[Senate Hearing 113-95]
[From the U.S. Government Publishing Office]


                                                         S. Hrg. 113-95

 
              ESSENTIAL ELEMENTS OF HOUSING FINANCE REFORM
=======================================================================


                                HEARING

                               before the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS

                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

   DISCUSSING THE ESSENTIAL ELEMENTS THAT MUST BE A PART OF HOUSING 
  FINANCE REFORM LEGISLATION AND ENSURING THAT REFORM OF THE HOUSING 
  FINANCE SYSTEM IMPROVES THE CURRENT SYSTEM WITHOUT CREATING MARKET 
 DISRUPTIONS THAT THREATEN OUR HOUSING RECOVERY OR INCREASE COSTS FOR 
                               BORROWERS

                               __________

                           SEPTEMBER 12, 2013

                               __________

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


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




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska4
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 Fuher, Professional Staff Member

                  Kari Johnson, Legislative Assistant

                  Greg Dean, Republican Chief Counsel

            Chad Davis, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                      THURSDAY, SEPTEMBER 12, 2013

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2
    Senator Tester...............................................     3

                               WITNESSES

Julia Gordon, Director of Housing Finance and Policy, Center for 
  American Progress..............................................     4
    Prepared statement...........................................    35
    Response to written question of:
        Senator Corker...........................................    85
Jerome T. Lienhard, II, President and Chief Executive Officer, 
  SunTrust Mortgage, Inc.........................................     5
    Prepared statement...........................................    54
    Response to written question of:
        Senator Corker...........................................    86
Richard Johns, Executive Director, Structured Finance Industry 
  Group..........................................................     7
    Prepared statement...........................................    55
    Response to written question of:
        Senator Corker...........................................    88
Mark Zandi, Ph.D., Chief Economist, Moody's Analytics............     9
    Prepared statement...........................................    62

                                 (iii)


              ESSENTIAL ELEMENTS OF HOUSING FINANCE REFORM

                              ----------                              


                      THURSDAY, SEPTEMBER 12, 2013

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:17 a.m. in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order.
    I would like to thank the witnesses for joining us today as 
the Committee sets out on a path that I hope will lead to 
comprehensive housing finance reform. Our witnesses are here to 
help educate us regarding what essential elements must be a 
part of housing finance reform legislation in order for it to 
be credible and successful. We must ensure that reform of the 
housing finance system improves our current system and does not 
create market disruptions that threaten our housing recovery or 
unnecessarily increase costs for borrowers.
    During our first housing finance reform hearing this 
Congress, Ranking Member Crapo and I explored whether a 
bipartisan solution to reform the housing market was possible. 
At that time, there was no agreement regarding the role of the 
Federal Government let alone what a new structure could look 
like. I would like to thank Senators Corker and Warner and the 
cosponsors of the bill for showing that there is bipartisan 
support for a Government guarantee in a new housing system and 
willingness to move legislation forward.
    Recognizing that there are many details that need to be 
explored and discussed by the full Committee and that many 
Committee Members have input of their own that they would like 
to include, we plan to hold hearings this fall to explore the 
finer points of proposed changes. This will give the entire 
Committee the opportunity to explore the various modifications 
and wholesale changes that we will consider. Ranking Member 
Crapo and I are undertaking this in-depth process with the goal 
of reaching agreement by the end of the year.
    To give a sense of what a massive undertaking this process 
is, our housing finance market is the second largest and most 
liquid financial market in the world. So the consequence of 
getting any major reform wrong cannot be overstated. To that 
end, it is essential that we fully understand the mechanics of 
how a new system would function, and how we should smoothly 
transition from the current system to a new one. Any new 
housing finance system and the transition to it could 
dramatically change the way that families qualify and affect 
who can afford to buy a home.
    I have asked the experts testifying today to help us 
analyze proposed changes to the system and to help us 
understand which essential pieces of the current system should 
be preserved. Better understanding the interaction between the 
pieces that we would like to preserve--like widely available, 
30-year, fixed-rate mortgages--and the changes we would like to 
make is critical in order to achieve meaningful improvements to 
the current system.
    With that, I will turn to Ranking Member Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman. There seems to be 
more traction toward moving forward with housing reform than 
there has been at any point during the 5-year conservatorships 
of Fannie Mae and Freddie Mac. Mr. Chairman, thank you for 
making this a top priority of the Committee during this 
Congress.
    In March of this year, this subject became one of our first 
hearings, and now I look forward to working toward a solution 
with you and all of the Senators of this Committee.
    Many other people deserve credit for getting the ball 
moving and getting it going forward well on this important 
topic. Senators Corker and Warner and all of the cosponsors of 
their bill have worked collaboratively in developing a proposal 
that will help shape our debate as we move forward, and I thank 
them and their staffs for their hard work.
    Senator Reed also has put a tremendous amount of work into 
helping us get toward the right answers and the right 
legislative language, and there are many other Senators on this 
Committee who may not have introduced legislation but who have 
put a tremendous amount of thought and effort into the issue 
behind the scenes advocating for a resolution.
    Chairman Hensarling likewise deserves a lot of credit and 
our thanks for his work in moving a proposal out of the House 
Financial Services Committee. In fact, given the President's 
recent comments, it appears we now are experiencing the first 
moment since the crisis that the White House, the Senate, and 
the House are all moving forward or advocating for reform.
    Given this circumstance, we must use this opportunity to 
concentrate on building consensus around ending the 
conservatorships while building a stable secondary market that 
brings back private capital and avoids repeating the mistakes 
of the past.
    As I noted, a tremendous amount of work on this topic has 
already been done by many of the Committee's Senators, and we 
must not lose this momentum.
    As such, the Banking Committee intends to hold a series of 
hearings to gain insight from experts, regulators, and 
stakeholders to ensure that the Committee moves forward in an 
educated fashion. These hearings will provide a more in-depth 
analysis of some of the necessary components of reform with a 
goal of marking up a bipartisan bill by the end of the year.
    There will be costs and tradeoffs associated with every 
decision that we make. As we evaluate those tradeoffs, I am 
pleased to have before us a panel that represents decades of 
real experience and study of our mortgage markets. I look 
forward to hearing from the witnesses, gaining their input and 
analysis about what are the essential elements of any reform. 
It will also be helpful to hear what questions we need to be 
asking to arrive at the best solutions.
    Despite the tough decisions that lie ahead, our task is 
vital. For more than 5 years, our housing finance system has 
remained in limbo, unable to innovate or even function outside 
of a massive Government intervention. In those 5 years, we have 
seen other financial markets recover while watching the housing 
market remain stagnant. During those same 5 years, we watched 
the bill to the American taxpayers rise to nearly $200 billion 
while simultaneously creating numerous legal questions that our 
courts may be sorting out for years to come. This cannot be 
allowed to continue.
    Chairman Johnson and I were able to work together with the 
other Senators on the Banking Committee to pass the Federal 
Housing Administration Solvency Act of 2013 out of Committee 
with a large, bipartisan vote. As a Committee, we must re-
create that consensus while turning our full attention to 
reforming the Government-sponsored entities and our broader 
housing finance market.
    Hopefully our past work and the further collaborating of 
our Senators has engendered a level of trust and good will that 
can lead this Committee to a strong product with an equally 
strong level of support.
    Mr. Chairman, again I thank you, and I look forward to 
working with you and all Members of the Committee as we move 
forward.
    Chairman Johnson. Thank you, Senator Crapo.
    Are there any other Members who would like to give a brief 
opening statement? Senator Tester.

                STATEMENT OF SENATOR JON TESTER

    Senator Tester. I would, and I apologize to Senator Corker 
right now because I know he hates these things, but I am not 
going to be here for the questions, so I have got to say this.
    First of all, I want to thank the Chairman and Ranking 
Member for their opening statements. We have got an opportunity 
here to do something good. I was sent to Washington, D.C., to 
try to fix what is wrong with Washington, D.C. We can make 
excuses up. We can talk about how we are too busy to do this. 
We can talk about Syria. We can talk about the debt limit. We 
can talk about all that stuff. But the bottom line is we can 
multi-task, we must multi-task. And if we let this opportunity 
escape us by not working together and pushing it forward--the 
same way we did with the FHA Solvency Act, I might add--then we 
are not doing our constituencies the services that they expect 
of us.
    So I look forward to working with everybody on this 
Committee to get the Warner-Corker bill across the finish line. 
Thank you.
    Chairman Johnson. Is there anyone else?
    [No response.]
    Chairman Johnson. I would like to remind my colleagues that 
the record will be open for the next 7 days for additional 
statements and other materials.
    Before we begin, I would like to introduce our witnesses 
who are here with us today.
    Our first witness is Ms. Julia Gordon, who is the director 
of housing finance and policy at the Center for American 
Progress.
    Mr. Jerome Lienhard is the CEO of SunTrust Mortgage.
    Mr. Richard Johns is the executive director of the 
Structured Finance Industry Group.
    And, finally, we have Dr. Mark Zandi, chief economist at 
Moody's Analytics.
    We welcome all of you here today and thank you for your 
time.
    Ms. Gordon, you may proceed.

  STATEMENT OF JULIA GORDON, DIRECTOR OF HOUSING FINANCE AND 
              POLICY, CENTER FOR AMERICAN PROGRESS

    Ms. Gordon. Good morning, Chairman Johnson, Ranking Member 
Crapo, and Members of the Committee. Thank you so much for 
inviting me to testify today. I am Julia Gordon, director of 
housing finance and policy at the Center for American Progress 
and convener of the Mortgage Finance Working Group, which 
released a comprehensive reform plan back in January of 2011 
and has been meeting weekly since then to study the future of 
housing finance.
    We stand at a critical inflection point for our Nation's 
housing finance system. While housing prices have begun to 
recover in many parts of the country, the fundamentals are not 
yet strong. The mortgage market today is significantly smaller 
than it was in the early 2000s. Two-thirds of originations are 
refinancings rather than home purchases. And much recent price 
appreciation can be attributed to cash investors.
    In the meantime, the demographics that represent the future 
of home ownership, such as first-time home buyers, millennials, 
and people of color, have largely been shut out of the 
conventional mortgage market.
    Production of apartment units is falling behind demand, and 
rents have risen significantly, with more than a quarter of all 
renters spending more than half of their income on housing. In 
our view, the status quo no longer serves the American public's 
best interests, and it is time to reform the system.
    We are pleased to see a broad consensus emerging on the 
general outlines of housing finance reform that we must have a 
Government backstop behind private capital, that the long-term 
fixed-rate mortgage is a crucial product for families 
interested in home ownership, that the system must include not 
just single-family but also multi-family finance, and that the 
system provide access to all creditworthy borrowers and lenders 
of all sizes.
    I commend Senators Corker and Warner for pushing this 
debate forward. By recognizing this consensus and developing a 
strong bipartisan framework for reform, they have done a true 
public service.
    However, we still have a great deal of work ahead of us to 
adjust and fill in this framework so that it will work well for 
all borrowers, all lenders, and all investors throughout all 
economic cycles.
    First and foremost, a new housing finance system must place 
the Nation's housing needs at the center of the system. The 
structures and processes of the secondary market are not ends 
in and of themselves. Providing broad access to affordable, 
sustainable credit will provide the greatest benefit in the 
long run not only to families but also to lenders and investors 
while protecting taxpayers from future bailouts.
    The system must provide a level playing field for all 
creditworthy borrowers in all geographic areas for all housing 
types and for lenders of all sizes. Additionally, it needs the 
capacity to help more families obtain mortgages in the 
conventional market through credit supports and safe innovation 
rather than relegating large swaths of borrowers to FHA 
unnecessarily, where mortgages are more expensive and where the 
Government will continue to provide a 100-percent guarantee. 
And to serve those families not yet ready for or interested in 
home ownership, the system should provide financing to preserve 
existing privately owned affordable housing stock and support 
the construction of new affordable units.
    To create a deep liquid market and support widespread 
availability of a long-term fixed-rate mortgage product, we 
need both a Government guarantee and a healthy TBA market. We 
agree that there is no reason for the Government to guarantee 
100 percent of the risk, and in our 2011 proposal we suggested 
that chartered bond guarantors stand in the first loss 
position, which is one of the options presented in the Corker-
Warner bill.
    However, we have significant concerns about the other 
option presented in that bill, which is having issuers lay off 
the risk directly through the private capital markets. We are 
concerned that structured transactions alone cannot effectively 
maintain the TBA market, provide broad access to sustainable 
credit, protect the taxpayer, and maintain access to credit 
throughout economic cycles. We expect, though, that bond 
guarantors will access the capital markets to lay off risk, 
perhaps along the lines of the Freddie STACR deal.
    It perhaps goes without saying, but any new system also 
must support effective and fair mortgage servicing practices as 
well as appropriate systems to provide clarity regarding 
property title.
    Finally, we need strong regulatory tools to ensure safety 
and soundness throughout the system, including examination, 
supervision, and enforcement authority for entities accessing 
the Government guarantee.
    Thank you again for inviting me to testify today, and I 
look forward to continued discussion on these important matters 
as the Senate moves forward on housing finance reform 
legislation.
    Chairman Johnson. Thank you.
    Mr. Lienhard, you may proceed.

   STATEMENT OF JEROME T. LIENHARD, II, PRESIDENT AND CHIEF 
           EXECUTIVE OFFICER, SUNTRUST MORTGAGE, INC.

    Mr. Lienhard. Good morning, Chairman Johnson, Ranking 
Member Crapo, and Members of the Banking Committee. I am Jerome 
Lienhard, president and CEO of SunTrust Mortgage, which is a 
subsidiary of SunTrust Banks. Thank you for allowing me to 
participate in the consideration of this important subject.
    I am appearing today in my capacity at SunTrust Mortgage, 
and this testimony was prepared after consultation with the 
Regional Bank Group, an informal coalition of mid-sized lending 
institutions located throughout the United States. All views 
expressed today, however, are my own.
    SunTrust is headquartered in Atlanta and operates mainly in 
the southeastern United States. SunTrust Mortgage is based in 
Richmond, Virginia, and employs about 4,300 teammates. Last 
year, we originated over $32 billion in mortgage loans which 
helped more than 120,000 of our clients purchase a home or 
lower their monthly payment through refinancing.
    Today I would like to make two important points from the 
perspective of a regional bank:
    First, while there is a need to reform the housing finance 
system, it is critical to retain the basic ``plumbing'' of the 
system that draws in enormous sums of investment capital and 
provides borrowers with interest rate certainty. These features 
can be retained in a mortgage market that serves both the 
interests of borrowers and taxpayers alike.
    Second, reform must bring more private capital into the 
mortgage market in a principal loss position without reducing 
the global demand for mortgage-backed securities and while 
protecting competitive access for small and medium-sized 
institutions that serve millions of homeowners.
    I will spend a few minutes elaborating on each of these 
points.
    Out of thousands of mortgage loans that we make each year, 
on average we hold only one in six on our balance sheet. So 
while we own approximately $30 billion worth of mortgage loans, 
we actually originated and service more than $140 billion in 
mortgages involving more than 800,000 households. This is 
possible for us only due to the existence of the secondary 
mortgage market.
    To provide our clients with basic information regarding how 
much they can afford to pay for a house, we must be able to 
tell them the interest rate and the monthly cost of the loan. 
You cannot really buy a house if you do not know what your 
mortgage payment will be.
    We do this by referencing a daily pricing sheet that 
provides the interest rate and loan terms that we can offer on 
a guaranteed basis. These prices are set from the price of 
mortgage-backed securities trading in the ``To Be Announced'' 
or TBA market. The TBA security price assumes delivery of 
conforming mortgages into a Freddie Mac or Fannie Mae mortgage-
backed security on a forward basis. This forward-pricing 
mechanism of the secondary market allows us to lock in the 
interest rates for our clients for up to 90 days.
    But without that certainty, primary market lenders would be 
unwilling and, frankly, unable to provide forward price 
certainty to their customers.
    Through the combination of mortgage standardization and the 
function of the MBS market, the existing system provides a 
tangible benefit to borrowers. And these benefits are available 
for anyone who transact with originators of any size: local 
banks, Main Street banks such as SunTrust, as well as the 
largest mortgage originators.
    While there is a need to address taxpayer risk by making 
structural changes to the housing finance system, these are key 
features, elements, and processes essential to maintaining a 
secondary market.
    Regarding the critical issue of the structure of the credit 
guarantee, our markets perform so well in large part because 
credit risk associated with mortgage default is assumed by the 
GSEs. Investors from around the world allocate trillions of 
dollars of capital to our markets because it only involves 
interest rate risk to them.
    Now, the problem, of course, is that providing credit 
protection puts taxpayers at risk. Using private sources of 
capital to cover credit exposure can help alleviate taxpayer 
risk.
    We must also consider that if a variety of credit risk 
devices emerge in place of the relatively simple credit 
guarantee we have today, it could make mortgage-backed 
securities difficult for investors to value, fracturing the 
investor base, reducing liquidity, and increasing costs. If 
that market shrinks dramatically, so does lending to 
homeowners.
    To the extent that private capital is intended to stand 
before any taxpayer-backed guarantees, the entities and 
instruments must be subject to regulatory oversight. If 
regulators cannot understand nor keep track of the various 
risk-sharing mechanisms, there is a danger that they will not 
perform as needed under crisis conditions.
    And, finally, any new source of private sector credit 
protection should be available for all primary market lenders, 
including large, small, and Main Street institutions. Measures 
that create advantages for the very largest issuers of 
mortgage-backed securities or make the cost of market access 
more expensive for some and not others will reduce competition 
and must be avoided.
    Let me conclude by thanking the Committee again for the 
time, attention, and consideration. I look forward to answering 
any of your questions.
    Chairman Johnson. Thank you.
    Mr. Johns, you may proceed.

