[Senate Hearing 113-20]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 113-20
 
            BIPARTISAN SOLUTIONS FOR HOUSING FINANCE REFORM?
=======================================================================


                                HEARING

                               before the

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

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

  DISCUSSING HOUSING FINANCE REFORM AND SUGGESTIONS FOR IMPROVING THE 

      CURRENT HOUSING MARKET AND PROVIDING STABILITY IN THE FUTURE

                               __________

                             MARCH 19, 2013

                               __________

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


                 Available at: http: //www.fdsys.gov /



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                  Laura Swanson, Deputy Staff Director

                   Glen Sears, Deputy Policy Director

              Erin Barry Fuhrer, Professional Staff Member

                 Beth Cooper, Professional Staff Member

                 William Fields, Legislative Assistant


                  Greg Dean, Republican Chief Counsel

           Chad Davis,  Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                      Kelly Wismer, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 19, 2013

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    15

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2
    Senator Vitter...............................................     3
    Senator Menendez
        Prepared statement.......................................    33

                               WITNESSES

Mel Martinez, Co-Chair, Bipartisan Policy Center's Housing 
  Commission.....................................................     5
    Prepared statement...........................................    33
    Response to written questions of:
        Senator Menendez.........................................   122
Peter J. Wallison, Arthur F. Burns Fellow in Financial Policy 
  Studies, American Enterprise Institute.........................     7
    Prepared statement...........................................    41
    Response to written questions of:
        Senator Menendez.........................................   128
Janneke Ratcliffe, Senior Fellow, Center for American Progress 
  Action Fund....................................................     9
    Prepared statement...........................................   111
    Response to written questions of:
        Senator Menendez.........................................   131

                                 (iii)


            BIPARTISAN SOLUTIONS FOR HOUSING FINANCE REFORM?

                              ----------                              


                        TUESDAY, MARCH 19, 2013

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:11 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. Last Congress, the Banking Committee held 
18 hearings regarding housing finance reform and suggestions 
for improving the current housing market and providing 
stability in the future. I look forward to continuing that 
conversation with the new Ranking Member and the new Members of 
the Committee.
    I would like to thank the witnesses in advance for 
contributing to what I hope will be a lively and substantive 
debate about bipartisan solutions for housing finance reform. I 
would also like to commend the BPC's Housing Commission for 
producing a plan with broad support from both sides of the 
aisle.
    For housing finance reform to succeed, we must find areas 
of bipartisan consensus. A partisan bill or a bill full of 
ideology that ignores the realities of our economy would be 
irresponsible, especially when the housing market is beginning 
to show signs of strength. I will work with Ranking Member 
Crapo to establish a series of hearings to explore the issues 
that require more discussion before we can achieve a consensus 
bill.
    When the housing market began to decline, the Government 
took on a larger role--nearly 90 percent of the market. In 
previous hearings, witnesses testified that without Fannie Mae, 
Freddie Mac, and FHA providing liquidity, most families would 
not have been able to get a mortgage during the economic 
crisis. Witnesses also pointed out that, without Government 
involvement, the traditional 30-year, fixed-rate mortgage would 
be priced out of reach for most borrowers, if it remained 
available at all. Now that the housing market is showing signs 
of strength, private capital is starting to return to the 
market.
    While the participation of private capital is essential for 
the health of our economy, I am concerned that a completely 
private housing finance system would place home ownership out 
of reach for many middle-income families and rural communities 
like those in my home State of South Dakota. I am not 
interested in creating a system in which home ownership is only 
available to the few and most fortunate.
    We must find workable solutions that preserve the option of 
sustainable home ownership for future buyers and provide 
adequate financing for multifamily construction for those who 
prefer to rent or cannot afford to own a home. I look forward 
to hearing the suggestions of our witnesses.
    With that, I will turn to Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman.
    On September 7, 2008, then-FHFA Director James Lockhart 
stood jointly with then-Treasury Secretary Henry Paulson to 
announce that Fannie Mae and Freddie Mac were being placed into 
conservatorship. In describing the situation as a ``time-out,'' 
Secretary Paulson stated:

        We will make a grave error if we do not use this time-out to 
        permanently address the structural issues presented by the 
        GSEs. In the weeks to come, I will describe my views on long-
        term reform. I look forward to engaging in that timely and 
        necessary debate.

    It seems unlikely that anyone envisioned the time-out 
lasting 5 years, costing taxpayers nearly $190 billion. 
Further, during this time-out, we still have not had that 
timely and necessary debate, and I thank the Chairman for 
getting us into that process now.
    These conservatorships were designed to be temporary, but 
with each day that passes, Fannie Mae and Freddie Mac become 
further entrenched within our Government. According to the most 
recent conservators' report, Fannie Mae, Freddie Mac, and 
Ginnie Mae controlled 100 percent of the mortgage-backed 
securities, or MBS, market in the United States during the 
first three quarters of 2012. One hundred percent.
    Since 2008, these governmental entities have controlled no 
less than 95 percent of that market in any given year. Simply 
put, much of the private market has not been able to re-enter 
the market and compete with the Federal Government.
    What do the monetary policies of the Federal Reserve and 
their buying large amounts of mortgage-backed securities do to 
that? Those able to obtain credit are not yet fully feeling the 
effects of a market lacking private participation and 
innovation. Presumably, though, this subsidy will someday end, 
and at that time all consumers will suffer if our markets have 
not been allowed to evolve for an extended period of time.
    An equally disappointing byproduct of the current situation 
is the growing urge by some to use the conservatorships as 
piggy banks. Two years ago, the guarantee fee charged by Fannie 
and Freddie was increased, not to insure against risk but to 
pay for an unrelated tax cut. This increase, which is nothing 
less than a hidden tax on home buyers, will last for 10 years, 
even though it paid for a tax cut that lasted only 2 months.
    Unfortunately, the proposed Senate budget that we are 
currently considering would further extend that tax to pay for 
new spending. I was pleased to see a bipartisan group of 
Senators from this Committee--Senators Corker, Warner, Vitter, 
and Warren--who recently introduced legislation that would 
prohibit this.
    I, too, have long had concerns about this, so I am glad to 
see that we have a bipartisan consensus building against this 
practice. Hopefully together we can correct this wrongful 
policy on the floor.
    However, regardless of that outcome, this new attempt 
reminds of us of the importance of ending these 
conservatorships. It is my hope that this hearing can serve to 
reignite discussions on how to proceed with reform of our 
Nation's housing market.
    There has been little movement on this since the 
Administration released a brief white paper more than 2 years 
ago. Within the amendment and across this Committee, there is 
certainly a wide range of views as to what would be the optimal 
solution. Some of these differences will be discussed today, 
and that is productive. However, for far too long, our 
differing views as to the optimal solution seem to have 
prevented substantive negotiations from even starting.
    While it is true that today we do not even agree on what 
should be the final product, this should not preclude us from 
beginning negotiations or even jointly identifying problems in 
today's market.
    Mr. Chairman, again, I thank you for holding this hearing, 
and I stand ready to work with you and am eager to begin 
necessary bipartisan negotiations that will help us to end 
these conservatorships.
    Thank you.
    Chairman Johnson. Thank you, Senator Crapo.
    Are there any other Members who wish to make a brief 
opening statement? Senator Vitter.

               STATEMENT OF SENATOR DAVID VITTER

    Senator Vitter. Thank you very much, Mr. Chairman. I 
appreciate the opportunity. I will be very brief, and, 
unfortunately, I cannot stay for the remainder of the hearing. 
But I also wanted to thank you for this additional hearing on 
mortgage finance reform and to encourage bipartisan Committee 
action on this.
    Specifically, I did want to underscore what Senator Crapo 
just mentioned, this jump-start GSE reform bill that was 
recently introduced by Senators Warner and Corker and myself 
and Senator Warren. This is a bipartisan, realistic approach, a 
good start which fits the parameters that you described, and I 
think it is fully consistent with the process you described. 
And, therefore, we would urge you to schedule a markup of this 
bill in April.
    Again, the bill has broad bipartisan support and wide 
industry support, including specifically the Mortgage Bankers 
Association and the National Association of Realtors. Let me 
just quote briefly those two groups.
    MBA said, ``It is imperative that Congress as well as the 
White House and key members of the housing community come 
together to create a comprehensive, transparent process that 
properly addresses the concerns and objectives of all affected 
stakeholders involved with GSE reform.'' And they specifically 
support and endorse our bill.
    And the realtors wrote, ``The prevailing thought among 
NAR's members is: until housing finance reform is completed, 
specifically reform of the Government-sponsored enterprises 
Fannie Mae and Freddie Mac, housing will continue to limp along 
in a state of purgatory.''
    Mr. Chairman, we are 5 years now removed from the start of 
our crisis. We have passed major legislation, and yet in all of 
that, four words have been missing completely: ``Fannie Mae, 
Freddie Mac.'' I think it is absolutely time to start acting in 
this area, and I think our legislation is a very good, 
reasonable, bipartisan start. And so I would urge a markup in 
April, if at all possible, as I suggested.
    Thank you very much for your leadership.
    Chairman Johnson. Thank you, Senator Vitter.
    I would note that this bill and Senators Menendez and 
Boxer's refinancing bill are both commonsense measures, and 
they should move forward together. I look forward to working 
with Ranking Member Crapo and other Members of the Committee to 
accomplish this.
    Senator Tester?
    Senator Tester. Thank you, Mr. Chairman. I appreciate you 
holding this hearing today. I certainly believe there are some 
areas of bipartisan agreement on this issue with housing 
finance reform, at least from my conversation with folks on 
this Committee.
    As our housing market shows some signs of strengthening, I 
think it is time for us to be working toward solutions, and I 
look forward to working with you, Mr. Chairman and Ranking 
Member Crapo, to build consensus within the Committee on the 
future of housing finance reform.
    Now, Montana's housing market has seen its share of 
challenges over the past several years, but trouble areas are 
showing new signs of strength. And when I talk to folks across 
my State, they are tired of the rhetoric, and they agree that 
it is time for policymakers to begin making implement decisions 
about the future of housing finance. And I think many of us 
agree that we need to bring back more private capital to 
mortgage markets and to bear additional risk to better protect 
taxpayers, and that we should preserve the option of a 
traditional 30-year, fixed-rate mortgage.
    Being from rural American, from my perspective one of the 
most important assets of any future housing finance reform 
system is that small financial institutions that serve rural 
America remain on equal footing with the big guys when it comes 
to accessing the secondary market. If these communities banks 
and credit unions are cut out of the picture, then so, too, 
would many of the rural communities across this country be cut 
out. Rural communities are served and served well by small 
community-based institutions, so anything that would put them 
at a disadvantage would be a death knell for rural America.
    I want to thank the Committee Members for being here this 
morning. I look forward to your testimony, and I look forward 
to the questions and answers that follow thereafter. A special 
welcome back to Senator Mel Martinez.
    Chairman Johnson. Anyone else?
    [No response.]
    Chairman Johnson. Thank you all.
    I want to remind my colleagues that the record will be open 
for the next 7 days for opening statements and any other 
materials you would like to submit.
    Now I would like to introduce our witnesses.
    The Honorable Mel Martinez is the co-chair of the 
Bipartisan Policy Center's Housing Commission. Senator Martinez 
served in the Senate and as a Member of this Committee from 
2005 to 2009. Senator Martinez also served as Secretary of 
Housing and Urban Development from 2001 to 2003. I welcome our 
colleague back to the Committee.
    The Honorable Peter Wallison is the Arthur F. Burns Fellow 
in Financial Policy Studies at the American Enterprise 
Institute. Mr. Wallison also served as a general counsel for 
the Treasury Department during the Reagan administration.
    And, finally, Ms. Janneke Ratcliffe is a senior fellow at 
the Center for American Progress and the Executive Director of 
the Center for Community Capital at the University of North 
Carolina.
    Senator Martinez, please begin your testimony.

STATEMENT OF MEL MARTINEZ, CO-CHAIR, BIPARTISAN POLICY CENTER'S 
                       HOUSING COMMISSION

    Mr. Martinez. Mr. Chairman, thank you very much, and 
Senator Crapo and Members of the Committee. It is a real 
pleasure to be back with all of you friends and to have an 
opportunity to talk about an issue that I know we all care a 
great deal about.
    I have been privileged to serve as one of the co-chairs of 
the Bipartisan Policy Center's Housing Commission, and along 
with former Senator George Mitchell, Senator Kit Bond, and 
former Secretary of Housing Henry Cisneros. We are the co-
chairs. And there was another group of another 21 people from 
both sides of the aisle with expertise in a variety of areas, 
the whole housing gamut.
    Over the last 16 months, we met and had a lot of 
conversation about what the future of housing should be. We 
issued a report last month, and it covers home ownership, 
affordable rental housing, rural housing, and the housing needs 
of our Nation's seniors. Today I am going to highlight for you 
and discuss the recommendations of the report as it relates to 
housing finance.
    So as has been pointed out, our housing finance system is 
broken. It has been more than 4 years since Fannie Mae and 
Freddie Mac were placed into Government conservatorship, with 
no clear path forward even now. So the commission felt that 
there was an opportunity to fill this policy void and offer a 
blueprint for a new system that can support both the home 
ownership and rental markets for years to come. The commission 
reached consensus on five key objectives for this new system.
    Our first objective is a far greater role for the private 
sector in bearing credit risk. The dominant position of the 
Government, as was pointed out by Ranking Member Crapo, is 100 
percent currently in this current time, and more than 95 
percent for the last several years. This is unsustainable. 
Private capital is now flowing through the system, but it 
absorbs very little of the system's credit risk. Instead, much 
of that risk lies with the Government. Nearly 90 percent of the 
single-family home ownership market remains Government 
supported, and reducing the Government footprint and 
encouraging more private participation will protect taxpayers 
while providing for a greater diversity of funding sources.
    The second objective is a continued, but much more limited, 
role for the Federal Government as the insurance backstop of 
last resort. The commission recommends the establishment of an 
explicit, but very limited, Government guarantee administered 
by a new entity that we call the ``Public Guarantor'' to ensure 
timely payment of principal and interest on qualified mortgage-
backed securities. There really just is insufficient capacity 
on bank balance sheets alone to meet our Nation's mortgage 
finance needs. A strong, vibrant secondary market for these 
securities is essential to freeing up additional capital for 
mortgage lending and connecting our Nation's local housing 
markets to global investors.
    Investors in the secondary market require a Government 
guarantee protecting against catastrophic credit risk. These 
investors are willing to assume the risk of interest rate 
volatility, but they are unwilling to participate as a 
practical matter to underwrite the hundreds, if not thousands, 
of mortgages that make up mortgage-backed securities. In the 
absence of this catastrophic guarantee, investor interest in 
the secondary market would wane, mortgage credit would become 
more expensive, and widespread access to affordable, fixed-rate 
mortgage financing--particularly a 30-year mortgage--would 
disappear.
    In our proposal, the Government stands in the ``fourth 
loss'' position behind three layers of private capital: 
mortgage borrowers and their home equity; private credit 
enhancers, ranging from capital market products to highly 
capitalized mortgage insurers; and the corporate resources of 
the securities' issuers and mortgage servicers. These private 
companies would be subject to stringent capital requirements 
that would enable them to weather losses similar in magnitude 
to those experienced during the Great Recession.
    The limited Government guarantee would kick in only after 
the private credit enhancers standing ahead of it had depleted 
all of their resources. Even then, these losses would be paid 
for through a fully funded catastrophic risk fund capitalized 
through the collection of insurance premiums over time, or 
guarantee fees, from mortgage borrowers. In many respects, this 
model is very similar to today's Ginnie Mae.
    The third objective is the ultimate elimination of Fannie 
Mae and Freddie Mac over a transitional period--perhaps 5 to 10 
years. And like other observers, the commission believes the 
business model of the two Government-sponsored enterprises--
publicly traded companies with an implied Government guarantee 
and other advantages--should not be reproduced.
    The commission recognizes that a dynamic and flexible 
transition period will be necessary before the new, redesigned 
housing finance system is fully functioning. During this period 
of transition, it will be critical to avoid market disruption 
and to adjust course, when necessary, in response to shifts in 
the market and other critical events. The goal would be 
transition, not turbulence.
    If I may have just a couple minutes more, Mr. Chairman, the 
fourth objective is ensuring access to safe and affordable 
mortgages for all borrowers. This is a core principle for all 
of us. The housing finance system of the future must be one 
from which all Americans can benefit on equal terms. The 
commission believes that access to the Government-guaranteed 
secondary market must be open on full and equal terms to 
lenders of all types, including community banks and credit 
unions, and in all geographic areas. Again, Ginnie Mae's 
success in empowering smaller institutions to participate in 
programs like this is instructive here.
    And, finally, the FHA, the Federal Housing Administration, 
must return to its traditional mission of primarily serving 
first-time home buyers and borrowers with limited savings for 
downpayments. The recent concerns over the solvency of FHA's 
single-family insurance fund only underscore the urgency of 
what we have--that far more risk-bearing private capital must 
flow into our Nation's housing finance system. A system in 
which private capital is plentiful will reduce the pressure 
that is sometimes placed on the FHA to act as the mortgage 
credit provider of last resort and allow it to perform its 
traditional missions more effectively.
    Our proposals for reforming the rental, or multifamily, 
housing finance system are rooted in the same principles as 
single-family reform: the gradual wind-down of the GSEs; a 
greater role for capital to enter into the picture with the 
same catastrophic risk protections by the Government.
    Mr. Chairman, our report goes into considerable detail 
about individual components of the housing finance system that 
we envision. It describes the structure and responsibilities of 
the Public Guarantor as well as the roles of the private actors 
in this system.
    We have proposed a bipartisan plan that substantially 
reduces the Government intervention in the housing market and 
also protects the taxpayers, while ensuring the broad 
availability of affordable mortgage credit. I believe it 
strikes the right balance among competing policy goals and 
deserves your consideration.
    As a final note, the commission report identifies several 
factors that continue to stall a housing recovery in the 
immediate term, and those factors include: overly strict 
lending standards, which now go well beyond those in place 
before the housing bubble; and put-back risk--that is, the risk 
that lenders will be required to buy back a delinquent loan 
from Fannie Mae, Freddie Mac, or the FHA.
    While not our primary focus, we believe that these issues 
must be resolved before the housing market can fully recover.
    Mr. Chairman, it is a real pleasure to be back before the 
Committee, and I look forward from to--while it is much more 
pleasant to ask questions, I look forward to trying to answer 
some of your questions.
    [Laughter.]
    Chairman Johnson. Welcome back, Senator.
    Mr. Wallison, please proceed.

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

    Mr. Wallison. Thank you very much. Mr. Chairman, Ranking 
Member Crapo, and Members of the Committee, good morning.
    There is no reason that housing, like virtually every other 
sector of the U.S. economy, cannot be privately financed. A 
private system will produce a low-cost and a stable market. The 
consistent failure of Government efforts to finance home 
ownership--examples are the collapse of the S&Ls in the late 
1980s, and the insolvency of Fannie Mae and Freddie Mac--should 
make Congress very reluctant to authorize another Government 
program. Many groups around Washington are suggesting 
imaginative ways to get the Government back into the housing 
business while avoiding, they claim, the mistakes of the past.
    These proposals are illusory. Government involvement will 
always result in losses because it always creates moral hazard.
    Fannie and Freddie are good examples. Because of their 
Government backing, no one cared what risks they were taking. 
That is what moral hazard does.
    In 1992, Congress adopted the affordable housing goals. To 
meet HUD's quotas for low-income loans under these goals, the 
GSEs had to abandon their traditional focus on prime mortgages 
and substantially loosen their underwriting standards. By 1995, 
they were buying mortgages with 3-percent downpayments, and by 
2000 they were accepting mortgages with no downpayment at all. 
By 2008, they were insolvent. This will happen every time the 
Government backs the housing finance business.
    How, then, would a private system work? My colleagues and I 
at AEI have proposed a simple idea--that the housing finance 
market will operate steadily and stably if only private 
mortgages are securitized. Before the affordable housing goals, 
when the GSEs would only buy prime mortgages, we had such a 
stable market. Subprime and other low-quality loans were a 
niche business. We should eliminate the GSEs, of course, but 
Congress can achieve the same mortgage market stability simply 
by requiring that only prime loans are securitized. This idea 
is at the root of the qualified residential mortgage in Dodd-
Frank, but very poorly implemented.
    Reasonable underwriting standards and prime mortgages will 
not limit the availability of mortgage credit for those who can 
afford to carry the cost of a home. When Fannie and Freddie 
were accepting only prime loans, the home ownership rate in the 
United States was 64 percent. After the affordable housing 
goals, the rate went to almost 70 percent. But half of all 
mortgages in the United States, 28 million loans, were subprime 
or otherwise weak. When they defaulted in unprecedented numbers 
in 2007, we had a mortgage meltdown and a financial crisis. We 
paid a terrible price for that last 5 percent.
    Some argue that investors will not buy mortgage-backed 
securities unless they are Government guaranteed. If it were 
really true that investors were afraid of credit risk, nothing 
in our economy would be financed. However, prime mortgages and 
mortgage-backed securities based on them are not risky 
investments. Their traditional default rate was well under 1 
percent. The natural investors in mortgages are insurance 
companies, pension funds, and mutual funds. They need long-term 
assets to match their long-term liabilities.
    Today these institutional investors, which, according to 
the Fed's flow of funds data, have over $21 trillion to invest, 
do not buy any significant amount of GSE or Ginnie Mae 
securities. They earn their returns by taking credit risk, and 
the yields on these securities on which the taxpayers are 
taking the risk are simply too low.
    Institutional investors have told us that if there were a 
steady flow of mortgage-backed securities on prime mortgages, 
they would be avid buyers. Securitizers and mortgage insurers 
have told us that a private system based on prime mortgages 
with mortgage insurance could finance a fully prepayable, 30-
year, fixed-rate loan for about 20 basis points more than 
Fannie and Freddie are now requiring.
    Thus, a private system based on prime mortgages would 
operate at close to the cost of the current Government-
dominated system without involving any risks to the taxpayers. 
To make such a system possible, the GSEs should be wound down 
over 5 years by reducing the conforming loan limits, and in 
light of the devastation caused by the most recent Government 
intervention in the housing market, this is a chance for 
Congress to end this very painful cycle of failure.
    Thank you.
    Chairman Johnson. Thank you.
    Ms. Ratcliffe, please proceed.

