    [Senate Hearing 113-187]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 113-187

       HOUSING FINANCE REFORM: POWERS AND STRUCTURE OF A STRONG REGULATOR
    =======================================================================

                                    HEARING

                                   before the

                                  COMMITTEE ON

                       BANKING,HOUSING,AND URBAN AFFAIRS

                              UNITED STATES SENATE

                        ONE HUNDRED THIRTEENTH CONGRESS

                                 FIRST SESSION

                                       ON

      EXAMINING THE CURRENT REGULATORY STRUCTURE RELATED TO THE SECONDARY
      MORTGAGE MARKET AND EXAMINING ISSUES RELATED TO PROPOSED REGULATORY
                                   STRUCTURES

                                   __________

                               NOVEMBER 21, 2013

                                   __________

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

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

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      TIM JOHNSON, South Dakota, Chairman

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

                           Charles Yi, Staff Director

                    Gregg Richard, Republican Staff Director

                      Laura Swanson, Deputy Staff Director

                  Erin Barry Fuher, Professional Staff Member

                       Glen Sears, Deputy Policy Director

                      Kari Johnson, Legislative Assistant

                      Greg Dean, Republican Chief Counsel

                  Jelena McWilliams, Republican Senior Counsel

                Chad Davis, Republican Professional Staff Member

                           Dawn Ratliff, Chief Clerk

                           Taylor Reed, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)

                                C O N T E N T S

                                  ----------

                          THURSDAY, NOVEMBER 21, 2013

                                                                       Page

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

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

                                   WITNESSES

    Alfred M. Pollard, General Counsel, Federal Housing Finance
      Agency.........................................................     4
        Prepared statement...........................................    26
        Responses to written questions of:
            Senator Reed.............................................    67
    Diane Ellis, Director, Division of Insurance and Research,
      Federal Deposit Insurance Corporation..........................     6
        Prepared statement...........................................    29
        Responses to written questions of:
            Chairman Johnson.........................................    69
            Senator Warren...........................................    70
            Senator Kirk.............................................    72
    Kurt Regner, Assistant Director, Arizona Department of Insurance,
      on behalf of the National Association of Insurance
      Commissioners..................................................     7
        Prepared statement...........................................    34
        Responses to written questions of:
            Chairman Johnson.........................................    76
            Senator Kirk.............................................    77
            Senator Coburn...........................................   125
    Bart Dzivi, Chief Executive Officer, The Dzivi Law Firm, P.C.....     9
        Prepared statement...........................................    49
        Responses to written questions of:
            Chairman Johnson.........................................   127
    Robert M. Couch, Counsel, Bradley Arant Boult Cummings, LLP, on
      behalf of the Bipartisan Policy Center Housing Commission......    11
        Prepared statement...........................................    58
        Responses to written questions of:
            Chairman Johnson.........................................   130
    Paul Leonard, Senior Vice President of Government Affairs, The
      Housing Policy Council of the Financial Services Roundtable....    13
        Prepared statement...........................................    61
        Responses to written questions of:
            Chairman Johnson.........................................   133

                                     (iii)

       HOUSING FINANCE REFORM: POWERS AND STRUCTURE OF A STRONG REGULATOR

                                  ----------

                          THURSDAY, NOVEMBER 21, 2013

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:12 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.
        This hearing continues the Committee's effort to examine
    housing finance reform proposals. Today we will explore the
    current regulatory structure related to the secondary mortgage
    market and survey the issues related to the proposed regulatory
    structure in legislation.
        S.1217 creates a new regulator: the Federal Mortgage
    Insurance Corporation, or FMIC. The new regulator would wear
    many hats, as the operator of the insurance fund, the regulator
    of the home loan banks, mutual organization, and Common
    Securitization Platform; and authorizer of issuers, servicers,
    and guarantors with regard to guaranteed mortgages.
        Because the structure of the housing finance system is
    complex with a wide range of market participants taking part,
    it is critical that we have a strong, effective regulator. Any
    piece of legislation will need to clearly detail the structure,
    functions, and powers of the new regulator. This regulator will
    need to coordinate closely with a variety of other Federal and
    State regulators to be effective and have flexibility to set
    appropriate standards and rules. In addition, we need to
    consider whether the new regulator should regulate for safety
    and soundness, conduct exams, set capital standards, play a
    countercyclical role, crack down on bad actors through
    enforcement actions, and resolve failed institutions it
    regulates.
        We should not forget that we have experience with a weak
    secondary mortgage market regulator. OFHEO was widely viewed as
    weak, which contributed to the problems at Fannie and Freddie,
    and Congress created FHFA in 2008 in response. We cannot afford
    to return to the days of weak regulatory oversight of the
    secondary mortgage market, so Congress should be clear and
    explicit about the responsibilities and range of tools any new
    regulator should have.
        Today's witnesses bring a wealth of experience to this
    important conversation. They will outline essential tools
    needed by the new regulator, as well as important lessons they
    have learned as regulators of the Deposit Insurance Fund,
    insurance companies, and the secondary mortgage market.
        We are all aware that housing is a key part of our Nation's
    economy. A well-equipped, appropriately structured regulator
    will provide certainty to market participants and ensure a
    strong and stable housing finance system that provides mortgage
    credit to Americans across this country.
        With that, I turn to Ranking Member Crapo for his opening
    statement.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you, Mr. Chairman.
        Today the Committee will discuss how to best structure a
    strong, independent regulator with appropriate checks and
    balances as part of the new housing finance system. We have a
    broad panel of witnesses, and I thank you all for coming.
        In past hearings, I have highlighted the mistakes of Fannie
    Mae and Freddie Mac before they were placed into
    conservatorship. Not only did they operate as undercapitalized
    companies holding just 45 cents in capital for every $100 in
    mortgages they guaranteed, but they acted like highly leveraged
    hedge funds, purchasing nearly 40 percent of the private label
    subprime securities at the peak of the housing bubble.
        These forces culminated in a perfect storm whose cleanup
    cost taxpayers billions of dollars in bailouts, crushing our
    economy and undermining America's international standing. We
    must learn from these mistakes. When considering reform, we
    must address three pivotal issues about the new regulator.
        First, how can it appropriately balance its dual role as
    regulator and reinsurer in a highly complex market with diverse
    stakeholders?
        Second, what authorities and powers should be vested in the
    new agency to ensure it is effective without duplicating
    existing efforts?
        Third, how should we structure the governing board so that
    the agency is well equipped to carry out its responsibilities
    on day one?
        S.1217 would create the Federal Mortgage Insurance
    Corporation, or FMIC, as the primary regulator for taxpayer-
    backed mortgages. The FMIC would provide catastrophic loss
    insurance funded by premiums and guarantee fees on eligible
    mortgage securitizations. As such, it would be a hybrid between
    the Federal Deposit Insurance Corporation and the Federal
    Housing Finance Agency.
        The FDIC was created as an independent Federal agency in
    response to the bank failures of the 1920s and early 1930s. It
    is comprised of a five-person board of directors with no more
    than three directors from the same political party.
        The FDIC has survive 80 years without depositors losing a
    single cent of insured funds, in large part because its board
    is designed for long-term stability and continuity, without
    sudden movements or extreme policy shifts.
        As the guaranteed mortgage industry will need similar
    stability and continuity, the new regulator should have a
    similar balance of views. In addition, the new regulator will
    serve as the principal line of defense for the taxpayers and
    should have a strong, clearly defined purpose. Its activities
    and the activities of those it regulates must result in strong
    underwriting standards and responsible homeownership. Any
    reinsurance fund, industry participant, and ensuring or
    mortgage or financial product must be well capitalized to
    insulate the taxpayers from unwarranted risk. And to adequately
    oversee a diverse industry and to coordinate with State and
    other regulators, the new agency will need superb technical
    expertise.
        In order to accomplish all these goals, we ought to reach
    consensus on key principles. The new regulator should be an
    independent agency, resolute in its mandated and unwavering to
    political whims. Its leadership has to be balanced out to
    ensure true political independence. Its safeguards and
    underwriting standards must be based on qualifying standards to
    provide mortgages but to protect taxpayers. Its finances must
    be frequently examined to ensure accountability and
    transparency, including appropriate stress tests. And, last,
    the agency cannot exist in a regulatory vacuum. It must
    coordinate with other agencies in a holistic approach to
    achieve sensible regulation. Any new regulator must avoid
    regulatory duplication that leads to increase paperwork and
    regulatory burdens which increase the cost of credit while
    creating legal nightmares.
        Adopting these principles is crucial because the agency
    will be tested immediately upon its creation. Some of the
    immediate tasks it will have to undertake include to establish
    rules for the structure and use of a federally insured mortgage
    market within perimeters set by Congress, determine approval
    criteria and guidelines for market participants, and set up a
    cooperative to ensure access for small participants in a manner
    that also maintains adequate taxpayer protections. Today's
    hearing is a good platform to discuss how best to enable this
    new agency to succeed.
        Thank you, Mr. Chairman.
        Chairman Johnson. Thank you, Senator Crapo.
        Are there any other Members who would like to give brief
    opening statements?
        [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. I will now introduce the
    witnesses that are here with us today.
        First, Mr. Alfred Pollard is General Counsel for the
    Federal Housing Finance Agency.
        Ms. Diane Ellis is Director of the Division of Insurance
    and Research at the Federal Deposit Insurance Corporation.
        Mr. Kurt Regner is assistant director of the Arizona
    Department of Insurance, testifying on behalf of the National
    Association of Insurance Commissioners.
        Mr. Bart Dzivi--am I pronouncing that correctly?
        Mr. Dzivi. Yes, Senator.
        Chairman Johnson. He is chief executive officer of the
    Dzivi Law Firm.
        Mr. Robert Couch is counsel at Bradley Arant Boult
    Cummings, LLP, testifying on behalf of the Bipartisan Policy
    Center Housing Commission.
        And Mr. Paul Leonard is senior vice president of Government
    affairs, Housing Policy Council of the Financial Services
    Roundtable.
        We welcome you all here today and thank you for your time.
    Mr. Pollard, you may begin your testimony.

       STATEMENT OF ALFRED M. POLLARD, GENERAL COUNSEL, FEDERAL
                         HOUSING FINANCE AGENCY

        Mr. Pollard. Thank you, Mr. Chairman, Ranking Member Crapo,
    and Members of the Committee. I appreciate the invitation to
    testify on the powers and structure of a regulator for a
    revised housing finance system.
        As you know, I work at the Federal Housing Finance Agency,
    the safety and soundness regulator for the Federal Home Loan
    Bank System and Fannie Mae and Freddie Mac. As the Chairman
    noted, the enactment of the Housing and Economic Recovery Act
    of 2008, creating this new agency, represented a major step by
    Congress similar to the task that you now have before you:
    empowering an agency with a full array of supervisory tools,
    including explicit authority to impose and enforce prudential
    standards, including capital standards; obtaining reports from
    parties on a regular and on an as-requested basis; conducting
    examinations; requiring remedial actions and authorities to
    undertake enforcement actions necessary to oversee the housing
    finance market.
        Here are reflected lessons learned about a regulator that
    lacked a full array of authorities to deal with an increasingly
    complex financial market. FHFA has deployed a broad supervisory
    team and has administrative enforcement powers regarding the
    regulated entities and the ability to access judicial relief if
    necessary to address third parties through independent
    litigation authority.
        For emergency situations, the agency does not possess a
    fund such as the Deposit Insurance Fund to cover specified
    losses. It does maintain a working capital fund and has the
    ability to make special assessments. Temporary emergency
    funding was provided in the form of a support agreement with
    the Treasury Department in 2008.
        Including lessons learned from the current financial
    crisis, I will comment on the structures of S.1217 and what may
    be improved per the request of the Committee.
        S.1217 would establish a new model for a secondary mortgage
    market and a new supervisory agency, the Federal Mortgage
    Insurance Corporation, or FMIC. The range of its duties and
    responsibilities represents a movement away from traditional
    examination- and enforcement-based supervision to a
    multifaceted construct that covers availability and
    transparency of information, standard setting to enter and
    participate in the market, and supervision of participants.
    Implementation of these varied elements will require careful
    planning over the 5-year transition period. It must be noted,
    however, that a key lesson learned during the financial crisis
    is that, even with adequate powers, regulators will not always
    get it right. If taxpayers are going to be exposed to risk of
    losses, sufficient private capital must be available in front
    of taxpayers, as contemplated in S.1217.
        The bill provides FMIC with limited explicit regulatory
    authority, though additional tools may be implied and,
    importantly, an incidental privilege provision is included.
    Making regulatory authority clear and explicit, including
    establishing prudential standards, setting capital
    requirements, and taking enforcement actions, will provide a
    higher degree of confidence to market participants. These
    powers are familiar to current participants in the housing
    finance market and, to the extent they have not been provided
    to FMIC or are only implied in the bill, they should be made
    explicit.
        As noted, greater sharing of supervisory information among
    regulators has been a lesson learned; greater cooperation among
    regulators and greater transparency for markets is essential.
        The Committee has posed two key questions: Does the
    legislation get the right structural pieces in place for the
    new market to function smoothly? And does it provide for an
    effective transition from the current system? We have
    identified some areas where the bill could more fully answer
    these questions.
        The bill authorizes consultation of FMIC with other
    regulators, but really does not strike an appropriate balance
    of a two-way street of consultation and cooperation. We
    recommend that to the Committee.
        FMIC and FHFA roles in the Financial Stability Oversight
    Council should be clarified, and FMIC should have an
    appropriate and explicit place on the Federal Financial
    Institutions Examination Council.
        There are gaps to be filled, such as oversight of nonbank
    mortgage servicers, who may not be subject to prudential
    oversight.
        As to funding, the bill provides for FMIC to be funded
    exclusively by insurance fees. Relying exclusively on such fees
    as a funding base, particularly as the new market is
    developing, may present certain challenges. Growing the
    insurance reserve could require rather large insurance fees in
    FMIC's early years. These challenges may be addressed by
    expanding FMIC's sources of funding to include other fees and
    assessments, such as application fees, which are not explicit,
    and restoring assessments on the home loan banks for their
    supervision.
        Now, transition to the new agency involves a simultaneous
    wind down of the enterprises and the transfer of functions and
    employees from FHFA to FMIC.
        FHFA's experience in standing up a new agency argues in
    favor of immediate transfer of all FHFA personnel and
    responsibilities to FMIC, thus permitting a smooth integration,
    a focus on meeting the bill's 5-year goal of full
    implementation, and maintaining the congressional direction to
    wind down Fannie Mae and Freddie Mac.
        Funding in a transition will also be critical so that there
    is a smooth start for FMIC with a solid capitalized reserve
    fund, systems and technology in place, and resources to address
    challenges that may arise.
        I will end. FHFA supports early congressional action to
    make clear for its regulated entities, for borrowers, and for
    financial markets the directions you believe most appropriate
    to protect taxpayers, maintain access to housing finance
    products and services, and the strongest regulatory structure
    that is credible, empowered, clearly defined with needed
    flexibility, and transparent to carry out your directions.
    While all of this has complexities, that should not deter
    prudent actions. The certainty that can come from such efforts
    will benefit homeowners, investors, and taxpayers.
        Thank you for your efforts in this direction.
        Chairman Johnson. Thank you.
        Ms. Ellis, you may proceed.

