
about 3.5 percent. This suggests that credit unions are still
willing and able to grant first mortgage loans to their
members. Also, prior to the recession, credit unions were
primarily portfolio lenders, selling only a quarter to a third
of their new loans. Last year credit unions sold over half of
new production because of the risks inherent in holding long-
term, fixed-rate loans during a period of very, very low
interest rates.
Q.2. One significant point in the housing finance reform debate
has centered on the use of ``guarantee fees.'' How much of the
housing reforms could be accomplished just through proper
establishment and use of guarantee fees? How should they be
established? What would be the increase to the cost of the
average mortgage?
A.2. This is of course the crux of establishing a responsible
program. In general, a guarantee fee would need to be
sufficient to cover the risks to the Government. Following are
some likely useful features of a guarantee fees:
Fees should be sufficient to build a substantial
minimum reserve fund for losses. Fees should err on the
side of more than fully funding possible losses rather
than the other way around.
A series of reserve levels could be established,
with the guarantee fee reduced each time a higher
reserve level is reached.
Guarantee fees should reflect loan-specific risks
factors, but under no circumstances should they be
zero.
Guarantee fees should be set by a single entity
within the Government, rather than by competing GSEs.
Q.3. What would be the price of private guarantee fees? Should
there be consideration given to a gradient of guarantee? For
example, a guarantee of 60 percent or 75 percent or lower,
similar to current private mortgage insurance?
A.3. We do not have the expertise and information to opine on
the actual level of Government guarantee fees, but believe they
would likely be higher than historical fees charged by the
GSEs. Gradients of guarantee fees are unlikely to be very
attractive to investors, and might be an unnecessary
complication.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM CHRISTOPHER R. DUNN
Q.1. Mr. Dunn, in your testimony you state that creating
multiple sources of liquidity, including covered bonds, may be
the best way forward for housing finance reform.
What benefits would covered bonds provide for community
banks?
A.1. Covered bonds may be a potential additional source of
liquidity for community banks, but there likely would be
impediments to such use. In comparison, large banks are much
more likely to use covered bonds, because they have the scale
and investment ratings to enter capital markets readily. I do
not expect community banks to change their pattern of use of
collateralized borrowing from Federal Home Loan Banks (FHLBs)
to finance mortgage loans, even if covered bonds become
available. FHLB advances operate in a manner similar to covered
bonds, where advances to banks are backed by collateral which
generally is in the form of mortgage loans held in a bank's
portfolio. The FHLBs have the scale and investment rating to
issue debt directly in capital markets, which in turn funds
FHLB advances to banks and other lenders.
Q.2. Mr. Dunn, you advocate two methods for reducing Fannie and
Freddie's role in the mortgage market: raising the guarantee
fee and lowering the conforming loan limits.
Please explain how these two actions would help revive the
private market.
A.2. Simply stated, a private label mortgage securitization
market cannot develop if Fannie Mae and Freddie Mac are managed
in conservatorship in a manner which significantly underprices
the valuable Government guarantee that is being offered. Only
when investors face the full cost of the Government guarantee
will they actively consider and begin to chose alternative MBS
that can offer an enhanced yield equal to or greater than the
cost of the fully priced guarantee. No rational investor will
buy private label MBS as long as the Government guarantee is
being given away on the cheap.
Lowering the high cost area exceptions from loan limits
created at the start of the financial crisis will shrink the
pool of loans on which the full guarantee is available, opening
the door further for the private market to address needs in the
higher loan value categories. This has already been occurring,
because the high cost area exceptions were defined to be 125
percent of median area home prices, up to a maximum of
$729,000. As median home prices have declined over the past 3
years, the permissible high cost area exceptions have also
declined in frequency. It is time to reduce the maximum high
cost limit from $729,000 to keep pace, as is scheduled to
commence in October, 2011.
Q.3. Mr. Dunn, a key issue in housing finance reform is what
should be done with the portfolios of Fannie Mae and Freddie
Mac. Currently, these portfolios are scheduled to be
dramatically reduced. However, some have argued that Congress
should preserve the portfolios when it undertakes housing
finance reform.
Do you believe that it is appropriate to continue reducing
the GSEs' portfolios?
Do you believe that portfolio lending by a public sector
entity is necessary for there to be a healthy secondary market?
A.3. The American Bankers Association strongly believes that
the GSE's portfolios should be reduced and eventually
eliminated but for a small portfolio which may be necessary to
facilitate balance sheet and liquidity management.
We do not believe that a GSE must retain a significant
portfolio. While a small portfolio may be necessary for balance
sheet and liquidity management, anything further is unnecessary
and counterproductive to an efficient private mortgage market.