   STATEMENT OF JANNEKE RATCLIFFE, SENIOR FELLOW, CENTER FOR 
                 AMERICAN PROGRESS ACTION FUND

    Ms. Ratcliffe. Good morning, Chairman Johnson, Ranking 
Member Crapo, and Members of the Committee. I am Janneke 
Ratcliffe, and in addition to being a senior fellow at the 
Center for American Progress Action Fund and with the UNC 
Center for Community Capital, I am also a member of the 
Mortgage Finance Working Group.
    In 2011, we drafted a ``Plan for a Responsible Market for 
Housing Finance''--and thank you so much for having me here 
today. While I will present recommendations from that plan, I 
speak only for myself today.
    As the crisis has taught us and our research confirms, many 
of the benefits arising from housing depend on the way in which 
housing is financed, and that is precisely the reason why since 
1932 the Government has sought to foster a mortgage marketplace 
that is stable, safe, efficient, and affordable.
    A hallmark of Government support is the long-term fixed-
rate mortgage. Partly as a result, home ownership has served as 
a crucial building block of our strong middle class. However, 
the housing finance system is not functioning so well today, as 
we have discussed here, at least not for families and 
communities. It is too hard to get a mortgage, and many of 
today's renters must spend too much of their income on housing.
    Fortunately, there is a bipartisan way forward. The 
Bipartisan Policy Center's Housing Commission agrees that we 
urgently need a better system for financing rental housing, and 
that all creditworthy borrowers should be able to access home 
ownership. Perhaps most importantly, the commission's plan is 
one of at least 18 proposals, including other bipartisan 
proposals and our own, that call for Government support of the 
core of the market now served by Fannie Mae and Freddie Mac. We 
see a very broad consensus emerging.
    Now, we could continue to discuss Government's role, and 
meanwhile the Government would continue to take full credit 
risk on nearly all mortgages. But I hope that we can also 
discuss how to structure a role that is safe for taxpayers and 
good for the economy as well.
    Like the Bipartisan Policy Commission plan, our plan seeks 
to bring in as much private capital as possible. We propose 
privately run, well-capitalized regulated entities who would 
take the credit risk function that the GSEs currently have, on 
mortgage-backed securities only that meet specific standards. 
These chartered mortgage institutions, or CMIs, would also pay 
into a Government-managed reinsurance fund. This backstop would 
be explicit. It would be paid for and well protected by private 
capital, and that is in stark contrast to the prior GSE 
situation where the guarantee was ambiguous at best, not paid 
for, and much too highly leveraged.
    Comparing our plans with others highlights key 
considerations for addressing the important issues you raised 
in your invitation to speak today. First, broad availability of 
the long-term fixed-rate mortgage depends on a Government 
guarantee. Without it--many analysts have confirmed this--the 
30-year fixed-rate mortgage is likely to be much less widely 
available and more expensive.
    Second, equal access for smaller lenders and those serving 
smaller communities is one feature of the current system that 
should be retained and built on. We warn against putting small 
originators at the mercy of their large competitors for access 
to the Government guarantee and against concentrating credit 
risk with big banks. In our proposal, originating lenders would 
not be allowed to operate a CMI.
    Third, the system should provide access for all qualified 
borrowers and market segments rather than serving only higher-
income portions of that market. We propose anti-creaming 
measures alongside a market access fund that would foster 
innovation and access safely.
    Fourth, funding rental housing. This has been neglected by 
many plans. We applaud the attention paid by the commission to 
the crisis in affordable rental housing. Our plan envisions 
that Government-supported liquidity for multifamily lending 
would also include some income targeting.
    And then, fifth, protecting taxpayers. Serving the Nation's 
housing needs requires Federal support yes, but only in a 
limited role that is well buffered by private capital and paid 
for, as we have discussed.
    Finally, economic recovery and stability of the housing 
market. Spelling out a clear plan with a flexible approach to 
transition can give the market needed certainty and limit 
disruptions in the near term. We must also keep our eye on 
long-term stability. Reliance on private capital does 
inherently introduce volatility. We, therefore, recommend 
building in countercyclical measures to maintain liquidity in 
times of economic stress when private capital tends to flee, as 
well as measures that impose risk management discipline in good 
times, as Mr. Wallison's plan points out.
    In any event, the future state should prioritize what is in 
the best interest of the overall economy over the long run. 
What is at stake is the future of home ownership and economic 
opportunity for generations to come. These decisions should not 
be left to a conservator with a substantively different 
mandate. You now have the opportunity to build a mortgage 
market that is fair, accessible, affordable, and fiscally sound 
that works better for more households and communities than ever 
before.
    I look forward to your questions.
    Chairman Johnson. Thank you. Thank you all for your 
testimony.
    As we begin questions, I would ask the clerk to put 5 
minutes on the clock.
    Senator Martinez, the BPC's report states that continued 
Government involvement is essential to ensuring that mortgages 
remain available and affordable to qualified home buyers. Did 
the commission investigate what would happen to the cost of 
mortgages for the majority of American families if a Government 
guarantee did not exist? If so, what did the commission 
conclude?
    Mr. Martinez. Mr. Chairman, the commission addressed that 
issue, and let me say that I come at the conclusions that we 
reach, particularly on the Government backstop, as one who 
fundamentally began learning about the GSEs by listening to 
Peter Wallison's warnings that their system was fatally flawed. 
And it was. And so I am one that is very reluctant, because I 
was a great advocate of better regulatory and governance, if at 
all, with the GSEs for a long, long time, as HUD Secretary and 
then as a Senator, very reluctant to embrace any sort of a 
Government involvement in the system.
    However, I think the judgment was made by the commission 
that a 30-year mortgage was a desirable goal for the American 
people and something that is kind of embedded into our housing 
finance system and expectations that we have. Not all of the 
world enjoys a fixed-rate, 30-year, low-cost mortgage. So we 
are unique in that. And part of that uniqueness, we came to the 
conclusion, resides in having some form of a Government 
backstop ultimately.
    While there may be a market for mortgage-backed securities 
that are purely private label, unquestionably there are places 
like central banks in distant lands and a whole lot of foreign 
investors as well as other domestic investors who just simply 
will not buy a mortgage-backed security that does not have some 
sort of Government backstop.
    So the way we approached it is to put the Government in the 
most protected position we could put the Government and in the 
most limited way possible with a funded fund. And the idea was 
to simply have three layers before you ever get to the 
Government and the creation of a credit enhancer in between 
that would be well capitalized, well regulated, and that would 
provide the real backstop at any point unless there was just 
this cataclysmic, catastrophic sort of event.
    Chairman Johnson. Senator Martinez, a BPC report seems to 
recommend a Government backstop with powers similar to Ginnie 
Mae and the FDIC. Is that accurate?
    Mr. Martinez. That is correct, Mr. Chairman, and the thing 
we want to make sure we would not do is in any way replicate 
the model that was so fatally flawed in Fannie and Freddie. So 
that is correct. It is a Ginnie Mae-based model.
    Chairman Johnson. In that model, would the Government 
guarantor have exam and enforcement authority over the private 
entities standing in front of the Government guarantee in the 
primary and secondary market?
    Mr. Martinez. That is correct, sir.
    Chairman Johnson. Senator Martinez and Ms. Ratcliffe, both 
of your respective plans recommend a Government backstop, but 
the plans differ when they come to how loans are securitized. 
Under your respective plans, how would small community banks 
and credit unions access the secondary market? Senator 
Martinez, let us start with you.
    Mr. Martinez. Well, Senator, we made clear that our system 
was one that would be designed similar to Ginnie Mae, and in 
that regard, that it would be open to community banks, it would 
be open to credit unions, and it would be open to the small 
players in the marketplace. And we feel like that is a very 
important component not only for the liquidity that it brings 
about but also because it is just a fair system that allows all 
players to play an equally important role.
    Chairman Johnson. Ms. Ratcliffe?
    Ms. Ratcliffe. Thank you. We are completely in agreement--
--
    Chairman Johnson. Turn on your mic.
    Ms. Ratcliffe. Thank you. We are completely in agreement 
that the ability of small banks and banks in small communities, 
to be able to offer the same kinds of products that are equally 
priced and transparent and well understood, that has to be 
maintained in the system going forward. And that is a function 
that Fannie and Freddie largely have allowed to happen.
    There are some ways in which our plan differs technically 
from the BPC plan, but we also looked to the Ginnie Mae model 
where very small issuers can put out pools of loans.
    The difference in our case is that, instead of the issuer 
being responsible for obtaining the credit enhancement, the 
first loss credit enhancement, it would be left to specialized 
institutions that would be providing that function only and not 
doing the issuing. So that is the difference. And we feel that 
that would enable smaller institutions to be able to access 
that kind of guarantee on the same terms as large institutions.
    Chairman Johnson. Ms. Ratcliffe, I am very concerned that 
low- and middle-income families in rural areas might be ignored 
by private capital. Based on your research, are these fears 
valid? And what underwriting requirements should a new system 
include to ensure families have access to affordable mortgages 
while also protecting taxpayers?
    Ms. Ratcliffe. Yes, sir. I think that is a legitimate 
concern. The market does tend to provide the best products to 
the parts of the market where it is easiest to do so, and that 
tends to be more affluent borrowers, and so they can tend to 
cherrypick or cream and leave out large segments, particularly 
lower-wealth borrowers, lower-income borrowers, borrowers in 
less well resourced communities.
    We have lots of evidence that shows that lending to these 
kinds of families can be done safely and soundly. Case in 
point: For the last 10 years, we have been studying a portfolio 
of almost 50,000 loans made to borrowers by banks around the 
country. The median borrower earned $35,000 a year. Most of the 
borrowers put down less than 5 percent, and half of them had 
credit scores below 680. Today they would not be able to get 
mortgages, and yet even through the crisis, they have managed 
to perform pretty well. And it is a sign that, when provided 
safe and sound products, like the 30-year fixed-rate mortgage, 
and well underwritten and given access to the mainstream prime 
market, you can make safe and sound mortgages.
    So we think it is very important not to let these segments 
go underserved. It is very important to the rest of the market. 
It is the first step of home ownership that allows other people 
to move up and sell their homes and so on and so forth. So it 
is a critical function of a well-functioning market to see that 
that market gets served.
    That does lead us to how you do it, and our plan has an 
extensive discussion. We agree with many other people that the 
affordable housing goals that Fannie and Freddie were subject 
to were not the right way to go about achieving this. They were 
blunt instruments and, frankly, not that effective. And so in 
our plan we talk about a more plan-based strategic approach to 
ensuring that this access is provided. And in addition to 
having a sort of duty to serve on these entities, we would 
offer tools that could help make that possible, such as a 
market access fund, which could provide a safe and sound way 
for institutions to try research and development and find new 
ways to expand the market safely.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman. I want to start 
out, I hope briefly, with the question that I raised in my 
opening commission relating to Congress' tinkering with the 
guarantee fees.
    As I indicated in my opening comments, I have my opposition 
and there is bipartisan opposition on this Committee to using 
an increase in the guarantee fees to offset, in one case, tax 
cuts and, in the current proposal in the budget, spending 
increases.
    Do any of you believe that we ought to be offsetting 
Government spending, which may or may not even be related to 
housing policy, through increases in the guarantee fees charged 
by Fannie Mae and Freddie Mac?
    Mr. Martinez. I clearly do not, sir, and I applaud the 
bipartisan bill that has been offered.
    Senator Crapo. Thank you.
    Mr. Wallison?
    Mr. Wallison. I am of the same view. I think it would be a 
big mistake to get the GSEs involved in paying for other 
aspects of the Government's activities.
    Senator Crapo. Ms. Ratcliffe?
    Ms. Ratcliffe. I see that we have bipartisan consensus 
here, and I would agree. And I would suggest that we also be 
thinking about constructive ways that surplus g-fees could be 
used in some ways to start capitalizing for a new system of the 
future as well as thinking about the Housing Trust Fund and the 
Capital Magnet Fund that have still gone unfunded.
    Senator Crapo. Well, thank you, and I would like all of you 
to respond to this. I am going to start with Mr. Wallison, but 
the next question I want to get into is how we correctly price 
risk and whether there really is a consumer benefit if we 
correctly price risk.
    I think one thing we have learned is the Government is not 
very good at pricing risk, but some experts have suggested that 
if we assume the Federal Government was able to accurately 
price risk and actually charged fees that are high enough to 
fully offset that risk, then the pricing benefit that is 
traditionally associated with a Government guarantee would 
disappear. Instead, the Government would have to charge as much 
or nearly as much as the private sector would to assume this 
risk, and, thus, the only way to achieve lower pricing through 
Government guarantees would be by having the taxpayers 
subsidize risk.
    Could you comment on this point, Mr. Wallison?
    Mr. Wallison. Yes. I do not think there is any evidence 
that the Government can effectively price for risk. There are 
several reasons for this. One is that the Government does not 
have the incentive that insurance companies have to price for 
risk. Another is that to protect against catastrophic events it 
is necessary to build up a fund. What we find all the time is 
that once the fund is created, the interests come in and argue 
that the fund is large enough, we do not have to charge any 
more, and Congress agrees. As a result, the fund never gets to 
the size that it should in order to deal with the catastrophes 
that eventually occur.
    We can see that, of course, because the Government just had 
to bail out the Flood Insurance Program because there was not 
enough money in that fund. That was an insurance fund. The FDIC 
was insolvent for a period of time after 2008 because it had 
not built a big enough fund.
    It will again be a mistake if we set up another fund. We 
will find, 10 years from now, when we have a problem, that the 
fund was not adequately funded.
    Senator Crapo. Thank you.
    Ms. Ratcliffe, do you have an opinion on this?
    Ms. Ratcliffe. Yes. First of all, we also have some 
evidence that the private sector has some problems pricing 
risk, so I do not think it is an either/or thing.
    To Peter's point--and the commission's proposal and our 
proposal both use the mechanism of putting private capital at 
risk, in our case private entities whose capital would have to 
be fully depleted before the backstop--first, the fund would be 
hit and then depleted before a backstop. So clearly this puts 
the onus on the private sector entities to figure out the right 
risk pricing.
    In contrast to the GSEs, you know, they had to hold 45 
basis points of capital on the risk, and the commission's plan 
and ours are similarly recognizing that, you know, the recent 
crisis gives us a pretty good idea of the high watermark that 
we need to be thinking about. Maybe it is a 4 to 5 percent kind 
of capitalization requirement. That would be many times higher 
than what the GSEs were carrying.
    So I think if you can put private entities in a meaningful 
first loss position that is not too highly leveraged, then you 
will have the combination, the best combination, of private 
sector discipline and public sector oversight.
    Senator Crapo. Mr. Martinez?
    Mr. Martinez. We largely agree, particularly with the last 
comments Ms. Ratcliffe made, and I believe particularly in the 
sense that we are looking to well capitalize credit enhances 
that would be well regulated and well capitalized all along, 
putting the Government in the very last position.
    So, to me, I view--by the way, the FDIC is a good model as 
well. While they may have had a hiccup around 2008 when a lot 
of things were not going to exactly right, it ultimately 
righted its own ship. And I believe that the FDIC is a model 
that can be replicated in terms of funding a fund that will 
ultimately be there.
    One other thing that has not been touched on and I think is 
very important that we discuss in terms of the Government 
guarantor is the necessity for there to be a TBA market. The 
to-be-announced market is an essential ingredient of secondary 
mortgage markets, and without a Government guarantor, the TBA 
market would not exist. And I think before we think that it can 
be dispensed with, we should give a very close look to the 
importance of the TBA market and the importance the TBA market 
has in creating the kinds of liquidity and fungibility that 
mortgages have today that allows them to be traded forward.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman. 
Thank you, panel, for your excellent testimony. And welcome 
back, Mr. Secretary. Good to see you.
    As the author of the National Housing Trust Fund and the 
Capital Magnet Fund, I was very pleased to see that your 
Housing Commission recommended retention of these two entities 
in a reformed housing system. Can you comment upon the basis of 
your recommendation and why we need to maintain these programs?
    Mr. Martinez. Well, Senator, I think that there was a 
recognition that these programs, although still in----
    Senator Reed. Infancy.
    Mr. Martinez. In the infancy, correct--were an important 
way in which, you know, we can create affordability and create 
accessibility to those that otherwise might not have it. And so 
there was not a lot of dissension in terms of that. I mean, 
obviously some would differ, but I think the consensus of the 
group was that it should be maintained and it should be left as 
it is.
    Senator Reed. Thank you very much, Mr. Secretary, and, 
again, thank you for your service both here and over at HUD. 
Thank you very much.
    Mr. Martinez. Thank you.
    Senator Reed. Ms. Ratcliffe, I was pleased to see that in 
your comments you mentioned rental housing, because one of the 
perceptions is this is just about home ownership and that our 
housing goals have to embrace that. But you also indicate that 
we have to have responsible plans for financing affordable 
rental properties.
    Could you elaborate upon that? Again, I think one of the 
conclusions coming out of the last several years is that rental 
housing is for some people the best choice, not just the 
default choice. If you would comment?
    Ms. Ratcliffe. Sure. Right, I agree that we really cannot 
get on track without a strong rental housing finance system. 
More than a third of Americans live in rental housing, and more 
than half of them spend more than 30 percent of their income on 
housing, which is a much higher share than of homeowners' 
spending that much of their income on housing.
    There has been a sharp drop in construction of multifamily 
rental residences, but it is quite--everybody projects an 
increase in the demand for rentals. So we only see this 
pressure on rental rates rising.
    Providing long-term, efficient, affordable capital for 
rental housing also results in long-term affordable, stable 
rental rates. And so we see the direct connection between the 
secondary market system for the multifamily market to that kind 
of stability for renters.
    Stability in housing and affordability in housing for 
renters is a way that they can start to create some space 
between their income and their monthly payment, that they can 
start building some assets and some economic stability. So we 
think it is critical that the system take that into account. 
And in some ways, you know, for renters, renting might be an 
option for now, but having that kind of stable rental where you 
can start to build some savings is also in a sense the first 
step on the ladder to home ownership.
    Senator Reed. One of the other phenomena that we are 
beginning to recognize now is that there is a whole cohort, a 
whole generation of Americans that have extraordinary debt from 
their college education, from postsecondary education. In fact, 
the Pew report I think just last week indicated this could 
defer home purchases for several years from 25 to 35, which 
does several things: one, it impacts home ownership, which you 
are struggling with, that issue; but also I think it 
underscores the need, again, for rental housing, because there 
are going to be many young families who 20 years ago would have 
had the downpayment, bought the house, et cetera, and now are 
going to be waiting 10 years as they pay off their college 
loans, and they will need rental housing. Is that another 
factor that we have to consider?
    Ms. Ratcliffe. Absolutely. Yes, sir, we do. And I think 
just looking generally ahead at the demographic trends, the 
home buyers of the future or, for that matter, the renters of 
the future, the source of housing demand in the future is going 
to come from households that are less wealthy, younger, more 
likely to be households of color. So we need to be sure that 
our system serves that segment of the market.
    Senator Reed. It goes back to this issue of affordability 
and not just, you know, having the market mechanisms in place.
    Mr. Secretary, do you have a comment?
    Mr. Martinez. Yes, I just want to add to that. Anecdotally, 
you can also in the marketplace see that there is just not a 
lot of available, much less affordable, rental housing today. 
And I wanted to also add the elderly into the mix, which is a 
real difficult problem. Affordable housing for the elderly, and 
adequate housing, and aging in place and all of those things 
continue to be, I think, a tremendously important issue that we 
cannot overlook.
    Senator Reed. Just a quick question. I am sorry, Mr. 
Wallison. Your testimony is always extremely thoughtful. There 
are two issues if we go--and this is very conceptual--into an 
exclusively private market. One of the problems, I think, we 
saw in 2008 and 2009 was very poor underwriting. And then when 
you get to the securitization market, credit rating agencies, 
they could not perform properly.
    Is the basis of one of your assumptions going forward with 
an essentially purely private model that these underwriting 
problems, which were notorious at Countrywide and other places, 
can be corrected, will be corrected? And does that imply much 
greater oversight by regulators like OCC and other Federal 
regulators and the underwriting process and also dealing with 
the credit rating agencies?
    Mr. Wallison. Well, first of all, the reason that we had 
poor underwriting in those periods--and it is not just 2008 and 
2009, but actually, again, in the mid-1990s--was because Fannie 
Mae and Freddie Mac were striving to meet the quotas that HUD 
was establishing for them under the affordable housing goals.
    Senator Reed. But excuse me. Countrywide was being forced 
to write terrible loans even as their market share grew much 
more dramatically than Fannie Mae because of the affordable 
housing goals.
    Mr. Wallison. Sure, but how----
    Senator Reed. They were not subject to those goals.
    Mr. Wallison. Right, they were not partly responsible. But 
they had a buyer in Fannie Mae and Freddie Mac. They were the 
biggest suppliers to Fannie Mae. And the reason they created 
all those terrible loans was because Fannie Mae and Freddie Mac 
wanted them.
    We cannot just look at the originators. We should look at 
the customers that they had, and the customers were in the 
Government.
    Senator Reed. Well, what about private securitizations of 
Wall Street which became hugely important, which did not have 
affordable housing goals, which essentially were going to 
Countrywide and saying, ``You do not need Fannie and Freddie, 
you got us and we got you, and we got the credit rating 
agencies''? They were not at all a problem?
    Mr. Wallison. I agree that the private sector was also 
guilty here.
    Senator Reed. Well, thank you.
    Mr. Wallison. I am not saying the private sector was not 
partly responsible. But if you look at where those bad 
mortgages went, 74 percent of them were on the books of the 
Government agencies in 2008; 26 percent were on the books of 
private agencies, private organizations. So the main malefactor 
in our problems in 2008 was the Government.
    Senator Reed. By 2008, 6.2 percent of these GSE mortgages--
I think you were talking about it--were seriously delinquent 
versus 28.3 percent of non-GSE securitized mortgages. So where 
did the bad mortgages go? To Fannie or to the private Wall 
Street crowd?
    Mr. Wallison. With all respect, Senator, Fannie became 
insolvent, and so did Freddie. And the reason they became 
insolvent----
    Senator Reed. And Countrywide did, and----
    Mr. Wallison.----was because they acquired so many terrible 
mortgages.
    Senator Reed. And Countrywide did, and many others did, and 
one could argue that some of the major financial institutions 
in the United States would have been insolvent except for being 
bailed out by the Fed.
    Thank you.
    Chairman Johnson. Senator Martinez.
    Mr. Martinez. You mean Menendez.
    [Laughter.]
    Senator Reed. No comment.
    Senator Menendez. We are both Cuban, Mr. Chairman, but he 
is better looking than I am.
    [Laughter.]
    Senator Menendez. Let me thank you all for your testimony. 
You know, the one thing I hear pretty universally--maybe 
different views exactly, but there has to be some Government 
backstop here, or else the market as we know it, particularly 
for the aspirations of typical families would not be realized 
at the end of the day.
    I would like to ask you, Ms. Ratcliffe, there are nearly 12 
million Government-sponsored borrowers who are current on their 
loans, but they are underwater and they cannot refinance under 
today's lower mortgage rates. Both I and Senator Boxer have 
introduced legislation that would help these hard-working 
families to lower their payments and, in doing so, continue to 
be responsible borrowers, solidify a part of the housing 
market, and in my view, also unlock some economic potential 
because if I have the roof and it has been leaking and I cannot 
afford to replace it and I now have an additional $300 or $400 
in my cash-flow because I have reduced my mortgage payments, I 
can replace the roof. That means I am going to hire somebody. 
That means it is going to have a ripple effect in the economy.
    What are your thoughts on the outcome of such legislation 
might be on the current market?
    Ms. Ratcliffe. So, generally, we are supportive of 
principal reduction when it can be a win-win-win situation for 
the borrower and the investor and the community that they are 
in. Early research that we did has demonstrated that default 
rates and recoveries on loans where a principal reduction is 
granted are much more favorable than when you go ahead with the 
foreclosure. And it still escapes me why servicers are so eager 
to go ahead with short sales and other situations where they 
get back less for the sale of their property than when a 
principal reduction to the current owner might actually achieve 
a better economic outcome. So we have generally supported 
principal reduction where it can be----
    Senator Menendez. And I appreciate that. In our case, what 
we are just simply saying is let us remove the barriers to 
refinancing on the historically lower rates right now----
    Ms. Ratcliffe. And, absolutely, that even goes without 
saying, even further. The debt loads that people are carrying 
right now on their housing is one of the things that is holding 
back the housing recovery. So if you can alleviate that, I 
think it would be good for the economy.
    Senator Menendez. Let me ask Senator Martinez: The 
Coalition for Sensible Lending recently presented to Congress 
its findings on what the credit space would look like for 
first-time home buyers and minority families if the QRM rule 
incorporated even a 10-percent downpayment. The results were 
not encouraging considering that the average time for a medium-
income African American family to save 10 percent on a medium-
priced home was 31 years and 20 years for a comparable white 
family.
    What does this mean for discussions on limiting the 
Government's role or using a 20-percent downpayment as the gold 
standard?
    Mr. Martinez. Senator, I think it would be very, very 
difficult to have a viable opportunity for home ownership for a 
whole lot of Americans, and I am thinking that a 20 percent 
goal would be really--it would just put way too many Americans 
out of the dream of home ownership.
    So in a responsibly actuarial way, with good underwriting, 
you know, verifying employment, and a whole lot of other things 
that ought to go into it that at some time in the recent past 
were abandoned, I think there still should be a place for there 
to be a low loan-to-value sort of mortgage for families that 
are struggling to reach the American dream.
    Senator Menendez. And I think that you hit the nail on the 
head when you said looking at the variety of factors to 
consider in terms of risk and underwriting is incredibly 
important as well, not just a position on which you say 20 
percent.
    Ms. Ratcliffe, in a countercyclical time, when private 
capital retreats from the market without a vehicle to provide 
mortgage credit, how would American families buy a home? And 
would that not have a profoundly negative effect on the economy 
in terms of recovery?
    Ms. Ratcliffe. You raise a very challenging question for 
GSE reform, for the issues that lay ahead of you today.
    In our proposal, we would suggest--you know, the GSEs 
currently have this or used to have this portfolio function 
that they used a lot of times to address countercyclicality, 
and we do not call for that function to be continued in the 
reformed secondary market.
    We propose a mechanism where perhaps a special class of 
debt could be issued in times of crisis that would maybe move 
around a little bit the relationship between the Federal role 
and--the Government role and the private role of the fund and 
the private capital to keep a reliable flow of credit going in 
tough times.
    But I also wanted to come back to the point that what 
happens in tough times is largely a function of what you have 
allowed to happen as well in good times. If in times of strong 
markets, capital requirements are reduced, underwriting 
standards are loosened too much, you are basically setting up 
the failure during the tougher times.
    So it is very important to maintain strong capitalization 
of any risk-taking entities and strong risk management 
disciplines, and we see that this can be done if you establish 
specialized monoline entities to take that risk that are well 
regulated and well capitalized and well monitored, and that 
actually buildup capital in good times. So it is 
countercyclical in the good times as well as in the difficult 
times.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Menendez.
    Senator Corker?
    Senator Corker. Thank you, Mr. Chairman. I am out of 
breath.
    I welcome all of you, and certainly I always enjoy having a 
bipartisan, sort of the to right/sort of to the left 
presentation on something that is very complicated. I want to 
thank each of you for your--sorry.
    [Laughter.]
    Senator Corker.----for your support of the bill to at least 
begin making sure that g-fees are not being used to pay for 
other things and that we have the ability to know that, you 
know, we are going to do something different with the GSEs.
    The GSEs both--I am going to make more of a statement than 
ask a question, but the GSEs have been a political football for 
both sides for years. And each side has had a lot of fun with 
this political football. Certainly during Dodd-Frank, I know 
folks on our side did, and now we have an opportunity, I think, 
and I think the environment is right to actually do something 
very good, and I applaud all three of you for coming in and 
talking with us. And I certainly appreciate what each of you 
have done through the years to sort of help us think through 
this.
    I sort of feel the environment is getting right, and Ed 
DeMarco, who is at FHFA--you know, certainly I know some of my 
friends on the other side of the aisle have some issues with 
him, but as a technocrat, he has been pretty good at sort of 
laying--I see each of you nodding your head up and down, for 
the record. He has been pretty good.
    [Laughter.]
    Senator Corker. He has been pretty good at the technical 
issues of walking through. I know that some of my friends do 
not like some of the policy decisions that he ha made, but even 
on those, it looks like he is coming around a little bit to 
their way of thinking on some things.
    But, regardless, my point is that the GSEs are very 
complex. Numbers of us have sat down in bipartisan meetings to 
walk through the things that have to be dealt with on the GSEs. 
It is very complex. It requires a lot of things to work 
together, so walking through a transition to a reformed 
situation is going to be very difficult.
    The Administration recently has floated a name through the 
press of a person to lead the GSEs, and let me just mention, 
you know, I am Ranking Member on Foreign Relations. We had 
almost a unanimous vote for a politician to lead the State 
Department. We have a politician leading Defense. And I am all 
for politicians going on to grander things. But I think the 
GSEs are a very unusual situation, and that is that we really 
need somebody with technical strength and with no political 
bias whatsoever to help us walk through this. And the last 
thing that we need is a politician that has actually been 
involved in these issues for years leading the organization.
    And I would just ask you, if you agree, that regardless of 
whose technocrat it is, that between now and the actual 
implementation of a changed program we would be better off 
having a technocrat at the head--it can be the Democrats' 
technocrat or the Republicans' technocrat, but somebody that 
actually understands these issues and knows that he is going to 
have to walk through the reform process fully, and if it is not 
done with tremendous grace, it could do a lot of damage to an 
industry that is very important to our country.
    You can answer that yes/no.
    [Laughter.]
    Mr. Martinez. Senator, I think you are pretty accurate. I 
mean, I agree with you. I think it ought to be a very technical 
person, and I also agree that Ed DeMarco has done a great deal 
of--a great public service in his role, and I think someone 
that emulates his sort of nonpolitical role, who is well rooted 
in the intricacies of these very complicated entities, would be 
the ideal person.
    Mr. Wallison. Yes, I would agree, Senator Corker. Ed 
DeMarco has been a remarkable public servant. One of the things 
that he has done is he has begun a process of preparing the 
GSEs for either some sort of Government program or a private 
program without siding with either of those. And he has also 
helped a little bit to make it possible for the private sector 
to compete with the GSEs by raising the g-fees.
    So we need another person like Ed DeMarco, if not Ed 
DeMarco himself.
    Ms. Ratcliffe. So I think that depends somewhat on the 
extent to which the candidate understands the mortgage finance 
system and the intricacies and complexities that you described. 
And, of course, if they are from North Carolina, that would be 
a factor in my decision.
    [Laughter.]
    Ms. Ratcliffe. But, seriously, I think the important thing 
about reform is not so much who is in the conservator's seat 
with a conservator's mandate, but the necessity of this body to 
come up with a plan for reform of the secondary market.
    Senator Corker. I agree. And I think that, I mean, when you 
start going through the nuances of this, what really is going 
to happen--Mark Warner and I had a great meeting yesterday with 
someone to walk through--you are going to really end up 
depending upon that conservator. You cannot lay out every 
detail, and we saw that--I mean, my friends on the other side 
of the aisle understood that during Dodd-Frank. You cannot lay 
out every detail. You have got to leave it up to the regulators 
to have some discretion.
    Well, certainly, as we transition from where we are today 
to a new system, you are going to have to leave some of the 
guidelines somewhat broad so that there is discretion.
    So, again, I think making sure that we continue to have a 
neutral figure, if you will, one that is trusted, regardless of 
who it is, and has the ability to walk through the technical 
issues to me would be very important.
    I know my time is up. I thank you each. I know we have had 
multiple conversations. I look forward to more. And I do 
think--I hope, Mr. Chairman, that 2013 will not end without us 
doing something in a bipartisan way to reform these. I really 
do think that is possible, and I hope the Chairman and Ranking 
Member will decide to let that happen. So thank you.
    Chairman Johnson. Thank you.
    Senator Tester.
    Senator Tester. Yes, thank you, Mr. Chairman. And before I 
start with my questions, as long as Senator Corker is here, he 
is spot on, and I think Ms. Ratcliffe is spot on, along with 
the rest of you. We really need to tackle this problem, and I 
think the time is right. I think we played political football 
while the industries are out there looking at us and saying, 
``Why don't you get after it and get it done?'' And we will end 
up with something that not everybody is entirely happy with, 
but a hell of a lot better than we have now.
    And so I think that is really the crux of it, and that is 
why I really thank you guys for your testimony. And there was a 
lot of agreement up here, whether it is from the left or the 
right or the center, or wherever, on where we need to go.
    I am going to start out with you, Senator Martinez, and I 
want to thank you and the Bipartisan Policy Commission for 
specifically outlining the importance of housing in rural 
communities. And as the commission acknowledged, rural 
communities are home to about one-third of the U.S. population. 
They face unique challenges, which can include a dearth of 
quality housing and a significant number of household spending 
a substantial portion of their income on housing costs.
    And I also appreciate that you have explored the issue of 
rental housing. Critically important, I think it is absolutely 
important, especially in rural America, but maybe all over the 
country, and I think you have advocated USDA's role in 
supporting rural households.
    There is another issue that I was wondering whether you 
looked into or not. It is an issue that, quite frankly, my wife 
and I dealt with 20 years ago when we built a house. We could 
have rehabbed our old one, but it made more sense and it was 
more cost-effective just to start over. That is not true in all 
cases. Sometimes rehabbing a house is much better, much more 
cost-efficient.
    Did you look into whether there might be opportunities to 
finance rehabilitation as a more efficient way to improve 
particularly rural housing stock?
    Mr. Martinez. No, Senator, we did not really look at that. 
It is not an area that we delved into at all.
    Senator Tester. Well, let me ask any of the panelists up 
there. Is this something that you think has merit, or should we 
stay away from it? And what I am talking about is rehabbing 
versus rebuilding.
    Ms. Ratcliffe. Not only in the context of rural housing, if 
I may, but also in the context of community revitalization, 
clearly the role of--a need, a shortage of good financing for 
acquisition rehab, for example, has been identified, and so I 
would agree with you.
    And in terms of rural housing more generally, something 
else I would point to is HERA called for the GSE conservator to 
set ``duty to serve'' requirements on rural housing, 
manufactured housing, and affordable housing preservation, 
which touch on a number of issues for rural communities. And 
the idea behind this would be instead of having, you know, 
numeric goals, like the housing goals, there would be more of a 
strategic comprehensive plan that would lay out what the 
agencies would be expected to do to try to expand service to 
those markets. And those three subsets were identified as 
places where there is big financing gaps.
    And so I believe there is a proposed rule on that, but it 
has not been finalized yet.
    Senator Tester. OK. We will talk about smaller financial 
institutions. It has been talked about a lot already, and many 
of the questions have been answered. But particularly for 
Senator Martinez and Ms. Ratcliffe, in developing your plans, 
was there any analysis of the role smaller financial 
institutions play currently in the housing finance system and 
what impact a system that limited the access of these firms to 
the secondary market would have on mortgage costs and access to 
mortgage products in rural America?
    Mr. Martinez. There is no question, Senator, that that was 
an important consideration. We felt that access for the smaller 
institutions into the secondary market was an essential 
ingredient, not only the community banks but also the credit 
unions. And it was something that we emphasized in our report. 
And I should also add that Senator Kit Bond, who is a great 
advocate of rural housing, a former colleague of ours, you 
know, his role on the commission was a great champion of the 
whole rural housing in small communities and the community 
enterprises as well to be participants in the marketplace.
    Senator Tester. Ms. Ratcliffe, do you have anything to add 
to that?
    Ms. Ratcliffe. I mean, I would agree completely. I would 
just--as a case study, I described the program we have been 
studying for the last 10 years with the 50,000 mortgages that 
were originated by banks around the country, and a lot of these 
banks were doing this to meet the needs of their local 
communities as they identified them. But without a way to sell 
those mortgages into the secondary market, it really limited 
their ability to provide that financing.
    So what this program did was it created a partnership with 
Fannie Mae to be able to sell these loans to the GSEs, and that 
enabled those institutions to provide that kind of financing at 
the level that their communities need it.
    Senator Tester. Well, thank you, and I want to once again 
thank you all. And I also want to, as long as the Ranking 
Member is here with the Chairman, say how important I think 
this issue is. I talked in my opening remarks about how the 
housing market is coming back, and I think it is doing it in 
spite of us. And I think that if we were able to sit down and 
make this a priority for this Congress to get this through and 
get bipartisan support for a bill that will deal with the GSEs, 
I think it would be something we could all be proud of on this 
Committee and something whose time has come and passed, and so 
we need to deal with it.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman. Let me take off 
where my friend Senator Tester left off and simply echo his 
views that, you know, I really do think this is the moment. 
There were clearly concerns about kind of the ``do no harm'' 
over the last few years. The housing market was slowly 
recovering. I have the fear that, as the housing market now may 
be recovering very quickly, we are going to see enormous 
profits starting to flow back into Fannie and Freddie and the 
pressure to--you know, there is going to be this normal--well, 
let us just go back to the status quo, and maybe this is not a 
problem. And I think there are real challenges in this system 
that we have got right now, and that there is actually a lot 
more bipartisan accord than on many of the other issues.
    I would also say that one of the things that we have been 
looking at that I do not know, Senator Martinez--and it is 
great to see this panel back here again--whether you all looked 
at that there are certain almost utility-like functions that 
actually FHFA is trying to move forward with now and trying to 
bring more transparency around common standards in terms of 
appraisals, underwriting, you know, a single-securitization 
platform.
    There is a utility component in all of this that even my 
good friend Peter Wallison might say needs to be not done by a 
private sector entity but a utility function here. Did you look 
at all at that issue?
    Mr. Martinez. Well, Senator, in the Government guarantor, 
as we call it, there would be regulatory functions, there would 
be--those kinds of functions would reside there without 
creating anything akin to the current models of the GSEs. But 
there would be some functions in terms of ensuring that the 
private sector actors were well capitalized, you know, the 
kinds of functions that I think you would expect there to be.
    Senator Warner. I actually believe there may be something 
earlier on in the chain where there might be this kind of 
common information transparency platform that would be totally 
separate from any kind of Government backstop that currently 
Fannie and Freddie perform, but not very well. But it all 
starts, again, with a basis around transparency.
    Let me hit a couple other points. I have got a lot, unless 
we are going to get a second round.
    I do believe, as I think at least two out of the three 
panelists agree, that if we put enough tranches in front of any 
Government backstop, you know, home equity, mortgage insurance, 
risk reserves, a catastrophic FDIC-type fund, and then if all 
of that--an FDIC-type fund that would then be replenished from 
the industry, but there could still be some ultimate backstop 
during the moment of crisis.
    Now, I have spent a lot of time and have enormous respect 
for Peter Wallison in terms of our discussions, and, you know, 
I know never, ever, ever Government backstop anywhere messes up 
things. Here is my--here is my question to you:
    If we had--and just envision this as a potential; I want to 
hear all of you--but this Government backstop at some point, 
could you not, if that Government backstop, say, took 95 
percent of the risk, even within that Government backstop, sell 
off some small slice, some small sliver, 2 to 5 percent of a 
private part of that reinsurance, that could be that kind of 
private market warning system if everything along the way was 
sliding into too much complacency.
    Do you want to start? And then if the others----
    Mr. Wallison. I think it is possible to do something like 
that. I have not seen it done, but I think it is possible.
    I would like to say this, though, about these private 
backstops: The problem with them is that the idea is to protect 
the buyer of the mortgage-backed security. Once you have 
protected the buyer of the mortgage-backed security, that 
person is not worried anymore about the risks that are in the 
system, not worried about the quality of the mortgages, not 
worried about the capital of the issuer of that mortgage, or 
mortgage-backed security. And so you eliminate any kind of 
market discipline at that point.
    Now, the BPC plan and I think the other plan from CAP that 
we were talking about kind of assume that the Government is 
going to step in, and everyone in the industry will probably 
believe that, too. The people who are in mortgage insurers, the 
people who are the various corporations that are issuing these 
mortgages or mortgage-backed securities, will all assume that 
they are going to be bailed out if something happens in the 
market. And as a result of that, there will not be any kind of 
market discipline on any of them. We will end up with exactly 
the same process that we had with Fannie Mae and Freddie Mac.
    Senator Warner. Well, I am never going to get you to yes, 
but I am going to--I would love to sit with you with these 
various layers, and there may be a way on that ultimate 
backstop to take a slice.
    I know my time has expired. I just want to make one last 
comment. One of the things that I know at least, Senator 
Martinez and Ms. Ratcliffe, you have talked about is taking 
away--on the affordable housing piece, taking it away from this 
mixed kind of implied effort inside Fannie and Freddie. The 
question is: If we are going to do it within a housing trust or 
some other entity, how will we fund that? And how do we make it 
clear--and my time has expired, and maybe on a second round I 
can get your thoughts on that.
    Ms. Ratcliffe. Well----
    Senator Warner. I have gone over.
    Chairman Johnson. We will have a second round.
    Senator Warren?
    Senator Warren. Thank you very much, Mr. Chairman, Ranking 
Member Crapo. Thank you all for being here today.
    We take up three issues today that all deal with certainty 
in the market and how we repair the markets that were so badly 
broken and demonstrated in this huge financial crisis. 
Obviously, with GSE reform, I very much agree with Senator 
Crapo and many of my colleagues, the urgency of the moment, we 
have got to get this resolved, and we have got to get it 
resolved now, and I think that is what--the bipartisan bill is 
a first step toward that.
    Also the nomination of Mary Jo White, if you listened to 
the hearing, was very much about the importance of getting the 
rules in place going forward in response to what we discovered 
was wrong during the financial crisis.
    The CFPB nomination is also the same. This is an agency 
that was designed to deal with the fact that the consumer 
credit market was not working and people were getting cheated. 
We now have a nominee whom I believe everyone has described as 
balanced and effective, and yet despite the fact that I think 
he deserves an up-or-down vote, what has happened is we have no 
vote on him, we cannot get somebody confirmed, and the 
consequence of that is to produce uncertainty in the market, 
which just seems to me to head in the wrong direction. We need 
a strong, effective consumer agency. We need an honest consumer 
credit market, and that happens when we get a Director 
confirmed.
    You know, going forward on GSE reforms, I want to hit a 
couple of things we have not talked about because I think they 
are important. One of them is the role of complex financial 
agreements. We discovered, for example, in the consumer market 
that agreements about mortgage servicers were so loaded with 
fine print, lots of tricks, lots of variations on how they 
would be compensated, for example, that they left open the 
opportunity for misrepresentations, for deceptions, for 
outright fraud. And now the consumer agency has come up with 
uniform servicing agreements to try to deal with that and get 
an honest market where everybody knows what they are dealing 
with. You master the one agreement, you have got it.
    The question I have is about securitization agreements. 
Securitization agreements--I actually looked at some of those 
things--are complicated, very difficult to read and understand 
and to evaluate the risks associated with transactions there 
and I think the evidence shows left open the opportunity for 
misrepresentations, for deception, and for outright fraud.
    So the question I want to ask is: Would you support having 
a standardized security agreement? We will just go down the 
line. Ms. Ratcliffe, you are closest to me, so you can start.
    Ms. Ratcliffe. Yes, I do. And may I----
    Senator Warren. Please, sure.
    Ms. Ratcliffe. I mean, I do think----
    Senator Warren. When you are saying yes, you get to go 
longer, yes.
    [Laughter.]
    Ms. Ratcliffe. The model, to your point about creating 
infrastructure and standards and transparency that should apply 
to all participants in the market, you know, when accessing the 
standard mainstream Fannie/Freddie market of old, you know, as 
a borrower, all I had to do was, you know, back in the day, 
look in the newspaper, and I knew what I was getting, and I was 
able to see. And by the same token, investors on the other end 
of that transaction knew exactly what they were getting, and so 
obviously there is a model to be learned from.
    Senator Warren. Very good explanation. Thank you, Ms. 
Ratcliffe.
    Mr. Wallison?
    Mr. Wallison. Yes, I would agree that it would be a good 
idea to have a standardized kind of securitization agreement. 
They are enormously complicated, so it is not the sort of thing 
that Congress can legislate. But if you get the lawyers 
together who do these things and you have commentary on the 
pattern that is adopted, I think it might be worthwhile.
    Senator Warren. Good. That is very helpful. Thank you.
    Senator Martinez?
    Mr. Martinez. Senator, we did not consider that issue as 
part of our commission report, but it strikes me as a very good 
idea.
    Senator Warren. All right. Good. Thank you.
    I want to ask a question about risk pricing. You raised the 
point, Mr. Wallison, that you think the Government never gets 
it right. I think Senator Martinez said, ``Wait a minute, I 
remember the FDIC insurance model. I think they did a pretty 
good job.'' So let us call it a mixed record.
    I want to ask the question in the other direction, and that 
is, the private market. I just went back and thought about this 
one. In the 1900s, we had the mortgage title insurance company, 
a private insurer of mortgages. In the 1920s, we had the 
mortgage guarantee company. I think both of those ended up 
collapsing in a big scandal of fraud and deception and improper 
pricing. And then in the 1920s--I am sorry, in the 2000s, we 
had the private label insurers, which I believe a significant 
number of those now are either already bankrupt or in the 
process of winding down, a lot of trouble.
    So the question I want to ask, if you want us to move 
entirely to a private market, do we have some good examples of 
when the private market has done a good job of insuring 
mortgage pools? And I think I should start with you, Mr. 
Wallison.
    Mr. Wallison. Well, there are a number of things you have 
to look at when you consider this issue, unfortunately, because 
Fannie and Freddie had dominated the----
    Senator Warren. I am sorry. In the 1900s and the 1920s, I 
do not think we had Fannie and Freddie.
    Mr. Wallison. OK. Let me say generally, then, simply that, 
yes, the private market fails from time to time, but the----
    Senator Warren. Did it ever----
    Mr. Wallison. But the taxpayers, if I may continue, do not 
have to bail them out.
    Senator Warren. My question is: Can you give me an example 
of when the private market succeeded in correctly insuring 
mortgage pools and did not end up in collapse when the housing 
market reversed?
    Mr. Wallison. I cannot do that because we have always had 
the same system of Government involvement in the housing 
finance business for the last 40 or 50 years. The problem that 
happened recently, after the 2008 financial crisis, is that, in 
order to provide mortgages for the residential market, these 
mortgage insurance institutions, had to agree to use Fannie and 
Freddie's underwriting standards.
    Senator Warren. Well, Mr. Wallison, we have heard your 
arguments about Fannie and Freddie. That is why I started with 
the examples when there were no Fannie and Freddie. I will just 
stop at the point you are asking us to bet the entire mortgage 
market on a model that has absolutely no proof that it will 
work, that may be a problem. My time is up I see, so I will go 
back to the Chairman.
    Chairman Johnson. Thank you.
    Does Senator Moran have any questions?
    Senator Moran. Mr. Chairman, I have no questions. I do not 
want to delay the hearing, but I do appreciate the hearing 
being held. I think this is an important topic. The three 
witnesses have significant expertise and knowledge. I have read 
their testimony. I apologize for my presence on the Senate 
floor this morning instead of in this hearing room. But I am 
very interested in this topic, and I thank the Chair and the 
Ranking Member for hosting the hearing.
    Chairman Johnson. Good. We will go to a second round, but I 
urge the Members to not use up the 5 minutes.
    Ms. Ratcliffe, when constructing the underwriting standards 
for the new system, is downpayment the strongest indicator of a 
sustainable mortgage?
    Ms. Ratcliffe. I would say no, but I have to underscore 
that it is well known that downpayment does correlate with 
default. What our research shows--and, by the way, our program 
is not--the one we studied is not the only example. There is a 
program in Massachusetts where 15,000 mortgages were made with 
downpayments of 3 percent or less, and they have had default 
rates that have remained below prime mortgage default rates in 
that State.
    We also have the example of the State housing finance 
agencies. We have recently done a survey of the majority of 
those agencies and collected default information on them and 
found that their loans, which are typically low downpayment 
loans to first-time home buyers, have performed quite well in 
the crisis as well.
    So we believe that the risks associated with low 
downpayment lending can be mitigated. Probably the biggest 
mitigant for that risk is to provide a safe product, a 30-year 
fixed-rate mortgage, which has a predictable payment and over 
time builds equity in the home and also, you know, with even 
slight increases in income, the borrower is more and more able 
to--you know, their payment becomes more and more affordable 
over time.
    So having a good product, having it be something that is 
transparent and well understood by the borrower, having it 
underwritten for ability to repay, these things all can 
mitigate for the risk of low downpayment lending.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman. I just have one 
question, and I will ask the witnesses to try to respond 
succinctly. This is a question that could use up my 5 minutes 
in your responses.
    Philosophically, I am predisposed to believe that the 
housing market in the United States can operate without the 
intervention of the Federal Government. Yet I have many people 
who operate in the industry and many experts, like two of you 
on the panel today, who tell me that it cannot, that we cannot 
have a housing market in the United States work effectively 
without that Government guarantee.
    And so my question to each of you is--and I will start with 
you last this time, Mr. Wallison, because you went first last 
time. You will get the last word this time. But my question is: 
Can you tell me succinctly why is it that a housing market in 
the United States cannot work or can work without a Government 
guarantee? Mr. Martinez?
    Mr. Martinez. Senator, I would say if you make the judgment 
that you want a 30-year mortgage, you know, I do not think you 
will find another example of where it can be replicated. And so 
the 30-year mortgage, the necessary length of time for 
investors and so forth to participate in a 30-year mortgage 
dictates that there be a Government guarantor as the ultimate 
backstop, which is why we put them in the last position and 
created some safety between the guarantor and the Government 
position and the credit enhancers and so forth.
    So I will be, you know, as succinct as I----
    Senator Crapo. I know you can talk a long time on this.
    Mr. Martinez. Right, right. I will leave it alone at that 
point, but--and if you consider also that the to-be-announced 
market, and that is an arcane sort of thing, but trust me, it 
is incredibly important for there to be a functioning secondary 
market. And the TBA market will not work without a Government 
guarantee.
    Senator Crapo. Thank you.
    Ms. Ratcliffe?
    Ms. Ratcliffe. Sure. Two points on that.
    We see that there could be a private market, but we believe 
it was be smaller, more volatile, more expensive, and as 
stated, much more likely to be predominantly adjustable rate 
mortgages.
    Another point I want to make is that a lot of times we 
think we are alone in having a Government support of the 
mortgage market, and that is because when you look at a 
mortgage-backed securities market, the U.S. is almost alone in 
having most of its mortgages funded through securitizations. 
But other developed countries across Europe, for example, fund 
their mortgages through deposits, through the banking 
institutions, and some to some degree through covered bonds. 
And those, in fact, enjoy very clear Government guarantees, 
both in some cases explicitly and in other cases implicitly, 
and we saw a lot of those guarantees acted on in 2008 in the 
financial crisis.
    So it is not quite accurate to say that other countries do 
not provide a Government guarantee of their mortgage financing 
market.
    Senator Crapo. Thank you.
    Mr. Wallison?
    Mr. Wallison. I am always amazed to hear people say that we 
need the Government to back a particular market. Our economy 
has worked for years, works today, with the private sector 
financing almost everything else other than housing. And what 
the private sector does finance turns out to be a stable market 
over the long term.
    If we look at what the Government has financed over the 
last few years, since World War II, the S&Ls collapsed, the 
only time we have ever had an entire industry collapse; Fannie 
and Freddie collapsed, and we had a financial crisis, a 
mortgage meltdown. These were all because of the Government's 
involvement.
    Why people believe that housing, of all the activities in 
the U.S. economy, has to be supported by the Government is 
quite beyond me, especially in terms of the record that the 
Government has produced.
    Senator Crapo. Thank you.
    Mr. Martinez. May I just make a very brief comment, which 
is that we do not finance cars for 30 years, and we do not 
finance television sets or credit cards for 30 years. I am sure 
he has a comeback to that.
    Senator Crapo. I will still give him the last word.
    Mr. Martinez. He is much smarter than I am.
    Mr. Wallison. Well, that certainly is not true, but what I 
would like to say is that if you go to Google and you put in 
``30-year fixed-rate mortgage,'' you will find that many 
mortgages are being offered without Government backing. They 
are jumbo mortgages, and if they are jumbo mortgages, they are 
not backed in any way by the Government.
    There is such a thing as a 30-year fixed-rate loan. I found 
one, for example, just recently. Wells Fargo is offering a 30-
year fixed-rate jumbo mortgage for 12 basis points more than 
the Fannie Mae equivalent.
    So it is not true that you cannot have a 30-year fixed-rate 
mortgage without the Government's backing. The 30-year loans 
are made all the time for business. There are hedging 
mechanisms that allow this to be done, and the idea that the 
Government has to be involved is just not accurate.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Warner.
    Senator Warner. Although I would add that those of us who 
are able to qualify for jumbo mortgages is a relatively small 
strip of the housing marketplace. But I do appreciate, Mr. 
Wallison, you are absolutely consistent on all of these issues 
around Government backstops.
    But let me just--I want to ask a question or put out again. 
I think there is a growing sense that we can find some 
commonality on this, that we can put--maybe not to the extent 
of all the panel will agree, but a number of backstops and a 
waterfall of preconditions before you would ever get to some 
kind of Government guarantee. I think we can even price some of 
that at the back end with maybe, again, this idea of this slice 
of a private component that would help be a market signal 
warning.
    One of the areas that could be problematic in trying to get 
to yes for all of us, though, is around this issue--and I think 
Senator Reed raised it and Senator Menendez raised it--around 
affordable housing, how we think about this, where that 
function resides when we think affordable housing, rental 
housing, and other areas, how it is funded. And, again, 
recognizing the Chairman's request we do not want to take too 
long, I will maybe just ask Senator Martinez if you could talk 
for a moment about how you all approached this issue and where 
you deposited that, and how you funded it. I would appreciate 
it.
    Mr. Martinez. Well, affordable rental housing is a very big 
issue, and I think we dealt with that in a very forthright way, 
and I think there are some proposals there. I am not as 
prepared to talk about those as I am on the finance side. But 
suffice it to say that the view of the commission was that 
there had to be mechanisms in place to provide funding for 
affordable rental housing.
    There was some debate on the vehicle, but, you know, the 
idea that the mortgage insurance deduction is a subsidy of 
sorts, and while it is very important, there was a lot of 
debate about whether that should be a function that should not 
only be utilized for supporting home ownership but also for 
rental.
    Senator Warner. And I would only ask that that is an area 
that the more bipartisan consensus you can find from outside 
expertise to see, again, how it would be funded, where it sits, 
how we make sure it is a clearly defined, narrow mission that 
does not get into mission creep in the overall housing finance 
market is I think something that needs some more work.
    Mr. Martinez. And we keep it totally separate. We did not 
have any function along those lines.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. I just have two 
questions, but I will be quick with them.
    The first one is: I just wondered if any of you have dealt 
with or thought about the implications of using data tagging on 
mortgages so that over time we are able to create more robust 
information to develop a better insurance market, regardless of 
whether it is private or has a public backstop. Ms. Ratcliffe?
    Ms. Ratcliffe. Well, we would love that, of course, at the 
university. That would allow us to do more research. But I did 
want to draw your attention to the fact that----
    Senator Warren. That is not a bad thing.
    Ms. Ratcliffe.----the Home Mortgage Disclosure Act 
revisions actually are looking to have more of a mortgage 
identifier that could be linked so that you could find out 
about performance data over time. This is still being worked 
through, but there are some proposals on the table. It is an 
excellent idea.
    Senator Warren. Mr. Wallison?
    Mr. Wallison. No, that is not an issue I have looked at.
    Senator Warren. OK.
    Mr. Martinez. Nor us, no.
    Senator Warren. All right. Good. Thank you. And then just 
one other question. We have seen so much bank consolidation 
over the past several years, and I am particularly concerned 
that whatever reforms we end up doing with the GSEs that it not 
disadvantage the small banks and credit unions in getting 
access to the funds they need so that they can continue to be 
in the home mortgage lending business. And I know you spoke 
somewhat about this, Ms. Ratcliffe, but if I could just have 
each of you with your proposals just give us a very short 
summary of how you would make sure that the smaller financial 
institutions will still have access to the market. Ms. 
Ratcliffe?
    Ms. Ratcliffe. Thank you. As I mentioned specifically, we 
bar the large--any originator from owning, having an ownership 
stake of a CMI except under specialized circumstances like 
maybe some big cooperative type structure. And that would 
prevent the large originating institutions from accumulating 
all that risk on their balance sheets and from sort of using 
their market power to disadvantage and set the terms at which 
small institutions could access the secondary market. We think 
that that could actually have the effect of sort of re-creating 
Fannie- and Freddie-like institutions at the big banks who 
would also then be originators, servicers, and enjoy the 
backstop of the FDIC.
    Senator Warren. I do not want to put too fine a point on 
it, and I know I am trying to be mindful of the time. But what 
you are effectively saying is that the largest financial 
institutions should not be able to aggregate, and that is what 
you will count on to give adequate access to the smaller 
financial institutions so that they are going to have adequate 
funding. You are confident that is going to give them enough 
funding access?
    Ms. Ratcliffe. If the structure does not allow originators 
to operate the credit-loss-taking function, then I believe so, 
yes.
    Senator Warren. OK. Mr. Wallison?
    Mr. Wallison. I think, first of all, you have to start with 
the fact that the real danger to smaller institutions, the 
thing that is driving them out of the mortgage business, is the 
Dodd-Frank Act and the----
    Senator Warren. Mr. Wallison, we----
    Mr. Wallison.----new regulations that have been put upon 
them or will be----
    Senator Warren. Mr. Wallison, we can have that debate, and 
we are going to disagree on that.
    Mr. Wallison. All right. Of course, but----
    Senator Warren. But the question I have----
    Mr. Wallison. Those are costs that they have----
    Senator Warren.----is your proposal----
    Mr. Wallison.----to deal with.
    Senator Warren. Excuse me, Mr. Wallison. Your proposal is 
to let the market take care of it. Is that right? Is there 
anything that assures that there will be access to the credit 
markets for the small financial institutions that do not have 
the same capacity to have securitized pools?
    Mr. Wallison. There is not anything now, but as usual, if 
the Government removes itself from the business, people will 
offer the smaller institutions, which produce very good, high-
quality mortgages, an opportunity to issue their mortgages 
through a securitization----
    Senator Warren. Do you have any evidence that that would 
work?
    Mr. Wallison. You know, if you look at our economy, 
whenever there is an opportunity, a service is provided. If the 
Government is providing it, the private sector can't compete.
    Senator Warren. I will take that as a no.
    Mr. Wallison. That is why you do not see much----
    Senator Warren. Senator?
    Mr. Martinez. Senator, our proposal follows the model of--
recommends a model similar to Ginnie Mae, and Ginnie Mae has 
currently in the area of 350 different issuers, and that is the 
model we would recommend.
    Senator Warren. Good. Thank you, Senator.
    Thank you very much, Mr. Chairman.
    Chairman Johnson. I would like to thank all of the 
witnesses for being here with us today, and I look forward to 
continuing this discussion with my colleagues to build 
bipartisan consensus.
    This hearing is adjourned.
    [Whereupon, at 11:49 a.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
             PREPARED STATEMENT OF SENATOR ROBERT MENENDEZ
Introduction--Welcoming the Panel
    Thank you, Chairman Johnson and Ranking Member Crapo, and thank you 
to our panel of distinguished witnesses who have taken the time to be 
here today. We look forward to hearing their expert testimony and I 
applaud the efforts of this Committee in examining this issue that 
affects Americans every day, no matter their political beliefs.
    We are here today on a very serious matter that goes to the heart 
of our Nation's economic growth engine and that preserves the prospects 
of the American dream found in home ownership; and to our commitment, 
for all families, who were hit hard in the recession. Some of these 
families I would add are still struggling to balance making ends meet 
while continuing to dream of a better tomorrow.
    Mr. Chairman, we have done best as a Nation when we make sure we 
are inclusive, not exclusive. As Americans, we have always believed 
that when our neighbor does well, we do well. With that in mind--I 
think we should be aware today as we hear testimony and consider how to 
move forward, that in our Nation's past, we have already witnessed the 
prospects of a well-capitalized, wholly private housing finance system.
    Within this system, there was little prospect for growth and 
expanded prosperity, little chance for everyday people to not only live 
in America, but own a share of its bounty.
    No Mr. Chairman, it was the involvement of Government in one form 
or another that brought about a more robust housing industry, stability 
and liquidity for investors, and no doubt, this will continue to be the 
case for some time to come. We may surely debate in earnest though, how 
much or how little.
    Mr. Chairman, I again thank you for your leadership and for holding 
this hearing and I look forward to our discussion today in the hope 
that, in the end, we can all work to bridge differences and bring 
stability to our Nation's housing finance system in the 21st century, 
much as the National Housing Act did for millions of Americans in the 
last century.
    Thank you, Mr. Chairman, for your concern and leadership on this 
issue.
                                 ______
                                 