     STATEMENT OF DIANE ELLIS, DIRECTOR, DIVISION OF INSURANCE AND
            RESEARCH, FEDERAL DEPOSIT INSURANCE CORPORATION

        Ms. Ellis. Chairman Johnson, Senator Crapo, and Members of
    the Committee, I appreciate the opportunity to testify before
    you today regarding the elements of the deposit insurance
    system that the Federal Deposit Insurance Corporation has found
    to be the most important in achieving its mission.
        Drawing from lessons learned over the deposit insurance
    system's 80 years of operation, both Congress and the FDIC have
    made a number of improvements. My remarks will focus on the
    importance of certain authorities and regulatory tools through
    the lens of the FDIC's experience. These include clear and
    explicit statutory authority, ongoing monitoring to assess risk
    exposure and to take action when necessary, appropriate pricing
    of insurance, and adequate funding arrangements.
        Congress has given the FDIC a clear mandate: to protect
    depositors and maintain financial stability. Congress has
    clearly defined by statute the amount of deposits covered under
    the FDIC's deposit guarantee and the condition--that is, bank
    failure--that triggers the exercise of that guarantee. At the
    same time, Congress has allowed the FDIC flexibility to craft
    specific regulations to cover the many details of its
    operations.
        Clear statutory authority also has been critical to both
    our supervisory program and our resolution activities.
    Examination authority and reporting requirements enable us to
    monitor and control for the risk posed to the Deposit Insurance
    Fund, or DIF.
        For our resolution activities, authorizing statutes
    delineate the priority of claims and impose general
    requirements on the way the FDIC resolves failed banks. These
    statutes enable the FDIC to mitigate losses to the DIF and help
    maintain financial stability through the timely resolution of
    failed banks and payment of depositor claims.
        An effective insurance program also must include tools to
    identify and manage risk exposure, not only when insurance is
    granted but while it stays in force. The FDIC assesses the risk
    of an institution when it applies for insurance and engages in
    ongoing monitoring to identify new risks in the banking sector
    as they emerge. Importantly, explicit statutory authorities
    allow us to take action when an institution is engaging in
    potentially unsafe and unsound practices.
        Strong capital requirements are one of the most effective
    means for controlling risk taking by participants in the
    system, and the FDIC has found explicit capital standards to be
    an important tool to protect the DIF.
        The pricing of insurance also is a key element of a
    successful insurance system. The FDIC has had experience with
    both flat-rate and risk-based pricing. Initially, Congress
    directed the FDIC to charge all banks the same assessment rate.
    This flat-rate system resulted in less risky banks subsidizing
    riskier banks and did nothing to reduce the incentives for
    banks to take excessive risk.
        In response to the banking crisis of the late 1980s,
    Congress ended the flat-rate system and directed the FDIC to
    adopt a risk-based system. Since 1993, the FDIC has had a
    pricing system where banks that take on more risk pay more in
    assessments.
        Finally, funding arrangements play a critical role in the
    success of an insurance system. A well-designed system ensures
    that adequate funds are readily available to respond to
    problems as they arise and to avoid delays in closing failed
    banks or paying insured depositors. Those arrangements also
    determine the amount and timing of the industry's contributions
    toward the cost of insurance and the degree of taxpayer
    exposure.
        The FDIC has always had an explicit, ex ante fund paid for
    by the banking industry to satisfy claims as they arise.
    Alternative arrangements, such as pay-as-you-go or ex post
    assessments, increase the risk that bank closings will be
    delayed, increasing the ultimate cost of failure and
    undermining confidence in the banking system more generally.
        Prefunding for future losses is also more equitable and can
    be less procyclical. With other arrangements, surviving banks
    pay the costs generated by those that have already failed,
    which penalizes those banks that are less risky and imposes
    costs in the wake of failures when banks can often least afford
    it.
        A more difficult question is that of optimal fund size,
    which involves balancing significant tradeoffs. The Dodd-Frank
    Act increased the minimum reserve ratio to 1.35 percent and
    removed a hard cap, which had required the FDIC to rebate all
    amounts in excess of 1.5 percent. This new authority gives the
    FDIC the flexibility to determine the optimal target, so long
    as it is at least 1.35 percent of estimated insured deposits.
    This flexibility should allow us to maintain a positive fund
    balance without having to raise rates sharply when failures
    spike and banks can least afford to pay for insurance.
        Again, thank you for the opportunity to share with the
    Committee the FDIC's experience and insights. I would be happy
    to answer any questions.
        Chairman Johnson. Thank you.
        Mr. Regner, you may proceed.

         STATEMENT OF KURT REGNER, ASSISTANT DIRECTOR, ARIZONA
    DEPARTMENT OF INSURANCE, ON BEHALF OF THE NATIONAL ASSOCIATION
                       OF INSURANCE COMMISSIONERS

        Mr. Regner. Thank you for the opportunity to testify today.
    My name is Kurt Regner. I serve as the assistant director for
    the Arizona Department of Insurance. Arizona sits on the NAIC's
    Mortgage Guarantee Insurance Working Group, and it is on behalf
    of the NAIC that I present testimony today.
        State regulators have a responsibility to protect policy
    holders and ensure competitive markets. As insurance markets
    evolve, we are engaged with all stakeholders to promote an
    optimal regulatory framework. We carefully balance solvency
    standards with the availability of coverage in the mortgage
    insurance market. We appreciate the desire in Congress to
    address issues arising from the mortgage transaction, but any
    legislation must carefully consider the existing regulatory
    regime.
        At its most basic level, mortgage insurance underwrites the
    risk of borrowers defaulting on their loans. The borrower pays
    the premiums, and the lender is the beneficiary. Through the
    most recent financial crisis, the financial sector's collective
    assumptions about the housing market were proven wrong. This
    found PMIs exposed on the front lines. After all, they were the
    ones directly underwriting the risk of borrowers defaulting on
    their loans. While the main players in the PMI space survived
    the crisis, they are still recovering.
        PMIs are regulated by States in which they do business,
    with the State of domicile providing primary oversight. State
    laws and regulations that are specifically tailored for
    mortgage insurance control the risk PMIs can assume through a
    variety of limitations, including strict reserve requirements
    to protect against economic shock, 25:1 risk-to-capital
    requirements, investment in geographic risk concentration
    restrictions, and restrictions on nonmortgage insurance-related
    activities.
        The NAIC has a mortgage guarantee model act, and it has
    been adopted in substantial form by most States primarily
    responsible for the regulation of PMIs. We have spent the last
    year considering adjustments to regulatory requirements to
    address the risks uncovered by the crisis and identified three
    main problems: overconcentration of originations in a few
    banks, the cyclical nature of the mortgage insurance product,
    and the lack of incentives for strict underwriting during boom
    periods.
        I understand you are also interested in financial
    guarantors. Since Arizona does not serve as a domestic
    regulator for a financial guarantor, I have limited experience
    in this area. Nevertheless, I am an experienced insurance
    regulator. I have some thoughts on the state of the industry.
        Bond insurers base their business almost exclusively on
    selling their credit rating to other parties, initially focused
    on wrapping AAA ratings around lower rated municipal
    obligations. In the 1990s, bond insurers expanded their
    business into structured products. These more complicated
    investment vehicles, tied to subprime-backed mortgages, exposed
    bond insurers to greater risk, which became painfully evident
    during the financial crisis. Since then, the structured bond
    insurance market has basically dried up. On a positive note,
    this has created opportunities for surviving insurers and new
    entrants into the traditional municipal business.
        The NAIC has not taken a position on any housing finance
    reform bills, including Senate bill 1217, but we caution
    against legislative solutions that solely or substantially rely
    on the use of PMIs and financial guarantors as the lubricant
    for the housing market engine.
        PMIs appropriately insure individual loans, and there has
    been little experience with their insuring securities. There
    may be regulatory concerns with expansion into this business as
    they could in some cases take on risks in the same loan or type
    of loan as both a guarantor of the securities and the insurer
    of the individual loan. Conversely, financial guarantors have
    substantial experience in the area but failed to live up to
    their expectations during the crisis. Given our experience, we
    remain skeptical of their capability of insuring anything other
    than municipal debt, particularly if the underlying financial
    instrument they seek to insure itself is not appropriately
    capitalized and secure. Reliance on these entities should not
    be considered the panacea which will fix the housing finance
    market.
        Moreover, neither PMI nor financial guaranty insurance
    should be seen as a substitute for due diligence or sound
    underwriting by servicers or issuers. The NAIC is concerned
    with proposals for the creation of a new regulator charged with
    administering of a Federal guarantee that would have the
    authority to establish standards for the approval of insurers.
    Those responsible for a Government guarantee has a strong
    interest in protecting taxpayer dollars, but appropriate
    deference should be given to existing State requirements. The
    incentive is simply too great for a regulator charged with
    maintaining the viability of a Government guarantee to
    overshoot the regulatory objective and put in place overly
    stringent standards that threaten the availability of coverage.
    Instead, this new regulator should focus on establishing
    standards for the unregulated entities that may participate in
    the new housing finance framework and create standards for the
    administration of the new Government guarantee. As issues of
    common concern arise, any new regulator should work hand in
    hand with us to address them, as is done today with other
    regulatory agencies.
        In conclusion, State regulators are committed to working
    with Congress and other regulators to help ensure competitive,
    stable housing and mortgage insurance markets. We remain
    committed to effective regulation of the PMI and financial
    guaranty industries and to enhancing our regulatory structure
    where necessary. Good regulation makes for competitive markets
    and well-protected policy holders.
        Thank you again for the opportunity to be here.
        Chairman Johnson. Thank you.
        All Members are now required to report to the Senate floor.
    I ask the witnesses to stay here until we can determine if we
    can resume. If not, we will reconvene at a date and time to be
    determined.
        This hearing is in recess.
        [Recess.]
        Chairman Johnson. I call this hearing to order. Thank you
    all for your patience today.
        Mr. Dzivi, I believe you are next in line. You may begin
    your testimony.

    STATEMENT OF BART DZIVI, CHIEF EXECUTIVE OFFICER, THE DZIVI LAW
                               FIRM, P.C.

        Mr. Dzivi. Mr. Chairman, Ranking Member Crapo, thank you
    for continuing this hearing this afternoon, especially on
    behalf of us panelists from outside of the District. I do want
    to note for the record, being a former Senate staffer, I had
    the foresight to book a flight to return tomorrow instead of
    today.
        [Laughter.]
        Mr. Dzivi. My testimony is based on my own views and is not
    intended to reflect the views of any current or former clients
    of my firm. I commend the Committee for undertaking this
    hearing and the other hearings related to replacing Fannie and
    Freddie with a new structure to support housing finance through
    a vibrant secondary market that relies more on private capital
    and presents less risk to the American taxpayer. In so doing,
    the Committee should analyze both what was good about Fannie
    and Freddie for American homeowners and what was bad about
    Fannie and Freddie for American taxpayers. I urge the Committee
    to continue its thoughtful and deliberate approach to this
    issue.
        In framing my remarks today, I will use S.1217 as a point
    of departure. The introduction of S.1217 by Senator Corker and
    Senator Warner and their bipartisan cosponsors represents an
    important first step in raising the issue of creating a
    permanent replacement for Fannie and Freddie. I do, however,
    believe there are ways in which the structure proposed in that
    legislation, especially the regulatory structure, could be
    improved.
        I see two primary regulatory issues:
        First, what is the appropriate level of safety and
    soundness supervision of the various private entities that will
    be involved in the securitization process of Federal guaranteed
    mortgage securities?
        Second, should the Federal Mortgage Insurance Corporation
    itself, which will grant Federal guarantees on mortgage
    securities, be subject to safety and soundness oversight by a
    separate Federal agency?
        When examining the appropriate level of supervision of
    private entities, given that a Federal credit guarantee is
    involved, it is critical that any supervision of the private
    entities participating in the securitization be in the hands of
    a strong, independent Federal regulator. During the savings and
    loan crisis of the 1980s, the country learned the hard way that
    when providing access to Federal guarantees, it may not be
    prudent to rely on State legislatures and State regulatory
    officials with weak Federal oversight.
        In the 1980s, Congress allowed States wide authority to set
    the investment rules for State-chartered savings and loans, but
    allowed these companies to have access to Federal guarantees
    for deposit insurance. Before Congress slammed that door shut
    in 1989, weak State supervisors in just a few States loosened
    the rules and let a group of rogue operators acquire companies
    and ring up losses on the tab of the American taxpayer in the
    amount of $124 billion. Congress should be mindful of that
    history.
        I believe this legislation can be improved in three ways:
        First, Congress should expand the scope of the private
    parties who are subject to the Federal agency's authority.
        Second, Congress should expressly grant the Federal agency
    the same powers that bank examiners have to inspect the books
    and records of entities that participate in the mortgage
    securitization.
        Third, Congress should create an express enforcement system
    modeled after the Federal banking laws, including the power to
    issue cease-and-desist orders and prohibition and removal
    orders for violations of law and also for engaging in unsafe
    and unsound practices.
        If this new secondary market structure is meant to last,
    then the law must be drawn in a manner to give the Federal
    agency flexibility with the ability to adapt its rules to
    changing times and changing financial markets. Otherwise, over
    time, the agency will be left writing rules applicable to
    horse-drawn buggies as Google-powered self-driving cars cruise
    the freeways.
        S.1217 grants the FMIC itself the power to issue guarantees
    of mortgage securities. It does not subject the FMIC to
    supervision by a separate safety and soundness regulator. I
    think the sounder approach is to have a separate Federal
    agency, either a newly created one or the Federal Housing
    Finance Agency, exercise safety and soundness supervision over
    all the mortgage securitization participants, both the FMIC
    itself and the purely private parties doing business with it.
        In conclusion, Mr. Chairman, great care must be taken in
    designing a system where as yet unknown private parties will
    have access to a Federal guarantee in peddling their wares.
    Whatever you design will be a huge magnet for those trying to
    exploit the system to make a quick buck and leave the taxpayers
    holding the bag.
        Thank you, and I look forward to any questions you may
    have.
        Chairman Johnson. Thank you.
        Mr. Couch, you may proceed.