  STATEMENT OF RICHARD JOHNS, EXECUTIVE DIRECTOR, STRUCTURED 
                     FINANCE INDUSTRY GROUP

    Mr. Johns. Chairman Johnson, Ranking Member Crapo, and 
Members of the Committee on Banking, my name is Richard Johns. 
I am the executive director of the Structured Finance Industry 
Group, or SFIG, a trade industry group that includes over 160 
corporate members from all sectors of the securitization 
industry. On behalf of myself and SFIG's members, I thank you 
for this opportunity to address the Committee regarding 
proposed housing finance reforms, including the role to be 
played by the Government in the housing finance system and the 
importance of returning private capital to the residential 
mortgage market.
    SFIG is generally supportive of the framework contained 
Senate bill 1217 and believes the reform process, particularly 
in relation to the securitization markets, must proceed in a 
measured and deliberate way. We appreciate the Committee's 
methodical approach in considering such reforms.
    A central focus of any reform effort must be the 
preservation of the To Be Announced or TBA market, which is the 
third most liquid securities market in the world and handles 
over 90 percent of the Government-guaranteed MBS trading 
volume. The reason behind this deep liquidity of the TBA market 
is in its homogenous nature driven by standardization of loan 
pools and underwriting criteria, market standards and history, 
and the elimination of credit risk via the Government 
guarantee.
    This deep liquidity not only drives down costs allowing a 
cheaper interest rate to be charged to the consumer, but it 
also enables the mortgage originator to hedge its risk, which 
in turn can be passed through to the consumer in the form of a 
rate lock to give them certainty of interest rate. Any reform 
process needs to be considerate of the credit risk to the 
homogeneity of the TBA market. For this reason, we suggest that 
there are three sequential stages that any reform effort should 
follow in order to preserve the TBA market.
    First, the conversion into a common TBA should be adopted, 
making Freddie and Fannie MBS fungible and, therefore, 
deliverable into a single TBA market.
    Second, any legislation should provide for the creation of 
a single agency security. This would facilitate the conversion 
and continued liquidity of legacy securities and promote a deep 
and liquid new-issue MBS market.
    And then, third, a common securitization platform should be 
established to oversee and maintain the standardization of the 
market for Government-guaranteed MBS.
    SFIG believes that retaining a Government guarantee against 
catastrophic loss for MBS is crucial to preserving the health 
of the TBA market.
    Historically, rates investors have been attracted to the 
Government-guaranteed MBS in which the Government bears the 
bulk of the credit risk, and they have contributed trillions of 
dollars to the agency market because of those guarantees. 
Limiting the Government's involvement in the market by changing 
or ending the current infrastructure must account for the 
crucial contribution that rates investors make to the agency 
market and their historical aversion to credit risk.
    We also believe that private investors have a role to play 
in ensuring against the credit risks posed by residential 
mortgages. To that end, SFIG generally supports having private 
capital take on credit risk in the first loss position with the 
explicit Government guarantee covering catastrophic risk.
    SFIG continues to analyze the amount of risk that a private 
investor should assume, and we will provide the Committee with 
our ideas at a later date. However, whatever the final private 
enhancement is, it should be based on underwriting-related 
factors such as historical loss data, the likely loan times, 
and general housing and economic indicators.
    Turning next to the mechanics of transitioning to a new 
structure, this process must be transparent, appropriate to 
market conditions, and handled with great care to minimize the 
disruptions to the flow of credit to consumers and, in 
particular, to ensure the continued health of the TBA market.
    We believe steps must be taken to preserve the market for 
legacy securities while allowing sufficient time for eligible 
loans under the reformed system to be generated and take hold 
in the TBA market. SFIG believes that the best way to 
facilitate this transition is to create a single agency 
security to which the legacy securities would be converted. We 
also believe that the current and new infrastructure should 
operate in tandem for some period of time until the new 
framework has demonstrated that it will facilitate the 
continued functioning of the TBA market.
    Finally, there are a number of initiatives underway around 
the country in which governments plan to exercise their eminent 
domain power to seize underperforming mortgage loans. Such use 
of eminent domain will undermine congressional efforts to 
encourage private capital in the market, and we encourage the 
Committee to include a provision limiting it in any reform 
legislation.
    In conclusion, while we recognize the need to correct the 
errors of the past, we urge the Committee not to lose sight of 
the ways in which the agency market, and particularly the TBA 
market, has and continues to work well, enabling many Americans 
to enjoy the benefits of home ownership. We look forward to 
working with the Committee as it considers these vitally 
important issues. Thank you again for the opportunity to share 
SFIG's views.
    Chairman Johnson. Thank you.
    Dr. Zandi, you may proceed.

