[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

                               __________

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


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

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

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       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.
---------------------------------------------------------------------------
     \1\ ICBA's cooperative model is similar to a proposal favorably 
analyzed by the New York Federal Reserve and the Government 
Accountability Office.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
     \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.
---------------------------------------------------------------------------
    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.
                                ------                                


         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.
                                ------                                


        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.
                                ------                                


         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









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