[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
__________
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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
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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.
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\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.
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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\
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\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.
---------------------------------------------------------------------------
* The views expressed are those of the author alone and do not
necessarily represent those of the American Enterprise Institute.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
\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''.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
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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.
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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\
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\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.
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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\
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\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.
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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\
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\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.
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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\
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\5\ Moulton, Stephanie and Roberto Quercia, 2013, forthcoming.
Access and Sustainability for First Time Homebuyers: The Evolving Role
of State Housing Finance Agencies.
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% 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.
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\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
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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\
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\7\ http://www.americanprogress.org/wp-content/uploads/issues/2008/
04/pdf/shared_equity.pdf.
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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\
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\8\ http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/
hbtl_lubell.pdf, at pp 10.
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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\
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\9\ http://www.americanprogress.org/wp-content/uploads/issues/2010/
02/pdf/shared_equity.pdf.
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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\
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\10\ http://www.americanprogress.org/issues/housing/report/2011/
01/27/8929/a-responsible-market-for-housing-finance/ (MFWG Proposal).
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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.
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\11\ http://bipartisanpolicy.org/sites/default/files/
BPC_Housing%20Report_web_0.pdf (BPC Report).
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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\
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\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.
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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.
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\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
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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.
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\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.
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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.
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\19\ MFWG Propopsal.
\20\ BPC Report.