   STATEMENT OF MARK ZANDI, Ph.D., CHIEF ECONOMIST, MOODY'S 
                           ANALYTICS

    Mr. Zandi. Thank you, Mr. Chairman, Mr. Vice Chairman, and 
the rest of the Committee, for the opportunity to be here 
today.
    For the purposes of the meeting, the Committee hearing, you 
should know that I am on the board of MGIC. That is the largest 
mortgage insurer in the country. That is important for you to 
know. I am also on the board of the Reinvestment Fund. That is 
one of the Nation's largest CDFIs. And I am also, obviously, an 
employee of the Moody's Corporation. So those are very 
important things. These are my opinions, not those of Moody's 
or anyone else.
    There are many essential elements to a good, well-
functioning housing finance system. I go through many of them 
in my written testimony. I want to focus in my current remarks 
on one essential element, and that is the capital requirements 
of the new system. So I am going to talk a little bit about the 
amount of capital that is appropriate, the sources of that 
capital, and the cost of that capital.
    I should say up front that I am taking as given that we are 
in a world of a hybrid system; that is, private first loss 
capital with a catastrophic Government guarantee. So in almost 
all circumstances, private investors will shoulder the burden 
of the losses. In very rare circumstances, catastrophes, the 
Government would step in and backstop the system. The guarantee 
would be explicit. It would be paid for by lenders and 
borrowers and not taxpayers. And the hybrid system is in the 
spirit of Corker-Warner. It is also what the President has 
recently come out in support of.
    In terms of the amount of capital, in my view the 
appropriate amount of capital--a good benchmark for the 
appropriate amount of capital is the Great Recession. In the 
recession, Fannie, Freddie, the private MIs lost or will lose 
ultimately about 4 percent. That is the loss rate, all in. To 
be conservative, I think it would be appropriate to capitalize 
the system at 5 percent. I think that would cover all 
significant circumstances.
    That would be particularly conservative in the sense that 
the mortgages that get the Government guarantee in the future 
system under all proposals would be QM and, therefore, the 
loans that got Fannie and Freddie into real trouble, the Alt-A 
loans, would not be guaranteed in the future system. So I think 
5 percent would be appropriate.
    In terms of the sources of capital, they should be varied. 
We need capital--we need lots of capital. This is going to take 
a lot of capital, and it should come from everywhere. So we 
need capital coming from mortgage bond guarantors, MI 
companies, and the capital markets. Very important. When you 
have varied sources of capital, that creates stability in the 
system. That would be particularly, I think, the key feature of 
capital coming from mortgage bond guarantors. And it will be 
cheaper if you have it from varied sources of capital, and the 
capital markets are very, very important to that. And I think 
in the Corker-Warner legislation, one of the key features of 
that legislation that I find attractive is that it promotes 
varied sources of capital. We need that. It is very important 
to the future of the housing finance system.
    In terms of the cost of the capital, you know, it is not 
free. If we are going to have a higher capitalization rate, 
mortgage rates are going to be higher. The question is how much 
higher. Well, it depends on lots of moving parts, and it may 
have to make a lot of assumptions. But my sense is under 
reasons assumptions that to go from the current system to a 
system that is capitalized at 5 percent probably would add 
another 40 basis points to mortgage rates, roughly speaking--
excuse me, 40 basis points in G-fees, and that would be passed 
through largely in higher mortgage rates.
    Just for context, every 10 basis points is about $15 on a 
monthly mortgage payment, so you do the arithmetic, going to 
the new system under my assumptions would add about $60 to the 
average monthly mortgage payment.
    One other thing to note is that the cost will vary 
considerably depending on how the system is designed, and it 
will vary depending on the credit risk of the borrower, and it 
will vary according to where you are in the business cycle. The 
numbers I just articulated are for the typical borrower through 
the business cycle.
    Let me end by saying--this is very important--the current 
system is dysfunctional. We have to change it. It is not good 
for taxpayers. It is not good for home buyers. I think it is 
laudable that you are taking this up in a very serious way.
    Thank you.
    Chairman Johnson. Thank you very much for your testimony.
    As we begin questions, I will ask the clerk to put 5 
minutes on the clock for each Member.
    Ms. Gordon, I am very concerned about the mortgage access 
in rural areas. What is needed in a new system to ensure that 
borrowers with similar qualifications have equal access to 
mortgages no matter where they live? How would you design 
requirements to ensure that borrowers and lenders in States 
like mine are not left out?
    Ms. Gordon. Thank you for that question. It is a very 
important question, both for rural borrowers in States like 
yours and for any borrower who lives in either a rural area or 
who may be in an urban area or some area that is not as well 
and easily served by primary lenders.
    So what is important to remember is that while the 
interface for most borrowers with the system is through their 
primary lender, lenders will make those loans that the 
secondary market encourages them to make through policies. And 
we have had--in the system that, you know, we are hoping to 
reform, there have been mechanisms through Fannie and Freddie 
that do require lenders to be mindful that they are equally 
serving all creditworthy borrowers, you know, regardless of 
where they live or whether, you know, their file is a little 
bit harder to go through all the papers for than somebody 
else's.
    And we are very concerned that if we do not build in 
mechanisms to address that, lenders will be able to, you know, 
what you might think of as cream the market, just basically do 
the low-hanging fruit, do the easy mortgages, do the mortgages 
with higher balances within whatever the loan limits are of the 
system, and that people will be disadvantaged, particularly in 
States like yours.
    And so we think it is critical to establish in this bill 
some kind of responsibility for the secondary market to oversee 
making sure that all of these parts of the market are being 
adequately served, which means, you know, doing some kind of 
examination of the market, some kind of examination of where 
the demand and need is, and then looking at whatever entities 
ultimately are accessing the Government guarantee and providing 
the wrap, making sure that they are covering all of these 
different populations equally.
    Chairman Johnson. Mr. Lienhard, will qualified borrowers 
and lenders of all sizes have fair access to the secondary 
market if private capital is require to play a larger role in 
front of a Government guarantee? Will this work with the TBA 
market? And how does the TBA market impact borrowers and 
lenders?
    Mr. Lienhard. Thank you for the question, Senator. I think 
that the beauty of the TBA market or actually the beauty of the 
construct that we have now and what I think needs to be 
preserved, as I mentioned in my testimony, is this separation 
of credit risk from interest rate risk. And so presumably the 
interest rate risk investors do not differentiate between the 
creditworthiness of the borrower. That is disintermediated 
ahead of the TBA market by the credit guarantee function. So as 
I understand your question--and I would be happy to have you 
help make me more clear in that understanding--I think the 
answer to your question is properly structured, yes. But I 
think that the critical nature of that structure does not 
necessarily reside in the TBA market but, rather, in the 
guarantee aspect of whatever reform we do. I do not know if 
that is a comprehensive answer.
    Chairman Johnson. Mr. Johns, do you believe private 
investors are willing to stand in the first loss position 
before our Government guarantee both in good times and bad? 
What will investors need to accept credit risk of a first loss 
position? And does that work with the TBA market?
    Mr. Johns. I think the short answer is that investors are 
prepared to step into that role, as we have seen on the Freddie 
transaction. There was a sizable demand for the credit-linked 
note product, and I think there were 50 investors or over 50 
investors, and the investors were scaled back fairly 
significantly, and I think all reads from the market are that 
there will be support for, you know, being able to facilitate 
those transactions again.
    In addition, obviously, you have to look at the sort of 
broad swath of options out there such as the mortgage insurers 
and the bond insurers, you know, together with the capital 
markets, looking for the way to raise the private capital.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    I hope this question I want to get into here will evoke 
responses from all of you on the panel. I am going to start out 
with Dr. Zandi and Mr. Johns and then move to Mr. Lienhard and 
Ms. Gordon.
    The issue is the forms and sources of private capital that 
we need to bring into the market. I think there is pretty 
clearly an emerging consensus that whatever the shape of the 
future housing finance system we create is, it must be designed 
to attract more private capital and decrease the Government 
role from what we currently have.
    That being said, I think that I see in the testimony of the 
witnesses a little variation in terms of how we should approach 
that. Mr. Johns and Dr. Zandi, in your testimonies you both 
have advocated for the allowance of various forms of private 
capital to come into the system to meet market needs. So to 
start with you, what are the benefits that you see to sourcing 
private capital from many sources? And maybe you could also 
kind of define what you see those sources being broadly?
    Mr. Zandi. Well, there are two broad sources. The first is 
what I would call an insurance source--bond guarantors, private 
mortgage insurers, insurance entities. And the second I would 
label as capital market sources. Both are critical to a well-
functioning system.
    The insurance capital is more stable through thick and thin 
because of the way it is structured and set up, and one of the 
goals of any future housing finance system is that it obviously 
has to be stable. We need the flow of mortgage credit through 
good times and bad times.
    The strength of the capital markets source of capital is 
that it can bring down the costs, and most of you get price 
discovery. You get a clearer sense of what the cost of risk is, 
because capital markets are pretty good at doing that. And so 
by bringing in capital market sources, you will lower the cost 
to mortgage borrowers through lower mortgage rates. So both are 
very important.
    Now, how you structure that and how you align those two 
sources of capital up is a very difficult but critical 
question, and that is very, very important, but both sources 
are needed.
    Senator Crapo. Well, thank you, and we probably need to get 
into that in some depth, but I do need to move along. So, Mr. 
Johns, do you want to add anything to that perspective?
    Mr. Johns. I think that I would go along with what Dr. 
Zandi said, that we would support their--I think, you know, 
maybe a couple of points. It is all--well, it is not all 
about--a lot of our focus needs to be on making sure that the 
TBA market continues to function when you look at the private 
capital alternatives. And, you know, insurance is not something 
that necessarily can directly impact the pool of loans within 
the MBS, and, therefore, I think that is something that has 
some potential.
    The credit-linked note structure that Freddie did was a 
synthetic transaction, and, therefore, the actual loans that it 
referenced, you know, were not specifically sort of cash-flow 
impacted in the structure of the transaction, leaving the TBA 
market largely unaffected as a consequence.
    There are other structures, senior subordination, you know, 
structures where you might say--you know, have a sort of deep 
subordination piece of the transaction and then have a AAA or a 
senior rated piece that is delivered into the TBA market. That 
is a different structure that we would have to look at and 
evaluate exactly how we would get that to work with the TBA 
market that is currently based on a pass-through mechanism.
    Senator Crapo. All right. Thank you.
    And, Mr. Lienhard, I may have to get to you next time, the 
next round, because I am running out of time and I wanted to 
get to Ms. Gordon, because if I understand it correctly, you 
believe we should rely solely on bond guarantors. Is that 
correct?
    Ms. Gordon. That is what I believe, and it is really for 
two reasons. One is, as everybody has been discussing, the 
importance of the TBA market and the belief that even--you 
know, we have already heard that a senior substructure would 
pose some problems for TBA. But even if you have some other 
kind of reference pool type structure, the fact is that these 
sort of one-off deals do not lend themselves as well to the 
kind of homogeneity that you need for an effective TBA market. 
They do not do as good a job at allocating risks across years, 
regions, lenders, and the like, but especially across years 
that you have an insurance format.
    And also, just to Dr. Zandi's point regarding price 
discovery, we do have to--the private capital market's track 
record on pricing mortgage risk is checkered, as is 
everybody's, and so that is an area where you do introduce some 
uncertainty. And, again, even if in any individual structured 
transaction that actual transaction is funded, if you do not 
know how the investor institutions are carrying that on their 
books and evaluating it, you do not know if you are just 
exporting risk out of that particular mortgage-backed security 
into the larger financial system.
    Senator Crapo. Well, thank you. My time has run out, but we 
will get back to this.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman. I 
want to commend Senator Corker and Senator Warner for moving so 
thoughtfully on this issue. I think, again, I thank the 
witnesses, but also the Chairman and the Ranking Member 
because, as we move here, I think we appreciate with each step 
how complex, interrelated, and how thoughtful we have to be 
about these judgments. We are transforming a huge, huge part of 
our economy, and I am glad we started, and I think Senator 
Corker and Senator Warner deserve a great deal of credit. Thank 
you, gentlemen, very much, and I thank the Chairman and the 
Ranking Member.
    Mr. Zandi, just this very simple-minded question in a very 
complex field, but you talk about capital, but one of the--sort 
of looking back, there was a lot of mysterious capital in the 
banking field several years ago, i.e., people created entities, 
borrowed, leveraged themselves up to their--you know, wherever 
they could, and then it used that capital to go in and to 
invest in different products.
    I know there is an ongoing FHFA pilot program, $30 billion 
in credit risk, et cetera. In general, and in terms of the 
pilot, is that an issue we have to deal with? And how might we 
deal with it in terms of avoiding being overleveraged?
    Mr. Zandi. Well, that is a good question. One of the 
concerns about capital markets as a source of capital is, in 
fact, leverage in the entire system. This is what Ms. Gordon 
was referring to. And it needs to be considered in the context 
of the broader financial system and any future housing finance 
system that we establish. So that is a potential risk created 
by drawing capital from the capital markets.
    I do not think we are anywhere close to that yet. We are in 
early stages here, and what Freddie and Fannie are doing is 
quite small in the context of all the things that are going on, 
and quite appropriate, in my view, because we need to 
experiment. We need to see what works, what does not work, what 
the risks really are, and how to manage those risks.
    So what they are doing is entirely appropriate, but you are 
right when we are thinking about the future of the housing 
finance system and the capital structure and where the capital 
is coming from, this is one of the risks that we need to really 
think about because there is a potential systemic problem.
    Senator Reed. And that just touches on what I think 
everyone has reflected, that there has to be a regulatory 
authority here that is looking at where the capital is coming 
from, that is looking at: Are these products accessible, 
available to everyone? Do they include multi-family housing as 
well as single-family housing? And that is something I think we 
would all recognize.
    Mr. Zandi. Yes, I think I am taking as given that we are 
going to have a catastrophic Government guarantee. I cannot see 
any system that does not work without that, and that requires 
regulation.
    Senator Reed. And that guarantor would be effectively a 
regulator as well as a guarantor.
    Mr. Zandi. Exactly, yes.
    Senator Reed. Mr. Johns, you talked about the TBA market is 
very critical, and there are multiple proposals, but one 
proposal seems to separate it into sort of two categories: 
first, a guaranteed piece up front, and then an unguaranteed 
piece, which would be sort of--or senior/junior, however you 
want to describe it. The issue might be, How do you price the 
second piece? It is pretty easy with a guaranteed--or easier to 
price a guaranteed issuance. I think that is a fair assumption. 
Is that a problem with this, having this set of bifurcated 
approach to TBA markets?
    Mr. Johns. I do not know whether it is a problem 
necessarily. It is certainly something I am happy to take away 
to our members and talk about.
    What I might highlight there is that with that proposal you 
are creating a bifurcation of the old market versus the new 
market, and consequently, you will have a very shallow new 
market when you move forward with that structure, which creates 
its own liquidity issues in and of itself.
    Senator Reed. So the question then--one of the first 
questions not only in terms of pricing is liquidity. Would 
actually anyone come into that market given the narrow--the 
ability--the lack of liquidity. Is that a fair----
    Mr. Johns. I think so. I mean, look at liquidity as almost 
synonymous with cost. If you have shallow liquidity, the cost 
goes up. If you have deep liquidity, the cost goes down.
    Senator Reed. Again, I think this is extremely helpful, and 
as we go forward, I think we will learn more and I think very 
productively raise more questions than initially we will have 
answers, and that will allow us to come to a better answer at 
the end of the day. But thank you all for your excellent 
testimony.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Mr. Chairman and Ranking Member, thanks for 
having the hearing, and I do think we are at a point in time, 
after really 5 years--I remember how controversial the whole 
Freddie/Fannie issue was during the time we tried to do 
financial regulation. I think we are at a point where we are 
ready to take that on, and I thank you for having these 
outstanding witnesses.
    To the witnesses, you know, 10 Members of this Committee, 5 
on each side, have gotten behind the bill called S. 1217, and 
numbers of other folks on the Committee I know are working on 
this issue and have really spent a lot of time on it. And I 
commend everybody for the time they spent on this issue.
    But starting with you, Dr. Zandi, is Senate bill 1217, with 
10 Members of this Committee on it and probably others being 
added, a good starting point?
    Mr. Zandi. Absolutely. I think it is an excellent starting 
point. I think it shows a lot of hard work and a lot of good 
ideas and thoughts. And I do not know why you would want to 
start from scratch. I would start with that legislation. It is 
an excellent place to get going.
    Senator Corker. Mr. Johns?
    Mr. Johns. I would agree. I think, you know, as I 
testified, we do believe that there is a phased implementation 
that we can work with on this, but the framework in and of 
itself and the end game is something that in general the 
industry is supportive of.
    Senator Corker. Mr. Lienhard?
    Mr. Lienhard. I believe a multi-trillion-dollar industry 
being run in conservatorship is long term an untenable 
situation. I think this bill definitely highlights all of the 
issues in moving forward, so, yes, I think it is a very good 
start.
    Senator Corker. Ms. Gordon?
    Ms. Gordon. Absolutely I agree. I am just so glad that 
someone has started because I agree with Mr. Lienhard that we 
cannot continue in the conservatorship mode.
    There does remain, as I mentioned, work to be done. I think 
we have done a lot of work on the sort of asset class side of 
things. We still need to do a lot of work on the access for 
borrowers side to get the bill to a place where we will, you 
know, feel like it can pick up and do better than the last 
system.
    Senator Corker. I appreciate that, and I would hope 
everybody would continue to make what has been worked on for a 
year even better, and I thank you for that comment.
    One of the things I think that the 10 Senators who all made 
major contributions to this piece of legislation, all of which 
are on this Committee, tried to do was to create something that 
is more dynamic. I think all of us know we have this duopoly 
right now. I know that even though it has some strengths, there 
are a lot of weaknesses in that regard. And just again to go in 
the same order, have we done something with the construct? 
Again, we all know that, you know, there are tweaks that people 
would like to make, but have the 10 Senators on this Committee 
that have worked on this created something that is more dynamic 
in structure than the system we now have?
    Mr. Zandi. Yes, and I think that goes to the fact that in 
the legislation, you worked very hard to promote varied sources 
of capital. It is not just coming from one place. Let a 
thousand flowers bloom. Let us see what works here, what does 
not work. At some points in time, some sources of capital are 
going to work better than other sources of capital. And I think 
that makes the system dynamic, as you say, certainly more 
innovative because there is going to be more competition in the 
system as a result of that; lower costs because you are going 
to have capital coming in from different places; and, 
ultimately more resilient, as well.
    So, I think that is the strength of the legislation, that 
you are allowing the system to be, as you call it, more 
dynamic, yes.
    Senator Corker. Thank you.
    Mr. Johns. I would agree again with what Dr. Zandi says. I 
think as well the developments of a common securitization 
platform that allows you to have more dynamicism, and the 
various forms of capital that could be--you know, private 
capital that can be considered for the proposed enhancement I 
think as well leaves you with a dynamic element. Of course, 
that could, you know, settle hopefully as we feel our way as to 
what the most viable structure is.
    Senator Corker. OK.
    Mr. Lienhard. I am assuming we have the same definition of 
dynamic, yes, but one of the things I am concerned about--and 
it is not entirely clear to me that the bill yet addresses 
this--is the relative potential--the potential to disadvantage 
a regional originator versus a national originator, an 
unintended consequence of that simply because of the regional 
concentration or various exposures that exist in certain 
States, and so that would be something I would really be 
concerned about. So dynamic, yes, but I am not sure that is 
clear.
    Senator Corker. Well, and I am glad you made that comment. 
You know, I have spent a lot of time with your CEO and your 
former CEO, and, you know, regionals are kind of no-man's-land. 
You know, some people like that, some people do not. I think 
you all like it. But I do think that we have done a lot here to 
focus on, you know, where the--making sure the larger 
institutions do not have an advantage and making sure that the 
smaller institutions, as I think the Chairman alluded to when 
he began, had a lot of access. But I agree that we need to do 
some work to ensure that the regionals that in some ways are 
no-man's-land end up in a good place, and I appreciate you 
bringing that up. And I am not going to go to you, Ms. Gordon, 
because I am--I know I am out of time. I do want to say just if 
I could make one point, thank you, though for being here and 
thanks for your organization's contributions to helping us all 
with this bill.
    There has been some discussion about capital and the 
increased cost--of the 10 percent capital, I might add, Dr. 
Zandi. But I am just, of course, getting with you.
    The fact is, you know, there are numbers of things that 
actually lower the cost, and when you look at the increased 
competition, the fact that you have issuers who are going to be 
competing with technology, you have got a single security 
platform instead of a dual platform like we have now, you have 
the full faith and credit, you have got uniform PSA, you have 
got a clear definition of reps and warrants, and, candidly, you 
move beyond the legal limbo that we are in.
    So I know that there are some costs of capital, but when 
you create the kind of dynamic and clear clarity that we would 
be doing with this bill, you also have some things that would 
lower costs. Would that be a fair statement to make?
    Mr. Zandi. Absolutely. And I did not comment on the 10 
percent capital. In my view, 5 percent is appropriate. But 