                   PREPARED STATEMENT OF MEL MARTINEZ
        Co-Chair, Bipartisan Policy Center's Housing Commission
                        Tuesday, March 19, 2013
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, thank you for the opportunity to be here today to discuss 
housing finance reform. It is a pleasure to return to the Committee, 
and to see so many good friends and colleagues.
    I serve as one of the four co-chairs of the Bipartisan Policy 
Center's Housing Commission. Founded in 2007 by former Senate Majority 
Leaders Howard Baker, Tom Daschle, Bob Dole, and George Mitchell, the 
BPC is a Washington-based think tank that actively seeks bipartisan 
solutions to some of the most complex policy issues facing our country. 
In addition to housing, the BPC has ongoing projects on health care, 
homeland security, energy, political reform, immigration, and the 
Federal budget.
    The Housing Commission was launched in October 2011 with the 
generous financial support of the John D. and Catherine T. MacArthur 
Foundation. Along with Senator Mitchell, former Senator Kit Bond and 
former HUD Secretary Henry Cisneros have joined me as commission co-
chairs. In total, the commission has 21 members from both political 
parties who bring to the table a wide variety of professional 
experiences.
    Over the past 16 months, the commission engaged in an intensive 
examination of a broad range of issues in housing. We held public 
forums in different parts of the country, convened numerous meetings 
with housing providers and practitioners, consulted with dozens of 
experts, and commissioned several informative research projects that 
are available online at www.bipartisanpolicy.org/housing.
    Late last month, we issued our report, Housing America's Future: 
New Directions for National Policy, that covers topics such as home 
ownership, affordable rental housing, rural housing, and the housing 
needs of our Nation's seniors. Today, I am going to highlight the 
report's key recommendations on housing finance reform.
    Our Nation's system of housing finance is broken. It's been more 
than 4 years since Fannie Mae and Freddie Mac were placed under 
Government conservatorship, yet there is still no clear path forward. 
The commission felt there was an opportunity to fill this policy void 
and offer a blueprint for a new system that can support both the home 
ownership and rental markets of the future.
    1. Recommendations on the Key Objectives of the New System
    The commission reached consensus on five key objectives for this 
new system.
    Our first objective is a far greater role for the private sector in 
bearing credit risk. The dominant position of the Government in the 
market is unsustainable. Yes, private capital is now flowing through 
the system, but it absorbs very little of the system's credit risk. 
Instead, much of that risk lies with the government--nearly 90 percent 
of the single-family home ownership market remains Government 
supported. Reducing the Government footprint and encouraging more 
private participation will protect taxpayers while providing for a 
greater diversity of funding sources.
    The second objective is a continued, but more limited, role for the 
Federal Government as the insurance backstop of last resort. The 
commission recommends the establishment of an explicit, but limited, 
Government guarantee administered by a new entity that we call the 
``Public Guarantor'' to ensure timely payment of principal and interest 
on qualified mortgage-backed securities (``MBS''). There is 
insufficient capacity on bank-balance sheets alone to meet our Nation's 
mortgage finance needs. A strong, vibrant secondary market for these 
securities is essential to freeing up additional capital for mortgage 
lending and connecting our Nation's local housing markets to global 
investors.
    Many investors in the secondary market require a Government 
guarantee protecting against catastrophic credit risk as a condition of 
their investment. These investors are willing to assume the risk of 
interest-rate volatility, but are unwilling to assume the credit risk 
associated with the mortgages that make up a security unless these 
mortgages are of the highest credit quality. In the absence of a 
Government guarantee, investor interest in the secondary market would 
wane, mortgage credit would become more expensive, and widespread 
access to long-term, affordable, fixed-rate mortgage financing would 
likely disappear.
    In our proposal, the Government stands in the ``fourth loss'' 
position behind three layers of private capital: mortgage borrowers and 
their home equity; private credit enhancers, ranging from capital 
market products to highly capitalized mortgage insurers; and the 
corporate resources of the securities' issuers and mortgage 
servicers.\1\ (See Appendix A for an illustration of how the Government 
would stand in the ``fourth loss'' position under our proposal.) These 
private companies would be subject to stringent capital requirements 
that would enable them to weather losses similar in magnitude to those 
experienced during the Great Recession.
---------------------------------------------------------------------------
    \1\ Under the Commission's proposal, the issuer and mortgage 
servicer do not bear direct credit risk. That risk is borne by the 
private credit enhancer. However, the issuer and the servicer do bear 
other risks that help to shield the Government from loss. The issuer is 
responsible for the representations and warranties associated with the 
mortgage, and the servicer is responsible for the timely payment of 
principal and interest to investors out of corporate resources (as is 
currently the case with Ginnie Mae), although the servicer should 
eventually be reimbursed for this payment by the private credit 
enhancer.
---------------------------------------------------------------------------
    The limited Government guarantee would kick in only after the 
private credit enhancers standing ahead of it had depleted all of their 
resources. Even then, these losses would be paid for through a fully 
funded catastrophic risk fund capitalized through the collection over 
time of insurance premiums, or guarantee fees, from mortgage borrowers. 
In many respects, this model is similar to that of Ginnie Mae.
    The third objective is the ultimate elimination of Fannie Mae and 
Freddie Mac over a transition period--perhaps 5 to 10 years. Like other 
observers, the commission believes the business model of the two 
Government-sponsored enterprises--publicly traded companies with 
implied Government guarantees and other advantages--should not be 
reproduced.
    The commission recognizes that a dynamic and flexible transition 
period will be necessary before the new, redesigned housing finance 
system is fully functioning. During this period of transition, it will 
be critical to avoid market disruption and to adjust course, when 
necessary, in response to shifts in the market and other critical 
events. The goal should be transition, not turbulence.
    As first steps toward the new system, we support the continuation 
of current efforts to reduce the Government footprint through reduced 
GSE loan limits and sale of the GSE portfolios. We also believe the GSE 
guarantee-fee pricing structure should move closer to what one might 
find if private capital were at risk.
    The transition to the new system could be facilitated by continued 
use of existing capabilities at Fannie Mae and Freddie Mac. They have 
skilled staff, established processes, and state-of-the-art technologies 
that could and should be tapped. We can also build on the good work of 
the Federal Housing Finance Agency (``FHFA'') in laying out a plan for 
a single securitization platform and developing a model pooling and 
servicing agreement.
    The fourth objective is ensuring access to safe and affordable 
mortgages for all borrowers. This is a core principle for the 
commission--the housing finance system of the future must be one from 
which all Americans can benefit on equal terms. The commission also 
believes that access to the Government-guaranteed secondary market must 
be open on full and equal terms to lenders of all types, including 
community banks and credit unions, and in all geographic areas. Again, 
Ginnie Mae's success in empowering smaller institutions to participate 
in its programs is instructive here.
    And, finally, our fifth objective is for the Federal Housing 
Administration (``FHA'') to return to its traditional mission of 
primarily serving first-time home buyers and borrowers with limited 
savings for downpayments. The recent concerns over the solvency of 
FHA's single-family insurance fund only underscore the urgency of what 
the commission has proposed--that far more risk-bearing private capital 
must flow into our Nation's housing finance system. A system in which 
private capital is plentiful will reduce the pressure that is sometimes 
placed on the FHA to act as the mortgage-credit provider of last resort 
and allow it to perform its traditional missions more effectively.
    Our proposals for reforming the rental, or multifamily, housing 
finance system are rooted in the same principles as single-family 
reform: the gradual wind down of the GSEs; a greater role for at-risk 
private capital; a continued Government presence through a limited 
``catastrophic'' guarantee; and reform of FHA to improve administrative 
efficiency and avoid crowd-out of the private market.
    In addition, an ``affordability'' requirement for issuers of 
securities will ensure that the system primarily supports rental 
housing affordable to low- and moderate-income households.
    2. The Actors in the New System
    The commission's report goes into considerable detail about the 
individual components of the housing finance system we envision. It 
describes the structure and responsibilities of the Public Guarantor 
that will administer the limited catastrophic backstop. And it outlines 
the roles of the other actors in this new system--the originators, 
mortgage servicers, issuers of securities, and the private entities 
that will ``credit enhance'' these securities. Let me now take a moment 
to briefly describe the responsibilities of these actors in the new 
system we propose. More detail can be found in the commission's report.