      STATEMENT OF ROBERT M. COUCH, COUNSEL, BRADLEY ARANT BOULT
       CUMMINGS, LLP, ON BEHALF OF THE BIPARTISAN POLICY CENTER
                           HOUSING COMMISSION

        Mr. Couch. Chairman Johnson, Ranking Member Crapo, and
    Members of the Committee, thank you for the opportunity to be
    here today to discuss housing finance reform.
        Before I get into the substance of my remarks, I want to
    commend the Committee for the deliberative, bipartisan approach
    it has taken in examining this complicated but tremendously
    important subject.
        This past March, the Committee heard from my good friend
    Senator Mel Martinez, who outlined the recommendations of the
    Bipartisan Policy Center Housing Commission. As Senator
    Martinez laid out in his testimony, the commission strongly
    supports the objectives of S.1217, including a multiyear wind
    down of Fannie Mae and Freddie Mac, a greater role for private
    capital in assuming mortgage credit risk, and a continued
    Government presence through a limited catastrophic guarantee of
    mortgage-backed securities that is funded through the
    collection of actuarially sound fees. The commission believes
    that a limited Government guarantee in the secondary market is
    essential to ensuring widespread access to long-term, fixed-
    rate, single-family mortgage financing.
        The new system envisioned by the commission and outlined in
    S.1217 will only work with a strong regulator at the system's
    center. This regulator will function as ``Mission Control'' for
    the new system and will be charged with fulfilling two
    responsibilities that are admittedly in tension: promoting a
    widely accessible mortgage market, while protecting the wallets
    of American taxpayers.
        Looking at S.1217, let me highlight four areas where I
    believe the Committee can strengthen the FMIC's role while
    promoting mortgage liquidity.
        First, the commission examined a variety of models around
    which to design a new housing finance system. We concluded that
    the Ginnie Mae model offers several distinct advantages,
    including allowing for a greater number of financial
    institutions to be issuers of mortgage-backed securities. As
    applied to the FMIC, it would assure the alignment of interests
    among all the parties in the mortgage chain and allocate risk
    among them. As you revisit S.1217, I urge you to consider
    legislative language allowing the FMIC to replicate the Ginnie
    Mae model as a part of its ongoing operations.
        Second, the commission felt that developing a single
    security or ``common shelf'' for single-family mortgages was
    necessary to ensure the new system's liquidity, interact
    effectively with the TBA market, and establish an equal playing
    field for lenders of all sizes. A common shelf also allows
    mortgages with different terms, interest rates, and other
    attributes to be pooled into a single security.
        Based on our reading, it is unclear whether S.1217
    contemplates the FMIC guaranteeing a single, common security or
    multiple securities. We recommend explicitly directing the FMIC
    to provide a common shelf for the single-family segment of the
    market it backstops.
        Third, under the commission's proposal, the new regulator
    would have the authority to temporarily take over the business
    of issuers, servicers, and private credit enhancers that happen
    to fail and to transfer that business to other private
    participants in the mortgage system. S.1217 does not appear to
    give the FMIC the same type of resolution authority. With
    resolution authority, the FMIC can help preserve liquidity and
    ensure a fully functioning market.
        Finally, S.1217 provides the FMIC with emergency authority
    to absorb first-loss credit risk during periods of severe
    economic stress. But this authority is subject to a number of
    stringent conditions, including obtaining the written agreement
    of both the Chairman of the Federal Reserve Board and the
    Treasury Secretary. The Committee may wish to consider
    empowering the FMIC with the flexibility to respond more
    quickly to emergency conditions in the mortgage market.
        With respect to the governance of the new regulator, the
    commission recommended vesting authority in a single individual
    appointed by the President and subject to Senate confirmation.
    We concluded that putting a single person in charge of the new
    system would promote accountability and ease of decision
    making.
        Ginnie Mae does not operate under a board of directors, and
    in my view, as a former Ginnie Mae president, it has
    consistently been one of the best-run organizations within the
    Federal Government. But I certainly understand that the Ginnie
    Mae governance model is somewhat unique among Federal agencies,
    and there are logical reasons for establishing a board for the
    FMIC. The most compelling reason is that rebooting our Nation's
    housing finance system and running the FMIC is a huge
    undertaking requiring a deep bench of experience. An engaged,
    experienced board of directors can be a valuable asset to the
    FMIC Director.
        If, as contemplated by S.1217, the FMIC is to be managed by
    a board of Directors, then I encourage the Committee to amend
    the legislation to ensure that members of both political
    parties are represented on the board. Bipartisan representation
    on the FMIC board will provide some assurance that the board is
    making decisions for sound operational and risk management
    reasons, and not because of political considerations.
        Finally, I strongly support S.1217's requirement that
    members of the FMIC board have significant experience in
    various specified areas of housing finance. This requirement
    will help ensure that a full range of experience is
    represented.
        Thank you for your attention, and I look forward to your
    questions.
        Chairman Johnson. Thank you.
        Mr. Leonard, you may proceed.

    STATEMENT OF PAUL LEONARD, SENIOR VICE PRESIDENT OF GOVERNMENT
     AFFAIRS, THE HOUSING POLICY COUNCIL OF THE FINANCIAL SERVICES
                               ROUNDTABLE