getting to 10 percent, I think it can be organized in a way 
that it is not too costly. And you are absolutely right, there 
are things in the legislation--which should be, by the way, in 
every legislation--that will lower costs relative to where we 
are today, absolutely.
    Senator Corker. I thank all of your for your testimony and 
your contribution and Mr. Chairman and Ranking Member for 
having this hearing.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you all 
for your testimony.
    As the Committee considers its priority for housing finance 
reform, I think there are several objectives, but one that I 
would like to hear from you on that I think is very important 
and that I consider the bedrock of our current system is the 
30-year, fixed-rate mortgage, which has made home ownership 
more accessible and affordable for generations of Americans, 
and most assessments of the market have concluded that, without 
some form of public sector guarantee or backstop, the vast 
majority of home buyers would lose access to that type of 
product.
    So, number one, for the panel, do you all agree with this 
assessment? And, second, can you discuss what would be the 
impact to home buyers and even homeowners who, as they try to 
sell, would find themselves with a marketplace quite different 
in terms of who the buyer would be of losing a 30-year, fixed-
rate mortgage?
    Ms. Gordon. I am happy to take a start. Yes, we absolutely 
agree with you that the 30-year, fixed-rate mortgage has been a 
tremendous product for families. It is sustainable. It helps 
make home ownership affordable. And we think protecting it 
should be one of the key goals of the work we are doing here 
now.
    We believe you really need two things to protect that 
product: one is the Government backstop guarantee, and the 
other is the TBA market, which needs to be sufficiently liquid 
that institutional investors can move in and out as they are 
required to do so that they continue to have interest in 
participating in this system. And so that is--you know, as we 
go forward--assuming that we have now somewhat crossed the 
Rubicon of having the guarantee and these discussions, really 
digging down and making sure that we are really protecting that 
TBA market and that we fully understand the impact of these 
different structures on that is really important. You know, as 
Mr. Johns said, if we start to fragment that or make TBA 
shallower, it will not work as well.
    Mr. Johns. I would just follow on from Ms. Gordon there. I 
think Ms. Gordon highlighted the need for the TBA and the 
Government guarantee. I think the two are effectively the same. 
If you are going to have the TBA remain liquid, you know, then 
the guarantee is required. And if the guarantee is there, the 
TBA market should be there providing we are cautious not to 
fragment that market, which will enable the maintaining of the 
30-year fixed.
    Senator Menendez. Well, I hope we have crossed the Rubicon. 
I am never sure we have crossed the Rubicon until we cross it. 
But I hope that that is there. I think this is one of the 
essential elements, and I think those who have been working on 
this issue--I have shared my thoughts on it--I think they 
believe so, too.
    Another thing that I am concerned about is a multitude of 
housing finance reform plans that many of you have either 
authored and/or helped contribute to. I think most of those 
plans acknowledge the need to keep in place some form of that 
Government guarantee or backstop, and in doing so, the 
attention naturally turns to policies as it relates to 
protecting taxpayers from losses, which is an important 
interest.
    One example that is given in that regard is setting minimum 
underwriting standards for a mortgage to qualify for a 
guarantee. And as part of those standards, some proposals have 
suggested requiring a high minimum downpayment for a borrower 
to qualify.
    Now, certainly no- and low-downpayment mortgages were a 
major problem during the financial crisis, and a downpayment 
certainly can affect the size of the riskiness of a loan. But 
my concern is that if we go too far in the other direction and 
set the bar too high, we will end up shutting out the market of 
creditworthy individuals and families who will have other 
compensating factors and are in a high-risk default at all. I 
know that in my own case, the first home that I bought, if some 
of the standards that are being suggested were the case, I 
would never have achieved that. And I was a responsible 
borrower and have been a responsible borrower ever since.
    So my concern is a requirement that is too high can 
seriously undermine the goal of helping Americans afford home 
ownership. There is one prominent analysis that estimates that 
it would take an average family 14 years to save for a 5-
percent downpayment and 22 years to save for a 10-percent 
downpayment.
    So my question--maybe, Ms. Gordon, I think you have done a 
lot of work in this regard, but I am happy to hear from 
others--can you elaborate on the importance of getting the 
calibration right on the policies like downpayment requirements 
in order to properly balance the goals of protecting taxpayers 
but also meeting the goals that we have of making sure that we 
can give responsible borrowers the opportunity to have the 
ability to own their home?
    Ms. Gordon. Thank you so much for asking that question. 
This is a matter of utmost concern to us when we think about 
accessibility of the system to the average homeowner.
    First, let me just say that while we saw a problem during 
the crisis with loans that had low downpayments, it was not the 
low downpayment characteristic that caused these loans to be 
risky. These loans tended to be heavily risk layered; you know, 
maybe it was a negative amortization loan that had a low 
downpayment and had little or no underwriting that was taking 
place. And that caused loans that were low downpayment to be 
risky or to fail. There is quite a great deal of evidence that 
well-underwritten and safe fixed-rate mortgages that were made 
with low downpayments performed quite well throughout the 
crisis. And so, you know, I think we cannot just isolate that 
one factor and say this factor in and of itself is a big 
problem.
    That said, you know, different lenders will have different 
views as to downpayment, which I think is appropriate. What I 
do not think we should do is enshrine a particular number in 
legislation. I think that would be a mistake regardless of 
which number we pick.
    Senator Menendez. Thank you.
    Chairman Johnson. Senator Johanns.
    Senator Johanns. Let me also add my voice to those who are 
saying thanks to Senator Warner and Senator Corker. And to the 
Ranking Member and to the Chair, thank you so much for taking 
this issue on.
    Ms. Gordon, I could not agree with you more. Thank goodness 
somebody after 5 years has grabbed hold of this, because the 
one thing that seems clear from everybody's testimony is the 
current system is not where we want to be. We need to head in a 
different direction.
    Dr. Zandi, you are probably feeling picked on because I am 
going to start with you also at the start here.
    Mr. Zandi. Well, you know, all my life I have been at the 
end of the list.
    [Laughter.]
    Senator Johanns. That is right.
    Mr. Zandi. Bring it on. It feels good.
    Senator Johanns. It feels good to be in the A category, I 
guess.
    Mr. Zandi. In the A category, yes.
    Senator Johanns. I was following your testimony about 
capitalization, and I think there are a lot of central pieces 
to this legislation, S. 1217, but I think that has got--we have 
got to get that right, or this thing just does not work.
    You expressed an opinion that 5 percent is a good 
benchmark. I do not disagree with that. I think there is some 
safety built into that. You talked about varied sources of 
capital, and you have expanded on that.
    You then talked about G-fees and the impact on the monthly 
payment. I want you for the record, just so we are clear on 
this, to please explain how G-fees and other sources of capital 
are going to get us to this varied capital system, if you will. 
Do you follow my question?
    Mr. Zandi. I am not sure I do.
    Senator Johanns. Yes. What I am trying to figure out is: 
How would you describe G-fees relating to what we are trying to 
accomplish here? That is really what I am getting to.
    Mr. Zandi. G-fee is a guarantee fee. It is the cost to 
mortgage borrowers through the mortgage interest rate for 
paying for the potential losses that will occur from the 
lending. So, you know, you make loans. Some loans are going to 
go bad. That is going to create losses. And you need to charge 
a fee to compensate for those losses, and that is what the 
guarantee fee is.
    Now, if you want to be prepared for a little bit of loss, 
then you would only need a lower G-fee. If you want to be 
prepared for bigger losses, which I think we are talking about 
here--and we need to be prepared for bigger losses given what 
we went through--it is going to result in a higher G-fee or a 
higher mortgage rate.
    Senator Johanns. And to get to----
    Mr. Zandi. Does that make sense?
    Senator Johanns. It does.
    Mr. Zandi. OK.
    Senator Johanns. To get to the 5 percent that you think we 
should be focused on, you are saying that the net effect of 
this to the borrower is going to be roughly $60 a month.
    Mr. Zandi. Yes. That is obviously a lot of moving parts, a 
lot of assumptions. I am making assumptions about the future 
finance system, how we are going to organize ourselves. But my 
sense of it is that is a good ballpark figure. To get from 
where we are today, literally today, to that 5 percent world 
that we all feel really comfortable about and everything looks 
proper, I think it is going to be $60 a month, roughly.
    Senator Johanns. OK. Now let me shift focus a little, and 
others can jump into this. In my State, like so many other 
States, I am worried about the small lender, the community bank 
out there that is not looking to be regional, but they want to 
serve their clientele. They want to create a relationship and 
continue that relationship.
    We have tried with S. 1217 to make sure that their 
interests are protected. I would like your opinion as to 
whether you think S. 1217 gets us there.
    Mr. Zandi. Would you like my opinion?
    Senator Johanns. Yes. Start, and we can go right on down.
    Mr. Zandi. I do. I think it is clear that the legislation 
is very sensitive to this issue. There are two key elements of 
the legislation that address this. One is in the common 
securitization platform there will be multi-lender securities. 
So what that means is that small lenders--community banks--can 
sell into a security, and that security will get the Government 
guarantee. So they have access to the Government guarantee. So 
that is very important and I think critical to any system, 
because that is important for rural areas and more niche 
markets.
    The second aspect of this is in the legislation itself 
there is a carveout for a bond guarantor that would service, 
explicitly service small lenders. So it is in the legislation. 
It is there to help protect against some of the concerns that 
you might have.
    So I think there are things we can think about and we can 
tweak this and make this probably work a little bit better. But 
I think those two things go a long way to addressing that 
concern.
    Senator Johanns. I am just going to have to ask the rest of 
the panel if they see something different, because I am out of 
time. Mr. Johns?
    Mr. Johns. I would not say I see anything different. I 
would maybe sort of add to that that when you are looking at 
some of the constructs of, for instance, the credit-linked note 
product, you also want to be amenable--or we should as an 
industry be looking at potential structures that allow multi-
issuers to that extent, which also, I think, ties in with one 
of the points that Mr. Lienhard made earlier.
    Senator Johanns. Go ahead.
    Mr. Lienhard. As I look at the legislation, I do think that 
it has addressed the needs of small lenders well, and I think 
about the regionals as being the ones sort of disadvantaged.
    Senator Johanns. OK.
    Mr. Lienhard. I will answer in the negative.
    Senator Johanns. Ms. Gordon, any thoughts on that?
    Ms. Gordon. I am glad the legislation does have some 
specific structures that will help in this regard. You know, I 
think some other things that--there are some ways to prevent 
market concentration that are not in here, such as preventing 
an originator from also being a bond guarantor, that I think we 
should think about for this legislation.
    Senator Johanns. OK. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman.
    I want to again actually start with Mr. Zandi. I think you 
appropriately pointed out that any reform may add some costs. 
But wouldn't you agree that at this point in conservatorship 
that we have an artificially low, nonsustainable pricing system 
in that we have no private capital, we have a direct Government 
guarantee, Fannie and Freddie have--so that regardless of what 
reform would look like, there is going to be some bump-up in 
mortgage rates just because the system now has, in effect, no 
capital at risk?
    Mr. Zandi. Yes, I think that is clear. I mean, I think the 
question is ultimately who pays. Is it the taxpayer who is 
going to pay for the mortgage, or is it going to be the lender 
and the borrower who pays for the mortgage, the full, all-in 
cost going through thick and thin economies? And right now it 
is on the taxpayer.
    Senator Warner. Right now it is 100 percent on the 
taxpayers, no private capital at risk.
    Mr. Zandi. And I think that is not appropriate.
    Senator Warner. We, in effect, have while potentially 
artificially low mortgage rates at this point, we clearly have 
all taxpayer exposure.
    Mr. Zandi. It is all taxpayer exposure, and it is 
inappropriate. And, actually, given the rise in G-fees since 
the GSEs have been in conservatorship, this has become less of 
an issue, but it is certainly still an issue.
    Senator Warner. And would there be any disagreement on the 
panel in terms of the current status?
    Mr. Lienhard, let me acknowledge--one, thank you for coming 
up from Richmond. And, two, I agree with some of my colleagues 
that while we have, I believe, tried to make a very good-faith 
effort to make sure that the community-based banks, the credit 
unions and others, get access through a mutual or other entity 
so that they get that kind of fair pricing and nondisadvantage, 
that the regionals are kind of in between here. How will we get 
you into a market where there is--you get the same kind of 
pricing protection, but you get the kind of geographic 
diversity and others that you need? You know, at least as one 
of the group of 10 who have been involved in this, I am open 
for business on how we sort that through in a better way. I am 
not sure if you want to make any direct comment right now, but 
I look forward to----
    Mr. Lienhard. I mean, the only comment I would make is 
thank you for acknowledging that, Senator, and I think it is 
important to point out the fact that I believe our customers or 
our clients are advantaged by our ability to compete not only 
with small lenders but also the large lenders. And to the 
extent that the regionals are just by construct disadvantaged, 
that reduces the competition. So I appreciate both your and 
Senator Corker's acknowledgment of this and would really look 
forward to working with your staff on ways to resolve----
    Senator Warner. And let me also acknowledge, I think 
servicing improvements need to be made and there are multi-
family improvements.
    Ms. Gordon, I want to thank you again publicly for all the 
ideas and input you have had. I also want to make a bit of an 
editorial comment here in that, you know, kind of looking back 
at the old system, where we had a profit--you know, this 
profit-making enterprise that, as times were good, would make 
profits but when times were bad, the public bore the risk. It 
seemed like we had almost too many functions in Fannie and 
Freddie. We had a profit-making venture. We had this Government 
backstop entity. And we also had, you know, very important, 
again, goals that you have articulated quite well, you know, 
market access goals.
    I would argue that the way S. 1217 has tried to separate 
out those goals--and I know you have got ideas on tweaks, but 
actually make sense. And would you acknowledge at least--as a 
matter of fact, in the old system, unfortunately, these 
entities got criticism from both ends of the political 
spectrum. They got from those who were perhaps on the 
progressive end saying you are not doing enough, and you got 
interests from more the market-based section saying you are 
disrupting your market function by doing too much.
    Would you acknowledge that many of the very appropriate 
public housing goals that we would sometimes legislate with 
housing trust funds and others, worthy goals, but were 
oftentimes never funded?
    Ms. Gordon. Well, we have certainly had a problem in the 
past with not achieving, you know, exactly what we wanted to 
achieve. The National Housing Trust Fund and the Capital Magnet 
Fund are not being funded now even though the enterprises are 
awash in proceeds. And so I am not even sure why they are not 
being funded at this point.
    I think that in looking at the bill, which, you know, we 
are very glad to see, though we do, of course, want some 
tweaks, that there is the provision to collect a fund that will 
be used to support those borrowers or communities that need 
something of a leg up to participate in the conventional 
market.
    I do think, just to refer back to my answer to Chairman 
Johnson earlier, that the bill probably needs to do more to 
ensure that existing creditworthy borrowers are served, 
regardless of where they are or whether they are self-employed 
or whether they live in a rural area. I think we need to 
advance more on that.
    But I think we should be aware, you know, in a policy sense 
that Fannie and Freddie did have a very clear public purpose. 
It did have affordable housing goals. And while there are those 
who think, I think incorrectly, that the goals caused the 
crisis, whereas there are others, as you noted, on the 
progressive side who feel like the goals never did enough, the 
fact is if we are dismantling that system, it is absolutely 
critical to have a strong sense of public purpose at the center 
of this new system in a way that is sustainable and 
appropriate.
    Senator Warner. And my time is up. I would simply say--and 
I know there are others who disagree with part of this, but at 
least if we are going to have these goals and part of the 
nontax pricing function of this Government backstop would give 
this auditable, identifiable funding entity that you could--we 
could measure in a way that we were never able to measure when 
it was commingled in the old system. And, again, we may agree 
whether this is appropriate or not, but I actually think there 
is a lot more transparency and a lot better ability to audit 
than we had in the past. And I thank again the Chair and the 
Ranking Member for the hearing and their willingness to work on 
this.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman. I want 
to follow up in the direction that Senator Warner was going. 
But first a quick question. I hope there is unanimity about 
this. That is, with respect to this idea that some 
municipalities have floated that they will, under the 
justification that they give citing eminent domain, they are 
threatening to confiscate certain private-label mortgages from 
investors.
    So putting aside what strikes me as an egregious affront to 
the Constitution, the rule of law, and private contracts, does 
everybody agree that, to the extent that this were actually to 
take place, it would certainly discourage private capital from 
going into the residential mortgage market? Does everybody 
agree with that? And that that has, of course, the consequence 
of making mortgages either less available or more expensive or 
both?
    Mr. Johns. I would actually go a little further and say not 
just it will discourage, it is discouraging, the mere threat--
--
    Senator Toomey. The mere threat is already having that 
effect.
    Mr. Johns. Absolutely.
    Senator Toomey. Does anybody dissent from that?
    Ms. Gordon. I mean, I am not sure I will dissent that the 
threat is having an effect, but I will say that, first of all, 
I think this is a local matter; and, second, there have been 
numerous efforts for municipalities to be able to address the 
problem that they face. And until they have a way to address 
that problem, it is not surprising that a number of different 
avenues are being pursued.
    Senator Toomey. OK. Thanks.
    Let me go on to the heart of this, another matter, which is 
I am little concerned that it sounds as though it is almost 
given as a certainty that there must be a Government guarantee 
in this market. And I would remind everybody, for what it is 
worth, the House Banking Committee has passed out of Committee 
a GSE reform bill that has no Government guarantee. So this is 
not terribly unusual. I would also point out we have huge 
segments of our capital markets that have never had a 
Government guarantee. Nobody contemplates a Government 
guarantee, I trust, for commercial paper markets and corporate 
bond markets and other sorts of markets where the private 
sector provides massive liquidity on a routine basis.
    I also want to stress there are very substantial risks, I 
think, that attend to a Government guarantee. The obvious is it 
puts taxpayers at risk. And I think we should not overlook that 
risk that taxpayers bear.
    I think it tends to divert capital that would otherwise go 
to other places, but if the Government is weighing in with a 
guarantee, it creates incentives to send money in certain 
places. It probably encourages excessive risk taking.
    And the last and the biggest risk, I think we have heard 
allusions to it around this table today, which is the 
inevitable politicization of the process. If you have a 
Government guarantee, it is necessarily a political process to 
define the terms under which one has access to that guarantee. 
And in the process of setting those rules, what we hear--and, 
in fact, the Senator from New Jersey brought it up as his very 
next question--the concern that maybe not enough people will 
have that access. All the politics always drives toward ever 
expanding the universe of people who will have access to this, 
and I do believe that this political mandate to expand mortgage 
lending to people, including some who were not able to pay back 
those mortgages, was absolutely at the heart of the financial 
crisis that we just went through. And it seems to me 
maintaining a Government guarantee preserves--continues that 
risk. And it can be lessened somewhat. I am sure there are ways 
to do that. But I do not see how it ever goes away.
    Now, it seems to me the arguments I hear and justification 
for the Government guarantee usually seem to be variations on 
three arguments: one, we need it to maintain the 30-year, 
fixed-rate mortgage; number two, it helps keep mortgage rates 
lower than they would otherwise be; and, number three, it is 
the assurance that we will always have a liquid market, even in 
the worst of circumstances that might otherwise dry up the 
private capital.
    I think we should spend some time really evaluating these 
presumed advantages. I do not think we have challenged them as 
thoroughly as we might.
    A quick question. Mr. Zandi, I think you were asked the 
question in a House hearing, a Banking hearing, I assume, about 
whether or not you thought there would be a 30-year, fixed-rate 
mortgage product in the absence of a Government guarantee. And 
if my information is correct, the answer was that we probably 
would have such, and we do, after all, have private-label 
securities, including 30-year, fixed-rate private-label 
mortgages that have no Government guarantee. So the product 
does exist in the absence of a Government guarantee. Isn't that 
true?
    Mr. Zandi. It does. It would be a marginal product compared 
to where it is today. Europe, the rest of the world, would be a 
good case study for what the 30-year, fixed-rate would look 
like without a Government guarantee. And if you look at those 
markets, the share of the market that has a 30-year, fixed-
rate, fully prepayable mortgage is small, 10, 15 percent of the 
market.
    Senator Toomey. But there could be other differences that 
might explain part of that as well.
    Mr. Zandi. Could, yes, absolutely.
    Senator Toomey. And so it is not clear that that is the 
whole thing. And we have had private-label mortgages and jumbo 
mortgages that are 30-year and fixed and they have no 
Government guarantee.
    Mr. Zandi. Yes, but I think it is reasonable--a prudent 
planner would expect, without any Government guarantee--take 
the House financial services bill, the PATH bill. If that were 
law, taken as is, the share of the mortgage market that would 
be a 30-year, fixed-rate, fully prepayable mortgage would be 
much, much smaller than it is today.
    Senator Toomey. Or it might be maintained but at a higher 
rate.
    Mr. Zandi. Well, it would be at a higher rate, so then it 
would be unaffordable and therefore the share would be----
    Senator Toomey. Well, it is an open question as to how much 
of the difference in rate gets capitalized in land values and--
--
    Mr. Zandi. Absolutely. And, by the way, all your concerns I 
sympathize with. Those are very legitimate concerns and need to 
be explored. I totally agree with that, that you are absolutely 
right, those are things we need to worry about. That is why a 
high rate of capitalization in a hybrid system is critical 
because it addresses some of those concerns. It does not 