    a.  Securitization-Approved Issuers

    As noted above, the commission recommends a model similar to Ginnie 
Mae, where approved lenders are the issuers of mortgage-backed 
securities. The functions of an issuer of securities include:

    Obtain certification from the Public Guarantor that it is 
        qualified to issue MBS based on such factors as (i) ability to 
        meet credit and capital standards and cover all of the 
        predominant loss risk through a separate well-capitalized 
        credit enhancer, and (ii) capacity to effectively pool 
        mortgages.

    Ensure that the guarantee fee is paid for and collected 
        from the borrower along with all other fees and fully disclosed 
        to the borrower as a part of originating the mortgage.

    Issue the mortgage-backed securities and, where 
        appropriate, sell the MBS to investors through the To-Be-
        Announced (``TBA'') market.\2\
---------------------------------------------------------------------------
    \2\ The TBA market was established in the 1970s with the creation 
of pass-through securities at Ginnie Mae. It facilitates the forward 
trading of MBS issued by Ginnie Mae, Fannie Mae, and Freddie Mac by 
creating parameters under which mortgage pools can be considered 
fungible. On the trade date, only six criteria are agreed upon for the 
security or securities that are to be delivered: issuer, maturity, 
coupon, face value, price, and the settlement date. Investors can 
commit to buy MBS in advance because they know the general parameters 
of the mortgage pool, allowing lenders to sell their loan production on 
a forward basis, hedge interest rate risk inherent in mortgage lending, 
and lock in rates for borrowers. The TBA market is the most liquid, and 
consequently the most important, secondary market for mortgage loans, 
enabling buyers and sellers to trade large blocks of securities in a 
short time period.

    Retain responsibility for representations and warranties 
---------------------------------------------------------------------------
        under the terms specified by the Public Guarantor.

    b.  Servicing

    Under our proposal, servicers would need to be qualified by the 
Public Guarantor. Responsibilities of a servicer include:

    Make timely payment of principal and interest should the 
        borrower be unable to do so. The servicer will advance the 
        timely payment of principal and interest out of its own 
        corporate funds and will be reimbursed by the private credit 
        enhancer at the time the amount of the loan loss is 
        established.

    Work with the borrower on issues related to delinquency, 
        default, and foreclosure and advance all funds required to 
        properly service the loan.

    c.  Credit Enhancement

    The commission's proposed single-family housing finance system 
depends on credible assurance that private institutions will bear the 
predominant loss credit risk, will be capitalized to withstand 
significant losses, and will provide credit that is generally 
unrestricted with little leverage. As such, private credit enhancers 
will bear the risk on the mortgages they have guaranteed until they go 
out of business or have met their full obligation, as defined by the 
Public Guarantor, to stand behind their guarantee. Private credit 
enhancers will generally be single-business, monoline companies and 
will be required to:

    Provide regular reports to the Public Guarantor on the 
        nature of the credit enhancement, who holds the risk, the 
        amount and nature of the capital they hold, and other measures 
        of credit strength. These measures would include a quarterly 
        stress test to determine that available capital is adequate, 
        with a ``capital call'' to assure there are sufficient reserves 
        to protect the Government guarantee from being tapped except in 
        extreme cases.

    Establish underwriting criteria for the mortgages and 
        mortgage pools they will be guaranteeing beyond the baseline 
        underwriting criteria established by the Public Guarantor.

    Reimburse servicers for their timely payment of principal 
        and interest and other costs at the time the amount of the loan 
        loss is established. This reimbursement is paid out on a loan-
        by-loan basis until the private credit enhancer runs out of 
        capital and goes out of business.

    Establish and enforce servicing standards (in conjunction 
        with national servicing standards) in order to ensure that the 
        interests of the private credit enhancer and servicer are fully 
        aligned.

    Provide credit enhancement with standard, transparent, and 
        consistent pricing to issuers of all types and sizes, including 
        community banks, independent mortgage bankers, housing finance 
        agencies, credit unions, and community development financial 
        institutions.

    Meet credit enhancement requirements through one or a 
        combination of the following options: (1) well-capitalized 
        private mortgage insurance at the loan level for any portion of 
        the loan where specific capital requirements are established 
        and the servicer and/or Public Guarantor has the ability to 
        demand margin calls to increase capital if there is an adverse 
        move in house prices; (2) capital market mechanisms where the 
        amount of capital required to withstand severe losses is 
        reserved up front, either through a senior/subordinated debt 
        model with the subordinated piece sized to cover the 
        predominant risk or approved derivatives models using either 
        margined Credit Default Swaps or fully funded Credit Linked 
        Notes; and (3) an approved premium-funded reserve model, where 
        a premium-funded reserve is established, either fully 
        capitalized at the outset or where the reserve builds over 
        time.

    These approaches to meet capital requirements are designed to 
ensure that private capital will stand ahead of any Government 
guarantee for catastrophic risk. The Public Guarantor will establish 
the minimum capital levels required to survive a major drop in house 
values and will require any private credit enhancer to have sufficient 
capital to survive a stress test no less severe than the recent 
downturn (e.g., a home price decline of 30 to 35 percent, which would 
correspond to aggregate credit losses of 4 to 5 percent on prime 
loans).

    d.  Government Guarantee for Catastrophic Risk

    Under the commission's proposal, the Public Guarantor would 
guarantee the timely payment of principal and interest on the MBS, but 
this guarantee would be triggered only after all private capital in 
front of the guarantee has been expended. The guarantee would be 
explicit, fully funded, and actuarially sound, and the risk would apply 
only to the MBS and not to the equity and debt of the entities that 
issue and/or insure the MBS. Other functions of the Public Guarantor 
would include:

    Establish the level of capital necessary to ensure that 
        private-sector participants in the housing finance system 
        (issuers, servicers, and private credit enhancers) are all 
        properly capitalized.

    Establish the guarantee fees to be collected from the 
        borrower to cover the operating costs of the Public Guarantor 
        and to offset catastrophic losses in the event of a failure of 
        the private credit enhancer and/or servicer failure. For both 
        the single-family and rental housing markets, a reserve fund 
        would be established for catastrophic risk that will build over 
        time.

    Ensure the actuarial soundness of the funds through careful 
        analysis and the use of outside expertise, and report to 
        Congress regularly regarding their financial condition.

    Ensure access to the Government-guaranteed secondary market 
        on full and equal terms to lenders of all types, including 
        community banks, independent mortgage bankers, housing finance 
        agencies, credit unions, and community development financial 
        institutions. The Public Guarantor must ensure that issuers of 
        securities do not create barriers using differential guarantee-
        fee pricing or other means to unfairly restrict or disadvantage 
        participation in the Government-guaranteed secondary market.

    Provide one common shelf for the sale of Government-
        guaranteed securities to offer greater liquidity for the market 
        as well as establish an equal playing field for large and small 
        lenders.

    Establish a single platform for the issuing, trading, and 
        tracking of MBS. With multiple private issuers, this platform 
        could provide greater uniformity and transparency, and 
        therefore lead to greater liquidity.

    Create and enforce uniform pooling and servicing standards 
        governing the distribution of mortgage proceeds and losses to 
        investors and ensuring compliance with relevant Federal tax 
        laws.

    Encourage loan modifications when a modification is 
        expected to result in the lowest claims payment on a net 
        present value basis. The Public Guarantor should require 
        participants in the new Government-guaranteed system to 
        structure and service securities in a way that would facilitate 
        such loan modifications.

    Qualify private institutions to serve as issuers of 
        securities, servicers, and private credit enhancers of MBS. The 
        Public Guarantor will also have the power to disqualify an 
        issuer, servicer, or a private credit enhancer if it determines 
        that requirements and standards are not met.

    Establish loan limits, under the direction of Congress, so 
        that the loans backing the Government-guaranteed MBS will be 
        limited based on the size of the mortgage and any other 
        criteria Congress may prescribe.

    Set standards for the mortgages that will be included in 
        the MBS, including baseline underwriting criteria, permissible 
        uses of risk-based pricing, and clear rules of the road related 
        to representations and warranties.

    Specify standards for mortgage data and disclosures.

    For a graphic illustration of how the new system proposed by the 
commission would work, see Appendix B.
    The commission envisions the establishment of a single Public 
Guarantor with responsibility for both the single-family and rental 
housing markets. The Public Guarantor would consist of two separate 
divisions each with responsibility for administering its own separate 
catastrophic risk fund. Each division would also establish its own 
approval standards for lenders, issuers, servicers, and private credit 
enhancers as well as underwriting standards, predominant loss coverage 
requirements, and catastrophic guarantee fees.
    In the commission's view, the Public Guarantor should be 
established as an independent, wholly owned Government corporation. As 
a Government corporation, the Public Guarantor will be a self-
supporting institution that does not rely on Federal appropriations but 
rather finances the two catastrophic funds and its own operational 
expenses through the collection of guarantee fees. The Public Guarantor 
should operate independently of any existing Federal department and, 
with this greater independence, should be able to respond more quickly 
to contingencies in the market and operate with greater efficiency in 
making staffing, budgeting, procurement, policy, and other decisions 
related to mission performance.
    The commission recommends that the Public Guarantor be led by a 
single individual, appointed by the President of the United States and 
confirmed by the U.S. Senate, who would serve a director. The 
commission also recommends the establishment of an Advisory Council to 
the Public Guarantor consisting of the chairman of the Board of 
Governors of the Federal Reserve System as chairman of the Council, 
along with the director of the Public Guarantor, the secretary of the 
U.S. Department of the Treasury, and the secretary of the U.S. 
Department of Housing and Urban Development. The Advisory Council would 
meet on at least a quarterly basis to share information about the 
condition of the national economy, marketplace developments and 
innovations, and potential risk to the safety and soundness of the 
Nation's housing finance system.
    3. Potential Impact on Mortgage Rates
    While the new housing finance system proposed by the commission 
will minimize taxpayer risk, this protection will come at the cost of 
higher mortgage rates for borrowers. Three factors will contribute to 
the added costs:
    First, our proposal calls for a far greater role for the private 
sector in mortgage finance, with private capital taking the predominant 
loss risk and standing ahead of a limited Government guarantee. Private 
credit enhancers will charge a fee to cover the cost of private capital 
to insure against the predominant loss if a mortgage default occurs.
    Second, the Public Guarantor will charge an unsubsidized fee to 
cover catastrophic risk should a private credit enhancer be unable to 
fulfill its obligations to investors.
    Third, the Public Guarantor will be structured as an independent, 
self-supporting Government corporation that finances its activities 
through an operating fee.
    The borrower will indirectly pay for all three of these activities 
through a guarantee fee that is included in the mortgage rate.
    Analysis by Andrew Davidson & Co., Inc., using two research methods 
and a pool of nearly 5,000 conforming loans originated in 2012, 
provides a range of estimates of the possible costs of the commission's 
recommendations. Utilizing this pool of loans, Davidson & Co. estimates 
the guarantee fees paid by a borrower with no mortgage insurance will 
range from 59 to 81 basis points.\3\ By comparison, the guarantee fees 
for mortgages now supported by Fannie Mae and Freddie Mac are currently 
in the range of 50 basis points (including a 10 basis point charge paid 
to the U.S. Treasury to finance the payroll tax deduction). Some of 
these mortgages with higher loan-to-value ratios are also supported by 
private mortgage insurance.
---------------------------------------------------------------------------
    \3\ Andrew Davidson & Co., Inc., has prepared a working paper on 
this topic that provides the details of their analysis. See Modeling 
the Impact of Housing Finance Reform on Mortgage Rates found on the BPC 
Housing Commission Web site at www.bipartisanpolicy.org/housing.
---------------------------------------------------------------------------
    4. A Path Forward
    The commission has proposed a plan to substantially reduce 
Government intervention in the housing market and protect the 
taxpayers, while ensuring the broad availability of affordable mortgage 
credit. I believe it strikes the right balance among competing policy 
goals, and deserves your consideration.
    The commission recognizes there may be sound alternative approaches 
to achieving the same objectives, but the key to success is first 
achieving bipartisan consensus on what these objectives are. It is our 
hope that the commission's recommendations--the product of extensive 
deliberations and enjoying the broad bipartisan support of its 21 
members--will offer a viable way forward and serve as a catalyst for 
action.
    As Members of the Committee know, the Federal Housing Finance 
Agency--under the able leadership of Acting Director Ed DeMarco--is 
engaged in an effort to prepare Fannie Mae and Freddie Mac for a post-
conservatorship world. Without clear policy direction from Congress and 
the Administration, one possible and undesirable outcome of this effort 
is that the two institutions could become permanent wards of the State. 
Ironically, those who unrelentingly pursue a pre-Depression vision of a 
purely private mortgage market may end up hastening this outcome and 
strengthening the Government-dominated status quo. The idea of removing 
the Federal Government entirely from the housing market is not only bad 
policy; it is also unrealistic and politically unachievable. The goal 
should be to limit Government involvement and taxpayer exposure to the 
greatest extent possible, while ensuring that the system has sufficient 
liquidity to meet the mortgage needs of the American people.
    5. Short-Term Obstacles to Market Recovery
    As a final note, the commission has identified several factors that 
continue to stall a housing recovery in the immediate term. These 
factors are:

    Overly strict lending standards, which now go well beyond 
        those in place before the housing bubble;

    Lack of access to credit for well-qualified self-employed 
        individuals;

    Put-back risk--that is, the risk that lenders will be 
        required to buy back a delinquent loan from Fannie Mae, Freddie 
        Mac, or FHA;

    Ongoing issues with appraisals, including calls for 
        multiple reappraisals sometimes just days before closing that 
        can derail home sales;

    Application of FHA compare ratios; and

    Uncertainty related to pending regulations and 
        implementation of new rules.

    While not our primary focus, we believe these issues must be 
resolved before the housing market can fully recover.
    Thank you for your attention. I look forward to your questions.
    
    
    
    
                PREPARED STATEMENT OF PETER J. WALLISON
           Arthur F. Burns Fellow in Financial Policy Studies
                    American Enterprise Institute *
                        Tuesday, March 19, 2013
    Thank you for the invitation to testify before the Committee today, 
and to discuss the future of the U.S. housing finance system.
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     * The views expressed are those of the author alone and do not 
necessarily represent those of the American Enterprise Institute.
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    Many have pointed out that the Dodd-Frank Act ignored the 
fundamental causes of the financial crisis it was supposed to address. 
They note that the act imposed new, costly and growth inhibiting 
regulations on the entire financial system, but it failed to reform the 
U.S. Government's housing policies. These fostered the creation of 28 
million subprime and otherwise weak loans by 2008 and the development 
of a massive housing bubble between 1997and 2007. When the bubble began 
to deflate, weak and high risk loans began to default in unprecedented 
numbers, driving down housing values and weakening financial 
institutions in the U.S. and around the world.
    In this testimony, I will outline the major provisions of a 
proposal for housing finance reform that I and two AEI colleagues, Alex 
Pollock and Edward Pinto, developed in response to a white paper issued 
by the Obama administration in February 2011. Although no specific 
action was ever proposed by the Administration, the Administration 
white paper advanced three options for housing finance reform. One of 
those options was what I would call a completely free market system. 
The proposal I will describe today was embodied in a much longer paper, 
entitled ``Taking the Government Out of Housing Finance: Principles for 
Reforming the Housing Finance Market,'' that we issued in March 2011. 
That paper was intended to fill out the free market option that the 
Administration had proposed and respond to questions raised in its 
white paper. I respectfully request that the complete proposal I will 
summarize today be included with the records of this hearing.
    Our proposal is based on four principles that we believe should be 
the foundation of U.S. housing policy in the future. If these 
principles had been in place for the last 20 years, we would not have 
had a financial crisis in 2008. But that is water over the dam. We must 
now concentrate on reforming the U.S. housing finance system so that we 
do not face another housing-induced crisis in the future.
    The four principles are the following:
I. The housing finance market--like other U.S. industries and housing 
        finance systems in most other developed countries--can and 
        should function without any direct Government financial 
        support.
    Under this principle, we note that the huge losses associated with 
the S&Ls and Fannie and Freddie--as well as the repetitive volatility 
of the housing business--did not come about in spite of Government 
support for housing finance but because of Government backing. 
Government involvement not only creates moral hazard but sets in motion 
political pressures for further and more destructive actions to bring 
benefits such as ``affordable housing'' to constituent groups.
    Although many new ideas for Government involvement in housing 
finance are being circulated in Washington, they are not fundamentally 
different from the policies that have caused the losses already 
suffered by the taxpayers, as well as the losses still to be recognized 
through Fannie and Freddie.
    The fundamental flaw in all these ideas is that the Government can 
establish a risk-based price for its guarantees or other support. Many 
examples show that this is beyond the capacity of Government, and is in 
any case politically infeasible. The problem is not solved by limiting 
the Government's risks to mortgage-backed securities (MBS); the fact of 
the Government's guarantee eliminates an essential element of market 
discipline in this case--investors' risk-aversion--so that the outcome 
will be the same: underwriting standards will deteriorate, regulation 
of issuers will fail, and taxpayers will take losses once again.
II. To the extent that regulation is necessary, it should be focused on 
        assuring mortgage quality.
    This principle is based on the idea that high quality mortgages are 
good investments and have a history of minimal losses. Instead of 
relying on a Government guarantee to assure investors as to the quality 
of mortgages or MBS, we should simply make sure that the mortgages made 
in the U.S. are predominantly prime mortgages. We know what is 
necessary to produce a prime mortgage; these are outlined in our 
proposal. Before the affordable housing requirements were imposed on 
Fannie and Freddie in 1992, these were the standards that kept losses 
in the mortgage markets at minimal levels.
    Experience has shown that some regulation of credit quality is 
necessary to prevent the deterioration in underwriting standards. The 
natural human tendency to believe that good times will continue--and 
``this time is different''--will always spawn bubbles in housing as in 
other assets. Bubbles in turn spawn subprime and other risky lending, 
as most participants in the housing market come to believe that housing 
prices will continue to rise, making good loans out of weak ones. 
Bubbles and the losses suffered when they deflate can be minimized by 
interrupting this process--by inhibiting through appropriate regulation 
the creation of weak and risky mortgages.
III. All programs for assisting low-income families to become 
        homeowners should be on-budget and should limit risks to both 
        homeowners and taxpayers.
    Our proposal recognizes that there is an important place for social 
policies that assist low-income families to become homeowners. But 
these policies must balance the interest in low-income lending against 
the risks to borrowers themselves and the interests of the taxpayers. 
In the past, affordable housing and similar policies have sought to 
produce certain outcomes--for example, an increase in home ownership--
without concern for how this goal would be achieved. The quality of the 
mortgages made under social policies can be lower than prime quality--
the taxpayers may take risks for the purpose of attaining some social 
goods--but there must be limits placed on riskier lending in order to 
keep taxpayer losses within boundaries set by Congress and included in 
the budget.
IV. Fannie Mae and Freddie Mac should be eliminated as GSEs over time.
    Finally, Fannie and Freddie should be eliminated as GSEs and 
privatized--but gradually, so that the private sector can take on more 
and more of the secondary market as the GSEs depart. The gradual 
withdrawal of the GSEs from the housing finance market should be 
accomplished by reducing the GSEs' conforming loan limits by 20 percent 
each year, according to a published schedule embodied in statute so 
that the private sector knows what to expect. These reductions would 
apply to the conforming loans limits for both regular and the high cost 
areas. Banks, S&Ls, insurance companies, pension funds and other 
portfolio lenders will be supplemented by private securitization, but 
Congress should make sure that it doesn't foreclose opportunities for 
other systems, such as covered bonds.
    These principles are the underpinning of a plan that assumes that 
housing, like virtually every other sector of the U.S. economy, can and 
should be privately financed, and that the private market will produce 
a low-cost and stable system for financing homes.
    In the white paper it released in February 2011, the Obama 
administration recognized the advantages for the economy and the 
taxpayers inherent in a free market housing finance system:

        The strength of this option is that it would minimize 
        distortions in capital allocation across sectors, reduce moral 
        hazard in mortgage lending and drastically reduce direct 
        taxpayer exposure to private lenders' losses. With less 
        incentive to invest in housing, more capital will flow into 
        other areas of the economy, potentially leading to more long-
        run economic growth and reducing the inflationary pressure on 
        housing assets. Risk throughout the system may also be reduced, 
        as private actors will not be as inclined to take on excessive 
        risk without the assurance of a Government guarantee behind 
        them.\1\
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    \1\ Departments of Treasury and HUD, Reforming America's Housing 
Finance Market, 27.

I can't improve upon this statement, especially when we consider the 
consistent failure of all Government-based efforts to assist home 
ownership. In the post-war period, despite all the changes in the U.S. 
economy, there have been only two instances in which an entire industry 
has collapsed, with terrible consequences for the economy and the 
American people as homeowners and taxpayers. These disasters--the 
collapse of the S&Ls in the late 1980s and the insolvency of Fannie and 
Freddie about 20 years later--were the result of Government policies 
established for the purpose of helping Americans buy homes.
    We could do it again. There are now many groups suggesting 
imaginative ways to get the Government back into the housing business 
while avoiding, they claim, the mistakes of the past. These are 
illusions; the Government's involvement in the housing finance business 
will always result in losses because it distorts incentives and creates 
moral hazard.
    The disaster of Fannie and Freddie is a case in point. The two 
GSEs, for good reason, were widely believed to enjoy the backing of the 
Federal Government. This was denied repeatedly by the Government, but 
in the end--when they became insolvent--the markets were correct that 
the Government would rescue them. Proponents of Government involvement 
have now turned this into a general principle that the Government will 
always step in to rescue the housing market--thus creating a reason for 
the Government to be there from the beginning.
    Because Fannie and Freddie enjoyed the implicit backing of the 
Government, they had access to funds at rates that were only slightly 
more than Treasury's. This enabled them to dominate the housing finance 
market and provide substantial profits to their shareholders and large 
compensation packages for their officials. Moreover, and most 
important, because of their Government backing no one cared about the 
risks they were taking. This was moral hazard, and it is moral hazard 
that is the unavoidable accompaniment to every Government program that 
attempts to assist the housing system.
    The fact that the GSEs could use their Government support to 
produce slightly lower rates for middle class home buyers made them a 
target for the supporters of other groups, both inside and outside 
Congress. In 1992, under pressure from community activists, Congress 
passed legislation that was intended to extend the GSEs' largesse to 
low-income borrowers, and in the 2000s--under pressure from lawmakers 
who represented well-to-do districts-these benefits were also extended 
to high income groups. This is the way the Government works in a 
democracy. It cannot be otherwise. Whatever benefits the Government 
provides to some groups will eventually be extended to others. This is 
one of the reasons that the Government should be kept out of the 
housing finance business. Even if a program is started on a reasonable 
basis, it is inevitably expanded and its costs and subsidies increased 
until it causes huge losses for the taxpayers and sometimes outcomes 
that are even worse.
    The affordable housing goals are a particularly good example. 
Enacted in 1992, they originally required that at least 30 percent of 
the mortgages Fannie and Freddie bought had to be made to borrowers at 
or below the median income where they lived. But this modest 
requirement, that was probably easy to meet, was extended and tightened 
by HUD over succeeding years, so that by 2000 the Clinton 
administration adopted a 50 percent goal and the Bush administration 
pushed this requirement to 55 percent.
    In order to meet these quotas, the GSEs had to abandon their 
traditional focus on prime mortgages and substantially loosen their 
underwriting standards. The rest is history, as they say. By 1995 they 
were buying mortgages with 3 percent downpayments, and by 2000 they 
were accepting mortgages with no downpayment at all. So by 2008, these 
two firms, with gold-plated franchises and the ability to dominate the 
largest market in the United States, became insolvent, requiring the 
taxpayers, thus far, to keep them operating with more than $180 billion 
in financial support.
    This or something like it will happen every time we put the 
Government into the housing finance business. As too many people have 
already said, too many times, it is a sign of insanity to do the same 
thing over and over while expecting a different result.
How a private housing finance system would work
    How, then, would a private system work? Our proposal is based on 
the simple idea that the housing finance market will operate steadily 
and stably if a high preponderance of the mortgages it processes 
through securitization are prime loans.
    To achieve this will require a degree of regulation. That may come 
as a surprise to some who regard me and my AEI colleagues as ``free 
market ideologues,'' but in fact all believers in the superiority of 
free markets realize that regulation is necessary and appropriate in 
cases of market failure.
    We believe that the growth of housing bubbles, a natural phenomenon 
in free markets, is an example of market failure. Human beings simply 
cannot avoid the idea that this time it's different--that the 
unprecedented growth they see around them is not a bubble but the 
reflection of a real change in how the world works. So they continue to 
buy until the bubble collapses.
    That is not terribly harmful in commodity markets; the players 
there can generally take their losses. But in the housing market, as we 
have seen since the collapse of the giant bubble that developed between 
1997 and 2007, the development and ultimate collapse of a bubble can be 
very destructive.
    The reason such a large bubble developed is that housing bubbles 
tend to suppress delinquencies and defaults. As long as housing prices 
are rising, people who are in danger of default can refinance or sell 
the home for more than the amount of the mortgage. As weaker and weaker 
mortgages do not seem to be producing more delinquencies and defaults, 
lenders go further and further out on the risk curve and investors in 
MBS do not get the signals that should tell them their risks are 
increasing. The way to stop this from happening is to assure to the 
extent possible that only prime loans are securitized.
    Our proposal, accordingly, would require that only prime mortgages 
be permitted into the securitization system. Subprime mortgages could 
be made, of course, but these would have to be held on private balance 
sheets and not securitized. Subprime lending can be a good business for 
people who understand the risks.
    This is the only regulation we propose, but we believe it will be 
the foundation of a stable mortgage system if Congress can restrain 
itself from loosening underwriting standards again. Before the advent 
of the affordable housing goals, when Fannie and Freddie would only buy 
prime mortgages, the housing finance system was stable over all. Local 
bubbles developed, but could not grow to national proportions because 
the market for subprime loans was small without the GSEs' support. We 
believe a market like that can be recreated through regulation that 
assures only prime mortgages are securitized.
    Let's be clear where the problem lies. Community activists, 
realtors and homebuilders want loose underwriting standards. Loose 
standards mean more people can buy homes, but none of these groups 
suffer the losses when the market collapses as it did in 2008. Who is 
visiting congressional offices asking for tighter mortgage underwriting 
standards? The answer is no one. Those who suffer are the taxpayers and 
the families that bought homes they couldn't afford.
    The recent announcement of the Qualified Mortgage rule reflects an 
acceptance of the idea that the Government--which will accede to the 
wishes of the Housing Industrial Complex--will loosen underwriting 
standards. Under the rule, once a lender determines that a borrower can 
afford the mortgage, there is no need to impose any requirement for a 
downpayment or a good credit history. All that is required is to obtain 
the approval of the GSEs or FHA and the mortgage can be considered a 
prime loan. That puts the whole question of mortgage quality back in 
the hands of the Government, which has shown that it will worry more 
about increasing the availability of mortgage credit than creating a 
stable housing finance market.
    Reasonable underwriting standards will not limit the availability 
of mortgage credit for those who can afford to carry the cost of a 
home. When Fannie and Freddie were establishing the standards for prime 
loans, and accepting only prime loans, the homeownership rate in the 
United States was 64 percent. In 1991, the great majority of 
conventional loans (defined as being Fannie eligible, other than by 
loan size) had the following characteristics:\2\
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    \2\ Data from Fannie Mae's random--sample review covering single-
family acquisitions for the period October 1988-January 1992, dated 
March 10, 1992.