        Mr. Leonard. Thank you, Mr. Chairman. Mr. Chairman and
    Ranking Member Crapo, thanks for the opportunity to testify
    here today.
        The Housing Policy Council of the Financial Services
    Roundtable strongly supports reform of our Nation's housing
    finance system. Like others have said today, we truly
    appreciate the time and attention the Committee is devoting to
    developing bipartisan reform legislation, and we thank Senator
    Corker, Senator Warner, and their cosponsors for their major
    contribution to this effort through S.1217.
        As others have said, for many years consumers and the
    housing market benefited from the role that GSEs played in
    facilitating a secondary mortgage market. However, the
    financial crisis exposed fundamental flaws in the design and
    operation of the GSEs. A new model was needed for the secondary
    market that preserves the availability of stable mortgage
    credit for qualified homebuyers, retains key operations,
    systems, and people critical to the current system, but
    corrects the flaws in the GSE model by requiring more private
    capital and better protection for the taxpayers.
        A critical aspect of a new system is the structure and
    authority of the Federal agency that will oversee the
    successors to the GSEs. We support a strong prudential
    regulator to oversee the private participants and the solvency
    of a reserve fund that stands in front of any taxpayer backing.
        On the structure of a new regulator, the Housing Policy
    Council supports the structure of the independent agency as
    proposed in Corker-Warner S.1217, including a governing board,
    funding through assessments from industry participants, and
    different divisions to handle key duties such as underwriting
    and credit risk, as well as advisory committees to allow market
    stakeholders to provide input to the agency.
        On the duties of a new regulatory agency, fundamentally the
    priority duty of the agency should be to ensure the secondary
    mortgage market operates in a safe and sound manner. The agency
    should have the authority to federally charter the key
    participants in the guarantee securities market and have
    authorities set standards for that market, including credit
    terms. To enhance liquidity, the agency should establish the
    terms and conditions of pooling and servicing agreements and
    provide for the creation of a single form of guaranteed
    security. These standards and platforms should apply to the
    securities that carry the Federal guarantee, not the private
    label market.
        The agency should oversee the establishment of a
    securitization platform for federally guaranteed securities.
    The agency must have rulemaking authority, including the
    discretion to adjust conforming loan limits and set appropriate
    capital standards, much like Federal banking agencies.
        The agency should be required to seek public comment as it
    exercises its standard-setting authority. Public notice and
    comment is essential to ensure the understanding of and
    confidence in the agency's regulatory action.
        Where the agency has discretion, it should be required to
    explain the rationale behind its decisions through regular
    reports to Congress.
        It is important that the agency have examination and
    enforcement powers, including resolution powers for entities
    that may fail. The agency should have responsibility for the
    reserve fund that should stand in front of the Federal
    guarantee, much like the FDIC's authority over the Deposit
    Insurance Fund.
        Finally, as detailed in my written testimony on our vision
    for housing finance reform, the Housing Policy Council supports
    a guarantor structure built around privately capitalized
    companies chartered and regulated by this new agency. Lenders
    of all sizes and business models would originate mortgages that
    meet certain standards and sell those to the guarantors in
    exchange for mortgage securities or cash. The guarantor would
    then assume the credit risk on the securities. The securities
    issued should carry an explicit Federal backstop, and
    guarantors would pay a fee for that guarantee, part of which
    would be placed into a reserve fund.
        My written testimony also details some important
    transitional steps we have recommended that FHFA take as a way
    to move toward this new model such as the securitization
    platform, additional progress toward a single security, and
    additional clarity on representations and warranty standards.
        We believe the work of this Committee is vital to creating
    a housing finance system that works for the future, and we
    encourage you to continue this effort.
        Thanks for your time, and I will try to respond to any
    questions. Thanks, Mr. Chairman.
        Chairman Johnson. Thank you. Thank you all for your
    testimony.
        As we begin questions, I will ask the clerk to put 5
    minutes on the clock for each Member.
        Ms. Ellis, based on your experiences at the FDIC, what
    tools and authorities does a strong regulator need to protect
    the fund from losses of bad actors?
        Ms. Ellis. Mr. Chairman, over the FDIC's history, we have
    found it very important for the FDIC to have the ability to
    identify, and monitor risk posed to the Deposit Insurance Fund,
    and to take action where necessary. And we do this in a number
    of ways. We do this at the outset. We have the ability to deny
    or approve deposit insurance applications. We have the ability
    to collect information from members. We have the ability to set
    minimum capital standards. We have the ability to engage in
    ongoing monitoring and also, when needed, to take action if
    risks are escalating.
        Some of these authorities are explicit in a statute, and
    some come from more broad authorities, and we have found both
    very effective.
        Chairman Johnson. Mr. Pollard, in your testimony you raise
    concerns that the implied powers provided to FMIC in S.1217
    could undermine the operation of a national housing market. Do
    you believe that the legislation should be explicit about the
    supervisory and enforcement authorities that FMIC has?
        Mr. Pollard. Mr. Chairman, the view that we have is that
    S.1217 is a very strong start. We do believe, as the FDIC
    commented, that explicit authorities avoid litigation and other
    problems that can impair action. So that is really where we
    just believe an elaboration was appropriate.
        I would note we believe that the best model is strong and
    clear legislation, but with the flexibility on implementation
    to adjust to changing circumstances.
        Chairman Johnson. Mr. Dzivi, what do you think?
        Mr. Dzivi. I concur, and I think the legislation should
    have express inspection and examination powers and express
    enforcement powers modeled after the Federal banking laws.
        Chairman Johnson. Mr. Leonard, what elements of the
    regulatory structure are needed in legislation in order to
    provide certainty for market participants? What is flexibility
    needed? For example, should capital requirements be set in
    statute or set by the regulator?
        Mr. Leonard. Mr. Chairman, as others have said, I think the
    regulator should have some flexibility to set capital
    standards. I think the goal of S.1217, the ability of the
    system to withstand a significant market downturn is very
    important, but particularly as in S.1217, if you are allowing
    different types of credit enhancement, I think the regulator
    would need the flexibility to set different capital
    requirements for either an insurer guarantor or a capital
    markets credit enhancement process. So I think as others have
    said, I think the regulator needs some flexibility to be able
    to increase capital and respond to different situations.
        Chairman Johnson. Mr. Couch, do you agree or have anything
    to add?
        Mr. Couch. Generally I agree with Mr. Leonard, Mr.
    Chairman, and we approached it the same way at the commission.
    We backed into the capital requirements by asking, What would
    it take in terms of capital to protect the American taxpayer
    from having to pay on that backstop guarantee, that
    catastrophic guarantee? And we looked at it by saying what kind
    of downturn in the market should the system be prepared to
    withstand, and we said, well, it ought to be something worse
    than the Great Recession but not as bad as the Great
    Depression, and we came up with 30- to 35-percent housing price
    index deflation. And taking that into consideration, we thought
    that the capital requirement would be somewhere in the 4- to 5-
    percent range. I know S.1217 talks about 10 percent. But the
    devil is somewhat in the details on that, and that is where the
    regulator probably needs some discretion to determine what kind
    of capital we are talking about. Is it leveraged? Is it
    nonleveraged? You know, exactly how does it work?
        So, yes, I would probably agree with Mr. Leonard at a
    general level but we might disagree on some details.
        Chairman Johnson. Mr. Regner, the mortgage insurance
    industry went through difficult times during the crisis. What
    changes have been made or are under consideration through the
    regulation of PMI to strengthen this industry?
        Mr. Regner. Chairman Johnson, I am a member of the Mortgage
    Guarantee Working Group through the NAIC. The working group has
    been working together for about a little bit over a year now.
    We are in the process of putting in changes to the Model Act,
    and included in that Model Act are additional provisions that
    we feel necessary to protect the mortgage guarantee industry
    and policyholders.
        A number of things that we have included in our model are
    additional capital surplus standards, revisions to the
    contingency reserve standards. We have introduced some
    additional language on the geographical concentration. We have
    also put some provisions in there in regards to quality
    assurance. We have put standards in there for underwriting
    criteria, higher restrictions on dividend releases, higher
    restrictions on contingency reserve releases. We have put in
    provisions for rescissions, just to mention a few. But overall
    we are tackling just about every area that we could think of in
    order to cover any of the shortfalls that we have felt were
    needed during the crisis.
        Chairman Johnson. Mr. Pollard, when Acting Director DeMarco
    was before the Committee in April, he testified that FHFA was
    updating master policies and eligibility guidelines for private
    mortgage insurers. Can you detail the progress on those efforts
    and how these changes will better protect taxpayers?
        Mr. Pollard. The major point that I can tell you as general
    counsel is that I have been working with the team working on
    that. We do expect something to be made public shortly. The
    whole goal there is to undertake efforts that, first of all,
    have input that are measured and gradual. And that is what I
    would tell you today--any phase-in that the Director has ever
    supported has had those attributes. So right now it is still
    under review and discussion with the industry.
        Chairman Johnson. Senator Crapo.
        Senator Crapo. Thank you, Mr. Chairman, and before I begin
    asking questions, I want to also thank the members of the
    panel. You managed to be scheduled just moments before the
    detonation of the nuclear option on the Senate floor, and we
    all had to interrupt you and go down for a series of--what was
    it?--eight or nine votes while we had an unfortunate skirmish.
        That being said, you were very polite to remain here with
    us and continue to be available, and I appreciate that.
        Mr. Leonard, I want to start with you, but I would
    encourage all the witnesses to listen to the question because I
    would be interested in thoughts that any of you have on this
    issue. The issue that I want to discuss with you, Mr. Leonard,
    is the scope and authorities of the new regulator that we are
    contemplating establishing in this legislation. Each of you in
    one way or another, and many others who have commented to us,
    have talked about how important it is to be sure that certain
    authorities and powers are given to FMIC if FMIC is established
    as this legislation contemplates. And as you sit back and look
    at what we are poised to do here, it is, as I see it, the
    creation of yet another very big, powerful, comprehensive
    regulator in our financial system. And I see the need for that.
        The question that I have is: How do we assure that we
    establish this new regulator with the appropriate authorities,
    powers, and scope but avoid the duplication with the existing
    regulators in this space and avoid what I consider to be
    serious potential for increased regulatory cost and burden,
    inefficiencies, which will then play out in the marketplace as
    a higher cost of credit and so forth?
        So I know it is a broad question, but I think it is a very
    critical question that we have got to answer. Mr. Leonard.
        Mr. Leonard. Senator Crapo, that is a very good question. I
    think this is such an important--normally, as a representative
    of industry, you know, we have--you know, obviously we do not
    want to be regulated too much. But having said that, this is
    such an important part of the economy and it is so important to
    get this right that, you know, significant regulatory authority
    for this new regulator is necessary.
        I think FHFA, through what the Congress did through HERA in
    2008, obviously at that time it was too late to save Fannie and
    Freddie, but FHFA has a lot of the authority now that the new
    regulator would need. I think it would have to be clarified and
    added to, since I think the prudential authority to essentially
    act like a bank regulator, look at their--you know, be able to
    go in, look at their practice of the guarantors of these new
    entities that would be providing the private credit
    enhancement. I think the regulator needs the kind of authority
    much of which FHFA has now, but I think as others said, it
    needs to be refined and added to in some respects so that the
    regulator can understand what is happening in each of these
    companies, are they following the practices on the types of
    steps that they should be taking as they do their own due
    diligence on the mortgages that they are guaranteeing?
        I think the point that you make is very true in that there
    is a lot of mortgage regulation that has already been put into
    effect through Dodd-Frank, and it is really not now having an
    effect. You know, I think as we envision it--and others can
    comment--obviously anything getting the Government guarantee
    would be a qualified mortgage. I think that a lot--we would ask
    that the new regulator--and, you know, I think the kind of
    legal authority has to be carefully considered in terms of is
    it consultation or coordination or mandated joint rulemaking
    with either CFPB or some type of coordination on the consumer-
    facing aspect of mortgage regulation and what originators and
    the insurers have to do.
        So I think we are leery of, you know, too much overlapping
    regulation, but I think for the most part, for the new entities
    that would be doing credit enhancement, the new regulator, FHFA
    Plus or FMIC, would have to have some pretty significant
    authority.
        Senator Crapo. Mr. Pollard, your thoughts?
        Mr. Pollard. Yes, I think the concern is valid, but I also
    think we have lessons learned and experience coming from this
    crisis.
        First, many of the participants in this market are already
    regulated. There needs to be respect for that. I do not think
    S.1217 disrupts that.
        We at FHFA have both formal and informal relationships. As
    I stressed in my testimony, cooperation and consultation is a
    very good thing. Many of the rules in Dodd-Frank have required
    people to work together--sometimes challenging, but I think it
    has been a good experience in terms of that.
        Also, FMIC could employ what now exists similar to the Fed,
    the FDIC, and the States, which is a State and Federal working
    group, which can help smooth and make sure things work
    effectively. I would note that CSBS has been made part of the
    FFIEC, so the State bank examiners have been incorporated to
    facilitate that.
        I think what Mr. Leonard said is very important. I think
    markets do want active regulation, appropriate regulation.
    There is a fear of contagion. We do not want another systemic
    event. And I believe that making explicit authorities but
    having some flexibility, as S.1217 proposes, is a course to
    take. None of us wants overlap or additional burden.
        Senator Crapo. Thank you. And to the other witnesses, my
    time is up, but if I do not get to come back to you on that, I
    would welcome your written responses as well.
        Chairman Johnson. Senator Corker.
        Senator Corker. Thank you, Mr. Chairman. It is lonely here
    today.
        Chairman Johnson. Yes.
        [Laughter.]
        Senator Corker. So we thank you guys for being here, more
    witnesses than Senators, but I know the record will benefit
    from your testimony, and thank you all for the patience you
    have had.
        Ms. Ellis, one of the things that people have talked about
    in the 1217 bill that is generating a lot of discussion--and I
    know the Committee itself is looking at obviously reforms
    relative to housing finance--is the issue of hard wiring
    capital. And some people say, in other words, in the 1217 bill
    we hard-wire the amount of capital that is necessary in advance
    of any kind of Government guarantee. And some people have said
    that is unprecedented, but isn't it true that Section 38 of the
    FDI Act actually hard-wires capital relative to what your
    institution is governed by?
        Ms. Ellis. Right, well, Senator, you are referring to what
    we refer to as the ``prompt corrective action rules,'' and,
    yes, Congress did define several capital categories, and it
    also defined restrictions that would occur as you breached
    different capital categories. And Congress in the law did
    define the threshold for the worst capital category, if you
    will, critically undercapitalized. It said that a bank
    essentially has to have a 2-percent capital ratio in order to
    stay open.
        Above that threshold, for the other capital categories, it
    left it to the regulators to define what those thresholds would
    be, but then as I said, it prescribed what the restrictions
    would be if you breached those. So I would say it is a
    combination of hard-wired and flexible, and it has served us
    well.
        Senator Corker. And to Mr. Pollard and to yourself, I guess
    what we see around here is a watering down of things over time.
    Could the two of you speak to the benefits of having capital
    hard-wired in that manner?
        Mr. Pollard. We could consult first, as your bill calls
    for.
        [Laughter.]
        Mr. Pollard. But I think--if I can go first? OK. First of
    all, we agree with the 10-percent first loss position. It must
    be real, it must be sustained, and it must create a credible
    private sector role. The bill does talk about the ability to
    lower it in a crisis. I think that what I have heard from the
    private sector a lot, though, is certainty, and what they refer
    to as the value proposition. They need to know what the rules
    of the road are.
        Putting this in place and, as your bill does, tying it to
    safer mortgages should not make this a burden. Indeed, it
    reinforced prudent underwriting. And as I said in my written
    testimony, and oral, if we are going to put Federal taxpayer
    dollars on the line, it seems to me that the regulators serve a
    valuable role, but the private sector needs to be there as well
    for a sustained participation.
        Senator Corker. Thank you.
        Ms. Ellis. And, yes, as I indicated, we think the capital
    framework that we have has served us well. Having hard-wired
    minimums is helpful. It is also helpful to have the flexibility
    to impose higher capital standards as circumstances warrant, as
    risks develop in the system or an individual institution.
        I would echo the idea that one of the lessons we learned
    during the crisis is that not only is the amount important, not
    only should it be sufficient, capital should be of high
    quality, and it should be there when losses occur. It should
    not be something that can flee in a time of stress.
        Senator Corker. Thank you. Thank you very much.
        Mr. Pollard, one of the things we also sought to do in this
    bill, especially, again, after we saw what had happened, as Ms.
    Ellis was referring to, during the crisis and what led up to
    is, is to also have some underwriting standards, some minimum
    underwriting standards. They do not address everything, but we
    have in the bill, one of the bills that is being discussed,
    1217, QM plus 5, and I am just wondering if you might respond
    to something like that being in a bill like this.
        Mr. Pollard. We are very comfortable with that approach.
        Senator Corker. That is not much of a filibuster.
        [Laughter.]
        Senator Corker. I am not accustomed to answers like that,
    but I thank you for that.
        Mr. Pollard. Senator, most of the people that know me are
    tickled pink that I gave a short answer.
        [Laughter.]
        Senator Corker. Mr. Leonard and Mr. Couch, I wonder if--I
    know you all have looked at 1217. I know that we have had
    discussions about it in the past. But, generally speaking, do
    you think that it does a good job of preserving the good things
    that exist in our housing finance system and eliminating those
    bad things that exist?
        Mr. Couch. Yes, Senator, I do. Following Alfred Pollard's
    model for brevity--yes.
        Senator Corker. Very good. Thank you. That is about as
    clear as it could be.
        Mr. Leonard.
        Mr. Leonard. Senator, we agree. I think S.1217 goes a long
    way toward correcting those problems, and obviously capital is
    one, regulation is another, and, you know, we are talking about
    not FHFA but OFHEO, the types of authorities that OFHEO had at
    the time. And issues like portfolio--you know, there should not
    be--and I think it has been well discussed in the Committee,
    and you have made the point. You know, you should not have a
    portfolio for arbitrage purposes. The portfolio should be for
    developing or maintaining a market, and it is obviously
    different from the single-family to the multifamily, but we
    agree there.
        So I think the short answer, not to filibuster, is that we
    think the bill has most of the things needed for reform.
        Senator Corker. Thank you all for your testimony, and, Mr.
    Chairman, for having the hearing.
        Mr. Couch. Senator, can I amend my statement with just one
    short sentence? With respect to your question about capital,
    the Bipartisan Policy Center is going to host on December 11th
    a day-long session that will bring in private marketplace
    participants, as well as Senators Johnson and Crapo, to address
    that very issue. So we hope you will send some representatives
    to hear what our folks have to say. Thank you.
        Senator Corker. I am sure they will be there. Thank you.
        Chairman Johnson. Senator Menendez.
        Senator Menendez. Thank you, Mr. Chairman, and I appreciate
    all of your testimony. I was at a hearing on a disability
    treaty, so I had a chance to glance through some of the written
    testimony, and I appreciate it on this subject matter. But I
    want to direct my questions to Mr. Pollard since I do not
    always have the opportunity to have you before the Committee.
    With reference to Director DeMarco's intentions to unilaterally
    reduce the maximum size of mortgage loans that Fannie and
    Freddie can finance, families in my home States of New Jersey,
    like many other families in States throughout the country, can
    face particularly high housing costs, and I am concerned that
    the reductions to the conforming loan limits can
    disproportionately harm them.
        So we, meaning a group of bipartisan Senators, including
    Senator Isakson as well as several Members of this Committee,
    sent a letter to Mr. DeMarco basically urging him not to take
    unilateral actions and questioning whether or not he had the
    authority to do so.
        Now, I would like to know from you as the agency's counsel,
    is the agency taking the position that Congress has expressly
    delegated authority to it to reduce the maximum size of loans
    financed by Fannie and Freddie or is it interpreting the scope
    of its conservatorship powers to include that authority?
        Mr. Pollard. Senator, let me address both legal and policy,
    if I might----
        Senator Menendez. Well, if you can just address the legal--
    --
        Mr. Pollard. I will address the legal then. The statute for
    well over 50 years has provided that the GSEs set limits; that
    is the first part; second, that the limit may not exceed a
    maximum, which is set through a formula. Thus, the maximum is
    not a mandate nor a floor. The Director in--so the enterprises
    at any time could have set a lower limit. They did not have to
    go to what is called the maximum.
        In the conservatorship, where the Director stands in the
    shoes of the board and management, he then has the same
    authorities and may set that limit.
        Senator Menendez. So your response to me is then saying you
    have both the legal authority and to the conservatorship powers
    you can do it either way. Is that what you are saying to the
    Committee?
        Mr. Pollard. Yes.
        Senator Menendez. Well, in 2011, the Director told the
    House Financial Services Committee, and I quote, ``I do not
    intend to act unilaterally in lowering the loan limits because
    the Congress of the United States has been so active in
    repeatedly involved in adjusting the conforming loan limits
    that I really and truly believe that the Congress of the United
    States is the body that should make the determinations about
    the future path of the loan limit if it is going to be
    something other than what current law provides.''
        Mr. Pollard. Right. That quote was in part of a response to
    a broader question on loan limits in general. But what I would
    note is he indicated talking about Congress and the maximum
    loan limit. The ability within that loan limit has never been
    altered by Congress, including when they adjusted the loan
    limit. They have not----
        Senator Menendez. So you are suggesting that if Congress
    does not want the Director to arbitrarily and capriciously on
    his own, despite a feel that Congress has repeatedly been
    engaged in setting, that, in fact, we should change the law to
    limit what he, in fact, can do in decreasing loan limits?
        Mr. Pollard. All I can say is that the construct that I
    have to analyze every day provides for the GSEs to set the
    limits, and there is a maximum that has been set and
    calculated, and that was set by Congress.
        Senator Menendez. Well, it seems to me that if Congress has
    actively and repeatedly been involved in adjusting the
    conforming loan limits, it would suggest that Congress has not
    delegated to the FHFA the discretionary authority to adjust the
    loan limits without an express authorize. It just also seems to
    me, with Congress actively considering housing finance
    legislation, as demonstrated by this hearing, and many other
    Members of this Committee who have had this view held on this
    topic, why does the FHFA think that now is a good time to take
    unilateral action on an issue in which it acknowledges Congress
    has shown a clear and repeated interest? I find the timing
    puzzling, to say the least. And for some of us, it will invoke
    a reaction that will be far more limiting to your agency's
    abilities.
        Mr. Pollard. What I would say is that the Director has
    indicated that he is very attentive to the market here and very
    sensitive to that. He has provided notice about this. He has
    indicated any change would be gradual. It would have a longer
    phase-in. And it is still under review, Senator.
        Senator Menendez. Well, finally, if I may, Mr. Chairman--
    and I am glad that you reconvened so that I could actually get
    here--I hope if the agency has an analysis as it relates to the
    benefit here--because it seems to me that everything I have
    seen is that loans that would be excluded by a reduction in the
    loan limits actually performed better than the average. And it
    seems to me that even if--or even if they have a positive
    value, that without ordering the GSEs to stop financing them
    would be an action that worsens rather than improves the GSEs'
    financial position. I would like to see all of this analysis
    that drives this decision, even in the face of repeated
    congressional action in a bipartisan basis. It just boggles my
    mind.
        Thank you, Mr. Chairman.
        Chairman Johnson. We will go with another round.
        Ms. Ellis, the structure of the FDIC Board tries to ensure
    diversity and independence while also balancing the background
    of the Board members with their duties to protect depositors.
    In your opinion, what are the strengths of this model? Could
    this model work for a new secondary mortgage market regulator?
    Also, do the FDIC's advisory committees, like the Community
    Bank Advisory Committee, provide a good avenue to consider
    stakeholders' views?
        Ms. Ellis. Mr. Chairman, in my experience in working with
    various members of the FDIC Board of Directors, they take their
    jobs very seriously. In fact, prior to assuming my current
    position, I worked as deputy to one of our current Board
    members, so I saw this up close. As you indicated, there are
    certain requirements ensuring some aspects of diversity on our