mitigate them, but it addresses them.
    Senator Toomey. I see I have run out of time, but I do hope 
we will drill down a little bit more on some of these issues. 
And, Mr. Chairman, I appreciate the indulgence.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. I am very pleased 
that the Committee is going to focus on housing finance reform 
this fall. I think it is very important. But as always, the 
devil is in the details, so I just wanted to ask a couple of 
questions.
    I want to go back to the question about underwriting 
criteria. As you know, there are lots of factors that go into 
that: income level, total assets, credit history, savings, 
outstanding debt obligations, downpayment amount, just to name 
some of them. And a borrower can do poorly on some of those but 
still do well on others and be a good candidate for a mortgage.
    Community bankers tell me that this very flexible, holistic 
approach is very important to them in placing mortgages and 
making their lending decisions based on individual 
circumstances and market conditions.
    So I understand why the Government would want to make its 
guarantee--make sure that its guarantee is available for 
mortgages that are likely to be repaid. But the question is how 
to make sure that the Government is insuring decent mortgages. 
So I want to ask a structural question as we are thinking about 
this statute.
    Should the statute set a specific condition that must be 
met, like a certain downpayment amount or a certain credit 
score or a certain income level, and then hold hard and fast to 
that no matter what as a matter of statutory law? Or is it 
better to let the mortgage market adapt based on market 
conditions and based on new information about what combination 
of underwriting criteria best predict repayment? Ms. Gordon, 
maybe I could start with you on that.
    Ms. Gordon. Sure. Thanks so much for this question, because 
I believe the answer is we absolutely should not set 
underwriting criteria in legislation in the context of the 
housing finance system.
    What we do have now that we did not have before is through 
the Dodd-Frank Act there are quite specific rules now governing 
the underwriting of mortgages, and those rules have been the 
subject of much discussion, much work by the Consumer Financial 
Protection Bureau, and, you know, quite a lot of interested 
parties have been involved in that process. And while not all 
of us agree with every part of the way the rules came out, 
those rules are there now, and they are underpinning that 
aspect of consumer protection. And so I think it would be 
difficult if we, as I said, enshrined things in legislation.
    Senator Warren. OK. And let me just ask that same question 
of Mr. Lienhard. You do this for a living.
    Mr. Lienhard. Yes, I think that one of the pitfalls I see 
with hard-coding underwriting standards into legislation is 
that underwriting expertise and criteria can change over time, 
and so presumably we get better and better at understanding the 
characteristics of borrowers and the collateral in terms of 
sort of what a downpayment or what debt-to-income ratios or any 
other criteria that might emerge years from now. So I think 
that is sort of problematic, because when it is in legislation, 
then it is hard to sort of innovate and advance.
    I also think that the capital standards for the private 
capital should be able to create very legitimate risk to the 
guarantees, and that will force, in my view, to borrow Senator 
Corker's word, a dynamic underwriting enforcement or mechanism 
that I think you are looking for through the guarantee, the 
private guarantee function. So I would be very opposed to hard-
coding underwriting standards.
    Senator Warren. Good. Thank you.
    I am going to assume that I am going to get a similar 
answer, because I want to try to hit a second question. So if I 
am not, you should flag me. OK?
    Mr. Zandi. Well, I think the loans that are guaranteed by 
the Government in the system should be QM.
    Senator Warren. All right. Got it.
    Mr. Zandi. And that should be hard-coded.
    Senator Warren. Got it. But it is QM.
    Mr. Zandi. QM.
    Senator Warren. Rather than coding in a specific quality.
    Mr. Zandi. Right. Should be QM, though, because that gets 
rid of a lot of the egregious loan products that are at the 
heart of problems we had.
    Senator Warren. Right. So I want to ask a different 
question then as well, and that is, there are--because there 
are limitations on the scope of the Government guarantee, there 
will be mortgage-backed securities that are not guaranteed. 
That is our private-label market. We might make an estimate, 
just to get us started, that that might be something like half 
the market, $5 trillion. We do not know. I realize it will 
depend on other factors and likely go up and down.
    But here is my concern. My worry is that we will have a 
guaranteed market and we will have a private-label market, but 
that the private-label market will create the same kind of 
problem that we ended up in in 2008. There is no explicit 
guarantee of the private-label market, but if it is so big and 
so important that the players in the market begin to believe 
that there is an implicit Government guarantee, that that in 
turn will create the problems of moral hazard, of excessive 
risk taking, the problems with Fannie and Freddie that got us 
here in the first place, and all the problems of they scoop up 
the profits in good times and then leave the taxpayer with the 
bill in bad times.
    So I am worried about the question of whether or not we 
need some Government regulation of the nonguaranteed market to 
ensure that this kind of aggregation of risk does not occur. 
Dr. Zandi?
    Mr. Zandi. I think it is appropriate for you to be 
concerned about this, and let me make a broad statement and 
then a more specific one.
    Broadly, it is very important to consider housing finance 
reform in the context of the entire mortgage finance system. 
You know, right now we have just been focused on the part that 
would get the Government guarantee, but we have to think about 
it in the context of bank lending in terms of the private-label 
securities market and what may come from other sources. So we 
have to think about this--and the FHA, by the way. So we have 
to think about this holistically, and that is one very good 
thing about the PATH Act. It did try to think about it 
holistically. So that is key. So that is a broad statement, and 
so you are exactly right that we should be focused on this.
    More specifically, I do think that there should be some 
levers to address this risk. I do think we have QRM. QRM feels 
like it is going to be set to QM. But I would argue that QRM 
and QM are not coming down from the Mount, right? These are 
things that we can adjust and set in the future if things seem 
to be going awry, because now regulators are looking at the 
system in a--looking at it in terms of systemic risk, that this 
is now a lever we have, the regulators have a lever to change 
it if we need to.
    The other thing I would say is that the regulator that we 
are talking about here in the context of housing finance reform 
should have broader authority as well to look at the entire 
system and make some changes, if need be. I am just making this 
as an example. You know, I think it might be appropriate that 
we have a rep and warranty system that is consistent across all 
lending so that, you know, we do not get that bifurcation in 
the mortgage finance system. And if you do that, then you can 
control for this risk right at the root, you know, in the 
origination process.
    Now, we have to think this through, and I am thinking out 
loud for you, but--and there may be things I am not thinking 
about, but I think that is the kind of way I would approach 
this, yes.
    Senator Warren. Good. Thank you very much, and thank you 
for your indulgence, Mr. Chairman. I hope we can pursue this 
later. Thank you.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you. Good to see you, Mark.
    I started wrestling with the GSE reform, as you know, and 
others probably, about 10 years ago. I had an economist that 
was advising the Banking Committee at the time I was Chairman 
of the Committee, and she came to me and told me then could she 
have 30 minutes of my time. I said, ``Absolutely.'' And she 
explained to me then how thinly capitalized Freddie and Fannie 
were and how concerned she was and we should be with the 
implicit guarantee. And also some of the underwriting standards 
had eroded, so to speak.
    We tried then to reform Freddie and Fannie. We were not 
trying to put them out of business. We were trying to build 
their capital up and so forth and change some things, to no 
avail. Of course, we are where we are today, and that is why we 
are having this hearing.
    I am concerned about the housing market. Right now Fannie 
and Freddie are about the only game in town. But we still--they 
are sitting in our lap. They are doing a lot better, I think, 
under the leadership of Mr. DeMarco. They are buying better 
mortgages. Is that fair, Dr. Zandi?
    Mr. Zandi. Yes, that is fair.
    Senator Shelby. All of that?
    Mr. Zandi. Yes.
    Senator Shelby. But still if we are going to reform the 
GSEs, how do we, if we do, limit or can you limit the implicit 
guarantee? See, a lot of us would like to create the private 
sector period, if we could. Is that possible? I do not know it 
is probable. And a lot of people do not want to have capital. 
Fannie and Freddie, as I just said, had some of the thinnest 
capital of any financial institution in the world left 
standing.
    Mr. Zandi. Right.
    Senator Shelby. Capital itself will not solve everything, 
but it is a cushion, a big one. Some people argue--and I have 
not analyzed everything in this proposal by Senators Warner and 
Corker, but we are doing it. Will this legislation--I will 
start with you, Dr. Zandi. Would this legislation change 
dynamically how the GSEs operate? Or will it be akin to what we 
had before?
    Mr. Zandi. It will change it wholesale, Senator. You know, 
I think just to give you context, Fannie and Freddie before the 
crisis had 50 basis points of capital, 0.5 percentage points, 
and that is being charitable.
    Senator Shelby. You could see through it, couldn't you?
    Mr. Zandi. The quality of the capital was highly 
questionable.
    Senator Shelby. Sure.
    Mr. Zandi. We are talking about in the Corker-Warner bill 
as written now 10 percent capital, and I am arguing, you know--
--
    Senator Shelby. I know.
    Mr. Zandi. Yes. So and then there are many, many other 
changes in the legislation. So we are talking--and it is an 
explicit guarantee. It is not implicit. You know, it is right 
there in our face, and we are saying it is explicit, and we are 
charging for it, and we have all the appropriate mechanisms for 
ensuring that taxpayers get their money back.
    Senator Shelby. But won't you have to tie capital, which is 
a cushion--is 5 percent maybe not enough? You can argue that. 
Or 10 percent or 8 percent. But adequate capital, good capital, 
with underwriting standards and so forth. You know, we have--we 
all have preached and pushed for people to have a chance to own 
a home here. But, gosh, we found out that everybody cannot or 
would not want to own a home or would ever make the payments 
and so forth, which is sad in a way. But some people do not 
want to buy. Our home ownership has gone down some. But isn't 
the key to any mortgage underwriting the underwriting itself, 
the credit, the downpayment, what they got in the game, and the 
capital of the institution, all this tied together?
    Mr. Zandi. Sure, absolutely. You can have all the capital 
in the world, but if you are making----
    Senator Shelby. Bad loans.
    Mr. Zandi. It is not going to matter, right? It is going to 
wipe out the capital. So we have to make sure it is not garbage 
in. We have to make sure that it is high-quality mortgages that 
are getting the explicit Government backstop, yes.
    Senator Shelby. What is your--and I will give, with the 
help of the Chairman maybe, others a chance to answer. You said 
you believe this is a step in the right direction, you know, 
this proposed legislation. You have got to have some concerns 
there. How can we improve this legislation?
    Mr. Zandi. I do have concerns.
    Senator Shelby. OK.
    Mr. Zandi. Some of it just resolves around the specific 
numbers. But in terms of structure, I would just mention one 
thing, and that is, I think it is very important that the 
institutions that are providing the capital cannot also be 
making the loans, that we need a clear break between these 
functions. Because if you allow them to combine, then you can 
get a vertically integrate market. What I mean is big 
institutions that feel like Fannie Mae and Freddie Mac that are 
too big to fail. So we need to separate those two things, those 
two functions, and that has to be clear in the future housing 
finance system.
    Senator Shelby. Heretofore they have been buying the loans, 
haven't they?
    Mr. Zandi. Yes. Now, in the current structure, Fannie and 
Freddie do not originate loans. We need to preserve that aspect 
of the current system.
    Senator Shelby. OK. Mr. Johns, do you have some 
observations on this?
    Mr. Johns. Yes, I think the capital does have to be tied to 
the underwriting standards. I think we would encourage, you 
know, if there is going to be a hard-coded number in the 
legislation, you know, in addition to that you want to have 
some regulatory flexibility that would allow you to take 
account of those differences in, you know, not just 
underwriting standards but any other criteria that should drive 
the loss number higher.
    Senator Shelby. Mr. Lienhard?
    Mr. Lienhard. I think my concern hinges around the 
execution. So while we need to move forward in terms of reform 
and the current system is untenable, it is very simple for an 
originator and the nature of the guarantee is very 
straightforward. There is no way we will replace that, but we 
will have multiple options, and those options involve in my 
mind, as I think about implementation, execution risk on the 
part of issuers.
    Senator Shelby. Give us a couple of examples.
    Mr. Lienhard. If you choose the wrong structure, if you 
choose the wrong guarantee and how that attaches to the TBA 
market and how--you know, we simply cannot----
    Senator Shelby. Should that be done by the regulator, the 
structure, or should we tie it to legislation and put it in a 
straitjacket?
    Mr. Lienhard. I think that the regulator is intimately 
involved in regulating those structures. That is actually 
really important. But the legislation should set the tone, and 
I think it is important for the Committee to recognize that, 
you know, it is not that easy for originators to just simply 
switch to a new structure or a new provider if, in fact, it is 
turning out that that mechanism is not working well. So I think 
the choice, the multiple choice and this idea of competition is 
a really good one, but the execution associated with sort of 
switching choices is challenging from an implementation 
perspective.
    Senator Shelby. Let me--well, you answer first, Ms. Gordon, 
and then I have got one follow-up.
    Ms. Gordon. Just a couple of comments on things that have 
come up throughout your remarks. I do think it is important to 
note that the erosion of underwriting standards was, in fact, 
initiated and led by what was happening in the private 
securitization market. It was not until toward the end of that 
period that Fannie and Freddie, because of their conflicted 
responsibility--well, because they were chasing profit and 
market share, they at that point abandoned what had been very 
sound underwriting standards that had kept the market safe for 
many years, and that was their big mistake, along with the 
gross undercapitalization that you have talked about.
    I do think now that we have instituted underwriting 
standards through QM and risk retention standards through QRM 
that it is easier to link up this new system to those 
standards, which will help on the underwriting side, and we 
have already talked about the capitalization side.
    Senator Shelby. Let me ask my last question here. We have 
had testimony before this Committee before on a number of 
occasions that in the multi-family area, conventional FHA, but 
conventional, too, that there are very few foreclosures. Very 
few. And I know that is--we are not talking about apples and 
oranges. We are talking about big apples and smaller apples 
here, I think. And I know that their underwriting is very 
important in multi-family for the most part, especially 
conventional. You have got to have some skin in the game. But 
is the lack of skin in the game--in other words, lack of 
downpayment underwriting--that causes some of our problem? Dr. 
Zandi? As opposed to multi-family.
    Mr. Zandi. Yes, I mean, I think in the single-family 
system, pre-crisis, currently, there is not enough skin in the 
game. We do not have enough capital, private capital. We do not 
require the folks that are receiving the mortgages and 
benefiting from issuing the mortgages to fully participate in 
the risk. So that is what we need to fix, and if we get that 
right, I think we will have a much sounder system with lower 
default rates and, you know, address some of the concerns that 
Senator Toomey has with regard to moral hazard.
    Senator Shelby. Mr. Johns, do you have anything?
    Mr. Johns. Are you talking about skin in the game from 
the----
    Senator Shelby. Downpayment.
    Mr. Johns. From the consumer perspective.
    Senator Shelby. Equity. In other words, if I--I remember 
anecdotally, I remember when I was very young--and that was a 
long time ago, but my wife and I bought our first house, built 
our first house, which we still live in. We want to pay as much 
down as we could to make the payments lower and also to pay it 
off as soon as we could, because we came from parents who came 
out of the Depression. They did not want debt. You understand 
that well. Now a lot of people do not want to pay anything 
down, even if they could. So I am speaking of skin the game.
    Mr. Johns. OK. So I think on that side I would support what 
Dr. Zandi is saying. It is an interesting sort of dichotomy 
because obviously you will have--we have many members within 
the Structured Finance Industry Group. You range from the 
issuers to servicers and the originators, and you have 
investors at one side. Clearly there is a balance of play there 
from a market perspective as to, you know, the more skin in the 
game that a homeowner has, then, you know, clearly there is 
less likelihood of default. At the same time, if you add that 
requirement to can you access the market, then it may reduce 
the amount of originations that you have that you can clear 
away and get low-cost funding for.
    So, you know, as an organization, it is something that we 
are very aware of. You know, if we look at the risk retention 
rules that have sort of recently come out, clearly it is an 
issue that will be debated over the next couple of months 
until, I think--at least until the common letters are submitted 
on October 30, and I would be happy to come back and give you a 
full read on where the industry as a whole sits on that.
    Chairman Johnson. Could the Senator think about wrapping 
up?
    Senator Shelby. I will conclude. You have been very 
generous with my time and yours, too. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Heitkamp?
    Senator Heitkamp. We all know how you feel, waiting to be 
last. We are in a spot where we have choices, and if we get 
bogged down on political ideology, we will make the choice to 
do nothing. Because I have been around here long enough now in 
my short time period to know that when we get into 
philosophical debates, we do not do reform. We do not do the 
things that we need to do to give certainty to the market, to 
give certainty to the American people, and to respond to their 
concerns.
    So I am going to ask one very broad question, which is 
three choices: Do nothing, which seems to be the kind of choice 
of default in Washington, D.C., as we bog down in philosophical 
debates. We have got the PATH Act, which shows that this is 
going to be market driven. Very little information--and maybe I 
am just not looking in the right places, but very little 
information about the consequences on the American middle class 
and home ownership and new families as a result of the lack of 
expression of explicit Federal guarantee and the availability 
of the 30-year, fixed-rate mortgage into the future. And we 
have got a hybrid. We have got an opportunity to do real 
reform, and I know that there are so many of you on this panel 
who have participated in that discussion. Great work. I have 
read a lot of the work that has come out of your organization 
and I really appreciate it. For somebody who brings maybe a new 
perspective to this issue, it has been extraordinarily helpful. 
And so those are our three choices. Obviously the bill that we 
are considering today is the hybrid. It is that choice.
    I want to ask you, Doctor, where can we better inform the 
American public about the actual consequences to our middle 
class and to our citizens on the consequences of those three 
choices? Where do we go for that information? Because I know 
you have been asked here kind of pick a choice or do a 
critique, and that was going to be my question, which is do a 
critique between the PATH Act and what we have in front of us 
in terms of affordability and availability of home ownership. 
But I want to know who is going to do that work so that we can 
better inform the public.
    Mr. Zandi. Well, I think the thing that would resonate with 
people is, you know, how much is this going to cost me? You 
know, what does it mean for my monthly mortgage payment? And--
--
    Senator Heitkamp. If I can just interrupt, it may also be, 
Can I get a mortgage?
    Mr. Zandi. That as well, sure, absolutely. But I think if 
we can come up with that number under different pieces of 
legislation, that would be quite informative. You know, I have 
taken a crack at that. I have done that for the PATH Act. I 
have done that for Corker-Warner, under different 
capitalization assumptions. And, of course, there are a lot of 
moving parts. But we have done that work. We can make it better 
and refine it as the legislation improves, but----
    Senator Heitkamp. And can you give some insight on your 
conclusions as a result of that work?
    Mr. Zandi. Yes. So if we go from the current system to 
where I think the system should be, 5 percent capitalization, 
that would add roughly $60 to the monthly mortgage payment.
    If we go to a 10 percent capitalization--so this is what is 
in Corker-Warner right now--that would probably add another $60 
to the monthly mortgage payment. So it would be $120 from where 
we are today. And, again, a lot of moving parts and a lot of 
assumptions.
    If we go to the PATH Act, then--and I am going to do this 
calculation for you precisely, but I am just going to give you 
a sense of the ballpark estimate. I do not want to be on the 
record saying a specific number and be wrong, but it is 
probably double that. You know, it is probably $240 a month 
from where we are today. So it is a significant increase in the 
cost.
    And, obviously, those are big numbers, right? I mean, just 
add it up. And that means that for the average typical home 
buyer, it is going to be a lot harder to get a mortgage. And 
then for the people--and those numbers I just gave you, that is 
for the typical borrower. That is for the person that is right 
down in the middle of the distribution of borrowers in a normal 
economic environment. If you go to the person--take QM and go 
to the end of the box, you know, the guy that is just marginal, 
still qualifies but is marginal, in a bad economy, in a 
recession, let us say, then the cost is going to be higher than 
that, measurably higher than that.
    So these decisions you are making really mean a lot for 
Americans. I mean, 65 percent of Americans own a home. You are 
going to affect them.
    Senator Heitkamp. And I see I am out of time, but I just 
want to reiterate the point that for so many Americans, their 
home has not just been a house. It has also been their 
investment, banking on the availability. And as we look at a 
reduction in the number of companies, in fact, an elimination 
in the number of people--entities in the private sector who are 
willing to do a defined benefit plan anymore, we are all now 
saving for our future. I worry greatly how all of this will 
affect retirements into the future, how all of this will affect 
our ability to supplement our older income. And so this is 
enormously important, not just to the American economy, but it 
is enormously important to Americans that we get this right. 
And I think, you know, we have this Committee, at least the 10 
of us who have sponsored this legislation, take a look at this 
and say if we do nothing, this place will not result in reform. 
And that may be the worst outcome for the people who most 
disagree with this provision.
    And so I just want to--you all have had an enormous 
opportunity, I think, here to provide input. I hope that you 
will continue that, and I thank you for the work that you have 
done on behalf of the American people and on behalf of the 
American economy. It has been extraordinary, and I have really 
enjoyed listening.
    Chairman Johnson. Thank you again to all of our witnesses 
for being here today. Your testimony will help guide our 
hearings going forward. I look forward to continuing this 
discussion and working with Senator Crapo and all of my 
colleagues on the Committee to achieve an agreement on housing 
finance reform.
    This hearing is adjourned.
    [Whereupon, at 12:07 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]






