    98 percent were loans on properties occupied as a primary 
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        or secondary residence.

    94 percent were loans with a loan-to-value ratio (LTV) of 
        90 percent or less.

    98 percent were to borrowers with one or no mortgage late 
        payments at origination and 85 percent had two or fewer 
        nonmortgage late payments at origination.

    90 percent were loans with housing and total debt-to-income 
        ratios of less than 33 percent and 38 percent, respectively.

    All loans had to be underwritten based upon verified 
        income, assets, and credit.\3\
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    \3\Fannie stopped acquiring low-doc or no-doc loans in 1990. 
Freddie followed suit in 1991. See ``Haste Makes . . . Quick Home Loans 
Have Quickly Become Another Banking Mess,'' Wall Street Journal, July 
5, 1991.

This was not, however, what the mortgage market looked like in 2008 
after the effect of the affordable housing goals. Then, half of all 
mortgages--28 million loans--were subprime or otherwise weak because of 
low downpayments or other deficiencies. By 2008, the homeownership rate 
was almost 70 percent, but we paid a terrible price--a financial 
crisis--for adding that additional 5 percent to the home ownership 
totals.
Where would financing come from?
    The next issue is who will buy mortgages and MBS that are not 
Government guaranteed. One of the most common objections to a fully 
private housing finance system is that the customary buyers of GSE MBS 
will not accept the risk of MBS that are not Government-backed. That 
may be true, but the customary buyers of Government-backed MBS are not 
the only possible buyers. As discussed more fully at the end of this 
testimony, where I deal with all the traditional objections to a 
private financing system, the natural buyers of private MBS will be 
insurance companies, private pension funds and mutual funds, all of 
which are looking for long-term investments to match their long-term 
liabilities.
    According to the Fed's Flow of Funds data, these investors--which 
collectively have about $21.5 trillion to invest--do not buy any 
significant amount of GSE or Ginnie MBS today. The reason is that these 
investors get paid for taking credit risk, and in the case of Ginnie 
and GSE MBS the risks have already been taken--by the taxpayers. As a 
result, the yields on these securities are simply not large enough to 
pay for their long-term liabilities. Instead, today, they are buying 
low quality corporate debt, which is risky but pays well.
    If there were a steady flow of MBS based on prime mortgages, these 
financial institutions would be avid buyers as long as they can be 
assured of the quality of the underlying loans.
    That assurance, under our proposal, would be provided by mortgage 
insurance (MI), which places the insurer's capital ahead of the 
investor's. We believe that the MI industry can be resuscitated into a 
viable system for providing assurance to institutional and other buyers 
of MBS. Recently, several new MI companies have been formed and 
capitalized, and legacy carriers have raised substantial additional 
capital, showing that investors believe that mortgage insurance has a 
future in the housing finance business once the GSEs are wound down and 
FHA limited to low-income first-time home buyers.
    Mortgage insurers do credit underwriting and place their capital at 
risk when they write their policies. This will provide assurance to 
institutional investors and others that the risks of buying private MBS 
have been assessed and covered by independent capital. We suggest that 
mortgage insurance provide coverage of mortgage defaults down to 60 
LTV. Below that level, experience suggests that the losses are so few 
that credit enhancement is not necessary.
    In discussions with mortgage insurers, we were advised that the 
combined cost of MI for the coverage of prime mortgages included in any 
privately securitized pool would permit private MBS to fund a freely 
prepayable 30-year fixed-rate prime loan with an all-in annual cost 
about 20 basis points higher than Fannie's cost for the same loan. This 
of course assumes a normal market, not one in which the Fed is buying 
GSE MBS. If the Administration continues to increase the GSEs' 
guarantee fees in order to provide more protection for the taxpayers, 
and a normal market returns, that difference could narrow 
significantly.
    Accordingly, a private system of housing finance would operate at 
close to the cost of the current Government-dominated system, without 
involving the risk that the taxpayers will eventually have to come to 
the rescue.
Small lenders and community banks.
    The Government's involvement in the housing finance market through 
Fannie and Freddie distorted the market's structure. Because the GSEs 
were able to bid more for mortgages than any competitors, they drove 
competitors from the secondary mortgage market and created a duopsony 
(a market with only two buyers). They were then able to discriminate 
among their suppliers, providing better returns to those, such as 
Countrywide,\4\ who provided the mortgages that they wanted, and 
penalizing those--primarily the small banks and S&Ls--that were unable 
to compete in the volume they could supply. Congress has now banned 
this behavior, but through the Dodd-Frank Act and the Consumer 
Financial Protection Bureau has now created more obstacles for 
community banks to overcome.
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    \4\ ``Mortgage Bankers Association chief economist Jay Brinkmann 
said the pricing strategies that Fannie and Freddie pursued contributed 
to the concentration of mortgage lending within the largest banks. The 
GSEs offered reduced `guarantee fees' for their largest customers, 
which placed smaller lenders at a competitive `disadvantage,' he told 
the NABE annual conference.'' See ``NY Fed Thinks Megabanks May Be the 
New GSEs,'' National Mortgage News, March 16, 2011.
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    The private market that will develop if our proposal is enacted 
will be entirely different from what existed before. Most mortgages 
will be prime loans--the kinds of loans that the small and community 
banks usually originate. These loans will be highly sought after 
because they will not only be good investments, but also the only kind 
of mortgage that could be securitized. Since most mortgages will have 
the same prime characteristics, the key function in this new market 
will be aggregating the mortgages into pools for securitization.
    This is a role that can be performed by the small and community 
banks, perhaps through the creation of a jointly owned and operated 
securitization facility, enabling the members to capture the profits 
that they previously had to give up to Fannie and Freddie or to their 
larger competitors. All that is necessary is regulatory approval to set 
up one or more joint ventures that will aggregate the mortgages 
produced by the members and prepare them for sale through 
securitization, or to institutional buyers who want to hold whole 
mortgages.
    The more competitors in this field, the more innovation there will 
be and the lower they will push mortgage rates. This will be possible 
because the approach we have described relies on prime loans, a core 
competency of community banks and risk-based pricing.
FHA and low-income borrowers.
    There are good policy reasons for Government to assist low-income 
families to become homeowners, but the value of this policy has to be 
weighed against the failure rate imposed on those ostensibly being 
helped as well as the cost to the taxpayers. Referring to the 
affordable-housing requirements imposed on Fannie and Freddie, even 
former House Financial Services Committee chair Barney Frank (D-MA) has 
noted that ``it was a great mistake to push lower-income people into 
housing they couldn't afford and couldn't really handle once they had 
it.''\5\ Moreover, any program of this kind must be on budget and 
contain mortgage quality standards that do not create market conditions 
similar to those that brought on the financial crisis.
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    \5\  Larry Kudlow, ``Barney Frank Comes Home to the Facts,'' 
GOPUSA, August 23, 2010, www.gopusa.com/commentary/2010/08/kudlow-
barney-frank-comes-home-to-the-facts.php#ixzz
0zdCrWpCY (accessed September 20, 2010).
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    One of the ways to do this is to rein in FHA by limiting the scope 
of its lending, making sure its losses are sustainable over the long 
term, and putting it on budget through a mechanism more effective in 
identifying risks and losses than the Federal Credit Reform Act.
    Government assistance to low-income families must not be undertaken 
without quality standards that limit the risks to homeowners, the 
Government, and taxpayers. By prescribing an outcome it wanted through 
the affordable housing goals, without controlling the means, the 
Government encouraged deteriorating underwriting standards. This 
inevitably led to greater lending with minimal downpayments along with 
lending to borrowers with impaired credit and higher debt ratios.
    Thus, if Congress wants to encourage home ownership for low-income 
families, then the mortgages intended to implement this social policy 
must be subject to a defined set of quality standards--not standards as 
high as those for prime mortgages, but standards that will ensure that 
working class families and neighborhoods are not subjected to excessive 
failure rates, as they did with Fannie and Freddie and the FHA, causing 
substantial burdens for taxpayers. The Nation's experience with the FHA 
demonstrates not only that standards are essential, but also that 
Congress has to avoid the political and other pressures that tend to 
erode the standards over time.
Elimination of Fannie and Freddie over time.
    A private housing finance market will never fully develop as long 
as Fannie and Freddie remain in existence, and yet it is obvious that 
they are essential to the current housing finance system. What is 
necessary, then, is a workable transition plan--one that allows the 
GSEs to continue to function but opens the housing finance system to 
private securitizers.
    A key transition feature that now appears to be generally accepted 
calls for a gradual reduction in the conforming loan limit that sets 
the maximum size of the mortgages that Fannie and Freddie can purchase. 
This idea is also in the BPC proposal. As this limit is reduced, Fannie 
and Freddie will be taken out of the market for loans above the limit, 
enabling private securitizers gradually to expand their activity.
    The elements of the transition away from GSE status should include:

    Reducing conforming loan limits. We recommend lowering the 
conforming loan limit by 20 percent of the previous year's cap each 
year, starting with the current general limit for one-unit properties 
of $417,000 and the high-cost area limit of $625,500. These limits, for 
loans, mean house prices of over $500,000 and over $800,000, 
respectively, are financed by the Government. In contrast, according to 
the National Association of Realtors, the median U.S. house price is 
$178,900. The general limit for a one-unit property would decrease to 
$334,000 in year one, $267,000 in year two, $214,000 in year three, 
$171,000 in year four, and $137,000 in year five. The high-cost area 
limit for a one-unit property would decrease to $500,000 in year one, 
$400,000 in year two, $320,000 in year three, $256,000 in year four, 
and $205,000 in year five. Final termination or ``sunset'' of GSE 
status would take place at the end of year five.
    Winding down investment portfolios. A useful approach to winding 
down the GSEs portfolios, without disrupting the market, would prohibit 
Fannie and Freddie from adding existing or newly acquired single-family 
or multifamily loans or MBS to their portfolios, with exceptions only 
for newly acquired loans held for a short period before securitization 
and the purchase of delinquent or modified loans out of an existing 
MBS. With no additions allowed, natural runoff should substantially 
reduce their portfolios over time. Under the current trajectory the 
portfolios will be down to about $500 billion by the end of 2018. To 
the extent a GSE has portfolio assets remaining at the fifth-year 
sunset, these should be put in a liquidating trust and defeased or sold 
to other investors. During the wind-down period, Fannie and Freddie 
should be allowed to buy only prime loans.
    Repeal affordable-housing goals and taxes. Consistent with 
Principles I and III above, repeal the GSE (including the FHLB) 
affordable-housing goals and affordable-housing support fees.\6\
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    \6\ Supra. Housing and Economic Recovery Act of 2008 (HERA). HERA 
imposed a 4.2-basis-point fee on Fannie and Freddie's mortgage 
purchases (currently suspended by FHFA).
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    Privatization. At the sunset date, the conservatorship will be 
converted to a receivership, the equity below the Treasury's holdings 
will be wiped out, and the GSEs will be divided into good bank/bad bank 
structures. If there are buyers for the GSEs as going concerns (no 
longer in GSE form), or capital is available for their restructuring as 
fully private nongovernment entities, the good banks will be sold and 
the bad banks will be liquidated by creating a liquidating trust that 
contains all remaining mortgage assets, guaranty liabilities, and debt. 
The obligations of the trust will be defeased with the deposit of 
Treasury securities.
Objections to a private housing financing system.
    Proposals for largely eliminating Government support for the 
housing market are usually met with a number of objections. None of 
them, in my view, should carry any weight when this Committee considers 
housing finance reform.

    1. The Government will step in anyway, so it should charge in 
advance to protect the taxpayers. Most recently, the Bipartisan Policy 
Center joined many others in arguing, in support of its housing finance 
proposal, that if there is ever a future disruption in the housing 
market the Government is going to step in at some cost to the 
taxpayers. In that case, BPC and others have argued, this ``reality'' 
should be recognized; the Government should create some kind of 
insurance system to cover the costs of its future actions and thus 
protect the taxpayers against loss.
    But the history of housing finance makes clear that the 
Government's role in the housing market--even if only as a brooding 
presence ready to act if the market collapses--will so distort the 
market that the Government is eventually required to step in. This is a 
repeating pattern. For one example, the Government had to rescue the 
S&Ls in the late 1980s and early 1990s because the Government's own 
support for and regulation of the S&L industry had made it impossible 
for the industry to survive the changes in market structure that are 
inevitable in an evolving financial system. Similarly, the reason we 
are here today, and considering what to do about the GSEs, is the 
result of Government housing policies that forced Fannie Mae and 
Freddie Mac to degrade their underwriting standards in order to comply 
Government housing policies.
    It does not matter how light the Government's touch. In the 
proposal of the Bipartisan Policy Center that you will hear today, the 
Government will have only a standby role in the housing market, 
stepping in only when the market is in trouble. Otherwise, the market 
will consist of private companies that will securitize mortgages and 
mortgage insurers that will insure them.
    But it's easy to see that even the limited Government role 
suggested by the BPC will have effects that will make a taxpayer rescue 
more likely. If the Government is ultimately insuring the mortgage-
backed securities (MBS) issued by private companies, the buyers of 
those MBS will not care about the quality of the underlying mortgages 
or the health of either the issuers or the mortgage insurers. That will 
remove from the market one major incentive for market discipline, and 
is one of the reasons the buyers of the GSEs' debt securities didn't 
care about either the quality of the mortgages they were securitizing 
or the GSEs' financial condition.
    Then there are the firms that will be issuing the MBS in the BPC 
plan. These firms will have shareholders and creditors. Will the 
creditors believe that the firms will be allowed to fail? That's 
doubtful. The whole premise of the BPC system is that the Government 
will step in if the market falters. It proposes a fund that will be 
available to back up the Government's obligations. This sounds like a 
kind of FDIC, and we know how successful that's been. Like the FDIC, 
these elements will diminish, if not eliminate, the market discipline 
that might be exercised by the creditors of the MBS issuers in the BPC 
plan.
    In addition, because the Government is taking a risk in backing the 
issuers of the MBS, it will be regulating them. In the BPC plan, this 
will be done by something called the Public Guarantor. Prudential 
regulation by this Government agency will be another reason that 
investors in those firms or in the MBS they issue will not exercise 
market discipline--the Government, they will believe, is doing that 
job. However, the collapse of the S&Ls, the failure of thousands of 
banks in the late 1980s and early 1990s, and the most recent financial 
crisis, not to speak of the collapse of the GSEs themselves, should be 
ample evidence that Government prudential regulation provides no 
assurance whatever that the regulated entities will not fail. It is 
important to keep in mind that only 2 months before the GSEs were taken 
over their regulator reported that they were adequately capitalized.
    The mortgage insurers will also have both equity investors and 
creditors. Again, the interest these groups may have in the health of 
the MIs will be tempered by the Government's presence. If the mortgage 
insurers should fail, the insurers' investors will believe, the 
Government will rescue them. Again, that is the very premise on which 
the BPC's proposal is based. So if the BPC and others who make this 
argument are correct that the Government will step in to protect the 
market, it is unlikely that investors in the MIs will pay much 
attention to their health, believing that the Government will bail them 
out if they should get into trouble. That, in turn, will mean that the 
MIs will be likely to fail because they have insured the low quality 
mortgages that the issuers were able to sell to investors because of 
the Government back-up.
    The idea that the Government can protect the taxpayers by charging 
a premium for its guarantees also does not stand up to analysis. The 
Government doesn't have the incentives to charge a premium that fully 
compensates it for the risks it is taking, and Congress is often 
willing to respond to complaints from the industry that the premiums 
are too high and are operating as a tax on consumers. Thus, Congress 
just had to bail out the National Flood Insurance Program to the tune 
of $9.7 billion. The NFIP had been charging premiums for flood 
insurance for many years, but when the fund was really needed it wasn't 
large enough. If the Government wants to do it as a matter of policy, 
OK, but Congress should realize that it will always end up as a cost to 
the taxpayers.
    The history of Government insurance programs is consistently 
dismal. The FDIC became temporarily insolvent in the 2008 financial 
crisis because Congress limited the amount it could charge for deposit 
insurance; the FHA is already insolvent and will have to be bailed out, 
the Pension Benefit Guarantee Corporation is also on its way to 
insolvency if not already insolvent. The pathology is always the same. 
The Government accumulates a fund, but the fund was too small for the 
occasional catastrophic event. The reason the fund is too small is that 
the private sector interests that are supposed to be protected want to 
lower their costs, and persuade Congress that the fund is large enough. 
So premiums are lowered, or not increased as costs rise, or stopped 
altogether as occurred at the FDIC. When the catastrophe occurs, as it 
always does when the Government is involved, the taxpayers have to pick 
up the tab.
    And then there is moral hazard. The fact that the Government would 
insure building in flood zones made it possible for people to do so. In 
the case of housing finance programs like that proposed by the BPC, the 
fact that the Government--i.e., the taxpayers--is there as final 
guarantor will mean that the whole system will operate without taking 
full account of, and paying for, the risks it is creating. As a result, 
there will be greater demand for the product--more and more and bigger 
and bigger homes--and the financing will get riskier and riskier. In 
these cases, in theory, the Government should add to the price of the 
insurance but is reluctant to do so. When the catastrophe comes, there 
will not be enough money in the fund to solve the problem and the weary 
taxpayers will have to pay up.
    Finally, the idea that the Government will step in to protect the 
housing market is a self-fulfilling prophesy. As noted above, the 
existence of the Government backing--because of moral hazard--makes 
default more likely. Once a fund of some kind is established, any 
restrictions on its use will fade away. A wholesale collapse of the 
industry will not be necessary; the failure of a single insurer or 
issuer will be enough to bring on a rescue. After all, what is the fund 
for but to protect the investors in the MBS? This in itself will prove 
to the market that the whole system is guaranteed by the Government, 
removing any vestige of market discipline that might have previously 
existed.

    2. Only the Government can assure the existence of a 30-year fixed-
rate mortgage. The first thing to say about this is that the Government 
should not be encouraging 30-year fixed-rate mortgages. They are 
harmful to most families that accept them. The second thing is that, if 
home buyers actually want 30-year fixed-rate mortgages, the private 
sector already makes them available without any Government support.
    There are several commonly cited advantages of a 30-year fixed-rate 
mortgage. It protects the borrower against rate hikes for 30 years, 
reduces the monthly payment, and increases the tax-deductibility of the 
monthly payment in the early years when most of the monthly payment 
consists of interest. Finally, in almost all cases the mortgage can be 
refinanced without penalty into another 30-years fixed mortgage at a 
lower interest rate if market conditions permit.
    These sound like significant advantages, but that is illusory. 
First, most families do not stay in a home for 30 years; the average is 
about seven, so when families take out 30-year fixed-rate mortgages 
they are paying for the lender's 30-year risk when they will not ever 
need it. A shorter maturity mortgage is less expensive and better meets 
the needs of most families, which would be well served by a 5-, 10-, or 
15-year fixed period, with a 20-, 25-, or 30-year amortization. Last 
week, Wells Fargo was offering a 30-year fixed-rate conforming (i.e., 
nonjumbo) mortgage at a rate of 3.75 percent, and a 15-year conforming 
mortgage at almost a full point less, at 2.875 percent. The point is 
that a private market would mix and match the elements of a mortgage to 
better meet the needs of particular families for the lowest possible 
cost.
    In addition, when a family that has taken out a 30-year fixed-rate 
mortgage finally sells its home to buy another they will not have 
accumulated very much equity. Most of their payment has been interest, 
and this interest rate has been higher than if they had chosen a 15-
year loan. It is true that they have received a tax deduction for this 
interest payment, but that is only if they itemize their deductions, 
and only 33 percent of families itemize.
    The idea that Government backing is required for a 30-year, fixed-
rate loan has some surface plausibility. Many people who don't follow 
the financial markets might assume that lending money for that long a 
period at a fixed-rate would be too risky for the private sector. Just 
about everyone in Congress seems to have been visited by a 
representative of the Housing Industrial Complex claiming that the 30-
year mortgage would not exist without Government backing.
    However, anyone can prove this assumption is wrong, simply by going 
to Google and typing in ``30-year jumbo fixed-rate mortgage.'' The word 
``jumbo'' is mortgage market jargon for loans that are too large to be 
bought by Fannie or Freddie, or insured by the Federal Housing 
Administration. That means a jumbo mortgage is not backed in any way by 
the Government. Still, a Google search will return many offers of jumbo 
fixed-rate loans. I found one offered by Wells Fargo last week at 3.875 
percent, about 12.5 basis points higher than the 30-year fixed-rate 
conforming (i.e., nonjumbo) loan that Wells was offering at the same 
time.
    In other words, Government backing is not necessary to make this 
loan available to homeowners, although the Government subsidy that 
comes with the conforming loan--where the taxpayers are taking the 
risk-could well be responsible for the 12.5 basis point difference in 
rate.
    We should have no objection, of course, if homeowners want this 
type of loan. The question is whether the taxpayers should take on the 
risk of backing the entire housing finance structure in order to 
provide a 12.5 basis point subsidy to home buyers, most of who don't 
need the 30-year fixed-rate mortgage they are assuming.
    Finally, we have just come through a period where everyone has 
seemed to recognize the dangers of leverage. Many in Congress preach 
fervently against excessive leverage. Perhaps they don't realize that a 
30-year fixed-rate mortgage is one of the principal ways that leverage 
is built into the housing system. As noted above, it takes many years 
before a homeowner builds up equity in the home through a 30-year 
fixed-rate mortgage. This means that for all this time the homeowner is 
using credit--leverage--to carry the home. If there is a market 
downturn during this period, the homeowner is likely to be underwater 
and unable to sell the home, a victim of leverage encouraged by the 
Government's promotion of the 30-year fixed-rate mortgage.

    3. The investors in MBS are rate buyers. They do not want to take 
credit risk. Without Government backing, and the assurance of a risk-
free investment, it is argued, we would not be able to find investors 
for MBS in the U.S. and around the world.
    This argument confuses cause and effect. It is true that most of 
the buyers of GSE and Ginnie MBS do not want to take credit risk. 
According to the Fed's Flow of Funds data, the principal buyers of 
Ginnie Mae and GSE MBS are U.S. banks, foreign central banks, and 
Federal, State and local pension funds. These entities are buyers 
because they are looking for returns without risk. If there were no 
Ginnie or GSE MBS, they would be buyers of Treasuries. This means that 
Treasury is paying more for its outstanding debt because it competes 
with GSE securities. In a recent memorandum, Steve Oliner, an AEI 
economist, and I estimated this cost to the Treasury at about $22 to 
$28 billion per annum, more than what the Government is now receiving 
in GSE dividends.
    In the private sector, however, investors are compensated for 
taking risks. They are not generally buyers of Ginnies and GSE MBS 
because the taxpayers are taking the risks associated with those 
securities and the yields are too low to meet their long-term 
obligations.
    Insurance companies, private pension funds and mutual funds should 
be the natural buyers of mortgages and MBS. These are long-term assets 
that would match their long-term liabilities. But as shown again by the 
Fed's Flow of Funds data, they are not buyers of Government-backed MBS, 
probably because the yields are too low when the taxpayers are assuming 
the risks (and not being compensated for it). In the absence of private 
MBS, these investors are generally buying low quality corporate 
securities.
    If there were a steady flow of private mortgage credit in the form 
of whole mortgages and MBS, insurance companies, private pension funds 
and mutual funds--which together have about $21.5 trillion to invest--
would be steady buyers. This would set up a financial win-win, in which 
there would be adequate credit for mortgages and a sound investment for 
long-term investors.

    4. Without Government backing there would be no TBA market and 
interest rates for all mortgages would rise. This is also incorrect. 
The TBA (To Be Announced) market is a hedging mechanism, which allows 
lenders to hedge the possibility of interest rate changes between the 
time they lock in a rate for a borrower and the time the loan actually 
closes. This is done by selling the pool of mortgages forward, just as 
a farmer might sell his wheat or corn crop forward. Then, if the price 
changes, he is protected. The buyer is speculating that wheat will be 
worth more when delivered than it is on the date of the forward sale. 
So in the same way, the mortgage lender sells its pool of mortgages 
forward to a buyer who is speculating that the mortgages will be worth 
more in the future when they are ultimately delivered. There are two 
keys to the effective operation of a TBA market--market liquidity and a 
general agreement on the principal terms of the mortgages in a MBS 
pool.
    In the current TBA market, in which the GSEs are the principal 
players, the liquidity is created by a convention among market 
participants about what they will accept as sufficient information 
about a particular mortgage pool. The agreement covers six factors--
issuer, maturity, coupon, price, par amount and settlement date. 
Participants in the market agree to buy a pool of mortgages that all 
fall within certain previously agreed parameters. It's the agreement on 
these parameters not creates the liquidity, not the Government 
guarantee of the credit risk. The credit risk is occasionally a factor, 
but the purpose of the TBA market is to hedge interest rate risk, not 
credit risk.
    Once the private market become active enough so that there is a 
liquid market for the purchase and sale of mortgage pools the TBA 
market will function.

    5. Without Government involvement, a steady flow of credit to 
housing cannot be guaranteed. Why should housing, as opposed to all 
other industries, be guaranteed a steady flow of credit? Every other 
industry has to live with the prospect that interest rates will rise 
and credit will be tight. This encourages prudence and care in making 
commitments, reduces overbuilding and the use of leverage that has 
contributed to housing bubbles in the past. A steady flow of credit to 
housing has, ironically, been the cause of much of the volatility in 
the housing market in the past.
    That concludes my prepared testimony. 