Some flexibility may be desirable to allow for temporary and
contained growth of portfolios during times of market
disruption to ensure that a GSE is able to step in during a
market failure, but such flexibility should be limited and
tightly controlled.
Q.4. Mr. Dunn, many have argued for continuing, or even
expanding, certain housing goals within the future secondary
mortgage market.
Based upon your experience, is imposing arbitrary social
goals upon mortgage market participants the appropriate method
for the Government to implement social policy?
A.4. We do not believe that social goals should be imposed as a
part of secondary market facilitation by the Federal
Government. The goal of Federal involvement in the mortgage
markets should be to ensure liquidity and stability in the
mortgage markets for lending to qualified borrowers.
Affordability and other social goals may be important, but
should be addressed through other, more direct means such as
Federal programs through the Department of Housing and Urban
Development.
Q.5. There has been discussion lately about various approaches
to housing finance reform. However, until we identify the most
important objectives of any new entity, speculating on the
structure of that entity or its products is premature.
Setting aside any characteristics of a future structure and
its products, please list and describe the most important,
specific priorities that community banks have in the reform of
our Nation's housing finance system.
A.5. First, the paramount priority for community banks is
equitable access to the capital markets, and preserving the
function of Federal Home Loan Banks is a key priority. It is
imperative that the accessibility and services provided by
FHLBs to their members/owners not be disrupted. Community banks
do not have the capability to access the capital markets
directly, and the cooperative FHLB system has proven to be a
safe and reliable means for community banks to fund loans,
particularly during the recent crisis.
Second, community banks support a much smaller Government
footprint in mortgage markets. We believe that a predominantly
private secondary market will best serve borrowers and lenders
alike. At the same time, we believe that a secondary mortgage
market GSE(s) based on a guarantee business model only should
be maintained in an important, if residual, role. We believe
that some form of ``controlled'' secondary market GSE should be
maintained to ensure that community lenders have equitable
market access regardless of the size of the institution. Such a
GSE structure also would offer an operating fail-safe in the
event of future mortgage market disruptions.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM CHRISTOPHER R. DUNN
Q.1. Recently, the Wall Street Journal reported that the
percentage of mortgage applications being rejected by the
largest lenders increased last year to more than 1 in every 4
(and increasing in every State except Delaware). Has there been
a similar increase in rejections by community banks? If so,
what is driving the increase? How has demand changed?
(Community bank lending appears to have increased.) How have
borrowers changed their behavior, if at all?
A.1. It is difficult to answer this without great speculation;
however, there is no doubt that lower appraisals and tighter
underwriting standards contributed to an increase in declines
throughout the industry. Nevertheless, borrower demand is
clearly down, most likely due to uncertainty about housing
prices and a fear by some borrowers of buying now when prices
may still fall further. Additionally, many potential borrowers
are in the process of paying down other debts before
considering new borrowing.
It should be noted that the article referenced covers a
period in time where many customers were focused on
refinancing. Many of these existing borrowers shortened their
loan term to pay off their loans sooner.
Q.2. One significant point in the housing finance reform debate
has centered on the use of ``guarantee fees.'' How much of the
housing reforms could be accomplished just through proper
establishment and use of guarantee fees? How should they be
established? What would be the increase to the cost of the
average mortgage?
A.2. The American Bankers Association believes that adjusting
guarantee fees (G-fees) charged by the GSEs is a critical first
step in bringing about reform. The full guarantee being
provided by the Federal Government to Fannie and Freddie is
significantly underpriced at the moment. G-fees should be
carefully, but deliberately ratcheted up to a level more
appropriately reflecting the true value of the guarantee.
Eventually, as these fees increase, the private market will
likely return and offer products without a guarantee at a lower
price which will then be considered competitive.
Q.3. What would be the price of private guarantee fees? Should
there be consideration given to a gradient of guarantee? For
example, a guarantee of 60 percent or 75 percent or lower,
similar to current private mortgage insurance?
A.3. The price of the guarantee fee, as well as the usefulness
of a gradient is more accurately determined by the investor
channel, so we would defer to those market participants for
input on this question.
Q.4. In your written remarks, you note that ``[w]ith a high
enough [guarantee fee], the private market will be able to
price for risk'' What is the differential in that rate? How
should it be set? What would be the impact on the rate of an
average loan?
A.4. Again, this is likely a question better addressed to the
investor community. It will be up to investors to determine how
much risk is offset by the guarantee (and how much they will
pay for that offset) and how willing they are to invest in
products that could potentially be offered without such a
guarantee.
Additional Material Supplied for the Record
LETTER SUBMITTED BY THE NATIONAL ASSOCIATION OF FEDERAL CREDIT UNIONS