                                 ______
                                 
              PREPARED STATEMENT OF JEROME T. LIENHARD, II
     President and Chief Executive Officer, SunTrust Mortgage, Inc.
                           September 12, 2013
    Good morning Chairman Johnson, Ranking Member Crapo and Members of 
the Banking Committee. I'm Jerome Lienhard, president and CEO of 
SunTrust Mortgage, a subsidiary of SunTrust Banks. Housing finance 
reform is a critical matter with wide-ranging implications. Thank you 
for allowing me to participate in the consideration of this important 
subject.
    I am appearing today in my capacity at SunTrust Mortgage and this 
testimony was prepared after consultation with the Regional Bank Group, 
an informal coalition of mid-sized lending institutions located 
throughout the United States. All views expressed today, however, are 
my own.
    SunTrust is headquartered in Atlanta and operates mainly in the 
Southeastern United States. We are committed to Lighting the Way to 
Financial Well-Being by listening to client needs and offering a broad 
range of banking, borrowing, and investment services for individuals 
and small to-mid-sized businesses.
    SunTrust Mortgage, the organization that I lead, is based in 
Richmond, Virginia and employs about 4,300 teammates. Last year, we 
originated over $32 billion in mortgage loans which helped more than 
120,000 clients purchase a home or lower their monthly payment through 
refinancing.
    The Regional Bank Group consists of 18 financial institutions that 
share a business model and a set of values dedicated to providing 
banking products and services to America's families and businesses. We 
take in deposits and redeploy them by making loans in our communities. 
Our clients are people and businesses with real needs such as checking 
accounts, loans and payment services.
    Today I'd like to make two important points from the perspective of 
a regional bank:

    First, while there is a need to reform the housing finance 
        system, it is critical to retain the basic ``plumbing'' of the 
        system that draws in enormous sums of investment capital and 
        provides borrowers with rate certainty. These features can be 
        retained in a mortgage market that serves the interests of 
        borrowers and taxpayers alike.

    Second, reform must bring more private capital into the 
        mortgage market in a principal loss position without reducing 
        the global demand for mortgage-backed securities and while 
        providing competitive access for small and medium-sized 
        institutions that serve millions of homeowners.

    I will spend a few minutes elaborating on each of these points.
    Out of thousands of mortgage loans that we make every year, on 
average, we hold only one in six on our balance sheet. So while we own 
$30 billion worth of mortgage loans, we actually originated and service 
more than $140 billion in mortgages involving more than 800,000 
households. This is possible for us, and other regional banks, due to 
the existence of the secondary mortgage market.
    This vast majority of the mortgages we originate for sale in the 
secondary market are either ``conforming'' loans, meaning they comply 
with the guidelines set by Fannie Mae and Freddie Mac; FHA loans, which 
comply with the insurance terms established by the Federal Housing 
Administration in HUD; or VA loans eligible for the Veterans 
Administration's guaranty program.
    The process by which we price and close the loan and package it for 
the secondary market are important to a well-informed discussion 
relating to housing finance reform.
    Our clients come to SunTrust Mortgage through our branches, on-line 
or through our network of loan officers and institutional mortgage 
partners. We listen closely, assess needs, and thoroughly explain the 
full range of products that we have available to our clients.
    To provide the client with basic information regarding how much 
they can afford to pay for a house, we must be able to tell them the 
interest rate and the monthly cost of the loan. You can't buy a house 
if you don't know what your mortgage payment will be.
    We do this by referencing a daily pricing sheet that provides the 
interest rate and loan terms that can be offered on a guaranteed basis. 
These prices are set from the price of MBS trading in the ``To Be 
Announced'' (TBA) market. TBA security prices assume delivery of 
conforming mortgages into a Freddie Mac or Fannie Mae mortgage-backed 
security on a forward basis. The forward-pricing mechanism of the 
secondary market allows us to lock in the interest rate for clients for 
up to 90 days.
    Once we lock an interest rate, we proceed through the mortgage 
lending process. Acting as an agent for Fannie Mae and Freddie Mac, we 
make sure the client's mortgage is properly qualified, underwritten, 
documented, settled and delivered using GSE guidelines and 
requirements. This requires expertise and very detailed execution.
    But it all starts with the certainty we have regarding how we are 
funding the mortgage. Without that certainty, primary market lenders 
would be unwilling and unable to provide forward price certainty to 
borrowers. The MBS market solves the ``chicken or egg'' problem of 
funding risk by allowing lenders to set mortgage loan delivery terms up 
front, while allowing execution and delivery to follow.
    Through the combination of mortgage standardization and the 
function of the MBS market, the existing system provides a tangible 
benefit to borrowers. And these benefits are available for borrowers 
who transact with originators of any size: local banks, Main Street 
banks such as SunTrust, as well as the largest mortgage originators.
    While there is a need to address taxpayer risk by making structural 
changes to the housing finance system, the securitization platform, the 
standard-setting on lending and documentation and the servicing 
requirements are absolutely essential to maintaining a secondary 
market. This infrastructure is so foundational that we must emerge from 
housing finance reform with these key functions intact.
    Let me conclude with a few remarks on the critical issue of the 
structure of the credit guarantee. Our markets perform so well in large 
part because credit risk associated with mortgage default is assumed by 
the GSEs. Investors from around the world allocate trillions of dollars 
of capital to our market because it only involves interest rate risk.
    The problem, of course, is that providing credit protection puts 
taxpayers at risk. Using private sources of capital to cover credit 
exposure can help alleviate taxpayer risk.
    However, if changes are made to the credit guarantee function, it 
must work well for investors. It must also operate transparently and 
with scale. The U.S. mortgage market involves trillions of dollars. 
This quantity of private capital required to backstop the market is 
very significant. If that market shrinks dramatically, so does lending 
to borrowers.
    We must also consider that if a variety of credit risk devices 
emerge in place of the relatively simple credit guarantee we have 
today, it could make mortgage-backed securities difficult for investors 
to value, fracturing the investor base, reducing liquidity and 
increasing costs.
    To the extent that private capital is intended to stand before any 
taxpayer-backed guarantees, the entities and instruments must be 
subject to regulatory oversight. If regulators cannot understand nor 
keep track of the various risk sharing mechanisms, there is a danger 
that they will not perform as needed under crises conditions.
    Finally, any new source of private sector credit protection should 
be available for all primary market lenders--including large, small and 
Main Street institutions. If certain entities cannot obtain competitive 
access to credit protection in the secondary market, they will have a 
great difficulty competing in the primary market. Measures that create 
advantages for the very largest issuers of MBS, or make the cost of 
market access more expensive for some and not others, will reduce 
competition and must be avoided. Additionally, any new framework should 
maximize the secondary market liquidity in the new MBS to ensure that 
regulated financial institutions are able to participate as investors, 
use the securities as liquid assets, and pledge them as collateral.
    Let me conclude by thanking the Committee again for its time, 
attention and consideration. We stand ready to provide you with any 
assistance or advice you may need as your important work continues. I 
look forward to answering any of your questions.
                                 ______
                                 
                  PREPARED STATEMENT OF RICHARD JOHNS
    Executive Director, Structured Finance Industry Group (``SFIG'')
                           September 12, 2013
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee on Banking, Housing and Urban Affairs:

    My name is Richard Johns. I am the Executive Director of the 
Structured Finance Industry Group, Inc. (``SFIG''), a trade industry 
education and advocacy group established in March 2013 that presently 
is comprised of over 160 corporate members from all sectors of the 
structured finance and securitization market, including investors, 
issuers, financial intermediaries, law firms, accounting firms, 
technology firms, rating agencies, servicers, and trustees. A key 
element of SFIG's mission is to educate and advocate on behalf of the 
structured finance and securitization industry with respect to policy, 
legal, regulatory and other matters affecting or potentially affecting 
the structured finance, securitization and related capital markets. It 
is with that mission in mind that I thank you for this opportunity to 
address the Committee regarding proposed housing finance reforms, 
including the role to be played by the Government in the housing 
finance system and the importance of returning private capital to the 
mortgage market.
    As this Committee continues its examination of potential reforms to 
our system of housing finance, SFIG welcomes the opportunity to provide 
commentary and analysis, particularly as it relates to the impact of 
various reform options on the securitization markets. Before I proceed, 
I want to acknowledge the effort of all those who are working to make 
reasonable but necessary reforms to the housing finance system. SFIG 
believes that the reform process must proceed in a measured and 
deliberate way, and we appreciate the Committee's methodical approach 
in considering reforms that are so inherently critical to the U.S. 
housing market and the economy as a whole. As an organizing principle 
for this process, we suggest that there are three sequential stages 
that any reform effort should follow in order to preserve the TBA (``To 
Be Announced'') Market. First, a conversion into a common TBA should be 
adopted, making Fannie and Freddie MBS fungible and therefore 
deliverable into a single TBA Market, eliminating current pricing and 
liquidity inefficiencies in the Agency Market.\1\ Second, any reform 
legislation should provide for the creation of a single agency security 
that not only would facilitate the conversion and continued liquidity 
of legacy securities but also would promote a deep and liquid new-issue 
MBS market. Third, a common securitization platform should be 
established for the purpose of overseeing and maintaining the 
standardization of the market for Government-guaranteed MBS. With that 
organizing principle in mind, SFIG believes that there are a number of 
issues that must be addressed in any reform process, specifically:
---------------------------------------------------------------------------
    \1\ In order for a common TBA to be implemented successfully, a 
number of issues need to be considered and addressed, and SFIG believes 
originators, financial intermediaries and investors must play a major 
role in that process.

    An integral part of any reform will be to ensure the 
        continued liquidity of the TBA Market, which is the most 
        efficient and cheapest mechanism to enable a mortgage consumer 
        to ``lock in'' the interest rate at the time when a mortgage 
        loan is approved and thereby minimize the cost of borrowing. 
        The TBA Market also creates efficiencies and cost savings for 
        lenders that are passed on to borrowers in the form of lower 
        rates. Currently, the TBA Market is reliant in part on the 
        existence of Government-guaranteed MBS, making it imperative 
        that any reform legislation include provisions that preserve 
---------------------------------------------------------------------------
        some form of a Government guarantee.

    The best approach to risk sharing in a reformed housing 
        finance system would be for private capital to assume the first 
        risk of loss, the proper amount of which should be flexibly 
        assessed in light of market factors, while retaining an 
        explicit Government backstop against catastrophic loss. The 
        retention of the catastrophic Government guarantee is critical 
        to ensuring the continued participation of institutional ``rate 
        investors,'' which provide a majority of the capital currently 
        invested in the Agency Market.

    The transition from the status quo to a new housing finance 
        structure must be transparent, appropriate to market 
        conditions, and handled with great care to minimize any 
        disruptions to the flow of credit to consumers, and in 
        particular to ensure the continued functioning of a healthy TBA 
        Market. Of utmost concern is that steps must be taken to allow 
        the fulfillment of existing commitments (including contracts 
        for future delivery) and preserve the market for legacy 
        securities (i.e., outstanding Government-guaranteed MBS), while 
        allowing sufficient time for eligible loans under the reformed 
        system to be generated and take hold in the TBA Market. SFIG 
        believes that the best way to facilitate this transition would 
        be to create a single agency security to which legacy 
        securities would be converted and which Fannie and Freddie 
        could begin issuing even before a single securitization 
        platform is fully functional. This would allow for cost savings 
        as well as greater liquidity in the TBA Market. Failure to take 
        such steps not only would discourage investors from 
        participating in both the leftover and post-reform TBA Market, 
        but it also would create substantial mortgage funding issues.

    Any new infrastructure for the housing finance system must 
        provide for or facilitate the standardization of MBS 
        instruments that receive an ultimate Government guarantee in 
        order to ensure the continued functioning of the TBA Market. 
        Standardization is critical to maintaining the fungibility and 
        liquidity of the Government-guaranteed MBS that drive the TBA 
        Market.

    Any reform legislation should leave to regulators, working 
        with market participants, the determination of the specific 
        types of representations, warranties, enforcement provisions 
        and recourse to be used in the new housing finance system.

    With respect to affordable housing, Congress should 
        explicitly promote that goal through a stand-alone program not 
        linked in any way to the operation of the secondary mortgage 
        market, and should fund that program through separate 
        legislative mechanisms.

    Conversely, Congress should reduce the upper loan limits 
        for Government-guaranteed loans to ensure that the benefits of 
        low-cost mortgage loans are directed at the segment of the 
        population most in need of those loans.
REFORMS MUST PRESERVE THE SMOOTH FUNCTIONING OF THE TBA MARKET.
    As shown in the chart below, the TBA Market is the third most 
liquid securities market in the world.\2\
---------------------------------------------------------------------------
    \2\ Sources: Securities Industry and Financial Markets Association; 
UK Debt Management Office; FRG Finance Agency; Japan Securities Dealers 
Association; AsianBondsOnline.com; Agence France Tresor Monthly 
Bulletin.