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                                 ______
                                 
                PREPARED STATEMENT OF JANNEKE RATCLIFFE
        Senior Fellow, Center for American Progress Action Fund
                        Tuesday, March 19, 2013
    Good morning Chairman Johnson, Ranking Member Crapo, and Members of 
the Committee. I am Janneke Ratcliffe, a Senior Fellow at the Center 
for American Progress Action Fund and the executive director for the 
Center for Community Capital at the University of North Carolina at 
Chapel Hill. I am also a member of the Mortgage Finance Working Group, 
a group of housing experts convened by CAP back in 2008 to chart a path 
forward for the mortgage market. The working group originally released 
our comprehensive ``Plan for a Responsible Market for Housing Finance'' 
back in January of 2011.\1\ Since then, we have continued to offer 
comment on a variety of regulatory developments. While I will present 
recommendations from that plan, I speak only for myself today.
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    \1\ Mortgage Finance Working Group, ``A Responsible Market for 
Housing Finance'' (Washington: Center for American Progress, 2011), 
available at http://www.americanprogress.org/issues/housing/report/
2011/01/27/8929/a-responsible-market-for-housing-finance/.
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    We are here today to discuss not just the future of the housing 
finance system, but the future of housing and economic opportunity for 
Americans. To quote from the Bipartisan Policy Commission, ``restoring 
our Nation's housing sector is a necessary precondition for America's 
full economic recovery and future growth.''\2\
---------------------------------------------------------------------------
    \2\ Bipartisan Policy Center Housing Commission, ``Housing 
America's Future: New Directions for National Policy,'' (2012), 
available at http://bipartisanpolicy.org/library/report/housing-future.
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    As technical as this debate can be, we encourage you not to lose 
sight of the ultimate impact of the housing finance system on 
households, communities, and the economy. Research and our lived 
experiences confirm the link between housing and economic opportunity 
in this country, from the importance of decent and affordable rental 
housing and the many benefits of home ownership to the central role of 
the housing economy on economic vitality.
    What I want to stress, and what the BPC report articulates so well, 
is that much of the benefit derived from housing depends on the way in 
which housing is financed. That is why, since 1932,\3\ the Government 
has sought to foster a mortgage marketplace that is stable, safe, 
efficient and affordable. One visible hallmark of Government's 
involvement is the long-term fixed-rate mortgage. Partly as a result, 
home ownership has served as a crucial building block of a strong 
middle class in the 20th century.\4\ The mechanisms have evolved over 
time and in response to crises, from the creation of the Federal Home 
Loan Bank System and Federal deposit guarantees to the more recent 
bailouts of private institutions and the conservatorship of the 
Government-Sponsored Enterprises. Now we have the opportunity to put in 
place a system that will serve the next generations even better than 
the systems that have preceded it.
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    \3\ See the Federal Home Loan Bank Act, Pub.L. 72-304, 47 Stat. 
725.
    \4\ Bipartisan Policy Center Housing Commission, ``Housing 
America's Future''.
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The State of the Housing Market Today
    As the market struggles to right itself, I suggest we remain 
mindful of the urgency and importance of the task ahead. Our national 
mortgage market today is significantly smaller than it was in the early 
2000s.\5\ The homeownership rate has dropped from close to 70 percent 
to 65 percent,\6\ and while the housing market's recent performance is 
heartening, we fear the fundamentals are not yet there for a robust, 
accessible and sustainable market to develop.
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    \5\ U.S. Department of Housing and Urban Development, ``U.S. 
Housing Market Conditions Historical Data,'' available at http://
www.huduser.org/portal/periodicals/ushmc.html.
    \6\ Ibid.
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    To start, approximately three quarters of mortgage originations in 
2012 were refinances, not home purchases.\7\ Among the purchases that 
are occurring, the National Association of Realtors estimates that 
investors represented 20 percent in 2012, high above their historic 
norm of 10-12 percent.\8\ This investor presence may support housing 
prices and perhaps even inflate them,\9\ but will not necessarily 
stabilize neighborhoods or pave the way for move-up buyers or home 
ownership in the future.
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    \7\ U.S. Department of Housing and Urban Development and U.S. 
Department of Treasury, ``The Obama Administration's Efforts to 
Stabilize the Housing Market and Help American Homeowners,'' (2013), 
available at http://portal.hud.gov/hudportal/documents/huddoc?
id=HUDJanNat2013SC_FINAL.pdf.
    \8\ National Association of Realtors Realtor Confidence Survey, 
available at National Association of Realtors Realtor Confidence 
Survey.
    \9\ Susan Berfield, ``What Crash,'' Bloomberg Businessweek (March 
2013).
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    In the meantime, first-time home buyers, young home buyers and home 
buyers of color--the future of home ownership in the United States 
\10\--have largely been shut out of the conventional mortgage market. 
The Federal Housing Administration backed financing for 46 percent of 
first-time buyers in 2012 and about half of home purchases obtained by 
home buyers of color in 2011.\11\ Homeownership rates for young people 
(ages 25-34) are among the lowest in decades.\12\ This decline in home 
ownership has led to an increase in renters. With rents rising, this is 
only putting more pressure on the Nation's renters, more than half of 
whom are ``rent impoverished,'' or spending more than one-third of 
their income on housing.\13\ These figures do not suggest well-
functioning single and multi-family housing finance markets.
---------------------------------------------------------------------------
    \10\ George S. Masnick, Daniel McCue, and Erick Belsky, ``Updated 
2010-2020 Household and New Home Demand Projections,'' Working Paper 
W10-9 (Harvard Joint Center for Housing Studies, 2010), available at 
http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/w10-
9_masnick_mccue_belsky.pdf.
    \11\ National Association of Realtors, ``Profile of Home Buyers and 
Sellers 2012'' (2012); FHA Annual Report to Congress Fiscal Year 2012 
Financial Status FHA Mutual Mortgage Insurance Fund, available at 
http://portal.hud.gov/hudportal/documents/huddoc?id=F12MMI
FundRepCong111612.pdf.
    \12\ HUD, ``U.S. Housing Market Conditions Historical Data''.
    \13\ United States Census Bureau, American Housing Survey.
---------------------------------------------------------------------------
    What's more, it has now been close to 5 years since Fannie Mae and 
Freddie Mac went into conservatorship. The GSEs are slowly 
deteriorating, with no clear plan for a restructured secondary market. 
In the absence of direction from Congress, the Federal Housing Finance 
Agency is unilaterally making significant policy decisions and 
investments. Some of these we support, and some we oppose. For example, 
of the decisions that have been disclosed by the agency, we agree that 
it makes more sense to invest in a single securitization platform for 
the mortgage giants rather than to retool the companies' own systems, 
while we strongly disagree with the decision not to pursue some form of 
principal forgiveness for delinquent loans or the decision to not fund 
the Affordable Housing Trust fund or Capital Magnet Fund. Other 
important decisions are not even to be found in the strategic plans, 
and are opaque to the public, such as decisions regarding how and when 
to extend credit to first-time home buyers.
     But it doesn't matter whether we agree or disagree. What matters 
is that these decisions will impact American families broadly whether 
they own their home, hope to become homeowners someday, or are seeking 
affordable rental options-and will lay the foundation for the shape of 
the market for many years to come. I believe these decisions are far 
too important to leave to one single agency whose deliberations largely 
take place behind closed doors, and whose officials are not elected, 
appointed, or confirmed.
A Bipartisan Way Forward
    It is time to set a clear direction for the future state of the 
mortgage secondary market--one that considers the interests of all 
stakeholders, and does so in the context of broader, long-term 
considerations and priorities.
    You've asked whether there is a bipartisan way forward on housing 
finance reform. There is. The Bipartisan Policy Center's housing 
recommendations are based on a view shared across the political 
spectrum that home ownership is a desirable option when viable, and 
that those who do not buy a home ought to have access to affordable, 
quality rental housing.\14\ More specifically, this group agrees that 
the 30-year, fixed-rate product is the gold standard for a safe and 
sustainable mortgage market; that there is a critical need for a 
reformed multi-family finance system to meet the demand for affordable 
rental; and that the system must provide access to safe and affordable 
mortgages for all creditworthy borrowers, including those of low and 
moderate income.
---------------------------------------------------------------------------
    \14\ Bipartisan Policy Center Housing Commission, ``Housing 
America's Future''.
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    Perhaps most important, the bipartisan plan recognizes the need for 
the Government to retain a guarantor role in the core portion of the 
GSE-supported market going forward. At this point, the Bipartisan 
Policy Center's reform plan is one of 18 proposals (including several 
bipartisan ones) that call for some explicit Government support for the 
segment of the market traditionally served by the GSEs, while only a 
few plans propose no Government role beyond FHA.\15\
---------------------------------------------------------------------------
    \15\ For a summary of plans, see John Griffith, ``The $5 Trillion 
Question: What Should We Do with Fannie Mae and Freddie Mac?'' 
(Washington: Center for American Progress, 2013), available at http://
www.americanprogress.org/wp-content/uploads/2013/03/NewGSEReform
Matrix.pdf.
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    In other words, while a couple of outlier proposals still call for 
withdrawal of all support, we see a very broad consensus emerging. It 
is time to move on from this question because ironically, until we do 
so, the Government will continue to provide a 100 percent guarantee for 
the vast majority of mortgages.
    The Commission's recommendation is a critical first step, but it is 
just a beginning. Now it is time to have a robust, in-depth 
conversation about how to structure the secondary mortgage market with 
an explicit, paid for and actuarially sound Government backstop.
    For these reasons, I'm very excited about today's hearing, and I 
hope it signals Congress's readiness to enter into a serious 
conversation about re-visioning our housing finance system.
Principles of a Responsible Housing Finance System
    In 2008, the Mortgage Finance Working Group brought together 
experts to collectively strengthen their understanding of the causes of 
the crisis and to discuss possible options for public policy to shape 
the future of the U.S. mortgage markets. The Group's vision of a well-
functioning and responsible market that protects taxpayers is grounded 
in five principles similar to those that underpin the proposal of the 
Bipartisan Policy Commission: liquidity, stability, transparency, 
access and affordability, and consumer protection.
    Liquidity: The system needs to provide a reliable supply of capital 
to ensure access to mortgage credit for both rental and homeownership 
options, every day and in every community, during all kinds of 
different economic conditions, through large and small lenders alike. 
The capital markets have come to play an essential role in mortgage 
finance, but as the past decade so stunningly demonstrated, capital 
markets on their own provide highly inconsistent mortgage liquidity, 
offering too much credit sometimes and no credit at other times. These 
extremes can have a devastating impact on the entire economy.
    Stability: Private mortgage lending is inherently procyclical. 
Stability for the market requires sources of countercyclical liquidity 
even during economic downturns. For families, stability means that they 
will not experience wild fluctuations in home values, allowing them to 
plan financially for their families, education, businesses, or 
retirement. Stability also requires sustainable products and capital 
requirements that are applied equally across all mortgage financing 
channels for the long cycle of mortgage risk. As we saw in the previous 
decade, capital arbitrage can quickly turn small gaps in regulatory 
coverage into major chasms, causing a ``race to the bottom'' that 
threatens the entire economy.
    Transparency: Underwriting and documentation standards must be 
clear and consistent across the board so consumers, investors, and 
regulators can accurately assess and price risk and regulators can hold 
institutions accountable for maintaining an appropriate level of 
capital. Secondary market transparency and standardization lower costs 
and increase availability, and are a fundamental precondition for the 
re-emergence of a private mortgage-backed securities market.
    Access and Affordability: The lower housing costs produced by the 
modern mortgage finance system (before the recent crises) helped more 
families become homeowners, which enabled them to live in a stable 
community, to build equity, and to pass on assets to their heirs. 
Similarly, the Government-backed mortgage finance system has provided 
developers of affordable multifamily rental housing with a source of 
long-term, fixed-rate mortgages, while the purely private market 
prioritizes market-rate rental housing.\16\ The Government guarantees, 
along with associated regulatory and consumer protections, confer 
significant benefits to households who can access it--and that should 
include all credit-worthy borrowers. Left to its own devices, 
participants tend to ``cream'' the market, leaving perfectly 
creditworthy lower wealth, lower income or minority segments 
underserved. With appropriate incentives and tools, these segments can 
be well-served, to the benefit of the entire system.
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    \16\ Ethan Handelman, David A. Smith, Todd Trehubenko, 
``Government-Sponsored Enterprises and Multifamily Housing Finance: 
Refocusing on Core Functions,'' (Washington: National Housing 
Conference, 2010), available at http://www.nhc.org/media/files/
NHC_GSE_core
_functions_v8_2_101001.pdf.
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    Consumer Protection: The purchase of a home is a far more 
complicated, highly technical transaction than any other consumer 
purchase and occurs only a few times in a consumer's life. Mortgage 
consumers are at a severe information disadvantage compared to lenders. 
In addition, a mortgage typically represents a household's largest 
liability. As the current crisis has demonstrated, consumer protection 
is inextricably linked with financial institution safety and soundness. 
Along with regulators such as the Consumer Financial Protection Board, 
any structure supporting the Nation's housing market must share a 
commitment to ensuring that the system supports rather than undermines 
the financial health of the consumer.
Basic Structure of Our Proposal
    The Mortgage Finance Working Group's proposal creates a system that 
preserves the traditional roles of originators and private mortgage 
insurers, but assigns functions previously provided by Fannie Mae and 
Freddie Mac to three different actors: (1) issuers; (2) chartered 
mortgage institutions, or CMIs; and (3) a catastrophic risk insurance 
fund. Our plan seeks to use the least and most remote public guaranty 
necessary to leverage the greatest amount of private capital in a first 
loss position, which in turn will provide interest rate investors the 
assurance to fund long-term mortgages.
    Issuers: Issuers are purely private entities that originate or 
purchase and pool loans and issue mortgage-backed securities (MBS).
    Chartered Mortgage Institutions (CMIs): Issuers will purchase 
credit insurance on MBS that meets certain standards from CMIs. These 
entities also will be fully private institutions, but will not be owned 
or controlled by originators. They will be chartered and regulated by a 
Federal agency and their function would be to assure investors of 
timely payment of principal and interest on those securities that can 
qualify to be covered by the Catastrophic Risk Insurance Fund.
    Catastrophic Risk Insurance Fund (CRIF): This on-budget fund would 
be similar to the FDIC's Deposit Insurance Fund, i.e., run by the 
Government and funded by premiums on CMI-guaranteed MBSs. In the event 
of a CMI's financial failure, the explicit guarantee provided by the 
CRIF would protect the holders of qualified CMI securities. The 
Government would price and issue the catastrophic guarantee, collect 
the premium, and administer the fund. The fund would establish the 
product structure and underwriting standards for mortgages that can be 
put into guaranteed securities and the securitization standards for 
MBSs guaranteed by the CMIs, and also establish reserving and capital 
requirements for CMIs that would be at higher levels than those 
presently held by Fannie and Freddie. In addition, the CRIF would 
regulate pooling and servicing standards to ensure a liquid market for 
the MBS and appropriate treatment of delinquent loans to protect the 
fund and consumers.
    Under our plan, there will be several layers of protection standing 
ahead of the CRIF: borrower equity, the CMI's capital, and in some 
cases private mortgage insurance. All of these private sources of funds 
would need to be exhausted before the CRIF would have any exposure to 
loss. And the CRIF would have to fail before any taxpayer funds would 
be required to meet the Government's guarantee to security holders.
    In addition, to provide tools that encourage safe and sound 
innovation and access, we propose establishment of a ``Market Access 
Fund'' which would support research and development, provide limited 
credit enhancements, and offset the costs of support services such as 
housing counseling. This fund would be supported by a per-loan 
contribution from all securitized loans, as the entire system benefits 
from the provision of prudent and affordable lending to enable more 
households to advance up the housing ladder. In addition, the Capital 
Magnet Fund and the National Housing Trust Fund, both of which were 
created in 2008 and intended to be funded by Fannie Mae and Freddie 
Mac, would become funds within the Market Access Fund.
Comparing our Proposal to Other Proposals
    In your invitation to testify today, you identified the essential 
objectives policymakers should aim for as they seek to structure the 
future mortgage markets: the continued availability of the standard 
affordable long-term fixed-rate mortgage, equal access to the secondary 
market for all lenders, equal access for all qualified borrowers and 
market segments, availability of stable liquid and efficient funding 
for both multi-family and single-family housing, the protection of 
taxpayers, and the impact on economic recovery and stability.
    A comparison of our plan with others illustrates several 
considerations for how to structure a well-functioning secondary 
mortgage market that achieves these objectives.\17\ Our proposal is 
just one of many proposals, including the proposal of the Bipartisan 
Policy Commission, recognizing the need for Government support of the 
core mortgage market. Although there are differences in the structural 
details, such proposals share the common principals of liquidity and 
stability that are required for a well-functioning housing system.
---------------------------------------------------------------------------
    \17\ For a side-by-side comparison and links to 22 plans, see 
matrix on CAP Web site at http://www.americanprogress.org/wp-content/
uploads/2013/03/NewGSEReformMatrix.pdf.
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Preserve the standard affordable long-term fixed-rate mortgage
    The explicit Government guaranty--even a remote one, such as our 
plan calls for--preserves the long-term, self-amortizing, fixed-rate 
mortgage, which maximizes affordability and economic security for the 
majority of American homeowners.
    This type of mortgage, which is generally a 30-year, fixed-rate 
mortgage, provides borrowers with cost certainty regardless of market 
conditions. Adjustable rate mortgages expose borrowers to interest rate 
risk. Shorter-duration products with balloon payments that are designed 
to be refinanced every 2 to 7 years expose borrowers not only to 
ordinary interest-rate risk, but also to the risks that they may not be 
able to refinance when they need to due to other adverse changes in 
market conditions.
    Research conducted at the UNC Center for Community Capital confirms 
the important role that safe and sustainable products play in making 
home ownership work better for more households. A longitudinal study of 
nearly 50,000 families, with a median income of around $35,000 who 
purchased homes in the decade leading up the bubble and bust, has found 
relatively low default rates, despite the fact that most of these 
borrowers put down less than 5 percent on their home purchase and about 
half had credit scores below 680. Although these borrowers would be 
very unlikely to get approved for a mortgage in today's tight market, 
they turned out to be good credit risks even through a major recession, 
and they even managed to build some equity at the median. These loans 
were prime-priced, fully underwritten loans, extended by banks around 
the country and sold to Fannie Mae.\18\ Comparison with similar 
borrowers receiving adjustable-rate and other nontraditional loan 
features via the purely private market, who defaulted at rates three to 
five times as high, highlights the important role that good products 
play in reducing credit risk.\19\
---------------------------------------------------------------------------
    \18\ Roberto G. Quercia, Janneke Ratcliffe, and Allison Freeman, 
Regaining the Dream How to Renew the Promise of Homeownership for 
America's Working Families (Washington: Brookings Institute Press, 
2011).
    \19\ Lei Ding, Roberto G. Quercia, Wei Li, and Janneke Ratcliffe, 
``Risky Borrowers or Risky Mortgages: Disaggregating Effects Using 
Propensity Score Models,''Journal of Real Estate Research 33 (2) 
(2011): 245-278, available at http://www.ccc.unc.edu/documents/
Risky.Disaggreg.5.17.10.pdf.
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    Providing borrowers with that kind of stability also has benefits 
for the economy as a whole. Prior to the introduction of the major 
housing and finance reforms of the 1930s, the United States had a 
mortgage system that closely resembled the purely private system 
conservatives are arguing for today. Mortgages were typically for a 
term of 5 years and depended on regular refinancing.\20\ That system 
failed spectacularly when the Great Depression hit and half of all 
homeowners defaulted on their mortgage (although foreclosure rates 
remained lower than today due to the Government's creation of the Home 
Owners' Loan Corporation).\21\
---------------------------------------------------------------------------
    \20\ Richard K. Green and Susan M. Wachter, ``The American Mortgage 
in Historical and International Context,'' Journal of Economic 
Perspectives 19 (4) (2005): 93-114, available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=908976.
    \21\ David C. Wheelock, ``The Federal Response to Home Mortgage 
Distress: Lessons from the Great Depression,'' Federal Reserve Bank of 
St. Louis Review 90 (3) (2008), pp. 133-48, available at http://
research.stlouisfed.org/publications/review/08/05/Wheelock.pdf; Green 
and Wachter, ``The American Mortgage in Historical and International 
Context.''
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    Without Government involvement of some kind, the 30-year, fixed-
rate mortgage is likely to be a product of the past.\22\ Some have 
asserted that the significant development of the financial sector since 
the 1930s means that a purely private mortgage system could effectively 
serve the mortgage needs of Americans today. They point to the nascent 
recovery in the so-called jumbo mortgage markets, an area that lacks 
any Government support because these mortgages are for the high end of 
the housing market, as evidence supporting the idea that the purely 
private markets can capably serve the mortgage markets.\23\
---------------------------------------------------------------------------
    \22\ Richard K. Green, Testimony before the Senate Banking 
Committee, ``Housing Finance Reform: Should there be a Government 
Guarantee?'' September 13, 2011, available at http://
www.banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=56068079-9c03-40d4-b36a-
72913d3850b4.
    \23\ Peter Wallison, ``Going Cold Turkey,'' (Washington: American 
Enterprise Institute, 2010), available at http://www.aei.org/outlook/
economics/financial-services/housing-finance/going-cold-turkey/.
---------------------------------------------------------------------------
    However, the fact that the purely private markets may be able to 
meet the mortgage needs of a small, wealthy slice of home buyers does 
not mean that they will be able to meet the mortgage needs of all 
Americans. This argument ignores the limited investor appetite for 
long-term debt investments--the type of investments that fund home 
mortgages-in the absence of a Government backstop. While investor 
demand for long-term sovereign debt is enormous, totaling many 
trillions of dollars for U.S. Treasuries alone, the demand for 
privately issued long-term mortgage obligations that don't carry a 
Government backstop is small in comparison.\24\ What's more, the jumbo 
market is enabled by the existence of the conventional market, as 
lenders need to compete with a product that wealthier borrowers could 
access with a larger downpayment. The conventional market also provides 
transparent pricing information and benchmark prices and rates that the 
jumbo market can piggyback on.
---------------------------------------------------------------------------
    \24\ Bryan J. Noeth and Rajdeep Sengupta, ``Flight to Safety and 
U.S. Treasury Securities,'' The Regional Economist 18 (3) (2010):18-19 
available at http://www.stlouisfed.org/publications/re/articles/
?id=1984; see also Ben S. Bernanke, ``Housing, Housing Finance, and 
Monetary Policy,'' August 31, 2007, available at http://
www.Federalreserve.gov/newsevents/speech/bernanke20070831a.htm.
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    As noted, any plan that maintains a Government guaranty will give a 
broad class of investors the confidence to invest in the U.S. housing 
finance system at efficient, fixed rates. In our view, similar to the 
proposal of the Bipartisan Policy Commission as well as several others, 
this Government guaranty needs only to cover the catastrophic level to 
serve this function as well as to support the TBA market,\25\ provided 
there is sufficient standardization. Proposals that call for the 
investors to share in some tail risk are unlikely to achieve this end. 
On the other hand proposals that call for the Government to take a 
larger share of the risk, for example through a single, Government-
owned entity that takes both predominant and catastrophic risk (similar 
to the way the GSEs are functioning now, or FHA and Ginnie Mae 
combined) may result in marginally greater efficiencies to the extent 
that greater homogeneity drives greater liquidity. For example, even 
today, with full Government support, Fannie Mae and Freddie Mac 
securities do not trade the same.
---------------------------------------------------------------------------
    \25\ The TBA, or ``To be Announced,'' market is a type of futures 
market for mortgage-backed securities that allows lenders to provide 
consumers with interest rate forward commitments or ``locks'' on their 
mortgage interest rates before the final mortgage is signed and sealed. 
For more information on the importance of the TBA market, see Mortgage 
Finance Working Group, ``A Responsible Market for Housing Finance''.
---------------------------------------------------------------------------
Ensure that both large and small lenders have access to secondary 
        market finance to help ensure broadly available access to 
        credit in all communities.
    A diverse lending market is crucial for ensuring broad access to 
credit for all borrowers and communities, including rural communities, 
communities of color, and communities that have been hard-hit by the 
recession. A secondary market that enables lenders of all sizes in all 
communities to offer mortgages on equal and well understood terms is 
one of the major beneficial functions of Fannie Mae and Freddie Mac 
that, going forward, the reformed system must retain and even improve 
on.
    Our proposal recognizes the risks of building a system that favors 
large, well-capitalized banks (and their affiliates) and leaves small 
originators at the mercy of their larger competitors as to whether and 
under what terms they can access the Government-guaranteed market. In 
our proposal, multiple chartered mortgage institutions (CMIs) would 
perform the predominant credit risk-taking function of Fannie and 
Freddie. These entities would enhance competition and ensure equal 
access by small lenders to the secondary market. Originating lenders 
would not be allowed to own a CMI, except as part of a broad-based 
mutually owned entity designed to ensure access at equitable prices to 
smaller lenders such as community banks, credit unions and community 
development finance institutions. In that context, and to assist in the 
achievement of public policy outcomes that may not coincide with the 
interests of private owners of CMIs, consideration might also be given 
to permitting CMIs established by Government entities, such as housing 
finance agencies, individually or collectively.
    Some proposals would explicitly allow banks and originators to 
perform the predominant credit risk-taking function. In a marketplace 
already characterized by extreme concentration of origination and 
servicing in entities that have both explicit Government guarantees (on 
deposits) and implicit guarantee (``too big to fail''), this structure 
would only extend the large banks' market power and encourage the 
accumulation of risk with an implicit Government guaranty. In effect it 
would be recreating Fannie and Freddie, except under the control of the 
largest originators. While proponents point to the Ginnie Mae model 
where originators are also issuers, they ignore the fact that the 
credit risk-taking function is not provided through Ginnie Mae or the 
issuers, but through FHA on a per-loan basis, universally available on 
equal terms. In the case where issuers themselves are determining the 
risk parameters and pricing for the predominant credit risk, such a 
transparent and level playing field will be hard to achieve.
    Some of those proposals do identify this market power risk but 
would manage it administratively rather than structurally. Such plans 
would prohibit discriminatory pricing by issuers or credit-risk-takers. 
For example, the BPC plan calls for the Public Guarantor to set rules 
of the road that would prevent issuers (who are charged with choosing 
how to cover the credit risk) from creating ``barriers using 
differential guarantee-fee pricing or other means to unfairly restrict 
or disadvantage participation in the Government-guaranteed secondary 
market.''\26\ However, managing that risk administratively may be 
easier said than done.
---------------------------------------------------------------------------
    \26\ Bipartisan Policy Center Housing Commission, ``Housing 
America's Future,'' p. 57.
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    By contrast, cooperatively owned and ``utility'' models 
deliberately seek to equalize small lender access through structural 
mechanisms. At the far end of the spectrum, proposals that call for a 
single entity such as a nationalized secondary market would go even 
further to minimize this risk.
Ensure that all creditworthy borrowers and market segments have access 
        to the mainstream housing finance system.
    As noted previously, many of the benefits we associate with stable 
and affordable housing options stem from the way in which that housing 
is financed. Left to its own devices, the market will tend to deliver 
the best loans where it is easiest to do so and to channel higher cost 
loans where borrowers are easier to exploit and have fewer options. 
Such cherry-picking practices result in the benefits flowing primarily 
to private shareholders and to a narrow group of advantaged borrowers, 
rather than the economy as a whole. To further the goal of access and 
affordability, CMIs in the new housing finance system would be 
responsible for providing an equitable outlet for all primary market 
loans meeting the standards for the guarantee, rather than serving only 
a limited segment of the business, such as higher-income portions of 
that market.
    This obligation would have four parts:

    CMIs would be expected to mirror the primary market 
        (roughly) in terms of the amount and the geography of single-
        family low- and moderate-income loans (other than those with 
        direct Government insurance) that are securitized and are 
        eligible for the CMI guarantee. They would not be allowed to 
        ``cream'' the market by securitizing limited classes of loans. 
        (This approach relies on effective implementation of the 
        Community Reinvestment Act, which requires banks and thrifts to 
        serve all communities in which they are chartered; note that 
        the Community Investment Act likely requires some updating for 
        it to function optimally, and the Federal banking regulators 
        have been engaged in a lengthy process to do this.)

    CMIs that guarantee multifamily loans would be expected to 
        demonstrate that at least 50 percent of the units supported by 
        securitized multifamily loans during the preceding year were 
        offered at rents affordable to families at 80 percent of the 
        relevant area median income, measured at the time of the 
        securitization.

    CMIs would be required to provide loan-level data on 
        securitizations to the Government (which will be required to 
        make these data public) that are more robust than those of the 
        Public Use Database currently produced by the Federal Housing 
        Finance Administration.

    All CMIs would participate in a yearly planning, reporting, 
        and evaluation process covering their plans for and performance 
        against both the single-family and multifamily performance 
        standards and Government-identified areas of special concern, 
        such as rural housing, small rental properties, and shortages 
        created by special market conditions such as natural disasters.