    Board of Directors, and it has been my view that having people
    with a broad range of experience and good judgment is
    important. Also important is to avoid conflicts of interest.
    There are certain rules in place that, for example, prevent the
    Board of Directors from working for an insured depository
    institution at the same time, and there are certain post-
    employment restrictions if they do not serve a full term.
    Things of that nature are very helpful.
        As far as the advisory committees go, yes, we have actually
    several advisory committees right now. You mentioned one,
    Community Bank Advisory Committee. We also have one on
    financial inclusion and another on systemic risk. And it is a
    very good way to get industry and other public views' input on
    important policymaking decisions.
        Chairman Johnson. Mr. Leonard, S.1217 proposes the
    regulator have, within the consent of other officials,
    emergency powers in a crisis that lasts only 6 months. Should
    we consider expanding that authority of providing other
    countercyclical tool that a regulator may need in a future
    crisis?
        Mr. Leonard. Thank you, Mr. Chairman. We have not taken a
    formal position on that, but I think it is worth considering
    that the regulator may need more--you know, as we saw from this
    last crisis, you know, at different times there were different
    estimates on whether we were recovering or whether it was
    continuing. So I think our initial view is that the regulator
    may need more flexibility than just 6 months.
        Chairman Johnson. Senator Crapo.
        Senator Crapo. Thank you very much, Mr. Chairman, and
    before going back to my first question with the witnesses who
    did not get a shot at it, I do want to try that, but I wanted
    to follow up quickly, Mr. Pollard, with you on the question of
    loan limits.
        As I understand it, your explanation is that there is a
    loan limit, and then there is an authorized maximum amount of
    loan that will be authorized as the entities are managed. And I
    get that. There is, as Senator Menendez indicated, a continuous
    debate here in Congress about what we should set as the loan
    limits.
        But I wanted to give you an opportunity to get into the
    policy considerations about why we should or should not be
    setting the maximum authorized loans at this point at the
    highest levels possible or at the current levels that are being
    discussed.
        Mr. Pollard. Right. I do not think the issue is whether
    Congress has set them. I think the issue for me, and trying to
    be the person who avoids the Director doing anything arbitrary
    and capricious, is that the maximum--the language in the
    statute begins with, ``The enterprises shall set limits.'' It
    says this about three times, and then only says that the
    maximum limit ``should not exceed . . . .''
        Senator Crapo. Right.
        Mr. Pollard. So the policy behind this right now is--and I
    should have had a chance to say to Senator Menendez, and I
    apologize for this--that we also have a policy to try and
    reduce the footprint of the enterprises in the marketplace
    which stands at 75 percent of the entire domestic mortgage
    finance market. And this is part of an effort of several steps.
    We are trying to do new credit risk transfers that are
    recognized in S.1217 to share risk. We are talking about a 10-
    percent insurance type approach with a first loss. All of this
    is to bring in more private sector and restore more of an
    equilibrium and reduce the burden on taxpayers. So I think that
    is part of the coordinated effort.
        We certainly have heard the debate on this. The Director is
    very sensitive--he said there would be tons of notice--very
    sensitive to how the market would adapt to any change. And,
    again, it is under review and, you know, it has not occurred
    yet.
        Senator Crapo. Thank you. And before I get back to my first
    question, I want to quickly ask you, Mr. Regner, in your role
    as the assistant director for the Arizona Department of
    Insurance, I am sure you have dealt with the myriad of issues
    affecting mortgage insurance from undercapitalized private
    mortgage insurance companies to regulatory interaction among
    various entities at both the State and Federal levels.
        What specific powers should the new Federal regulator have
    to effectively deal with the private market insurers in a
    reformed housing finance system?
        Mr. Regner. Well, before, I guess, to answer the question,
    I think from our testimony that I gave today we feel that the
    powers or the guidance that is directed within the bill, that
    the solvency and capital standards should still be maintained
    and regulated by the States in order to maintain a capital
    level that is adequate to allow for new entrants and for the
    continuation of a competitive market. Capital is very
    expensive. When you get into areas of getting into it being
    excessive, the possibility of loss of entrants or the
    continuation of that line of business could be lost. That is
    some consideration you may want to think about. And, of course,
    the NAIC staff would be more than happy to work with you in
    regards to maybe coming to some sort of resolution to that type
    of concern that we have.
        Senator Crapo. All right. Thank you.
        Now I will just get back to the four of you who did not get
    a chance, if you choose, if you would like to, to respond to my
    first question, which was really the broader question of how do
    we solve this issue of creating a very, very, what I see as
    extensive and powerful new regulator in a field where we
    already have very significant regulators playing in a number of
    different positions. And how do we make sure that we give
    appropriate authorities to but assure that we do not simply
    pile on, if you will, the regulatory level of burden that we
    have put on our housing finance system? Would any of you like
    to jump into that?
        Ms. Ellis. Sure. I would be happy to.
        Senator Crapo. Ms. Ellis.
        Ms. Ellis. I would be happy to share some of our
    experiences at the FDIC. Hopefully it will be helpful. The FDIC
    has a long history of working with other regulators, both at
    the State and Federal level. We are primary supervisor for some
    banks in the U.S., but we are a backup supervisor for other
    banks in the United States. And where we are backup supervisor,
    we have well-established protocols, some facilitated by
    statute, others facilitated just by informal agreement among
    the agencies, for things like information sharing, the sharing
    of examination reports, participation on examinations, and even
    when it comes to disagreeing over the condition of institution,
    we actually have protocols for how to go about disagreeing. All
    of these are important to reduce the duplication that goes on
    as well as the confusion that it could cause to the regulated
    entity.
        Senator Crapo. Mr. Dzivi.
        Mr. Dzivi. Yes, Senator. I think one of the key methods of
    increasing the efficiency of the regulatory structure is the
    sharing of information, and there are provisions in the draft
    legislation that permit sharing of information, but Congress
    may consider actually requiring sharing of information because
    sometimes agencies like to butt heads a little before they turn
    over each other's documents. So that might be one thing for
    Congress to consider.
        Senator Crapo. Thank you.
        Mr. Couch.
        Mr. Couch. Senator, I cannot add to--the other witnesses
    have adequately described the cooperative systems that are in
    place now, but I would compliment you for thinking about it
    because it is important, and I think it should be covered.
        Senator Crapo. Thank you. Mr. Regner.
        Mr. Regner. Just a quick comment. Information sharing is
    very important to keep that avenue open so that we can learn
    off each other's experiences and the work that we both have put
    into the efforts of looking at these type of industries.
        Senator Crapo. Mr. Leonard.
        Mr. Leonard. Senator, just one more point on your question.
    For example, in the area of mortgage servicing, I think there
    is more that could be done to improve coordination particularly
    in loss mitigation requirements. And obviously there was a need
    for improved loss mitigation because servicers did not have
    adequate standards, as we found out during the crisis. But now
    you have multiple standards. You have Making Homes Affordable,
    you have the National Mortgage Settlement, you have the OCC
    consent agreements, and you have CFPB and GSE guidelines. In
    some areas, many of these are coordinated. In others, the
    requirements are slightly different, so servicers are
    operating, you know, in times--like, for example, times where
    you have the number of days you have to respond to the
    customer, things like that.
        I think as you look at a bill, like, for example, on
    servicing standards, additional thought about how the agencies
    can coordinate, and it is moving together but there is still--
    what we hear from servicers, there are a number of different--
    standards still vary, and it causes some confusion. So I think
    it is an area that still needs to be looked at.
        Senator Crapo. Thank you. Mr. Pollard, you get the last
    word.
        Mr. Pollard. Thank you.
        Senator Crapo. Unless the Chairman wants to give somebody
    the last word.
        Mr. Pollard. I want to be sure that something is made clear
    that a lot of us have used terms today, and I want to be sure I
    am clear for the Committee on our perspective. We talked a lot
    about setting standards in the market. I think it is very
    important to recognize that third-party service providers are
    very important, and any regulator that is providing a
    successful standard like this has to be able to look at them.
    They do pose potential risk. So people one step away from the
    person you are dealing with may be very important, and I think
    that is one of the things we are talking about. I do not want
    to mislead the Committee. We think that ability, that capacity,
    is needed.
        And, second, when you are putting Federal taxpayer dollars
    on the line, I think there is a challenge to address the reach
    of the Federal authorities here. They need to be broad. We are
    talking about putting Federal tax dollars on the line and the
    ability of the Federal Government to be able to look into, to
    track, to set standards that may affect all regulated parties.
    Within this framework, not expanding it, but within the very
    area we are talking about, just this area, is part of an
    interesting point that I do think needs to be addressed and
    confronted.
        Senator Crapo. Thank you. I am sorry I went a little over
    there, Mr. Chairman.
        Chairman Johnson. Thank you to all of our witnesses for
    being here today. I want to thank Senator Crapo and all of my
    colleagues for the time today to discuss the structure of the
    new secondary market regulator.
        This hearing is adjourned.
        [Whereupon, at 3:26 p.m., the hearing was adjourned.]
        [Prepared statements and responses to written questions
    supplied for the record follow:]
                    PREPARED STATEMENT OF ALFRED M. POLLARD
                General Counsel, Federal Housing Finance Agency
                               November 21, 2013
        Chairman Johnson, Ranking Member Crapo, and Members of the
    Committee, thank you for your invitation to testify on the powers and
    structure of a regulator for a revised housing finance system. My name
    is Alfred M. Pollard and I am General Counsel for the Federal Housing
    Finance Agency (FHFA), which is the safety and soundness regulator of
    the Federal Home Loan Bank System and Fannie Mae and Freddie Mac. The
    introduction of S.1217 and the work of the cosponsors and of the
    Chairman and Ranking Member in moving forward with housing finance
    reform are important steps. I have addressed the questions you put to
    me in your letter and will be pleased to answer any questions you may
    have.
    Supervisory Tools Available to FHFA
        Following enactment of the Housing and Economic Recovery Act of
    2008 (HERA), the new Federal Housing Finance Agency came into existence
    with an enhanced array of supervisory tools. These include explicit
    authority to impose and enforce prudential standards, including capital
    standards; obtain reports from parties on a regular and on an as-
    requested basis; conduct targeted and full scope examinations; oversee
    executive compensation, including incentive compensation and golden
    parachutes; require remedial actions; and authorities to undertake a
    full range of enforcement actions.
        FHFA's predecessor as supervisor of Fannie Mae and Freddie Mac was
    the Office of Federal Housing Enterprise Oversight (OFHEO). In general,
    OFHEO did not have a full range of authorities, including authority to
    set capital requirements or to undertake supervisory actions that were
    comparable to those of other financial regulators; HERA corrected that.
    At OFHEO, congressional appropriations were required, subjecting the
    regulator to potential disruptions if a budget were not in place; HERA
    corrected that. At OFHEO, no receivership authority existed which
    symbolized a regulator without a full range of capacities; HERA
    corrected that. At OFHEO much had to be done with implied authorities;
    HERA corrected that, providing explicit authorities and language
    regarding ``incidental authority.'' In addition, by merging OFHEO and
    the Federal Housing Finance Board, FHFA's predecessor as supervisor of
    the Federal Home Loan Bank System, HERA increased synergies over the
    regulation of the Government-sponsored sector of the housing finance
    market. Overall, HERA made important changes to the regulatory
    authority over Fannie Mae and Freddie Mac, but by the time the law was
    passed it was too late to implement those authorities prior to the need
    for conservatorships.
        More specifically, let me cover a few of the basic regulatory tools
    that FHFA has today:
        Supervision and Examination. FHFA has a full array of supervisory
    tools, many of which were unavailable to OFHEO, but provided under HERA
    to FHFA. Since its creation in 2008, FHFA has implemented these tools
    through a comprehensive supervisory program described here.
        FHFA supervision is carried out by two divisions--the Division of
    Enterprise Regulation with responsibility for Fannie Mae and Freddie
    Mac and the Division of Bank Regulation with responsibility for the 12
    Federal Home Loan Banks and the Office of Finance. Both Divisions
    employ on-site examination and off-site analysis and carry forward
    prudential standards set forth in regulation to meet FHFA's
    responsibilities relating to safety and soundness and compliance with
    laws and regulations.
        With respect to Fannie Mae and Freddie Mac, even in
    conservatorships, FHFA maintains a permanent on-site presence of
    examiners who conduct examinations and monitor business activities, key
    risks and compliance. With respect to the Federal Home Loan Banks, FHFA
    typically carries out three on-site examinations per quarter so that
    all 12 FHLBanks are examined on-site once per year. As with Fannie Mae
    and Freddie Mac, FHFA has an ongoing program of off-site monitoring of
    the FHLBanks.
        FHFA has established comprehensive examination manuals that serve
    as guides for examination efforts and are available to the regulated
    entities and to the general public. FHFA continues to issue Advisory
    Bulletins on a timely basis regarding key matters such as credit risk
    management and model risk governance. Typically, these are based on
    best practices that have emerged in bank regulation, though
    appropriately adapted to the unique characteristics of our regulated
    entities, starting with the fact that they are not commercial banks.
    FHFA remains the only financial regulator tasked with providing an
    annual report to Congress on its examination results.
        FHFA's two supervisory Divisions work closely with the Division of
    Housing Mission and Goals that has expertise in mortgage-related
    products and markets, to ensure the agency maintains a comprehensive
    view of risks and housing finance activities. Together these three
    divisions also conduct the mission oversight of the regulated entities.
        With Fannie Mae and Freddie Mac each in conservatorship, FHFA's
    oversight of these companies goes beyond traditional supervisory
    activities. As the conservatorships have lasted far longer than
    originally anticipated, FHFA has responded by developing an Office of
    Conservatorship Operations and an Office of Strategic Initiatives that
    carry out FHFA's responsibilities regarding the current operations of
    the conservatorships. These Offices coordinate and collaborate with the
    other divisions to enable FHFA to meet its responsibilities and its
    mission of ensuring our regulated entities operate in a safe and sound
    manner so they may serve as a reliable source of liquidity and funding
    for housing finance and community investment.
        Enforcement. FHFA may take a broad range of enforcement actions by
    statute and, by regulation and policy guidance, has elaborated on the
    conduct of such powers. Cease and desist orders, civil money penalties,
    debarment of officials, the ability to act against institution-
    affiliated parties all exist within the ambit of our statute;
    additionally, the Agency has created a process for suspending
    individual or corporate counterparties found guilty of criminal law
    violations. Overall, FHFA has broad administrative enforcement powers
    regarding the regulated entities and the ability to access judicial
    remedies if necessary to address third parties through its independent
    litigation authority.
        Emergency Tools. HERA provided FHFA a broad range of regulatory
    tools for addressing emergency situations. The Agency does not possess
    a fund such as the Deposit Insurance Fund to cover specified losses,
    but it does maintain a working capital fund and has the ability to
    impose special assessments on the regulated entities to address any
    shortfalls in its resources in order to respond to emergency
    situations. Temporary emergency funding was provided in the form of a
    support agreement with the U.S. Treasury Department in 2008 and this
    remains the main source of funding to provide capital support to the
    conservatorships. Finally, FHFA has employed its authorities and they
    have been affirmed in a number of important court rulings.
        As to those court decisions, several have aided in rounding out
    FHFA authorities. Significantly in a case in the Southern District of
    New York, the Court found not only that FHFA had examination privilege,
    but also shared similar authorities to banking regulators. This
    solidified the examination privilege that facilitates effective
    supervision, but as well made clear that FHFA supervisory actions find
    support in long-standing bank regulatory powers. For a new agency,
    these judicial decisions are important.
        In sum, the agency is equipped to meet the mission Congress has set
    for it. What I will now address is the regulatory structure set forth
    in S.1217, and, based on some of the lessons learned during this
    crisis, where areas exist for improvement in terms of regulatory
    structure and powers.
    S.1217, Housing Finance Reform and Taxpayer Protection Act of 2013
        FHFA has endorsed the need for legislative action on housing
    finance reform. S.1217 is an important effort in moving that process
    forward.
        Proposed Regulatory Structure. S.1217 would establish a new model
    for the secondary mortgage market and a new supervisory agency, the
    Federal Mortgage Insurance Corporation (FMIC). The range of FMIC's
    duties and responsibilities represents a movement away from traditional
    examination- and enforcement-based supervision to a multifaceted
    construct that covers availability and transparency of information,
    standard-setting to enter and participate in the market, supervision of
    participants, access to credit and the secondary mortgage market,
    insurance of securities and establishment and operation of databases
    including a mortgage data repository. Implementation of the bill's
    varied elements will require careful thought and planning over the 5-
    year transitional period and the undertaking of appropriate
    transitional steps. It must be noted, however, that beyond the
    regulatory structure and authorities, a key lesson learned during the
    financial crisis is that, even with adequate powers, regulators will
    not always get it right; therefore, if taxpayers are going to be
    exposed to risk of losses, sufficient private capital must be available
    in front of taxpayers, as contemplated in S.1217.
        Regulatory Tools That Should Be Added. The bill provides FMIC with
    limited explicit regulatory authority, though additional tools may be
    implied and, importantly, an ``incidental powers'' provision is set
    forth. Making regulatory authority clear and explicit, including where
    appropriate the ability to establish prudential standards, set capital
    requirements and take enforcement actions, would enhance market
    stability and provide a higher degree of confidence to all market
    participants. Further, the ability to address both the primary parties
    to be regulated and to have certain authorities in relation to their
    contractual counterparties would be in line with existing legal
    practice. Where the bill implies authority, but does not expressly
    confer it, action FMIC would determine to take could lead to litigation
    and result in different outcomes in different jurisdictions,
    undermining the operation of a national housing finance market.
        Reliance on implied authority also makes it difficult to say what
    is missing. What is clear is that FMIC needs a full array of
    supervisory and enforcement authorities with regard to the market
    participants for which it must set standards and approve entry,
    including the authority to set capital standards, request reports from
    and examine these participants, establish enforceable prudential
    standards, require participants to undertake remedial actions where
    appropriate and impose penalties for bad behavior and bad actors. In
    the structure proposed in S.1217, providing FMIC with these tools is
    not only important for market integrity, but also to protect taxpayers
    in light of the risks associated with FMIC insurance. These powers are
    familiar to current participants in the housing finance market--many of
    which are already subject to supervision by FHFA or by a State or
    Federal regulatory authority--and to the extent they have not been
    provided to FMIC or are only implied in S.1217, they should be made
    explicit.
        FHFA has provided language to demonstrate how these powers, which
    could be implied and are incidental to other authorities already
    expressed in S.1217, could be made clearer in the bill. For example,
    FMIC has authority to approve or suspend approval for participants and
    ``suspending'' implies requiring remedial action; this should be made
    explicit. Also, FMIC's authority to revoke approvals implies the
    ability to revoke participation and thus prohibit participation; such
    prohibition should be made explicit.
        Finally, as reaffirmed by the crisis, greater sharing of
    supervisory information among regulators, greater cooperation among
    regulators, such as FHFA-CFPB efforts on a national mortgage data base,
    and greater transparency for markets, such as FHFA directing the
    publication by the Enterprises of historical loan data, are critical.
    These are core areas on which FHFA is working and will continue to
    build.
        Improvements to S.1217 Regulatory Structure. Because S.1217 sets a
    new direction for the housing finance market, two questions are
    critical--as the Committee has asked, does the legislation get the
    right structural pieces in place for the new market to function
    smoothly and efficiently and does it provide for an effective
    transition from the current system to the new market? FHFA has
    identified some areas where the bill could more fully answer these
    questions.
        For example, S.1217 acknowledges that many likely participants in
    the new market are already subject to prudential supervision by other
    safety and soundness State or Federal regulators by authorizing
    consultation or directing FMIC to coordinate with another agency, but
    more could be done to ensure that other regulators share information
    with FMIC and that exams are coordinated, reducing burdens on
    participants and improving supervisory approaches and outcomes. FMIC
    and FHFA roles in the Financial Stability Oversight Council should be
    clarified to ensure that during market transition appropriate
    representation remains in place. FMIC should have an appropriate and
    explicit role in the Federal Financial Institutions Examination
    Council.
        There may also be gaps to be filled. For instance, today all
    mortgage servicers are subject to certain compliance oversight with
    regard to consumer protections, but nonbank servicers may not be
    subject to prudential oversight. The bill does not address enhanced
    supervision of nonbank servicers, even though their safety and
    soundness and their conformance with required practices are critical to
    FMIC's mandate to protect taxpayers. Assigning regulatory oversight to
    FMIC with the ability to set and enforce prudential requirements could
    help fill this gap. Additionally, FHFA has seen certain State and local
    laws that may impair the efficient operation of a national secondary
    mortgage market.
        The bill also provides for FMIC to be funded exclusively by
    insurance fees, which would be collected on mortgage-backed securities
    that FMIC insures. Relying exclusively on fees as a funding base,
    particularly as the new market is developing, may present certain
    challenges. Clearly, at its inception, FMIC should have sufficient
    resources to be fully operational and sound. Further, funding FMIC and
    growing the insurance reserve could require rather large insurance fees
    in FMIC's early years. In times of market distress, FMIC revenues could
    drop substantially. These challenges may be addressed by expanding
    FMIC's sources of funding to include other fees and assessments; for
    example, creating application fees, which are not explicit, and
    restoring assessments on the Home Loan Banks for their supervision.
        Transition. Transition to the new agency involves a simultaneous
    wind down of the Enterprises and the transfer of functions and
    employees from FHFA to FMIC and the hiring of additional employees as
    needed to fulfill the new agency's responsibilities. FHFA was created 5
    years ago by merging the functions and employees of three agencies--
    OFHEO, the Finance Board and elements of the Department of Housing and
    Urban Development--into a single agency with all of the functions of
    its three parts. Here, the transition involves employees from one
    agency, but into a framework with multiple responsibilities. S.1217
    establishes a two-step transition that would have FHFA and FMIC coexist
    for 5 years, which could be confusing and inefficient for both market
    participants and agency employees.
        FHFA's experience in standing up a new agency would argue in favor
    of immediately transferring all FHFA personnel and responsibilities to
    FMIC, thus permitting a smooth integration, a focus on meeting the
    bill's 5-year goal of full implementation and maintaining the
    congressional direction to wind down Fannie Mae and Freddie Mac. In
    particular, moving all employees to the new agency--or, possibly,
    renaming and empowering FHFA as FMIC--avoids issues of dispersion of
    resources and expertise that may prove beneficial to the various tasks
    assigned in the legislation. Guidance would be helpful on the legal
    authority of FMIC's Director to act before the Board is fully
    constituted. Funding in transition may be critical to assure that a
    smooth start for FMIC occurs with a solid capitalized reserve fund,
    systems and technology in place and providing resources to address
    challenges not anticipated at this time.
        New Utilities. FHFA continues work on the Common Securitization
    Platform. As FHFA and, later, FMIC move to develop more fully the
    National Mortgage Database and an approach for a national mortgage
    market repository for notes and other documents, it may be beneficial
    to address these two items with additional legislative language. A
    national note repository can bring benefits to homeowners, lenders, the
    State foreclosure process and efforts of groups such as the Uniform Law
    Commission to make more uniform State foreclosure laws.
    Conclusion
        FHFA continues to support early congressional action to make clear
    for FHFA, for its regulated entities, for borrowers and for financial
    markets the directions you believe most appropriate to protect
    taxpayers, maintain access to housing finance products and services and
    the strongest regulatory structure that is credible, empowered, clearly
    defined and transparent to carry forward your directions. While all of
    this has complexities, that should not deter prudent actions.
        In closing, FHFA appreciates the opportunity to work with you and
    your staffs and those of the cosponsors, as well as those of other
    Committee Members, to assist in any way we can as you move forward on
    this critical task of addressing a new housing finance structure. The
    certainty that can come from such efforts will benefit homeowners,
    investors, and taxpayers.
                                     ______