    Moreover, more than 90 percent of Government-guaranteed MBS trading 
volume occurs in the TBA Market. Accordingly, any reforms must be 
complemented by steps to ensure the TBA Market's continuing efficiency 
and liquidity.
    The TBA Market creates efficiencies and cost savings for lenders 
that are passed on to borrowers in the form of lower rates. It also is 
the most efficient and cheapest mechanism to enable a consumer to 
``lock in'' the interest rate at the time when the loan is approved, 
rather than take the risk that interest rates will rise between 
approval of the loan and the closing of the loan, which would increase 
the cost of the mortgage loan to the consumer and possibly make it 
unaffordable. The TBA Market does this through a system of forward 
trades of mortgage loan pools for guaranteed MBS that facilitates the 
shifting of interest rate risk into the capital markets. Thus, 
originators can offer consumers this ability to ``lock in'' mortgage 
rates by hedging the risk that interest rates will rise between 
application and closing. In this way, the TBA Market allows for 
stability between the time of loan origination and loan closing, 
ensuring that the terms of a mortgage loan do not fluctuate due to 
macroeconomic changes and reducing costs to consumers.
    The distinguishing trait of trades in the TBA Market is their 
homogeneity (i.e., standardized underwriting criteria and loan 
features, the Government guarantee, the geographic diversification 
incorporated into the pooling process, the limited number of issuers, 
the simple structure of ``pass-through'' security features, and the 
restriction of the range of interest rates on loans deliverable into a 
single security). The parties to the trades agree only on certain 
criteria of the securities to be delivered: issuer, maturity, coupon, 
price, par amount, and settlement date. The actual securities to be 
delivered at trade settlement are not specified on the date the 
transaction is executed. Rather, just before the settlement date, the 
seller notifies the buyer of the specific securities that will satisfy 
the TBA agreement.
    Because TBA buyers are indifferent as to the specific securities 
delivered, originators are able to easily and inexpensively cover their 
hedges should they originate less collateral than expected in any given 
period, significantly reducing the cost to hedge and rate lock. 
Moreover, since the TBA Market simplifies the analytical and risk 
management challenges for participants, a broader group of investors 
participates in the TBA Market than would otherwise participate if 
investment decisions were more complex. The additional investors-
specifically foreign central banks, mutual funds and hedge funds-inject 
more capital into the market for financing mortgages and ultimately 
reduce the cost of capital to consumers.
    Homogeneity is what makes the TBA Market possible, specifically, 
the fungibility of the conforming loan product (through standardized 
underwriting criteria and loan features) and a Government guarantee, 
which equalizes credit risk. Additionally, due to the specific 
exemption from SEC shelf registration requirements applicable to 
Government-guaranteed securities, specific collateral need not be 
identified, thus allowing forward selling. It is not possible to 
replicate the TBA Market without these factors. Any reform which does 
not accommodate, or suitably replace, the existing TBA Market will 
undoubtedly impact mortgage originators and consumers both severely and 
negatively by reducing price transparency, liquidity, and the 
originators' options to rate lock and thus satisfy consumer needs.
    In short, the TBA Market removes uncertainty from the mortgage 
origination business and keeps mortgage rates low for potential 
borrowers. As noted in a report published by the Federal Reserve Bank 
of New York, ``the TBA market serves a valuable role in the mortgage 
finance system,'' and ``evaluations of proposed reforms to U.S. housing 
finance should take into account potential effects of those reforms on 
the operation of the TBA market and its liquidity.'' TBA Trading and 
Liquidity in the Agency MBS Market, James Vickery and Joshua Wright, 
FRBNY Economic Policy Review, May 2013.
    One factor that any reform must account for is that the TBA Market 
is reliant in part on the existence of MBS that are guaranteed by the 
Government. For that reason, the TBA Market is extremely sensitive to 
any changes to the role that the Government will have in the housing 
finance system going forward. Indeed, the TBA Market could not be 
recreated without the features discussed above that are unique to 
Government-guaranteed MBS. Accordingly, SFIG believes that the 
maintenance of a partial, second-loss Government backstop against 
catastrophic loss for MBS is crucial to preserving the health of the 
TBA Market and continuing to promote stability and affordable interest 
rates for consumers in different market cycles.
THE HOUSING FINANCE SYSTEM WORKS BEST WHEN THERE IS RISK-SHARING AMONG 
        PARTICIPANTS.
    Mortgage securitization is by nature a process by which the risks 
associated with residential mortgage lending are spread among various 
investors with differing appetites for risk. Attracting private capital 
to undertake these risks is of critical importance to the consumer and 
the economy as a whole. The Government has always guaranteed a large 
percentage of residential mortgage securitization, but historically the 
market also included securitizations funded solely by private capital 
with no explicit Government guarantee. These two markets cater to two 
different types of investors distinguished by the type of risk that 
each is willing to undertake, specifically, ``rate risk'' and ``credit 
risk.'' For this reason, any reforms that aim to limit the Government's 
involvement in the Agency Market by changing or ending the current 
infrastructure must account for the impact that such changes will have 
on the flow of private capital that historically has favored 
Government-guaranteed MBS.
    As noted, there are two main risks associated with residential 
mortgage lending. The first, called market or rate risk, results from 
interest rate changes. After the interest rate on a residential 
mortgage loan is set (for example, the interest rate on a fixed-rate 
residential mortgage), that mortgage loan becomes less valuable over 
time if current residential mortgage rates rise, because the owner of 
that mortgage loan earns less in interest than it would if it owned a 
mortgage loan at the current (higher) market rate of interest. In 
addition, a consumer generally has the right to prepay his residential 
mortgage loan at any time (for example, if the consumer decides to sell 
the home), which may reduce the economic upside to the owner of the 
mortgage loan. Furthermore, refinancing of residential mortgages 
generally occurs when interest rates fall. The specific market risks 
associated with owning residential mortgage loans are dependent on the 
precise terms and types of mortgage loans.
    The second risk associated with mortgage lending is credit risk. 
Credit risk consists of two components: (1) default risk; and (2) loss 
severity risk. Default risk is the risk that the consumer fails to 
repay the loan. Loss severity risk is the risk that, after a consumer 
defaults, the lender will not recoup all of the principal lent and the 
expected interest on that principal.
    Private capital ``rates investors'' are willing to bear the rate 
risk and prepayment risk, but seek to avoid credit risk, because these 
investors operate under investment guidelines, capital requirements, 
and liquidity requirements that preclude them from purchasing private-
label securities in any significant concentration. Examples of rates 
investors are foreign central banks, domestic banks and mutual funds. 
Historically, ``rates investors'' have been attracted to Government-
guaranteed MBS--in which the Government bears the bulk of the credit 
risk--and they have contributed trillions of dollars to the Agency 
Market because of those guarantees. By contrast, ``credit investors'' 
such as insurance companies and investment funds have fewer constraints 
on taking credit risk, and may in fact actively seek it out in exchange 
for higher potential returns.
    Limiting the Government's involvement in the market by changing or 
ending the current infrastructure must account for the critical 
contribution that rates investors make to the Agency Market and their 
historic aversion to credit risk, as well as the limited pool of 
private capital available to fund credit risk. Accordingly, SFIG 
believes that retention of a catastrophic-loss Government backstop is 
essential to maintaining and increasing the participation of rates 
investors in the Agency Market. Indeed, SFIG believes that the TBA 
Market and the rates market for MBS cannot function without such a 
guarantee.
    However, we also acknowledge that private investors have a role to 
play in insuring against the credit risks posed by residential 
mortgages. To that end, SFIG generally supports the approach of having 
private capital take on credit risk, while also having a Government 
guarantee that is explicit and priced in a reasonable manner. Any risk-
sharing structure should be carefully reviewed to ensure that the TBA 
Market is not disrupted. Furthermore, we believe that private capital 
should be placed in the first-loss position, with the private credit 
enhancement being calculated to cover reasonable risks presented by the 
market and the Government backstop covering catastrophic risk, i.e., 
the Government guarantee will generally be called upon only when the 
operation of the secondary mortgage market as a whole is at risk.
    SFIG supports a variety of mechanisms to bring private capital into 
the mortgage market, including corporate guarantees and capital markets 
transactions. Various forms of capital should be allowed to compete on 
a level playing field that balances sufficient risk retention at each 
step of the origination process to align incentives with the separation 
of functions and responsibility necessary to attract diverse capital 
sources.
    As for the amount of risk that a private investor should be 
required to assume, SFIG believes that the 10 percent first risk of 
loss provided for in S. 1217 is too high, as shown in the chart 
below.\3\
---------------------------------------------------------------------------
    \3\ Source: Securities Industry and Financial Markets Association, 
Housing Finance, September 2013, at 10.


    We suggest that, if the Committee is determined to include some 
minimum level of risk assumption in the legislation, the level be 
considered a ``target'' that the Committee establishes based on 
underwriting-related factors, such as historical loss data in the TBA 
market. Furthermore, the regulators should have the discretion to 
deviate from the target based upon their own assessment of qualitative 
risk factors.
    The regulators will have to take a variety of complex factors into 
account to ensure that the private credit enhancement is rationally 
sized at a level that is commensurate with the qualitative attributes 
of risk-sharing structures. These factors include readily available 
historic information, the likely loan types, general housing/economic 
indicators, any applicable representations and warranties, and whether 
the various forms of insurance and guarantees--e.g., the combination of 
homeowner's equity and mortgage insurance, Mortgage Insurance Fund 
coverage, and the Government catastrophic guarantee--may be duplicative 
and overlapping due to counterparty risk, thereby reducing the amount 
of risk that private investors should assume.
    We believe that if the required private credit enhancement is too 
high and vastly exceeds the loss expectations of the associated assets, 
the redundant enhancement creates the potential for distortion. 
Originators must find a way to pay for the enhancement, and the 
available options may not be good for the consumer or housing market. 
For example, an originator may simply pass the cost of the redundant 
enhancement directly through to consumers via increased rates, thereby 
undermining one of the primary benefits that the Agency Market affords 
consumers, namely, lower cost loans. And even if such steps are taken, 
the possibility remains that there might not be sufficient private 
capital in the market to satisfy a private credit enhancement level 
that exceeds what is necessary to address the actual risk factors.
THE TRANSITION TO A NEW HOUSING FINANCE STRUCTURE SHOULD BE IMPLEMENTED 
        GRADUALLY AND WITH GREAT CARE.
    The transition from the status quo to a new housing finance 
structure must be handled with great care to minimize any disruptions 
to the flow of credit to consumers. The transition process should be 
carefully implemented, and to avoid severe market disruption should 
allow for: (1) a clear and transparent plan for transition; (2) a 
determination that market conditions are appropriate for the 
transition; (3) the fulfillment of existing commitments (including 
contracts for future delivery); (4) a determination that issues 
relating to legacy securities have been appropriately handled; (5) time 
to generate eligible loans; (6) testing or piloting the new structure 
in a real market environment; and (7) continuation of the TBA Market.
    SFIG's primary transition-related concern centers on ensuring that 
whatever system is put in place, it performs and functions properly and 
continues to facilitate a robust TBA Market. It is imperative that 
steps be taken both to preserve the market for legacy securities (i.e., 
outstanding Government-guaranteed MBS), while allowing sufficient time 
for eligible loans under the reformed system to be generated and take 
hold in the TBA Market. Otherwise, the post-reform TBA Market will 
stall as: (1) investors in legacy securities are left with orphaned 
securities that continue to lose value as they factor down and their 
market becomes smaller and smaller; and (2) the market for new agency 
securities takes time to ramp up.
    SFIG believes that the surest method of facilitating a smooth 
transition is to allow for a conversion mechanism such that existing 
Government-guaranteed MBS are interchangeable with the new Government-
guaranteed MBS. Fannie and Freddie could begin issuing a single 
mortgage-backed security even before the single securitization platform 
is fully functional. This would allow for cost savings as well as 
greater liquidity. Failure to take this step not only would discourage 
investors from participating in both the leftover and post-reform TBA 
Markets, but it also would create substantial mortgage funding issues 
as liquidity diminishes.
    SFIG also believes that all market participants would benefit to 
the extent that the current and new infrastructures operate in tandem 
for some period of time, or, in the alternative, appropriate portions 
of the current infrastructure are utilized by the new infrastructure. 
In addition, a final wind down of Fannie and Freddie should happen only 
after the new framework has been sufficiently tested and we can all be 
confident that it will facilitate the continued functioning of the TBA 
Market.
    We believe that these and other operational and delivery issues 
that will arise from the winding down of the existing framework and the 
ramping up of the new framework should be minimized by actively 
engaging directly with the relevant industry participants to determine 
the appropriate balance of regulatory discretion and legislative 
guidance regarding how the transition should proceed, as well as 
maintaining consistency (to the extent feasible) among the MBS issued 
across the platforms.
STANDARDIZATION IS ESSENTIAL TO THE FUNCTIONING OF THE REFORMED TBA 
        MARKET.
    Any new infrastructure for the trading of Government-guaranteed 
securities will necessarily include requirements for areas such as 
disclosure, documentation, data collection and overall standardization 
of Government-guaranteed MBS transactions. Indeed, standardization of 
documents (e.g., standard Government loan forms), structuring and 
underwriting (e.g., conforming loan limits, document verification, 
etc.) is critical to the TBA Market because it increases fungibility 
and liquidity of Government-guaranteed MBS. These requirements should 
be very transparent, take into consideration the needs of all parties 
to the transactions, and include investor protections. Important to 
this standardization of the market will be establishing common 
infrastructure in the form of a common securitization platform that 
will lower barriers to entry for new participants into the system and 
enable different entities to issue a single security without variation.
    We would also caution that standards and practices that may or may 
not be appropriate for the new Government-guaranteed securities may not 
be appropriate for private-label securities given the wide variety of 
loan types, origination practices, servicing contracts, deal structures 
and the difference in negotiating power of transaction participants. 
The newly reemerging private-label RMBS market should not be expected 
to align completely with the rules and standards that are developed for 
the new Government-guaranteed securities. As noted above, the two 
markets cater to two different types of investors.
LEGISLATION SHOULD NOT SPECIFY THE TYPES OF REPRESENTATIONS AND 
        WARRANTIES TO BE USED IN THE NEW HOUSING FINANCE SYSTEM.
    We do not believe that language specifying the types of 
representations, warranties, enforcement provisions and recourse to be 
used in the new housing finance system should be prescribed in 
legislation. Rather, these are matters that should be left to the 
discretion of regulators. SFIG is actively focused on evaluating 
different representation, warranty, enforcement and recourse approaches 
that have arisen in the private-label RMBS market. We have also begun a 
dialog with regulators and agencies regarding this topic to explore how 
the Government might incorporate our analyses into its current efforts. 
Areas of particular interest include common securitization platform, 
secondary market viability of loans that do not meet Qualified 
Mortgage-Safe Harbor and Qualified Residential Mortgage standards, 
Regulation AB 2 proposals and due diligence, data, breach, repurchase 
and other disclosures.
AFFORDABLE HOME OWNERSHIP SHOULD BE PURSUED THROUGH A SEPARATE, 
        EXPLICIT PROGRAM DEDICATED TO THAT GOAL.
    SFIG agrees that all segments of American society should have the 
opportunity to become home owners and that the Government can and 
should play an important role in making that goal a reality. However, 
we do not agree with the current system, which has led to implicit 
subsidies in the form of purchases of subprime loans from 
noncreditworthy consumers. Instead, SFIG believes that Congress should 
explicitly promote affordable housing through a stand-alone program not 
linked in any way to the operation of the secondary mortgage market, 
and should fund that program through separate legislative mechanisms.
    On the flip side of the equation, we also agree that the current 
upper limits for Government-guaranteed loans should be reduced, to 
ensure that the market is focused on the segment of consumers for whom 
the Government guarantee is most essential in obtaining reasonably 
priced residential mortgages.
CONCLUSION
    The issues confronting the Committee as it considers reforms to the 
housing finance system are critical not only to the health of the 
nation's housing market, but to the growth of the nation's economy 
generally. While we recognize the need to correct the errors of the 
past, we urge the Committee not to lose sight of the ways in which the 
Agency Market has worked well, and continues to work well (such as 
through the TBA Market), to facilitate the ability of Americans to 
enjoy the benefits of home ownership. To that end, we encourage the 
Committee to strive to retain the mechanisms, such as the Government 
guarantee, that have succeeded in bringing vast amounts of private 
capital into the housing market, while it takes steps to more equitably 
and effectively distribute the risks related to residential mortgages.
    We look forward to working with the Committee as it considers these 
vitally important issues. Thank you again for the opportunity to share 
SFIG's views.














































                                 ______
                                 

   RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER FROM JULIA 
                             GORDON

Q.1. During the hearing the issue of capital markets execution, 
as opposed to bond guarantor ``entity'' execution, was 
discussed. Could you briefly discuss the advantages of allowing 
multiple sources of capital--from both the equity and fixed-
income markets--take on credit risk? And to the extent you have 
concerns, if you have them, please make suggestions for how we 
might alleviate those concerns?