    Like all other secondary market participants, CMIs would be 
required to abide by nondiscrimination and consumer protection laws. 
Substantial underperformance by a CMI could lead to fines and possible 
loss of its CMI license.
Provide credit enhancement or other programs to serve those who cannot 
        be served by purely private markets.
    While rules against discriminatory lending and anti-creaming 
provisions, such as those we have proposed for CMIs, will help, they 
will not fill all the gaps left by a national history of discrimination 
and wealth disparities. These gaps are especially important to fill in 
the aftermath of the housing crisis, where many communities saw equity 
stripped by subprime lending or were hit very heavily by the recession 
and unemployment. These neighborhoods most in need of capital to 
rebuild likely will be the last to get it from a private market left to 
its own devices. The Community Reinvestment Act is too limited in scope 
to be expected to generate the level of support required solely through 
banks' balance sheet lending.
    However, many prospective homeowners and owners of rental homes who 
are not easily served by private markets demanding competitive rates of 
return can be well served with limited amounts of credit enhancement, 
or ``risk capital.'' These borrowers inhabit a ``grey zone'' between 
fully private credit and fully insured credit through agencies like the 
FHA, VA and USDA's Rural Housing Services (RHS). During their most 
effective years, Fannie Mae and Freddie Mac generated some of this 
innovation through their own risk capital by relying on standard, fully 
documented loans; their large market shares; and broadly priced credit 
products, using limited pilots or trusted partners Banks subject to the 
Community Reinvestment Act also do some of this on a limited scale, 
both internally and through support of mission-oriented intermediaries 
such as Community Development Financial Institutions (CDFIs).
    We therefore propose establishment of a Market Access Fund, which 
would have three broad functions:

    Provide support, both grants and loans, for research, 
        development and pilot testing of innovations in product, 
        underwriting and servicing geared to expanding the market for 
        sustainable home ownership and for unsubsidized affordable 
        rental.

    Provide limited credit enhancement for products that expand 
        sustainable home ownership and affordable rental but that, 
        without such credit enhancement, cannot be piloted at 
        sufficient scale to determine whether they can be sustained by 
        the private market, or, alternatively, are best served by FHA, 
        VA and/or USDA or by the States.

    Provide incentive grants to encourage development of self-
        sustaining support services, such as housing counseling, that 
        have proven effective in expanding safe and affordable home 
        ownership, but that so far have not developed a sustainable 
        business model that combines lender support, client fees and 
        limited Government and philanthropic subsidy.

We propose that the Market Access Fund be funded through a small (e.g., 
10 basis points) assessment on all securitized mortgages, whether or 
not an issue receives a Federal catastrophic guarantee. The fee would 
be structured as a ``strip'' from the mortgage coupon, in the same way 
that servicing fees are charged, and would continue for the life of the 
mortgage. This fee could be easily collected by the SEC on behalf of 
the Fund, or, if proposals for a single mortgage backed securities 
platform are implemented, by the platform.
    The Fund should be on-budget, allowed to grow over time, and its 
credit activities subject to credit scoring. Using 2000 as a ``normal'' 
year for mortgage-backed securities issuance, a 10 basis point 
assessment would generate approximately $630 million annually while 
only costing individual mortgage borrowers a negligible amount--about 
$250, or about $20 per month, on a $250,000 mortgage. Assuming mortgage 
backed securities remain outstanding for an average of 4 years and MBS 
issuance remain at the 2000 level, by the fifth year after initiation, 
the fee would be generating a steady revenue of $2.5 billion.
    By creating and using the Market Access Fund in this manner, all 
participants in the mortgage market will be contributing to the 
stability of that market and of the economy. That will be a marked 
contrast to the pre-crash system in which the so-called private market 
was able to use the credibility and stability of the U.S. capital 
markets to simultaneously abuse lower wealth borrowers and communities 
and make huge profits.
    In addition, the Capital Magnet Fund and the National Housing Trust 
Fund, both of which were created in 2008 and intended to be funded by 
Fannie Mae and Freddie Mac, would be relocated within the Market Access 
Fund. The National Housing Trust Fund allows the States to expand the 
supply of rental housing for those with the greatest housing needs. The 
Capital Magnet Fund enables CDFIs and nonprofit housing developers to 
attract private capital and take affordable housing and community 
development activities to greater scale and impact.
    Several other plans, including that of the Bipartisan Policy 
Commission, recognize the value of access and affordability in 
principal. There are plans that call for the secondary market entity(s) 
to maintain a portfolio--at a much smaller scale than Fannie and 
Freddie--for the purpose of funding niche and harder-to-securitize 
loans that expand access and affordability for single-family or 
affordable multi-family activities.
    However, to our knowledge, no other plan spells out specific 
mechanisms for proactively ensuring broad access for all qualified, 
creditworthy households to the mainstream mortgage market, rather than 
to FHA. Other proposals call for all low- and moderate-income lending 
to be served through the FHA. This approach ignores the fact that much 
of this segment can be well and safely served by the core conforming 
conventional market, and that the primary market's conventional lending 
to such segments, through CRA and otherwise, depends on a reliable 
secondary market outlet. Instead, it would institutionalize a dual 
mortgage market, with less choice and higher costs for borrowers who 
would most benefit from access to the prime conventional market, and it 
would unnecessarily and inefficiently drive credit risk onto the 
Government's balance sheet.
    We argue that access and affordability objectives can be achieved 
whether the GSEs are replaced by numerous private credit-risk takers, a 
public utility, or a nationalized secondary market. That said, the more 
centralized the credit-risk-taking entity (s), and the more authority 
it has, the easier it is to align the delivery of the guaranty with 
broader housing policy objectives.
Provide access to reasonably priced financing for both home ownership 
        and rental housing so families can have appropriate housing 
        options to meet their circumstances and needs.
    The need for affordable housing is growing more urgent for families 
in the United States. Over half of U.S. households spend more than 30 
percent of their income on housing, and one in four U.S. households 
spends over half of its income on housing. We applaud the attention 
paid by the Bipartisan Policy Commission to the crisis in affordable 
rental housing for working-class households, a segment that is not 
effectively served today by either the Government or the private 
market.
    Our plan will address the affordability crisis by supporting broad 
access to affordable mortgage credit in the multi-family markets. The 
Mortgage Finance Working Group's plan uses a carefully deployed and 
targeted Government guarantee to encourage private capital to bear risk 
ahead of the Government for affordable multifamily finance as well. We 
envision that CMI's, most likely specializing in multi-family, would 
take predominant risk ahead of the CRIF for permanent financing. These 
CMI's would be required, on an annual basis, to demonstrate that 50 
percent of the units financed by securities it guarantees are 
affordable to a family making 80 percent of median income.
    Some alternative proposals are silent on multifamily finance, or 
eliminate a Government guarantee, or call for splitting the secondary 
market for multifamily off from that of the single-family market. But 
any responsible plan must address the critical gaps in financing for 
affordable rental properties, a goal which has gone too long ignored in 
U.S. housing policy.
Protect taxpayers from unnecessary risk
    The Mortgage Finance Working Group envisions a system that is 
capitalized with as much private capital at risk as possible while 
still serving the Nation's housing needs. That will require Federal 
Government support, but only in a remote, catastrophic-backstop 
position, one that is well-buffered by several layers of private 
capital. The first layers of risk would be absorbed by owners' equity 
and, on lower-downpayment loans, by traditional private mortgage 
insurance. The next layer--what the Bipartisan Policy Commission refers 
to as the predominant credit risk--would be borne by private 
institutions specifically chartered for that purpose (CMIs). These 
entities would be regulated to hold adequate capital and reserves, and 
subject to strict standards for risk management. The next layer, which 
would be accessed only after failure of a CMI, would be covered by the 
Catastrophic Risk Insurance Fund, similar to the FDIC's Deposit 
Insurance Fund. This guarantee will be paid for by premiums set at 
rates designed to cover losses should a CMI fail. The Government 
guaranty of MBS would be specific and limited to investments in 
qualified mortgage backed securities, and would not protect the 
shareholders or creditors for the CMIs.
    At a high level, our plan is similar to the Bipartisan Policy 
Commission and several others that call for private capital in the 
predominant loss position with a fund standing behind that. Analysis 
presented by the Bipartisan Policy Commission finds that a 4 to 5 
percent aggregate loss cushion would absorb credit losses in a scenario 
of the severity just experienced (with a 30 to 35 percent decline in 
house prices) (p56). This cushion is a massive increase over the old 
minimum capital requirements on Fannie and Freddie of .45 percent on 
credit risk.\27\ All these plans recognize that mortgages would cost 
somewhat more, but estimate that the net effect will not be of a 
magnitude that would disrupt the market.
---------------------------------------------------------------------------
    \27\ This was the minimum statutory capital requirement for off 
balance-sheet obligations, with a 2.5 percent minimum for on-balance 
sheet assets; the regulator could and on occasion did require an 
additional factor (at its highest, +30 percent). The GSEs were also 
subject to risk-based capital requirements, but these were often lower 
than the statutory requirement.
---------------------------------------------------------------------------
    However, these plans differ as to the form that private capital 
would take. Some, like ours, call for specialized monoline 
institutions, while other plans envision a role for structured 
transactions. In my view, the institutional solution has significant 
advantages. It is easier to regulate and manage for safety and 
soundness, and it is more efficient at pooling and spreading risks. 
Structured transactions, to the extent that they cover a single or 
limited number of pools, cannot provide the benefit of a secondary 
market that can allocate risks and reserves across years, regions, 
lenders, and so on. The structured transactions approach also tends 
toward greater complexity and less transparency for purposes of pricing 
and regulation.
    Of course, for all these private-risk-capital proposals, one big 
unknown is whether and at what terms adequate private capital will be 
available. Under plans that call for a smaller role or no role at all 
for private capital, this question is of course less important.
Promote economic recovery and housing market stability
    A healthy mortgage secondary market is required for a healthy 
economy. This is true both with regard to shorter-term economic 
stability, and long-run stability.
    In the short term, uncertainty about the future state will continue 
to dampen lending activity, creating a self-fulfilling drag on 
recovery. At the same time, though, our tentative recovery would be 
derailed by disruptions to the current state. The Bipartisan Policy 
Commission calls for a congressionally adopted model coupled with a 
``dynamic, flexible transition'' for winding down the GSEs and moving 
toward the new model. The transition may take 5 to 10 years, and it can 
be eased by building the new model on the valuable infrastructure 
currently residing with Fannie and Freddie. This approach will help the 
market recover and transition to a new normal.
    We also must keep our eye on long-term economic stability, which 
derives from appropriate Government support of financial systems. While 
our plan calls for private capital to bear all but tail risk, we also 
recognize that the more central a role is played by private capital, 
the more instability is introduced. Private capital is inherently 
procyclical, meaning that it tends to be plentiful and cheap during 
good times and scarce and expensive during downturns, thus inflating 
bubbles and deepening downturns. While this is a challenging problem, 
we suggest that there are two keys to solving it.
    The first is to build in countercyclical capability in an 
intentional and effective way, through a series of dials that can be 
adjusted in times of economic stress when private capital simply flees. 
In addition to ramping up FHA activity, the other moving dials could 
include regulatory interventions and a shift in split of risk bearing. 
Our plan explicitly does not provide a guaranty for the GSE's 
historical portfolio function. Instead, we envision that in times of 
economic crisis, a Government guarantee of a specific class of senior 
debt (similar to the limited FDIC bank debt guarantee program of 2009) 
could accomplish this without reinstating the implied U.S. Government 
guarantee of all CMI debt.
    The second key to countercyclicality is to recognize that what is 
done in good times is just as important as what is done in times of 
stress. Adequate reserving and building up of capital is critical and 
can best be achieved using institutional risk taking solutions (rather 
than structured transactions). Regulatory discipline around pricing and 
risk management also needs to be imposed on the private market, and 
should be the charge of a strong regulator.
    In any event, the future state model should prioritize what is in 
the best interest of the overall economy over the long run. These 
decisions should not be left to a conservator, who has a substantively 
different mandate.
Comparison to a completely private market
    A completely private market alternative is one where all credit 
risk is borne by private capital. (Technically, the source of funding 
for all mortgages is ``private,'' but most of it relies on some form of 
Government credit guarantee in the event of default.)
    As the Bipartisan Policy Commission report documents, financing 
America's housing requires some 10 trillion dollars; attracting 
adequate capital without a Government backstop at that scale would 
surely be challenging. Commercial banks and savings institutions, which 
have Federal deposit insurance and, for larger institutions, implicit 
``too big to fail'' backing, only constitute a quarter of this debt, 
and according to the report, ``there is simply not enough capacity on 
the balance sheets of U.S. banks to allow a reliance on depository 
institutions as the sole source of liquidity for the mortgage 
market.''\28\ Today, the more purely private market is funding less 
than 20 percent of the rest.\29\
---------------------------------------------------------------------------
    \28\ Bipartisan Policy Center Housing Commission, ``Housing 
America's Future,'' p. 39.
    \29\ Center for American Progress calculations based on Federal 
Reserve ``Mortgage Debt Outstanding'' data, available at http://
www.Federalreserve.gov/econresdata/releases/mort
outstand/current.htm.
---------------------------------------------------------------------------
    A completely private market would mean a smaller market and a 
riskier one, and one that would not meet the fundamental requirements 
of stability and liquidity to support a robust housing market in this 
country. History has shown us that a housing finance system that relies 
on private risk-taking will be subject to a level of volatility that is 
not systemically tolerable, given the importance of housing to the 
economy and the American family. Moreover, completely private proposals 
would not achieve stability and, in fact, would expose taxpayers to 
even more risk from boom-bust cycles such as the one that triggered the 
financial crisis and that was fueled by recklessness in the private 
market.
    Importantly, even a well-regulated private market would 
predominantly offer loans with shorter durations and higher costs, 
while the long-term fixed-rate mortgage would not be available under 
terms affordable to most families.\30\ Likewise, rental housing would 
be less available to working families and would cost more, even as 
there is growing demand for it.
---------------------------------------------------------------------------
    \30\ Richard K. Green, Testimony before the Senate Banking 
Committee, ``Housing Finance Reform: Should there be a Government 
Guarantee?'' September 13, 2011, available at http://
www.banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=56068079-9c03-40d4-b36a-
72913d3850b4.
---------------------------------------------------------------------------
    Finally, there is the fact that, as demonstrated by the recent 
financial crisis, the Government has demonstrated that it will step in 
to prevent a systemic financial collapse regardless of structure. Even 
champions of a pure-private solution admit, that if that is the case 
``explicit guarantees with some taxpayer protection may be better than 
implicit guarantees with no protection.''\31\ They go on to suggest 
that ``taxpayers should evaluate all proposals for continuing 
guarantees with their eyes wide open and do what they can to reduce the 
extent to which they are unwittingly exploited in the future.''\32\
---------------------------------------------------------------------------
    \31\ Larry D. Wall, W. Scott Frame, and Lawrence J. White, ``Will 
Taxpayers Get a Truly Fair Deal with Housing Finance Reform?'' Center 
for Financial Innovation and Stability Notes from the Vault, March 
2013, available at http://www.frbatlanta.org/cenfis/pubscf/
nftv_1303.cfm.
    \32\ Ibid.
---------------------------------------------------------------------------
    We could not agree more. It is time to get to work on devising a 
system that provides the benefits of Government insurance with minimal 
risk to taxpayers through the structuring of a stable mix of public and 
privately administered credit insurance.
Conclusion
    From the 1930s through the end of the last century, the United 
States enjoyed a vibrant, stable, housing market that evolved to 
provide liquidity for mortgages in all parts of the country through 
every business cycle. The system was not perfect, but it contains 
valuable lessons for us as we look to rebuild. By applying those 
lessons to meet the goals outlined in this testimony, we have the 
opportunity to build a mortgage market that is fair, accessible, 
affordable, and fiscally sound, one that works better for more 
households and communities than ever before.
    Thank you for inviting me to talk about the work my colleagues and 
I have done and I would be happy to answer any questions.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM MEL 
                            MARTINEZ

Q.1. Currently, the U.S. housing finance system is largely 
comprised of loans insured by the Federal Housing 
Administration, loans guaranteed by the GSEs, and loans 
completely underwritten by private capital. Can you explain for 
us how the Commission's proposed policy would affect the 
agency-insured, conventional and jumbo loan spaces?

A.1. The commission expects that the single-family housing 
finance system of the future will have three distinct segments:

  1. LMortgages that are not covered by any Government 
        guarantee (including loans held in portfolio and 
        private-label mortgage-backed securities) would 
        comprise a substantial share of the overall market.

  2. LThe market share of mortgages insured or guaranteed by 
        the Federal Housing Administration (``FHA''), the U.S. 
        Department of Veterans Affairs (``VA''), and the U.S. 
        Department of Agriculture (``USDA'') would return to 
        pre-crisis levels.

  3. LMortgages covered by the new, limited Government 
        guarantee proposed by the commission would make up the 
        balance.

    After a suitable transition period, the commission 
recommends that the loan limits for the two Government-
guaranteed markets (#2 and #3 above) be established for each 
metropolitan area using a formula that takes into account the 
median house price in that area. Future policy choices by the 
Administration and Congress will determine the actual loan 
limits, but looking at historical loan limits before the crash, 
for many areas these loan limits might be in the range of 
$150,000 to $175,000 for the share of the market served by FHA, 
VA, and the USDA, and in the range of $250,000 to $275,000 for 
the share of the market covered by the new, limited Government 
guarantee proposed by the commission.
    The commission believes a dynamic, flexible transition over 
an extended period of time (5 to 10 years) will be needed to 
unwind the single-family operations of Fannie Mae and Freddie 
Mac in an orderly fashion and rebalance capital flows as the 
private sector steps in and the Government footprint becomes 
smaller. A gradual approach will minimize market disruptions 
and safeguard against the sudden potential loss of access to 
mortgage credit.
    During this transition period, several ``policy dials'' 
could be utilized to help reduce the size of Government 
involvement in the single-family mortgage market. A gradual 
reduction in the maximum loan limits for Fannie Mae, Freddie 
Mac, FHA, and VA should serve as the primary policy dial and 
will provide an indication of the private market's appetite for 
unsupported mortgage credit risk.
    Other policy dials have already been set in motion. The 
Federal Housing Finance Agency (``FHFA'') has recently 
increased the guarantee fees charged by Fannie Mae and Freddie 
Mac, in order to help move the Government pricing structure 
closer to the level one might expect if mortgage credit risk 
were borne solely by private capital, making the private market 
more competitive. The FHFA has also accelerated the reduction 
in the portfolios of Fannie Mae and Freddie Mac from 10 percent 
annually to 15 percent annually. In addition, FHFA has 
announced its intention to begin experimenting with single-
family mortgage-backed security (``MBS'') structures to allow a 
portion of the credit risk currently held by Fannie Mae and 
Freddie Mac to be sold to the private sector. Although only 
first steps, experimentation along these lines will enable 
greater private-sector involvement and set the stage for the 
transition to the new system.
    Another major action that would encourage a greater role 
for the private sector in the housing finance system would be 
clarifying the rules of the road going forward. Despite the 
Consumer Financial Protection Bureau's promulgation of final 
rules on Qualified Mortgages (``QM'') and mortgage servicing, 
regulatory uncertainty continues to hold back private-sector 
involvement. The pending rule regarding Qualified Residential 
Mortgages (``QRM''), along with other outstanding questions 
related to the Dodd-Frank legislation, must be resolved for the 
private sector to return to the mortgage market in a more 
robust manner.

Q.2. The Commission's proposal goes beyond ownership and calls 
for more Government assistance for rental, especially in low 
and extremely low-income households. How might the subsidies be 
structured? Through the tax code? Direct spending?

A.2. More than one-third of all households in the United States 
rent their homes. The Nation's 41 million renter households 
account for 35 percent of the U.S. population, and their 
numbers are likely to grow significantly in the coming years.
    With rental demand increasing, rents are rising in many 
regions of the country. As a result, our Nation's lowest-income 
renters find themselves spending larger shares of their incomes 
on housing than ever before. Our Nation's most vulnerable 
households--those with ``extremely low incomes'' of 30 percent 
or less of area median income--are squeezed even further by the 
huge mismatch between their numbers and the limited number of 
affordable rental units that are available in the market. In 
all, Federal rental assistance programs currently help 
approximately five million American households afford housing. 
However, because of the lack of resources, only about one in 
four renter households eligible for Federal rental assistance 
actually receives it.
    The commission proposes to respond to this problem with a 
multilayered approach that involves improving the performance 
of existing rental assistance programs, targeting most ``direct 
spending'' support to our Nation's most vulnerable households, 
and utilizing the tax code to support the production, 
preservation, and rehabilitation of rental units affordable to 
low-income households.

  1. LImproving Performance. The commission recommends a new 
        performance-based system for delivering Federal rental 
        assistance that focuses less on process and more on 
        achieving positive results for residents. This new 
        system will evaluate a housing provider's success in 
        achieving outcomes like improved housing quality, 
        enabling the elderly and persons with disabilities to 
        lead independent lives, and greater economic self-
        sufficiency for assisted households capable of work. 
        This proposed system would devolve responsibility from 
        the Federal Government to State and local 
        decisionmakers, as well as reward high-performing 
        housing providers with substantial deregulation, 
        providing greater freedom to innovate and depart from 
        standard U.S. Department of Housing and Urban 
        Development (``HUD'') practices and rules. Substandard 
        providers, on the other hand, would be subject to a 
        competitive process and potential replacement.

  2. LHelping the Most Vulnerable Households. The commission 
        recommends limiting eligibility for the Housing Choice 
        Voucher program to the most vulnerable households, 
        those earning 30 percent or less of area median income. 
        Given today's resource-constrained environment, the 
        commission believes that as families currently enrolled 
        in the program turn back their subsidies and new 
        vouchers are issued, it is appropriate to target 
        assistance to households at the lowest end of the 
        income scale. We recognize this deeper targeting 
        shrinks the pool of eligible beneficiaries, but it was 
        our judgment that this tradeoff is worth making if it 
        means that a greater number of our Nation's most 
        vulnerable households would be assured access to 
        assistance if they need it. To address the needs of 
        families above this income threshold, the commission 
        also recommends providing short-term emergency 
        assistance to low-income renters (those with incomes 
        between 30 and 80 percent of area median income) who 
        suffer a temporary setback such as a health crisis or 
        job loss. This assistance would be delivered through 
        the HOME Investment Partnerships program and could help 
        cover the payment of security deposits, back-rent and 
        other housing-related costs.

  3. LUtilizing the Tax Code to Increase the Supply of 
        Affordable Rental Housing. The commission supports 
        increasing the supply of affordable rental housing by 
        expanding the Low Income Housing Tax Credit (``LIHTC'') 
        by 50 percent over current funding levels and providing 
        additional Federal funding to help close the gap that 
        often exists between the costs of producing or 
        preserving LIHTC properties and the equity and debt 
        that can be raised to support them. The commission also 
        recommends additional Federal funding beyond current 
        levels to address the capital backlog in public 
        housing.

    In light of today's very difficult fiscal environment, the 
commission recognizes that a transition period will be 
necessary before these recommendations can be fully 
implemented. The commission supports the continuation of tax 
incentives for home ownership, but as part of the ongoing 
debate over tax reform and budget priorities, the commission 
also recommends consideration of modifications to these 
incentives to allow for increased support for affordable rental 
housing. Any changes should be made with careful attention to 
their effects on home prices and should be phased in to 
minimize any potential disruption to the housing market.
    As a final note, the commission recommends retaining in a 
reformed housing finance system the fee adopted by Congress in 
the Housing and Economic Recovery Act of 2008 and intended to 
be collected by the GSEs, to apply only to mortgages guaranteed 
by the Public Guarantor. Revenue generated should be used to 
fund the National Housing Trust Fund and the Capital Magnet 
Fund, with eligible activities to include housing counseling 
for first-time home buyers and support for affordable rental 
housing.

Q.3. The Commission's policy recommendation leans toward a 
system that is comparable to the Ginnie Mae platform that 
currently securitizes Government insured loans. That model 
utilizes about 300 lenders who must meet stringent capital 
requirements to be in the Government-backed securitization 
market. How might this work in a reformed housing finance 
framework? Will there be adequate competition and opportunity 
for small community banks and credit unions?

A.3. That is correct. The housing finance model endorsed by the 
commission is similar to the Ginnie Mae model.
    The commission strongly believes that access to the 
Government-guaranteed secondary market must be open on full and 
equal terms to lenders of all types, including community banks 
and credit unions, and in all geographic areas. Ginnie Mae's 
success in empowering smaller institutions to access the 
secondary market through its Ginnie Mae II program is 
instructive here. Under this program, one or more lenders may 
pool mortgages in the same security, which allows for a greater 
diversity of lenders to access the secondary market. The Ginnie 
Mae II program also enhances access for smaller financial 
institutions by allowing 1) securities to be issued with fewer 
mortgage loans than under the Ginnie Mae I program; 2) the 
pooling of adjustable rate mortgages and mortgages with a wider 
range of mortgage interest rates; and 3) the guaranteeing of 
securities backed by pools of manufactured housing loans where 
the interest rates can vary within a fixed range.
    The commission's proposal would also allow for the Federal 
Home Loan Banks to serve as master issuers of mortgage-backed 
securities for their community bank members, who would continue 
to act as the originators and servicers of mortgages.

Q.4. How much more might the risk premium charged to investors 
need to be in a normally operating market where private capital 
is in the first-loss position, than is currently charged by the 
GSEs? Would the FHA supplement this system or another entity? 
If so, would it do so at all times, or in cases of severe 
credit constriction?

A.4. While the new housing finance system proposed by the 
commission will minimize taxpayer risk by placing risk-bearing 
private capital in the ``predominant loss'' position, we 
recognize there is no such thing as a free lunch and that 
mortgage rates will rise as a result. Private credit enhancers 
will charge a fee to cover the cost of private capital to 
insure against the predominant loss if a mortgage default 
occurs. In turn, the Public Guarantor described in the 
commission's report will charge an unsubsidized fee to cover 
catastrophic risk should a private credit enhancer be unable to 
fulfill its obligations. This approach is far different from 
past practice in which there was little, if any, connection 
between actual risk and the guarantee fees charged by the two 
GSEs. The Public Guarantor will also charge a fee to cover the 
cost of its operations.
    According to an analysis performed by the well-respected 
financial research firm, Andrew Davidson & Co., Inc., the 
commission's proposal would increase mortgage costs for 
borrowers with no mortgage insurance by approximately 59 to 81 
basis points above the baseline interest rate. By comparison, 
the guarantee fees for mortgages now supported by Fannie Mae 
and Freddie Mac are approximately 50 basis points above the 
baseline interest rate (including a 10 basis point charge paid 
to the U.S. Treasury to finance the payroll tax deduction). 
What this means is that the actual net cost increase incurred 
by borrowers under our proposal would likely be in the range of 
9 to 31 basis points.
    While the commission recognizes the need for further work 
on the cost implications of its proposal, the estimates we have 
seen so far represent an acceptable tradeoff between increased 
costs and greater taxpayer protection.
    Since its creation during the Great Depression, the FHA has 
periodically been called upon to act as a stabilizing force 
within the single-family market. The FHA has also traditionally 
been an important source of mortgage credit for first-time home 
buyers and borrowers with low wealth. Looking ahead, the 
commission envisions an FHA that continues to play these two 
roles.
    Under normal economic conditions, the commission supports a 
more targeted FHA that returns to its traditional mission of 
primarily serving first-time home buyers. This goal can be 
achieved through the gradual reduction in FHA loan limits to 
those that existed before the collapse of the housing market. 
The recent concerns over the solvency of FHA's single-family 
mortgage insurance fund only underscore the urgency of what the 
commission has proposed--that far more risk-bearing capital 
must flow into our Nation's housing finance system. A system in 
which risk-bearing capital is plentiful will help reduce the 
pressure that is sometimes placed on the FHA to act as the 
mortgage-credit provider of last resort and allow it to perform 
its traditional missions more effectively and at lower risk to 
the taxpayer.

Q.5. How do we consider reforming the housing finance system 
considering that the recent CFPB rules on Qualified Mortgages 
have exempted agency insured and securitized loans? For better 
or worse, doesn't this imply that the GSEs in their current 
form would continue to exist for the next several years?

A.5. The commission supports the gradual winding down and 
elimination of Fannie Mae and Freddie Mac over a multiyear 
transition period. Although the commission's report does not 
address the QM exemption for mortgages insured and securitized 
by the two GSEs, my personal view is that this exemption could 
be narrowed during the transition period (for example, by 
reducing the GSE loan limits) as a way of reducing any 
regulatory advantage that the GSE-backed mortgage market may 
enjoy over the purely private market. Alternatively, as the 
operations of the two GSEs are wound down, a QM exemption could 
also be provided to mortgages that have met the baseline 
underwriting standards established by the Public Guarantor 
described in the commission's report.
    On a related issue, and speaking for myself only, it is 
critical that the QM rule and the pending QRM rule be aligned 
so that what constitutes a QM also qualifies as a QRM. Aligning 
the QRM and QM standards so that they work together--and not at 
cross-purposes--will reduce uncertainty, while promoting 
prudent mortgage lending. However, if Federal regulators 
ultimately decide to maintain the stringent downpayment and 
other restrictive requirements found in the proposed definition 
of QRM, they will add to the confusion in the marketplace and 
encourage more private capital to retreat to the sidelines.