                       PREPARED STATEMENT OF DIANE ELLIS
    Director, Division of Insurance And Research, Federal Deposit Insurance
                                  Corporation
                               November 21, 2013
        Chairman Johnson, Senator Crapo, and Members of the Committee, I
    appreciate the opportunity to testify before you today on ``Powers and
    Structure of a Strong Regulator''. As the Committee considers reforms
    to the Nation's housing finance system, including insurance and
    supervisory models similar to the Federal Deposit Insurance Corporation
    (FDIC), you have requested that we provide you with a description of
    the elements of the deposit insurance system that are the most
    important in achieving our mission.
        Many lessons have been learned over the deposit insurance system's
    80 years of operation. Drawing from these lessons, both Congress and
    the FDIC have made a number of improvements to the deposit insurance
    system. During our history, which includes two serious banking crises
    in the last few decades, certain authorities and regulatory tools stand
    out as particularly important. These include clear and explicit
    statutory authority, monitoring to assess risk exposure and to take
    action in response when necessary, appropriate pricing of insurance,
    and adequate funding arrangements. In addition, the FDIC has
    experienced the challenges of managing a transition between agencies,
    which occurred when the Resolution Trust Corporation, created to
    resolve failed savings and loan institutions during the early 1990s,
    was folded into the FDIC at the conclusion of that crisis.
        My testimony today elaborates on and describes these important
    authorities and tools through the lens of the FDIC's experience. In
    some cases, the elements of our regulatory and insurance regime may be
    relevant primarily to the FDIC's unique role and mission. In other
    cases, the Committee may determine that the lessons we have learned
    over the years provide insights that may be useful to the Committee in
    this important work. The FDIC stands ready to provide assistance to the
    Committee in this effort.
    Explicit Authority
        Since its founding in 1933, Congress has given the FDIC a clear
    mandate: to protect depositors and maintain financial stability. The
    FDIC has been successful in its mission in large part because Congress
    has clearly defined by statute the amount of deposits covered under the
    FDIC's deposit guarantee and the condition--bank failure--that triggers
    the exercise of that guarantee. At the same time, Congress has allowed
    the FDIC flexibility to craft specific regulations to cover the myriad
    details of its operations. The clarity of Congress' mandate provides
    credibility in the eyes of depositors, virtually eliminating the risk
    of bank runs and panics, thus providing a foundation of stability to
    our banking system during times of financial distress. While the
    banking industry pays the costs of deposit insurance, the full faith
    and credit of the U.S. Government ultimately backs the FDIC's deposit
    guarantee.
        The existence of clear statutory authority over the years also has
    served as the foundation of our supervisory approaches. Statutes
    clearly state congressional expectations and goals, enabling us to
    monitor and control for the risk posed to the Deposit Insurance Fund
    (DIF). For example, certain laws, such as prompt corrective action,
    provide statutory tripwires for supervisory action. At the same time,
    the statutes outlining our supervisory authorities provide flexibility
    to create a robust examination process within the statutory grant of
    authority.
        Clear statutory authority also has been critical to the FDIC's
    resolution activities, which enable us to mitigate losses to the DIF
    and help maintain financial stability through timely resolution of
    failed banks and payment of depositor claims. Our authorizing statutes
    delineate the priorities of claims and provide direction to all parties
    in the claims process. This clarity enables the FDIC to resolve failed
    financial institutions efficiently and effectively, usually over the
    span of a single weekend.
    Monitoring and Controlling Risk
        An effective insurance program must include a variety of tools to
    identify and manage risk exposure, not only at the time when insurance
    is granted but also while that insurance stays in force. As deposit
    insurer, the FDIC assesses the risk of an institution at the time that
    it applies for insurance. After admittance into the system, the FDIC
    monitors the condition of that institution through on-site examinations
    and remote monitoring, and through our back-up examination authority in
    the case of an institution primarily regulated by another Federal
    banking agency. Risk mitigation should include setting explicit capital
    standards and must be an ongoing process that allows for intervention
    before losses occur and insurance must be paid out. While the FDIC is
    not the primary Federal regulator of all FDIC-insured institutions, all
    FDIC-insured institutions are subject to the same, or very similar,
    framework of regulations, policies, guidance, examination protocols,
    ratings, capital standards, reporting requirements, and enforcement
    authority.
        In determining membership participation in the deposit insurance
    system, the FDIC carefully considers factors prescribed in section 6 of
    the Federal Deposit Insurance Act (FDI Act) and implements policies and
    guidance that supplement the factors when conducting reviews of deposit
    insurance applications. These factors include the financial history and
    condition of the institution, adequacy of the capital structure, future
    earnings prospects, general character and fitness of management, risk
    presented to the DIF, convenience and needs of the community to be
    served, and the consistency of the institution's corporate powers with
    the purposes of the FDI Act. Under one housing finance model the
    Committee is considering, the Government insurance fund would have
    authority to approve participation by four types of companies: private
    mortgage insurers, servicers, issuers, and bond guarantors. The factors
    for approving each of these companies differs slightly, and are similar
    to, but not the same as, the statutory factors found in section 6 of
    the FDI Act which the FDIC uses to determine eligibility for Federal
    deposit insurance.
    Capital Requirements
        Strong capital requirements are one of the most effective means for
    controlling risk-taking by participants in the system and the FDIC has
    found explicit capital standards to be an important tool to protect the
    DIF. As mentioned above, the prompt corrective action framework in
    section 38 of the FDI Act defines minimum capital ratios and imposes
    progressively tighter restrictions on an institution's activities once
    these minimums are breached. The ratios defined in section 38 are
    intended to trigger regulatory sanctions when banks become less than
    well capitalized, but individual institutions may be required to hold
    capital levels that are higher than statutory minimums based on their
    risk profile and activities. As the Committee considers various
    legislative approaches, it may want to consider inclusion of explicit
    capital standards for all significant participants in the new system
    and the consequences of breaching those standards.
    Ongoing Monitoring and Reporting Requirements
        Requirements for ongoing monitoring, reporting requirements, and
    access to records are essential to an effective regulatory regime. In
    the FDIC's case, these tools enable banking regulators to supervise
    FDIC-insured institutions on an ongoing basis and to identify and
    respond to increasing risk in the system. Providing the proposed
    mortgage insurer with similar authorities would enable that insurer to
    determine independently a participant's financial condition and
    compliance with laws and standards. For example, the FDI Act provides
    for the authority to conduct examinations and investigations, the
    minimum frequency of examinations, the authority to examine affiliates
    and other related entities, coordination and information sharing with
    other agencies, and penalties for obstruction of examination authority,
    among other things.
        This statutory examination authority underpins our program of
    regular examinations and is supplemented by regulations, policies
    (including the standard CAMELS ratings system used for all FDIC-insured
    institutions), guidance, and procedural manuals. Importantly, this
    authority also allows the FDIC to review examination findings for banks
    we do not supervise directly and to conduct backup examinations and
    reviews of those institutions as necessary. Similarly, a statutory
    basis for regular examinations and investigative authority would
    enhance the mortgage insurer's on-site monitoring ability. Where
    participants are subject to oversight by other Federal or State
    agencies, the proposed law could clarify requirements for coordination
    of examination activities and information sharing agreements.
        Additionally, supervisory monitoring efforts are enhanced through
    review of quarterly Call Reports that are required by section 7 of the
    FDI Act, provisions of which also impose penalties for failure to file
    accurate reports. Imposing reporting requirements on approved
    participants could enable the mortgage insurer to conduct off-site
    monitoring.
        The FDIC has also found it essential that its monitoring authority
    include the ability to create standards to determine whether there has
    been a change in ownership, which can alter a bank's risk profile.
    Authority To Take Enforcement Action
        Ongoing monitoring allows the FDIC to identify risks in the banking
    sector, but we also have explicit statutory authorities that allow us
    to take action when an institution is engaging in potentially unsafe
    and unsound practices. Supervisors of FDIC-insured institutions have a
    wide array of formal and informal enforcement actions to ensure
    compliance with rules and standards and to correct problematic
    practices or conditions before a bank becomes insolvent and causes a
    loss to the DIF. Informal enforcement actions can take the form of
    memoranda of understanding or Board resolutions. Section 8 of the FDI
    Act gives the FDIC the authority to pursue formal enforcement actions
    and civil fines against institutions, their affiliates and certain
    individual actors, after notice and an opportunity for a hearing. These
    actions include cease and desist orders, civil money penalties (CMPs),
    Prompt Corrective Action (PCA) Directives, written agreements, and,
    ultimately, termination of deposit insurance. The FDI Act also grants
    the authority to take actions against bank-affiliated individuals
    including removal and prohibition orders to prevent their participation
    in the financial services industry for certain misconduct and
    violations. Providing similar authorities to the Federal mortgage
    insurer might enable it to correct problem situations before they
    result in a loss to its insurance fund.
        While they are valuable supervisory tools in certain circumstances,
    provisions for suspension or revocation of the approved status of
    participants or the ability to impose CMPs are not sufficient alone as
    tools for effective risk management. Providing monitoring authority and
    authorizing a broader array of informal and formal corrective actions
    would enhance the mortgage insurer's ability to take corrective actions
    prior to losses being incurred.
    Insurance Pricing
        The FDIC has had experience over its history with both flat rate
    and risk-based pricing for insurance. Initially, Congress directed the
    FDIC to charge all banks the same assessment rate. This flat-rate
    system lasted for 60 years, but it had problems which became evident in
    the late 1980s when banks started to fail in large numbers. The flat-
    rate system resulted in less risky banks excessively subsidizing
    riskier banks and did nothing to reduce the incentives for banks to
    take excessive risk.
        In response to the banking crisis of the late 1980s, Congress ended
    the flat-rate system in 1991 and directed the FDIC to adopt a risk-
    based assessment. Since 1993, the FDIC has had a risk-based pricing
    system where banks that take on more risk pay more in deposit insurance
    assessments. An important feature of the risk-based pricing system is
    that it is forward looking. Since the system relies on measuring the
    likelihood that a bank could fail and cause a loss to the insurance
    fund, it is inherently more complex than a flat-rate system. To more
    accurately price for risk, the FDIC must collect a wide range of
    financial and supervisory information, which it does through quarterly
    financial reports prepared by banks as well as monitoring and
    supervising insured institutions.
        The FDIC supports a risk-based pricing structure for deposit
    insurance. However, deposit insurance may not be perfectly analogous to
    Federal mortgage insurance. A Federal mortgage insurer is likely to
    have a greater ability to mitigate risk at the outset, for example, by
    setting robust underwriting standards for the underlying mortgages.
    Funding
        Funding arrangements also play a critical role in the success of an
    insurance system, including the FDIC's deposit insurance system. A
    well-designed system ensures that adequate funds are readily available
    to respond to problems as they arise and to avoid delays in closing
    failed banks or paying insured depositors. These arrangements also
    determine the amount and the timing of the industry's contribution
    toward the costs of insurance and the degree of taxpayer exposure.
    The Importance of Prefunding
        The FDIC has always had an explicit, ex ante fund paid for by the
    banking industry to satisfy claims as they arise. Alternative
    arrangements, such as pay-as-you-go or ex post assessments, increase
    the risk that bank closings will be delayed. Delays in closing failing
    institutions (as the FDIC observed through the experience of the failed
    Federal Savings and Loan Insurance Corporation) increase the ultimate
    cost of failure and undermine confidence in the banking system more
    generally. Prefunding for future losses is also more equitable. With a
    pay-as-you-go or ex post system, surviving banks pay the costs
    generated by those that fail, which penalizes those banks that are less
    risky.
        Prefunding also allows an insurer to smooth the cost of insurance
    over time. The FDIC works to charge steady premiums and avoid
    procyclical pricing, where rates increase in difficult times--when
    banks can least afford to pay them and when those funds are most needed
    to lend and promote economic growth. Most bankers indicate that they
    prefer steady, predictable premiums rather than procyclical rates.
    Finally, as with any insurance arrangement, an ex ante fund is
    reassuring to depositors and taxpayers, thereby promoting confidence
    and enhancing financial stability.
    The Challenge of Determining the Size of the Fund
        The question of whether to have an ex ante fund is easier to answer
    than the question of fund size, which involves balancing significant
    trade-offs. The FDIC balances the need for a fund that is sufficient at
    all times to pay depositor claims against the possibility of holding
    funds that could be better used by banks for lending.
        Over its history, the FDIC has experienced mixed success with
    various approaches to determining an optimal fund size. For more than
    50 years, Congress set premium rates and there was no official target
    fund size, so the reserve ratio (the ratio of the amount in the DIF to
    estimated insured deposits) fluctuated considerably. This period
    coincided with great economic stability and few bank failures, so
    deposit insurance fund adequacy was not a pressing concern.
        That situation changed during the late 1980s as the U.S.
    experienced a large number of bank and thrift failures and large losses
    to both the banking industry and taxpayer. To address concerns about
    the viability of the deposit insurance fund in the aftermath of these
    losses, Congress made a series of changes to the FDIC's authorities for
    managing the size of the fund. In 1989, Congress instituted for the
    first time a target for the size of the fund, called a Designated
    Reserve Ratio (or DRR), which was initially equal to at least 1.25
    percent of estimated insured deposits. \1\
    ---------------------------------------------------------------------------
         \1\ Financial Institutions Reform, Recovery, and Enforcement Act
    of 1989, Pub. L. No. 101-73, 103 Stat. 183 (1989).
    ---------------------------------------------------------------------------
        In 1991, Congress required that, when the fund was below 1.25
    percent, the FDIC would be required to raise assessment rates to reach
    the target within 1 year or charge very high rates, even in periods of
    economic distress. \2\ In 1996, shortly after the reserve ratio reached
    its target, Congress prohibited the FDIC from charging well-capitalized
    and well-managed banks anything whenever the fund was at or above that
    target. \3\ The resulting hard target left the FDIC with almost no
    ability to let the size of the fund materially increase or decrease.
    ---------------------------------------------------------------------------
         \2\ Federal Deposit Insurance Corporation Improvement Act of 1991,
    Pub. L. No. 102-242, 105 Stat. 2236 (1991).
         \3\ Deposit Insurance Funds Act of 1996, Pub. L. No. 104-208, 60
    Stat. 446 (1996).
    ---------------------------------------------------------------------------
        This framework created a number of problems including:

        a decade during which at least 90 percent of the industry
            paid nothing for deposit insurance,

        a free-rider problem where new entrants and fast growers
            diluted the fund but paid nothing, and

        potentially volatile and procyclical premiums.

        In 2006, Congress removed the hard target and allowed the FDIC to
    manage the fund within a range of 1.15 and 1.50 percent of estimated
    insured deposits. \4\ Unfortunately, the recent crisis came soon after
    these changes were enacted and bank failures again caused the fund to
    become negative. To prevent a repeat of these problems, the Dodd-Frank
    Act increased the minimum reserve ratio to 1.35 percent and removed the
    hard cap, which had required that the FDIC return to the industry all
    amounts that would cause the reserve ratio to exceed 1.50 percent. This
    new authority effectively allows the FDIC to determine the optimal
    target, so long as it is at least 1.35 percent of estimated insured
    deposits. \5\ Some flexibility in determining a target fund size may be
    beneficial for the Federal mortgage insurer, preventing it from facing
    challenges similar to the fund management problems the FDIC faced in
    its past.
    ---------------------------------------------------------------------------
         \4\ Federal Deposit Insurance Reform Act of 2005, Pub. L. No. 109-
    171, 120 Stat. 9 (2006).
         \5\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
    Pub. L. No. 111-203, 124 Stat. 1376 (2010).
    ---------------------------------------------------------------------------
    Striving for Countercyclical Funding
        Given its expanded authority, the FDIC has a number of options to
    choose from in determining an optimal size for its fund. The FDIC has
    explored sophisticated approaches that draw upon the portfolio
    management techniques and best practices used by other financial
    institutions that have to manage capital and financial risks. \6\ The
    appeal of these model-based approaches is the promise of greater rigor
    and precision in determining potential losses and an optimal fund size.
    However, model-based approaches pose a host of practical challenges. It
    is difficult, for example, to accurately determine relationships
    between economic variables and the variables affecting a bank's failure
    or to project economic events.
    ---------------------------------------------------------------------------
         \6\ The FDIC developed a Loss Distribution Model, which views the
    deposit insurance fund as a portfolio of credit risks, representing
    exposure to different banks. For each bank, a probability of failure,
    loss given failure, and exposure upon failure were estimated to arrive
    at an expected loss for that bank. An economic model determined the
    statistical relationships among these elements of expected loss and
    economic variables such as interest rates, stock price indices, and
    housing prices. Finally, a simulation model was incorporated to
    determine a wide range of economic events and produce a distribution of
    possible future failures and losses to the deposit insurance fund.
    ---------------------------------------------------------------------------
        Therefore, in the end, the FDIC took a different approach to
    determine the most appropriate fund size, one grounded in the agency's
    actual financial experience. Having experienced two banking crises in
    the past three decades, it looked at the costs associated with these
    crises to address two related questions. First, how high did the fund
    need to grow to prevent it from ever going negative? And, second, what
    steady premium rates would have been required to achieve the desired
    balance? The analysis revealed that if the DIF had been allowed to grow
    to at least 2 percent of insured deposits prior to each of the two
    preceding banking crises, a steady average premium rate of a little
    over 8 cents per $100 of domestic deposits would have been required to
    meet these goals. This approach would have avoided the procyclicality
    that resulted in volatile premium rates, which necessarily increased
    during periods of bank failures.
        This straightforward approach remains the underpinning of FDIC's
    current fund management strategy. It was used to set a long-term
    reserve ratio goal (DRR) of 2 percent in 2011 which continues today.
    This 2 percent target is viewed as a soft, rather than hard, target.
    While the FDIC has set rates to achieve the statutorily required 1.35
    percent minimum reserve ratio, there is an explicit plan to reduce
    rates gradually, but not to zero, if the fund exceeds the long-term 2
    percent target. In determining an optimal size for a fund for mortgage
    insurance, similar trade-offs and historical experiences may be
    considered.
    Successful Transition of Assets From One Entity to Another
        The FDIC has unique experience with transitioning the assets and
    responsibilities of one entity to another. In response to the savings
    and loan crisis of the late 1980s, Congress dissolved the insolvent
    Federal Savings and Loan Insurance Corporation (FSLIC), and divided the
    duties of resolving the crisis between the FDIC and a temporary agency,
    the Resolution Trust Corporation (RTC). As the RTC was intended to be a
    temporary agency to address that specific crisis, Congress set a
    statutory termination date of December 31, 1995, and provided for the
    transfer of RTC's responsibilities to the FDIC.
        A number of factors contributed to the successful transition from
    the RTC to the FDIC. The resolution authorities and activities of the
    RTC and FDIC were very similar. The assets from failed savings and loan
    institutions resolved by the RTC were very similar to the assets of
    failed banks and savings and loan institutions being handled by the
    FDIC. In addition, both agencies shared similar policies, procedures,
    and organizational structures. The employees handling many of the RTC
    assets ultimately transitioned to the FDIC along with the assets.
        Even with these similarities, the FDIC and RTC managements engaged
    in extensive and cooperative planning for the transition to ensure the
    continuity of operations. The remaining RTC assets were managed and
    accounted for in a separate fund as they were wound down. The FDIC/RTC
    experience may provide some analogies to the housing finance reform,
    but other aspects of the reform are more complex. Transition in this
    context involves two large organizations in conservatorship with
    various assets and liabilities transferring partly into Federal hands,
    with other assets potentially being sold into the private sector.
    Conclusion
        Again, thank you for the opportunity to share with the Committee
    the FDIC's experience and insights regarding the elements essential for
    a Federal insurance program. As noted at the outset, our history may
    provide relevant lessons as the Committee contemplates the creation of
    a Federal mortgage insurance entity. The FDIC has benefited from
    explicit statutory authority, risk monitoring and control tools,
    appropriate pricing of insurance, and adequate funding arrangements. We
    are happy to provide any assistance that the Committee would find
    valuable as it continues its important work to address housing finance
    reform.
                                     ______