A.1. Thank you for your question and the opportunity to weigh 
in on this important issue. I do not believe any advantages 
theoretically provided by the opportunity for multiple 
executions outweighs the potential disadvantages of providing a 
Government wrap to individual structured transactions. As I 
highlighted in my testimony, I'm concerned about the capital 
markets execution for several reasons:

   LA system based on bond guarantors or other 
        ``entities'' is significantly easier to regulate for 
        safety and soundness. Not only will there be fewer 
        entities to monitor, but the insurance that bond 
        guarantors will provide is more easily understood by a 
        regulator than diverse and complex structured 
        transactions.

   LBond guarantors are much more efficient at pooling 
        and spreading risks, which is the core function of 
        insurance. Structured transactions, to the extent that 
        they cover a single or limited number of pools, cannot 
        allocate risks and reserves across years, regions, 
        lenders, and so on.

   LAs we have seen in recent private-label 
        securitizations, investors in structured transactions 
        have proven unwilling to assume risk on anything but 
        the most pristine mortgages. If investors are assuming 
        the first-loss risk, their high level of scrutiny will 
        result in higher prices for nontraditional but still 
        creditworthy borrowers, as the investors will demand a 
        premium for taking risk that is not well-understood or 
        serving borrowers who are perceived as more risky.

   LIndividual deals are much less likely to be able to 
        support a robust TBA market, as they do not offer the 
        same level of homogeneity in contract terms and the 
        structures likely will require high levels of loan 
        level disclosures. These higher levels of disclosure 
        will reduce liquidity by fracturing the market into 
        more individually priced securities that will not be 
        suitable for the fungible TBA market. Even if a system 
        can be found to permit the forward trading that 
        characterizes the current TBA market, the lack of 
        homogeneity over time/across different vintages of 
        loans will reduce liquidity.

   LEven if the structured transactions are 
        ``funded''--as in, the money to cover losses is 
        advanced to the instrument's issuer--it will be hard to 
        ascertain how these assets are accounted for on the 
        balance sheets of the involved parties. As a result, 
        risk could simply be exported out of the four corners 
        of the MBS into the larger financial sector. Recent and 
        on-going experience with regulating derivatives and 
        capital markets risk-sharing structures illustrates the 
        difficulties in even understanding how risks are 
        actually shared, let alone less in regulating them.

   LBond guarantors can provide more protection to the 
        taxpayer at less cost. If credit losses exceed the 
        level of capital allocated to a security--S. 1217 
        proposes capital of at least 10 percent--in a 
        structured transaction, the Government will be 
        responsible for the additional losses. Bond guarantors, 
        in contrast, would be obligated to use their corporate 
        resources before tapping the reinsurance fund. The 
        regulator could also require higher capital for bond 
        guarantors in light of changing economic 
        circumstances--an approach supported by the recent 
        experience of loan level mortgage insurers--but it is 
        unclear how this could be done when individual 
        securities are credit enhanced through bond structures 
        that, once set in place, are not amenable to changes.

    Please note that nothing that I have proposed would prevent 
bond guarantors from laying off credit risk in capital markets. 
As a result, capital market investors could still be taking on 
credit risk, and their capital would still be available to fund 
our housing finance system. While this practice may reintroduce 
some of the problems I noted above--notably, accounting and 
systemic risk issues--a system in which bond guarantors are 
primarily responsible for first-loss credit risk would be more 
stable and better suited to meet the housing needs of America's 
families.
    However, if the bill ultimately includes both executions as 
options, they must compete on a level playing field. As 
currently drafted, the bill encourages the pure capital markets 
approach, since that execution has little by way of regulatory 
requirements and can more easily meet the capital thresholds 
through leverage. Instead, the bill should include 
significantly stronger regulatory mechanisms for both 
executions. Initial ``approval'' of an issuer or bond guarantor 
does not equal oversight, and in fact, may be counterproductive 
in that it may give a green light to subsequent actions that 
are unmonitored by the regulator. Additionally, if the bill 
does hard-code first-loss capital requirements, we believe the 
10 percent number would be appropriate for structured 
transactions, while the appropriate level for bond guarantors 
could safely be in the 4-5 percent range.
                                ------                                


 RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER FROM JEROME T. 
                          LIENHARD, II

Q.1. During the hearing the issue of capital markets execution, 
as opposed to bond guarantor ``entity'' execution, was 
discussed. Could you briefly discuss the advantages of allowing 
multiple sources of capital--from both the equity and fixed-
income markets--take on credit risk? And to the extent you have 
concerns, if you have them, please make suggestions for how we 
might alleviate those concerns?

A.1. The health and stability of the secondary market for 
mortgages depends upon availability of a range of sources of 
capital to invest in the first-loss credit risk, meaning risk 
that will be taken ahead of the risk exposure of the Government 
on its guarantee. Broadly available investment capital will 
promote competition not only among institutions, but also among 
the forms and structures of investment execution. This 
diversity in turn will create an incentive for market 
participants to find the most efficient forms of execution.
    That said, we believe that allowing for a broad range of 
forms of investment and retention of credit risk is best done 
on the back-end of a guarantor model. That is, we believe that 
it would be better for legislators to create a system in which 
issuers of securities ultimately back-stopped by the Government 
would be required to use bond guarantors to lay off the top-
loss risk on their mortgage pools, allowing these bond 
guarantors to then further off-load that risk into the capital 
markets.
    We hold this view for three reasons.

   LFirst, creating a model that allows issuers to go 
        directly to the capital markets as part of the bond 
        structuring process runs the risk of fracturing the 
        types of securities offered in the market to such a 
        degree that it would compromise the ``TBA'' (To-Be-
        Announced) mortgage securities market. The TBA market 
        depends on a high degree of standardization and 
        homogeneity in issued securities. It would be unlikely 
        for such standardization to hold in a market in which 
        the credit risk of pools of loans were assumed and 
        distributed through complex structured transactions. 
        Moreover, participants in such transactions would 
        likely seek to apply their own credit risk preferences, 
        leading to more targeted pools of loans, with different 
        credit characteristics and differentiated pricing. Such 
        variability in the preferences of first-loss creditors 
        regarding the composition of mortgage pools would make 
        it more difficult to maintain fungibility of the pools 
        and, therefore, of the resulting securities. This would 
        materially inhibit forward trading through the TBA 
        market. This problem does not arise if the system 
        depends instead on issuers working with bond 
        guarantors, which would issue a more standardized form 
        of top-loss guarantee. These guarantors could then lay 
        off some of the risks that they assume from issuers to 
        the capital markets on the back end. In this way, the 
        bond guarantor function would work with the capital 
        markets in a transaction similar to reinsurance that 
        would enable homogeneity and fungibility (meaning, 
        ready trading markets) for the base mortgage 
        securities.

   LSecond, we are concerned that, in a time of 
        financial stress, the sources of capital in a pure and 
        direct capital-markets-dominated execution structure 
        could withdraw from the market quickly and 
        categorically, causing a crisis in liquidity. If 
        capital were to flee the market, the Government's offer 
        to provide a back-stop to pools of guaranteed loans 
        would be ineffective to ensure ongoing liquidity, 
        because there would not be market participants willing 
        to provide the first loss coverage on which the entire 
        system would depend. Again, this would not be as 
        significant a risk if there were a number of well-
        capitalized bond guarantors in place to take first loss 
        credit risk.

   LThird, we are concerned that regulatory oversight 
        of the credit risk taken ahead of the Government 
        backstop, which will be an essential function of 
        regulatory supervision in any new system, would be 
        prohibitively difficult if a significant share of 
        first-loss risk were being structured, assumed and 
        distributed through myriad and complex securitization 
        structures and transactions. It would be far more 
        straightforward to conduct regulatory oversight of the 
        Government's risk exposure if first-loss positions were 
        being assumed by counterparties to the Government 
        structured as bond guarantor agencies, as such 
        oversight would entail traditional capital adequacy and 
        risk management supervisory functions similar to those 
        conducted today through Federal and State banking and 
        insurance regulatory bodies.

    One final related point: We believe a bond guarantor 
structure could and should enable issuers to work directly with 
the top-loss bond guarantors to provide their own mortgage-pool 
level credit enhancement as part of the issuer-bond guarantor 
transaction. This would enable issuers to participate in 
optimizing the pricing of the bond guarantee, driving 
incentives for low-cost and high credit-quality practices.
    For these reasons, we would recommend allowing for a rich 
variety of sources of capital taking on credit risk in the 
system, but in a position supporting bond guarantors. The bond 
guarantors would interface directly with issuers and be 
directly accountable to the Government supervisory process 
where the Government is in a position of reinsuring that risk. 
This would preserve the critical forward trading function of 
today's TBA market while allowing intermediation of a wide 
variety of capital sources.
                                ------                                


  RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER FROM RICHARD 
                             JOHNS

Q.1. During the hearing the issue of capital markets execution, 
as opposed to bond guarantor ``entity'' execution, was 
discussed. Could you briefly discuss the advantages of allowing 
multiple sources of capital--from both the equity and fixed-
income markets--take on credit risk? And to the extent you have 
concerns, if you have them, please make suggestions for how we 
might alleviate those concerns?
The TBA Market
A.1. For markets to assume credit risk, a structure or 
structures are needed to replace the depth and liquidity of the 
current TBA or ``to be announced'' market. The TBA market is a 
forward-trading market that trades on limited information. The 
securities are guaranteed by the Government-Sponsored 
Enterprises (``GSEs'') and investors assume interest rate risk 
and prepayment risk. TBA investors do not assume credit risk; 
rather they assume only the risk that depending on the interest 
rate environment, they may receive their principal sooner or 
later than anticipated (generally due to borrower prepayment on 
the loans) or that the market value of the securities may 
fluctuate.
    As discussed in the testimony of our Executive Director, 
the TBA market is a crucial underpinning to the American 
mortgage market. Originators can hedge and fund their forward 
origination pipelines because they can ``lock in'' the rates 
and prices on the loans during the period between each trade 
and settlement date. The TBA market is a large, liquid market, 
where buyers and sellers are able to trade large blocks of 
securities in a short period of time. The liquidity of the TBA 
market creates efficiencies and cost savings for lenders that 
are passed on to borrowers in the form of lower rates and broad 
availability of mortgage products, and helps to maintain a 
national mortgage market. The TBA market is the benchmark for 
all mortgage markets--it is the reference by which other 
mortgage markets and products are priced. Investors in a TBA 
security presently have general guidelines that indicate to 
them the ``four corners'' of what is contained in a particular 
security, however at the time a trade is entered into the exact 
composition of the security is not revealed. As an example, an 
investor may have knowledge that their particular pool cannot 
have more than 10 percent of the balance of a pool consisting 
of high balance loans.
    SFIG is of the view that various structures may be able to 
function side by side with the TBA Market; however, because the 
TBA market requires a guaranty to function effectively, a 
capital markets execution should not be seen as an alternative 
to a guarantor model, but rather as a supplement. A guarantor 
should be able to raise capital to support its business through 
the equity and debt markets as well as pair off some of its 
risk to meet its capital requirements through risk transfers, 
swaps, credit-linked notes, etc. Raising these various forms of 
capital and having a guarantor act as the channel through which 
this risk is moderated acts as a countercyclical measure 
because it reduces the reliance on contemporaneous capital 
raises to fund mortgages.
Recent GSE Risk Transfer Transactions
    SFIG recognizes the importance of these transactions as a 
monumental first step in transferring credit risk to the 
private market. Several of our members were participants in 
these transactions and accordingly, we look forward to having 
the private market work (with SFIG's support) with the GSEs to 
further build upon the recent credit risk transfer pilot 
transactions. These transactions may prove to provide an 
effective mechanism to transfer certain credit risk as a 
follow-on to TBA transactions, but they are not intended to be 
a funding source for originations.
    SFIG is of the view that while the transactions are an 
artful way to effectively de-risk the GSEs, due to certain 
structural features, they cannot be seen as a capital markets 
execution that can unilaterally replace traditional GSE 
functions. This is primarily because the recent transactions 
still rely on the GSEs as the ultimate taker of catastrophic 
and systemic risk. In regards to the greater system of 
secondary market mortgage funding, the GSEs still act as the 
initial funding entity and the initial risk taker, thereby 
facilitating reliable pricing to the consumer and allowing for 
a functioning TBA market.
Alternative Structures
    A. Senior/Subordinate
    For banks and mortgage companies that fund originations via 
the private-label securitization market, (generally through a 
senior/subordinate RMBS transaction), the following 
prerequisites are necessary before the proceeds on the loan and 
the rate to the consumer can be determined:

   Lthe level of subordination likely required for each 
        rating tranche for each particular pool of loans; and

   Lthe likely price at which each tranche of these 
        securities will sell.

    Gain or loss on these senior/subordinate structures is 
typically determined through the subordination level that is 
required coupled with the pricing that the securities attain 
when sold. While hedging and rate-locking are possible in this 
type of market, it is more expensive and less efficient than in 
the current TBA market. Therefore, a lender is more exposed to 
market risk and uncertainty in a senior/subordinate structure 
than in a TBA security in the current market.
    The senior/subordinate structure also contains other 
inherent features that are irreconcilable with the TBA market. 
Specifically, in a senior/subordinate structure the purchaser 
of the subordinated securities (which bear the majority of the 
risk) requires much more information on each of the loans than 
is required or even possible for a TBA security. In fact, it is 
the lack of certain information that allows diverse borrowers, 
property types, and loan attributes, which ultimately comprise 
the housing finance market, to be converted into homogenous, 
credit-neutral assets through the TBA market. Further, because 
the TBA market is a forward market based on a hypothetical 
pool, loan-level data is simply not available at the time of a 
trade. Finally, because a TBA trade does not specify the 
collateral to be delivered, an investor who purchases (or even 
examines the loan-level data related to) a specific security 
would be barred from participation in the TBA market for that 
entire coupon. This would mean that investors in credit would 
not be able to hedge interest rate risk in the TBA market and 
would severely impact investor interest in either of these 
markets.
    A senior/subordinate structure may be used by the GSEs when 
loans are purchased by the GSEs in whole loan form for cash. 
These loans can be subsequently pooled into a senior/
subordinate structure.
    SFIG generally believes that senior/subordinate structures 
should predominantly exist in the private-label securities 
market, which serves as a supplement, not a replacement, for 
the TBA market, and also acts as a check and balance on 
guarantee fee pricing. Senior/subordinate structures could also 
be incorporated into the new housing finance system on a 
limited basis e.g., as described above with cash loans.
    B. Credit-Linked Notes, Swaps, Derivatives, and a risk index
    Credit-linked notes would most resemble the current GSE 
risk sharing transactions and would also be compatible with the 
TBA market as a follow-on transaction; however, they require a 
credit intermediary if they are to support a countercyclical 
market and a steady and reliable source of mortgage funding, as 
would all the aforementioned forms of risk-sharing. An index 
would be the most scalable and, if broad enough, would attract 
the deepest capital base and require the least amount of 
sophistication to invest; however, it would require a credit 
intermediary/guarantor as well. These risk-sharing and risk-
transfer options, the GSE risk transfer transactions, along 
with the use of swaps and other derivatives, are all artful 
ways to fund a guarantor entity which could provide 
countercyclical capital and act as a risk intermediary to allow 
for steady and reliable pricing to originators and ultimately 
to the consumer.
Conclusion
    It is SFIG's view, as indicated in our testimony, that some 
form of TBA market needs to exist to allow market participants 
to forward trade, which in turn allows borrowers to ``lock in'' 
interest rates well in advance of closing and facilitates a 
national mortgage market and the extension of mortgage credit 
in all credit cycles.
    Any private capital resulting in credit risk transfer 
should be scalable, compatible with the TBA market, and 
sustainable in both bull and bear markets. In our discussion 
above, we highlight several structures, including the recent 
GSE transactions. These structures are an excellent way to 
introduce private capital and supplement a guarantor or 
centralized risk intermediary and thereby support a TBA market. 
These structures should not be seen as a replacement for the 
TBA market or as a replacement for the need of a risk 
intermediary to ensure a steady source of funding for mortgage 
credit in all market cycles. While we have belief that 
preserving the TBA market requires an institution to perform 
the role of guarantor, we do not believe that the Government-
Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac need 
to be preserved in their current form to fulfill that role. We 
hope that you consider these views as you evaluate options to 
reform the housing finance system. We welcome the opportunity 
to discuss our views with you in person.


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