Q.6. We already have a number of Federal regulatory agencies 
that oversee the housing and mortgage finance, as well as 
related State laws and agencies. In terms of overseeing a 
reformed housing finance platform--whether wholly private or 
with Government involvement--how should regulation be handled?

A.6. The commission proposes to replace the GSEs with an 
independent wholly owned Government corporation, the ``Public 
Guarantor,'' that would provide a limited catastrophic 
Government guarantee for both the single-family and rental 
markets. Unlike the GSEs, the Public Guarantor would not buy or 
sell mortgages or issue mortgage-backed securities. It would 
simply guarantee investors the timely payment of principal and 
interest on these securities. As you point out, the model 
endorsed by the commission is similar to Ginnie Mae, the 
Government agency that wraps securities backed by federally 
insured or guaranteed loans. Other than the Public Guarantor, 
all other actors in the new system--originators, issuers of 
securities, credit enhancers, and mortgage servicers-should be 
private-sector entities fully at risk for their own finances 
and not covered by either explicit or implicit Government 
guarantees benefiting their investors or creditors.
    In this new system, the Public Guarantor would have 
significant standard-setting and counterparty oversight 
responsibilities. These responsibilities include qualifying 
institutions to serve as issuers, servicers, and private credit 
enhancers; 2) ensuring that these institutions are well 
capitalized; 3) establishing the guarantee fees to cover 
potential catastrophic losses; 4) ensuring the actuarial 
soundness of the two catastrophic risk funds for the single-
family and rental segments of the market; and 5) setting 
standards (including loan limits) for the mortgages backing 
Government-guaranteed securities. With respect to rental 
finance, the Public Guarantor would also have the authority to 
underwrite multifamily loans directly and would be responsible 
for establishing an affordability threshold that would 
primarily support the development of rental housing that is 
affordable to low- and moderate-income households.
    As a Government corporation, the Public Guarantor will be a 
self-supporting institution that does not rely on Federal 
appropriations but rather finances the two catastrophic funds 
and its own operational expenses through the collection of 
guarantee fees. The Public Guarantor should operate 
independently of any existing Federal department and, with this 
greater independence, should be able to respond more quickly to 
contingencies in the market and operate with greater efficiency 
in making staffing, budgeting, procurement, policy, and other 
decisions related to mission performance.
    To ensure continuity and build on existing Government 
capabilities, Ginnie Mae--enhanced with greater authorities and 
flexibilities--could assume the role of the Public Guarantor. 
In that case, Ginnie Mae would be removed from HUD, spun out as 
a separate and independent institution, and given the necessary 
authorities so that it could successfully discharge its 
responsibilities, including performing its traditional function 
as the guarantor of MBS backed by loans insured by the FHA, VA, 
USDA, and HUD's Office of Public and Indian Housing.
    The commission recommends that the Public Guarantor be led 
by a single individual, appointed by the President of the 
United States and confirmed by the U.S. Senate, who would serve 
a director. The commission also recommends the establishment of 
an Advisory Council to the Public Guarantor consisting of the 
chairman of the Board of Governors of the Federal Reserve 
System as chairman of the Council, along with the director of 
the Public Guarantor, the secretary of the U.S. Department of 
the Treasury, and the secretary of HUD. The Advisory Council 
would meet on at least a quarterly basis to share information 
about the condition of the national economy, marketplace 
developments and innovations, and potential risk to the safety 
and soundness of the Nation's housing finance system.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM PETER J. 
                            WALLISON

Q.1. You speculate that the Treasury's ownership of preferred 
stocks in the GSEs has potentially limited the ability of 
either Fannie or Freddie to retain enough earnings to grow 
their operations and ultimately move out of conservatorship. 
Could you elaborate for us?

A.1. The key question is whether Fannie and Freddie can move 
out of the conservatorship as GSEs. The longer they remain in 
the conservatorship and central to the liquidity of the housing 
market, the more likely it will be that Congress will 
eventually restore them to their former roles as GSEs. To do 
that, they will have to be capitalized. The fact that all their 
earnings are now paid to the Treasury means that they cannot 
generate any capital internally. Thus, to return as GSEs they 
will have to be attractive enough as investments to find 
private capital. On the other hand, if they were able to retain 
their profits, they would become very valuable. They would not 
need to raise private capital to operate. The common and 
preferred stock (that is, the preferred stock not held by 
treasury) are still outstanding and are owned by speculators 
who have been and will be urging Congress to restore their 
franchise as GSEs. If that happens, these speculators will reap 
substantial profits. But if Fannie and Freddie have no capital 
and have to be recapitalized before they can leave the 
conservatorship, the speculators will lose interest and there 
will be less pressure on Congress to restore their GSE 
franchises.

Q.2. You critique proposals that include a Government back-stop 
to a mostly private system, as being a driver of lower quality 
mortgages; mainly because it would reduce investor risk. How 
does this idea hold up in a post QM/QRM secondary market? Isn't 
mortgage underwriting already more rigorous today than what 
existed prior to the finance meltdown?

A.2. To some extent, yes. Negative amortization mortgages, no 
doc-low doc mortgages and interest only mortgages are now 
prohibited. However, it is an illusion to believe that subprime 
and other low-quality mortgages have been prohibited by QM. In 
fact, they have been encouraged. The traditional prime mortgage 
had a substantial downpayment, a good borrower credit score at 
660 or above, and a low debt-to-income ratio in the mid-to-high 
30s at the back end. Mortgages like this had less than a 1 
percent default rate. However, the QM requires neither a 
downpayment nor a good credit score, and the DTI is now as high 
as 43 percent. The only question under QM (apart from the price 
of the loan) is whether the buyer can afford the mortgage at 
the time of the commitment. That does not take account of any 
of the vicissitudes of life, such as job losses, illness, 
recessions, divorce, etc that occur after the closing. 
Moreover, the lender gets safe harbor protection for an even 
higher DTI if the mortgage is approved by the automated 
underwriting systems of the GSEs or FHA. This means that as 
long as the lender can get the approval of a Government AUS it 
can make a mortgage to a borrower who makes a 3 percent 
downpayment, and has a 580 credit score and a 50 percent DTI at 
the back end. The FHA insures these mortgages today. Loans like 
this used to be called subprime loans, and have a 25 percent 
default ratio over the usual 10 year cycle. In a competitive 
market, that's where the lenders will go, and the Government 
will approve these mortgages through the GSEs and FHA, so the 
lenders can claim the safe harbor. We also know that the 
Government will institute polices to push for even weaker 
credit standards. We have just recently seen evidence of this 
as the FHA actively encourages lenders to originate loans that 
have a 15, 20, even, 25 percent chance of foreclosure-all of 
which will receive the benefit of the safe harbor. Over time, 
because of the poor quality of the mortgages that will result, 
we will have another meltdown like 2007 and 2008. A Government 
backstop, as I said in my testimony, will only make things 
worse, since it eliminates any reluctance on the part of 
investors to buy MBS based on these subprime and low-quality 
mortgages. The investors know that the Government will bail 
them out.

Q.3. In a recent Wall Street Journal article, you offer that 
some of the origins of the subprime meltdown were the 1992 
Community Reinvestment Act (CRA) and recent increases in the 
mortgage limits at the GSEs and FHA. While there is no doubt 
larger than normal volumes of nonperforming loans in these 
organization's portfolios, doesn't research show that CRA and 
higher value loans actually perform quite well?

A.3. No. Actually, to be precise, CRA was only one of the 
factors that contributed to the mortgage meltdown and the 
financial crisis. The affordable housing goals placed on the 
GSEs were a larger and more important factor. Nevertheless, in 
my view, the analyses that have been done of CRA loans are 
wrong, and I believe were skewed to satisfy the supporters of 
CRA in Congress and elsewhere. First, the analyses covered only 
high cost loans, but most banks that make CRA loans have to 
cross-subsidize them, so the loans are not high cost and were 
not considered in the Fed's study. Second, the conclusion of 
the Fed's study was that CRA loans didn't perform any worse 
than subprime loans generally. That isn't what anyone would 
call ``quite well.'' Third, if you want to know how CRA loans 
perform look at the CRA-eligible loans acquired by Fannie and 
Freddie. These two firms became insolvent and had to be bailed 
out by the taxpayers even though they made efforts to buy only 
the best of the subprime loans available to them, and actively 
sought to acquire CRA loans from banks.

Q.4. Is it not accurate to say that Fannie and Freddie were not 
originating subprime loans, but were simply buying subprime 
backed, private label securities for the same reason other 
buyers were in the mid-2000s, because they were profitable in 
the short-term, not because of Government mandates? As a prime 
mover in the past mortgage securities bubble, shouldn't we be 
more suspect of purely private housing finance systems? Hasn't 
the private market shown at least an equal inability to 
accurately price risk with the public sector, whether through 
negligence or even worse, a tendency to misstate risk for gain 
of profit?

A.4. I do not defend what the private sector did in the years 
leading up to 2008, but I contend--and the data show--that the 
primary cause of the mortgage meltdown and the financial crisis 
was the Government's housing policies. In fact, without these 
policies I do not believe there would have been a financial 
crisis. The private sector makes mistakes and always will, but 
when their mistakes are serious enough they go into bankruptcy 
and disappear; only the Government can create a problem so 
large that it causes a financial crisis. What the private 
sector was doing, apart from the Government's activity, was 
simply too small to affect the larger economy. By 2008, half of 
all mortgages in the United States--28 million loans--were 
subprime or Alt-A. Of that 28 million, 74 percent were on the 
books of Government agencies like the GSEs and FHA. That shows 
where the demand for these loans came from, and they wouldn't 
have been made without that demand. It should be obvious that 
you can't just originate junk and sell it; there has to be a 
willing buyer, and in the overwhelming number of cases that 
buyer was the Government, particularly Fannie and Freddie. The 
private MBS based on subprime and Alt-A loans helped the GSEs 
meet the affordable housing goals. If these loans were so 
profitable, Fannie and Freddie would have bought as many as 
they could, but the data shows that as the AH goals rose their 
purchases of subprime loans also rose, never exceeding the 
applicable goal by very much. And in the end, of course, they 
became insolvent from buying these ``profitable'' loans. It is 
also an urban myth that the only subprime loans they bought 
were in private MBS. In reality, by 2008, the GSEs held or had 
guaranteed a total of $1.84 trillion in subprime and Alt-A 
loans. These were whole loans that they had purchased and 
either held in portfolio or securitized. At the same time, they 
held only $121 billion in subprime loans and $72.6 billion in 
Alt-A loans (a total of $193.6 billion) that were backing 
privately issued MBS. In other words, the subprime and Alt-A 
loans in privately issued MBS were only a little more than 10 
percent of the total exposure of Fannie and Freddie to these 
low quality loans.

Q.5. What role would quality housing counseling play in a 
reformed housing finance system? Couldn't it help with ensuring 
that mortgage consumers don't face an `information 
disadvantage' like they faced in the subprime crisis?

A.5. It could help, but it's marginal. People want to buy homes 
and if they are offered the opportunity and believe they can 
afford it, they will ignore counseling or rationalize it.

Q.6. How do we consider reforming the housing finance system 
considering that the recent CFPB rules on Qualified Mortgages 
have exempted agency insured and securitized loans? For better 
or worse, doesn't this imply that the GSEs in their current 
form would continue to exist for the next several years?

A.6. Yes, but the law can be changed. Dodd-Frank, the CFPB and 
Qualified Mortgages are not immutable. If Congress were to 
require, for example, that the GSEs can only approve or acquire 
prime mortgages, much would change.

Q.7. We already have a number of Federal regulatory agencies 
that oversee the housing and mortgage finance, as well as 
related State laws and agencies. In terms of overseeing a 
reformed housing finance platform--whether wholly private or 
with Government involvement--how should regulation be handled?

A.7. The answer depends entirely on what form of housing 
finance system is adopted. If the BPC system is adopted, a lot 
of new regulation will be required, because all the issuers of 
the MBS backed by the Government will have to be regulated to 
make sure that they remain well-capitalized. This is necessary 
because the investors in the MBS will not care about the 
quality of the underlying mortgages, nor will the creditors of 
the issuers, who will assume that they will be bailed out by 
the Government if one or more of the issuers fails. The BPC 
itself proposes that the guarantor of the MBS would be the 
regulator. On the other hand, if the plan I outlined were to be 
adopted, the only regulation necessary would be a requirement 
that only prime loans be securitized. That could be done by 
FHFA.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JANNEKE 
                           RATCLIFFE

Q.1. Can you describe for us the role of ``shadow banking 
units'' in the mortgage finance space prior to 2008? What 
effect did they have on mortgage underwriting standards?

A.1. This interesting question has been the subject of much 
literature on the crisis and financial sector. While purely 
private ``shadow banking units'' had little to do with the 
Government-Sponsored Entities (GSEs), shadow banks did have a 
significant role in the crisis.
    Shadow banks were part of what the Financial Crisis Inquiry 
Commission Report calls ``the runaway mortgage securitization 
train.''\1\ The shadow banking system's lack of transparency, 
huge leverage and debt loads, short-term loans, and risky 
assets were the rickety foundation that crumbled when housing 
prices fell and mortgage markets seized up. It is most likely 
true that if shadow banks had not provided the liquidity and 
capital to buy up mortgage securities and real estate backed 
assets, the market would not have been quite so frenzied, and 
mortgage-underwriting standards would not have fallen quite so 
dramatically.
---------------------------------------------------------------------------
    \1\ http://fcic.law.stanford.edu/report (FCIC Report).
---------------------------------------------------------------------------
    Meanwhile, as the chart below shows, the GSE's lost share 
to the pure private sector during the bubble period.


    One illuminating aspect of the housing bubble and crisis 
was that the Government-Sponsored Enterprises (GSE) maintained 
somewhat higher mortgage underwriting standards than the rest 
of the market, and the mortgages they securitized and loans 
they held defaulted at a much lower rate than the private 
market. From 2004 to 2006 in particular, well over 70 percent 
of GSE purchases were low risk loans, compared to well under 
half of private label securitized loans, while the PLS sector 
originated a greater share and volume of high-risk loans than 
the GSEs. While it is thus not surprising that the PLS market 
experienced default levels three to four times the those of the 
GSEs for those years' books of business, what is instructive is 
that even within each risk category (of LTV, credit score and 
loan type) the GSE's loans performed better than PLS loans 
within the same risk category.\2\
---------------------------------------------------------------------------
    \2\ FHFA, Data on the Risk Characteristics and Performance of 
Single Family Mortgages Originated from 2001 through 2008 and Financed 
in the Secondary Market. September 13, 2010. http://www.fhfa.gov/
webfiles/16711/RiskChars9132010.pdf.
---------------------------------------------------------------------------
    Moreover, loans originated through the shadow banking 
system were more likely to be adjustable rate, option-ARMS, 
broker originated, and to carry risky features such as no 
documentation and prepayment penalties. Analysis by UNC finds 
that these features are strongly associated with higher 
likelihood of default, compared to similar borrowers who are 
given prime, well underwritten, fixed-rate mortgages.\3\
---------------------------------------------------------------------------
    \3\ Ding, Lei, Roberto Quercia, Wei Li and Janneke Ratcliffe. Risky 
Borrowers or Risky Mortgages. Disaggregating Effects Using Propensity 
Score Models. Journal of Real Estate Research 2011, Vol. 33, No. 2, pp. 
245-278 May, 2010.
---------------------------------------------------------------------------
    The evidence suggests that unregulated shadow banks helped 
fuel the lowering of mortgage underwriting standards and the 
subsequent default crisis.

Q.2. Are a 20 percent downpayment, established credit, and low 
debt-to-income the best indicators of loan performance? Can 
well documented, prime loans be written for households that 
cannot meet these traditional loan requirements, and still 
perform?

A.2. The headline takeaway from this hearing should be that 
many good, safe loans have been (and can be) made with low 
downpayments and nontraditional ways to verify 
creditworthiness. There is some correlation between loan 
performance and established traditional credit and high 
downpayment. While these characteristics may seem appealing as 
indicators of loan performance, they should not be taken as the 
only way, and certainly not the best way, to measure the safety 
and soundness of loans.
    As a case in point, the UNC Center for Community Capital 
has tracked the performance of nearly 50,000 loans to low 
wealth, lower income borrowers, funded beginning in 1999, 
through a special program offered by a community development 
financial institution (Self-Help) and Fannie Mae. These loans 
were originated by banks around the country. The median 
borrower earned around $35,000 at origination, and more than 
half the borrowers put down less than 5 percent. Yet this 
portfolio has performed relatively well, especially considering 
the circumstances the borrowers have lived through over the 
last several years. The default rate on these loans has been 
below that for prime ARM loans, and well below that for 
subprime loans. These low downpayment borrowers have broadly 
managed to maintain home ownership and even build some equity, 
depending on their timing, even during a period of extreme 
volatility in real estate values and economic conditions.\4\
---------------------------------------------------------------------------
    \4\ Quercia, Roberto, Allison Freeman and Janneke Ratcliffe. 
Regaining the Dream: How to Restore the Promise of Homeownership for 
America's Working Families. The Brookings Institution. 2011.
---------------------------------------------------------------------------
    That is not the only case of low downpayment mortgages 
being done safely. For example, the Nation's State housing 
finance agencies (HFAs) have served low downpayment, first-time 
home buyers for decades. The chart below compares the 
performance of HFA mortgage revenue bond loans (HFA MRB) to 
other types of loans, and shows that despite the high loan to 
values, the HFA loans have performed on a par with all loans 
and much better than subprime.\5\
---------------------------------------------------------------------------
    \5\ Moulton, Stephanie and Roberto Quercia, 2013, forthcoming. 
Access and Sustainability for First Time Homebuyers: The Evolving Role 
of State Housing Finance Agencies.
---------------------------------------------------------------------------
% Loans 90+ Days Delinquent as of June 30, 2012


Source: Mortgage Bankers Association (MBA) National Delinquency Survey 
Q3, 2012; compared to HFA self-reported loan performance data per 2012 
author survey of State HFAs; N=30 HFAs with loan performance data. 
Moulton and Quercia (2013).

    As we consider what makes loans healthy and the housing 
market sustainable, we must recognize that there is a crucial 
tradeoff between risk and access. Mandating simplistic, one-
dimensional underwriting rules ignores the balance between risk 
and access. The UNC Center for Community Capital estimated that 
requiring a 20 percent downpayment would exclude 60 percent of 
creditworthy borrowers from the housing market.\6\ Putting too 
much stock into the 20 percent downpayment, or onto a specific 
agency's estimated credit score has the potential to seriously 
block the home ownership hopes of millions of families without 
accumulated wealth and easy access to credit and prevent them 
from getting a sustainable and low-risk mortgage. Instead, 
lenders should be encouraged to underwrite carefully and to 
offer safe products to mitigate the risks facing borrowers with 
smaller equity cushions.
---------------------------------------------------------------------------
    \6\ Quercia, Roberto, Lei Ding, Carolina Reid. Balancing Risk and 
Access: Underwriting Standards for Qualified Residential Mortgages. 
January, 2012. http://www.ccc.unc.edu/abstracts/QRMunderwriting.php.

Q.3. Millions of Americans face foreclosure, many with fixed-
rate loans, due to economic reasons beyond their control. That 
is, they did not take out exotic or unreasonable loans--but are 
feeling the market effects from those that did--due to high 
unemployment and foreclosure. Considering this point, is it 
possible that our housing finance market needs some flexible 
lending products like lease-purchases, risk shared loans, or 
shared equity loans that might preserve affordability and 
spread risk between the investor and borrower--without fully 
---------------------------------------------------------------------------
relying on Government backing?

A.3. High unemployment brought about by the foreclosure crisis 
is certainly negatively impacting the lives of millions of 
Americans. Nevertheless, many homeowners successfully sustained 
home ownership throughout this crisis, even those with low 
downpayments and nontraditional credit histories and that 
having a safe product has proven to provide some protection.
    Lending products like lease-purchases, risk shared loans, 
or shared equity loans are certainly one set of solutions that 
could allow some households to safely navigate home ownership, 
but they are not the products on which to build the entire U.S. 
housing market. These innovative products work best in niche 
markets that complement the standard loan market. There are a 
number of homeowners who are otherwise fully qualified for 
ownership (stable income, good credit, etc.) but lack family 
wealth for the downpayment. In the shared equity approach, a 
governmental or nonprofit finance source partners with that 
homeowner by providing some or all of the necessary 
downpayment, and shares in future appreciation of the home. The 
terms of the arrangement are intended to be a balance between a 
reasonable long-term share of appreciation to the homeowner, 
while keeping the house affordable to the next low/moderate-
income home buyer. This approach can also be used for 
underwater borrowers as part of a restructuring.\7\
---------------------------------------------------------------------------
    \7\ http://www.americanprogress.org/wp-content/uploads/issues/2008/
04/pdf/shared_equity.pdf.
---------------------------------------------------------------------------
    During the foreclosure crisis, shared equity home ownership 
consistently showed very low foreclosure rates even though the 
borrowers were similar in income, wealth and other 
characteristics as many of the homeowners subject to predatory 
lending. Community land trusts in particular reduced 
foreclosure rates to under 1 percent.\8\
---------------------------------------------------------------------------
    \8\ http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/
hbtl_lubell.pdf, at pp 10.
---------------------------------------------------------------------------
    One study by the Center for American Progress estimated 
that if even a reasonable amount of annual Federal spending on 
home ownership were channeled into shared equity ownership over 
the course of 5 years, ``a one-time investment of $5 billion 
could make home ownership possible for between 600,000 and 1.5 
million families over a 30-year period, based on typical rates 
of turnover, and depending upon size of initial subsidy.''\9\
---------------------------------------------------------------------------
    \9\ http://www.americanprogress.org/wp-content/uploads/issues/2010/
02/pdf/shared_equity.pdf.
---------------------------------------------------------------------------
    This is just one example of the need for avenues for safe 
innovation through research and development, activities that 
can be fostered with a properly structured secondary market. 
The Mortgage Finance Working Group proposes creating a new 
Market Access Fund that provides funding and a platform to 
quickly and efficiently collect data on such innovative loan 
products, which will allow market participants to build best 
practices and a foundation of experience for offering these new 
products.\10\
---------------------------------------------------------------------------
    \10\  http://www.americanprogress.org/issues/housing/report/2011/
01/27/8929/a-responsible-market-for-housing-finance/ (MFWG Proposal).
---------------------------------------------------------------------------
    It is also important to remember that the housing crash was 
much worse than it had to be, and one important reason it was 
so devastating is that mortgage servicing was not up to the 
task. Much has been learned about how to service distressed 
loans to minimize foreclosures and investor losses. Many who 
lost their homes were not given access to lower rate 
refinances, principal reductions, and other loss mitigation 
actions. In fact, even at this time, more can and should be 
done to enable performing borrowers to get out of onerous loan 
terms.

Q.4. What role would quality housing counseling play in a 
reformed housing finance system? Couldn't it help with ensuring 
that mortgage consumers don't face an `information 
disadvantage' like they faced in the subprime crisis?

A.4. Housing counseling could play an important role in a 
reformed housing finance system. In particular, the Bipartisan 
Policy Center's Housing Commission identifies the HUD Housing 
Counseling Assistance Program as an exemplary public-private 
partnership, which shows how to use counseling as a credit 
enhancer to help underserved communities access credit and home 
ownership.\11\ The housing counseling system, as it exists 
today, is a great tool, or enhancement, for getting people into 
safe mortgages.
---------------------------------------------------------------------------
    \11\ http://bipartisanpolicy.org/sites/default/files/
BPC_Housing%20Report_web_0.pdf (BPC Report).
---------------------------------------------------------------------------
    Counseling can reduce the risk of default. Previous studies 
suggests that counseling is effective at reducing default and 
delinquency, though the magnitude and explanations were 
mixed.\12\ \13\ Two newer studies provide empirical evidence 
that prepurchase counseling can reduce default rates by around 
30 percent. Brand new research from Freddie Mac shows large and 
significant effects of housing counseling on reducing 
delinquency. Zorn et al. (2013) (Freddie Mac) found that 
counseling reduces delinquency by 29 percent for first-time 
home buyers, and estimated the dollar benefit of counseling in 
reducing risk to be about $1,000.\14\ Similarly, Mayer et al. 
found that clients who used Neighborworks housing counseling 
were one third less likely to become 90+ days delinquent on 
their homes.\15\
---------------------------------------------------------------------------
    \12\ http://www.housingamerica.org/RIHA/RIHA/Publications/
76378_10554_Research_
RIHA_Collins_Report.pdf.
    \13\ Agarwal, Sumit, Gene Amromin, Itzhak Ben-David, Souphala 
Chomsisengphet, and Douglas D. Evanoff. 2009. Do Financial Counseling 
Mandates Improve Mortgage Choice and Performance? Evidence from a 
Legislative Experiment. SSRN eLibrary.
    \14\ Zorn, Avila, & Nguyen. The Benefits of Pre-Purchase 
Homeownership Counseling.
    \15\ http://www.nw.org/network/newsroom/documents/
ExperianMayer_FullReport.pdf.
---------------------------------------------------------------------------
    Counseling and education is not a simple solution, however. 
While housing counseling is beneficial, it cannot substitute 
for good products, good servicing, and consumer protection. 
Counseling also faces significant resource limitations. Despite 
the demand for counseling increasing from 250,000 to nearly 2 
million annual counseled households over the past 15 years, the 
counseling system, which is characterized by nonprofit, HUD-
approved counselors, often lacks financial resources.\16\ The 
challenge for the future will be obtaining sufficient funding 
and scaling up infrastructure to meet growing demand for 
counseling.
---------------------------------------------------------------------------
    \16\ http://huduser.org/portal/publications/hsg_counsel.pdf.

Q.5. How do we consider reforming the housing finance system 
considering that the recent CFPB rules on Qualified Mortgages 
have exempted agency insured and securitized loans? For better 
or worse, doesn't this imply that the GSEs in their current 
---------------------------------------------------------------------------
form would continue to exist for the next several years?

A.5. This is a very important question to consider when 
constructing a reformed housing finance system. CFPB's 
Qualified Mortgage rule was written with the current system, 
notably the GSE's, in mind. We generally applaud the acceptance 
of loans underwritten through the AUS systems of the GSEs as 
Qualified Mortgages, provided those AUS systems are carefully 
monitored for quality and fairness and that the underwriting 
exceptions are coupled with proven, safe product features. 
Though it may need to be rewritten, the QM rule's core could be 
extended into a post-GSE world as long as it accepts 
underwriting decisions made by a qualified Automated 
Underwriting System. The key is to ensure that there is strong 
independent validation and oversight of any such approved 
system, coupled with real risk exposure on the part of the 
sponsor of such systems.

Q.6. We already have a number of Federal regulatory agencies 
that oversee the housing and mortgage finance, as well as 
related State laws and agencies. In terms of overseeing a 
reformed housing finance platform--whether wholly private or 
with Government involvement--how should regulation be handled?

A.6. We have seen the results of markets with patchwork, 
conflicting regulation on multiple levels, and it failed. The 
Financial Crisis Inquiry Report details the way that Government 
permitted financial firms to choose which regulators oversaw 
them in what was described as ``a race to the weakest 
supervisor.''\17\ As irresponsible lending and fraud became 
pervasive, the Federal Reserve was slow to act, State 
regulators were often preempted by Federal agencies,\18\ and 
the Office of the Comptroller of the Currency and the Office of 
Thrift Supervision held turf wars over regulation.
---------------------------------------------------------------------------
    \17\ FCIC Report.
    \18\ Ding, Lei, Roberto Quercia, Carolina Ried and Alan White. 
August, 2010. The Impact of Federal Preemption of State Anti-Predatory 
Lending Laws on the Foreclosure Crisis. http://www.ccc.unc.edu/
documents/Preemption_final_August%2027.pdf.
---------------------------------------------------------------------------
    An important principle of housing finance reform should be 
unifying regulatory oversight over the whole market. The 
Mortgage Finance Working Group (MFWG) and BPC's Housing 
Commission have similar conceptualizations for how to handle 
regulation.\19\ \20\ Both see three important levels with 
slightly different names: mortgage and securities issuers, 
Chartered Mortgage Institutions/private credit enhancers, and a 
Catastrophic Risk Insurance Fund/Public Guarantor. In both 
cases, the Government entity responsible for insuring 
catastrophic risk would also set standards for product 
structure, underwriting and servicing, in line with national 
servicing standards. The BPC's Government entity would also 
provide a charter or qualification for issuers, servicers, and 
credit enhancers. The private credit enhancers would provide 
regular and detailed reports to the Government entity, which 
would also administer quarterly stress tests to ensure they 
have a sufficient amount of capital to withstand shocks to 
housing prices. Both scenarios also propose funding the 
Government entity through guarantee fees on insured securities, 
which could serve as the funding mechanism for the overarching 
market regulator.
---------------------------------------------------------------------------
    \19\ MFWG Propopsal.
    \20\ BPC Report.