                       PREPARED STATEMENT OF KURT REGNER
     Assistant Director, Arizona Department of Insurance, on behalf of the
                National Association of Insurance Commissioners
                               November 21, 2013
    Introduction
        Chairman Johnson, Ranking Member Crapo, and Members of the
    Committee, thank you for the opportunity to testify today. My name is
    Kurt Regner, and I serve as the Assistant Director, Financial Affairs
    Division of the Arizona Department of Insurance. Arizona sits on the
    Mortgage Guaranty Insurance Working Group of the National Association
    of Insurance Commissioners (NAIC), and it is on behalf of the NAIC that
    I present this testimony today.
        The NAIC is the United States' standard-setting and regulatory
    support organization created and governed by the chief insurance
    regulators from the 50 States, the District of Columbia, and five U.S.
    territories. Through the NAIC, we establish standards and best
    practices, conduct peer review, and coordinate our regulatory
    oversight. NAIC members, together with the central resources of the
    NAIC, form the national system of State-based insurance regulation in
    the United States.
        State insurance regulators appreciate the opportunity to offer our
    expertise and perspective on Federal efforts that impact our system of
    supervision. As the prudential regulators of insurance, we are in the
    business of protecting insurance policyholders and ensuring competitive
    insurance markets. As insurance markets evolve, State insurance
    regulators remain extensively engaged with all relevant stakeholders to
    promote an optimal regulatory framework and mortgage insurance is no
    exception. In that arena, we are very mindful of the need to carefully
    balance solvency standards with ensuring the availability of coverage
    in the market. We also appreciate the strong desire in Congress to
    address a number of issues arising from the mortgage transaction, but
    want to ensure that any legislation appropriately considers the
    existing regulatory regime that is designed to meet these important
    objectives.
        Today, I will provide the Committee with an overview of the private
    mortgage insurance (PMI) market, how participants are regulated by
    State insurance departments, and highlight actions underway at the NAIC
    and in the States. I will touch on related issues with respect to
    financial guaranty insurers, although this is not an area of my
    expertise. I will also offer impressions on how our regulation can fit
    in with the objectives of recent legislative proposals.
    History of Private Mortgage Insurance
        Any discussion of PMI should begin with an understanding of how the
    industry has evolved over time. The PMI industry dates back to the
    1880s, when mortgage banks were first formed to finance loans to people
    securing land in the Midwest and West. Then as now, PMI promotes home
    ownership by facilitating the flow of credit from lenders and investors
    who might not otherwise have the capacity or desire to assume
    incremental credit risk. PMI enables those lenders to mitigate default
    risk when a borrower makes a smaller downpayment, which inherently
    increases the risk of loss.
        The PMI industry went bankrupt and disappeared for some time
    following the Great Depression and the housing collapse of the early
    1930s, but reemerged in the late 1950s as alternatives to the Federal
    Government's Federal Housing Administration (FHA) and Veterans' Affairs
    (VA) mortgage insurance programs. State insurance regulators,
    understanding the lessons of the 1930s collapse, saw the need for
    stronger laws and regulations to ensure PMIs were equipped to handle
    economic shocks for all the tail risk (i.e., the least likely yet most
    severe risk) they carry. Since then, the PMIs have faced and largely
    managed episodes of severe stress in the 1980s, early 1990s, and most
    recently with the housing crisis a few years ago.
        Through the most recent financial crisis, the financial sector's
    collective assumptions about the housing market were proven wrong. As
    regulators, we recognized that regulatory requirements for mortgage
    insurers need to be enhanced to address the risks uncovered by the
    crisis. Today, the downturn's effects are clearly still being felt by
    PMI providers, although market and economic trends have generally
    stabilized in the last couple of years. The PMIs continue to suffer
    losses from the 2005-2007 books of business as some consumers continue
    to struggle with their mortgages. However, new defaults should keep
    trending downward assuming a continued housing and economic recovery;
    and newer, better priced, and higher credit quality business will
    continue to strengthen the PMIs. While the main players in the PMI
    space survived the crisis, they are recovering slowly as they try to
    improve their financial situations. We have been in the process of
    adjusting regulatory requirements to address the risks uncovered by the
    crisis. We have also been keenly focused on improving the competitive
    landscape for the mortgage insurance market by ensuring that
    opportunities exist for new market entrants and that our supervisory
    framework does not undermine the availability of coverage for new
    homeowners and the lenders that service them.
    How Private Mortgage Insurance Works
        At its most basic level, mortgage insurance underwrites the risk of
    borrowers defaulting on their loans. The borrower pays the premiums,
    and the lender is the beneficiary of the policy. PMI premiums are paid
    either in monthly installments or a single premium payment at loan
    origination. Unlike FHA or VA loans, the amount of loss coverage is
    usually capped as a proportion of lost loan principal, usually between
    20 to 30 percent of the loan balance.
        Generally, mortgage insurers provide coverage in four basic forms:
    flow insurance, bulk insurance, pool insurance, and reinsurance.

        Flow insurance provides coverage on an individual loan
            basis and is purchased at the time a loan is originated. The
            lender selects the carrier, but the cost is paid by the
            borrower.

        Bulk insurance provides coverage on each loan in a larger
            group of loans that have already been originated. These loans
            may have flow insurance already, in which case the bulk
            provides a second layer of protection against losses.

        Pool insurance provides coverage of multiple mortgages,
            generally in connection with mortgage securitizations. Insurers
            provide coverage for losses up to an aggregate limit.

        Private mortgage reinsurance, in which the primary insurer
            passes a portion of the risk to a third party insurer, has
            generally been written by ``captive'' reinsurers affiliated
            with lenders.
    Supervision of Mortgage Insurers
        PMIs are regulated by the States in which they do business, with
    the State of domicile providing primary regulatory oversight. Each
    domestic State conducts financial oversight of the companies operating
    in its jurisdiction. State laws and regulations that are specifically
    tailored for mortgage insurance control the risk PMIs can assume
    through a variety of limitations, including reserve requirements,
    capital requirements, investment and risk concentration restrictions,
    and restrictions on nonmortgage insurance related activities.
        PMIs are required to file all policy forms and premium rates with
    State insurance departments, and must also file audited financial
    statements, prepared in accordance with statutory accounting principles
    (SAP) developed by insurance regulators.
        The NAIC has a Mortgage Guaranty Model Act that has been adopted in
    substantial form by all the States primarily responsible for the
    regulation of mortgage guaranty insurers. \1\ As I alluded to
    previously, the NAIC is in the process of making adjustments to this
    model and it is anticipated that these States will adopt the new
    version of the model.
    ---------------------------------------------------------------------------
         \1\ NAIC Model Act #630-1. Attached as Appendix A.
    ---------------------------------------------------------------------------
    Capital Requirements
        PMIs are generally required to maintain risk-to-capital ratios not
    exceeding 25 to 1. Most State regulators are authorized to exercise
    discretion in administering this requirement.
        State regulators are currently considering modifying the NAIC model
    to replace the 25 to 1 risk-to-capital ratio with a more refined
    capital requirement. This includes most notably, conformance with a
    risk-based capital formula to be developed for mortgage guaranty
    insurers. Regulators are also considering a separate loan level cash
    flow projection capital model requirement if the risk-based capital
    formula falls below the required threshold.
        In addition to the capital ratio requirements, there are minimum
    capital requirements. Currently, PMIs cannot transact the business of
    mortgage guaranty insurance unless, if a stock insurance company, it
    has paid-in capital of at least $1 million and paid in surplus of at
    least $1 million, or if a mutual insurance company, a minimum initial
    surplus of $2 million. A stock company or a mutual company must
    maintain a minimum policyholders' surplus of at least $1.5 million.
    State regulators are currently considering modifying the NAIC model to
    increase the required paid in capital and paid in surplus to $10
    million and $15 million, and at all times thereafter a minimum
    policyholders' surplus of at least $20 million.
        As a practical matter, the minimum capital and surplus requirements
    are chiefly of importance in the technical details of organizing or
    reorganizing a PMI. Under the business plans of PMIs that are in
    business or in the process of being organized, a PMI writing business
    on a direct basis requires hundreds of millions or billions of dollars
    in capital and surplus.
    Reserve Requirements
        As I mentioned earlier, PMIs have significant reserve requirements
    to protect against economic shocks, given the large amount of tail risk
    they carry. PMIs maintain up to four separate reserve components:

      1.  Unearned premium reserves: This reserve requirement reflects the
            amount of premium for the portion of the insurance coverage
            that has not yet expired.

      2.  Contingency reserves: This is a long-term, countercyclical
            regulatory capital requirement. PMIs contend with cyclical
            volumes of claims that generally stay within certain parameters
            but occasionally spike, with potentially significant
            consequences. This risk is kept in check by requiring PMIs to
            keep in reserve 50 percent of net earned premiums for 10 years
            in anticipation of larger defaults. These reserves are built
            over time and drawn down only when losses exceed statutory
            thresholds (typically 35 percent of premiums or more) or State
            regulators authorize special releases.

          This requirement is also in place to prevent excessive dividends
            or otherwise dissipating reserves that might be needed to pay
            claims in a highly adverse loss scenario.

      3.  Loss reserves: This is a short-term regulatory reserve
            requirement. Sometimes called ``case basis loss reserves,''
            these must equal expected losses on delinquent loans of which
            the insurer is aware.

      4.  Premium deficiency reserves: This reserve is established when
            anticipated losses plus related expenses exceed expected future
            revenue. It is intended to cover potential losses from all
            business in force, since mortgage insurers can be responsible
            for future losses.

        Contingency reserves are intended to be built up over good times in
    stable markets, so that when the housing market slumps and PMI is most
    needed, the providers will be well-positioned to pay out claims.
        State regulators are currently considering modifying the NAIC model
    to increase the risk sensitivity of the contingency reserves previously
    mentioned.
    Coverage, Investment, and Geographic Restrictions
        Coverage provided by mortgage guaranty insurers ceded is limited to
    25 percent of the entire indebtedness to the insured.
        Insurance regulators also place limits on the ability of a PMI to
    invest in any particular security, and while they can invest in stocks,
    bonds, notes, and other instruments, they may generally not invest in
    real estate.
        PMIs are not allowed to insure loans that are individually in
    excess of 10 percent of the company's aggregate policyholders' surplus
    and contingency reserves. Also, PMIs are prohibited from having more
    than 20 percent of total insurance in force in any one ``Standard
    Metropolitan Statistical Area'', as defined by the United States
    Department of Commerce.
        These concentration limitations are intended to protect against
    sector and regional housing slumps--it enables PMIs to use premiums
    collected in more stable regions to offset losses incurred in
    distressed markets. It is worth noting here that the broad geographic
    scope of the housing crisis illustrates the unique challenge for PMIs.
    Geographic spreading of the risk is an effective tool, for example, for
    property insurance where natural disasters and economic events are not
    necessarily correlated. However, the 2008 crisis illustrated that
    lending risk can be correlated at the extremes, so there are unique
    challenge that PMIs and regulators must manage to address the unique
    characteristics of this product.
    Nonmortgage Activities
        PMIs are ``monolines'' and generally may not engage in activities
    other than mortgage related insurance because of the unique type of
    insurance risks involved. Unlike insurance designed to protect against
    loss of life or property, the risks faced by PMIs are directly
    correlated with the housing market and economic conditions. Although
    monolines are subject to unique risks, they are not exposed to the
    multitude of risks that a multiline writer is exposed to protecting the
    monoline writer from risks that they do not underwrite. However, PMIs
    may be affiliated with a variety of other types of businesses that do
    write other types of insurance or engage in other types of financial
    services.
    Recent Trends in the PMI Market
        Next, let me to turn to discussing the state of the PMI market. The
    financial crisis found PMIs exposed on the front lines--after all, they
    were the ones directly underwriting the risk of borrowers defaulting on
    their loans. Since PMIs provided coverage on high loan-to-value
    mortgages with very thin equity slices, they were vulnerable to
    potential losses in the event of rising delinquencies and defaults. \2\
    ---------------------------------------------------------------------------
         \2\ Center for Insurance Policy Research. ``Financing Home
    Ownership: Origins and Evolution of Mortgage Securitization--Public
    Policy, Financial Innovations, and Crises''. August, 2012. http://
    www.naic.org/cipr
    ---------------------------------------------------------------------------
        The PMI industry recorded its best year in terms of new insurance
    volume in 2007, with total new insurance written exceeding $300 billion
    for the first time. \3\ A short 2 years later, new insurance written
    had declined to $81 billion as the market for mortgage insurance
    shrunk, following the collapse of the housing market and the subprime
    crisis. As home prices plummeted, the wave of mortgage defaults and
    home foreclosures weakened mortgage insurers' capital position as a
    result of substantial losses. Having to set aside substantial capital
    to cover future claims severely constrained mortgage insurers' ability
    to write new business. The very challenging market conditions that the
    mortgage insurance industry experienced since the eruption of the
    crises are reflected in the sharp rise of the industry's loss and
    combined ratios. The industry's loss ratio (losses over net premiums
    earned) jumped from 41 percent in 2006 to a record high 218 percent in
    2008. \4\
    ---------------------------------------------------------------------------
         \3\ Mortgage Insurance Companies of America (MICA). ``2012-2013
    Fact Book and Member Directory''.
         \4\ Mortgage Insurance Companies of America (MICA). ``2012-2013
    Fact Book and Member Directory''.
    ---------------------------------------------------------------------------
        As of year-end 2012 there were a total 34 active monoline writers
    of mortgage guaranty products within 9 insurance groups. Of these 9
    insurance groups, 7 groups accounted for 95.7 percent of gross mortgage
    guaranty premiums.
        Gross premiums written for monoline mortgage guarantors have
    fluctuated over the past 5 years from low of $4.9 billion in 2012 to a
    high of $7.4 billion in 2008. Gross paid losses peaked in 2010 at $12.9
    billion (77.4 percent of which was reported within the six largest
    guarantors) compared to $2.8 billion for 2007. Contingency reserves
    were nearly exhausted over the past 5 years, totaling $221.4 million at
    year-end 2012 compared to $13.4 billion in 2007.
        It is also worth noting that today, most residential mortgages
    insured by PMIs are sold to Fannie Mae and Freddie Mac, the Government-
    Sponsored Enterprises (GSEs). They have a statutory requirement to
    obtain credit enhancement on single-family residential mortgages
    purchased with loan-to-value ratios of over 80 percent. PMI is the
    major credit enhancement they use. \5\ A recent study on the role of
    PMI explained that in addition to the regulatory structure, PMIs are
    preferable to other credit enhancements because of lender
    diversification, delayed losses, and acquaintance with the risks. \6\
    However, in the event the GSEs are wound down, it is unclear how PMI
    providers will be affected.
    ---------------------------------------------------------------------------
         \5\ GAO Report: ``FHA Mortgage Insurance: Applicability of
    Industry Requirements Is Limited, But Certain Features Could Enhance
    Oversight''. September, 2013.
         \6\ Promontory Financial Group, LLC, ``The Role of Private
    Mortgage Insurance in the U.S. Housing Finance System''. January, 2011.
    ---------------------------------------------------------------------------
        Although market and economic trends appear to have generally
    stabilized in the last couple of years, this trend has not yet helped
    mortgage insurers to materially improve their financial situation. Many
    mortgage insurers have been able to obtain additional capital, but the
    losses were material enough that it's expected to take additional time
    to fully recover.

    State Regulators' Ongoing Efforts To Make Adjustments to MI Regulations
        State insurance regulators are actively studying what changes are
    deemed necessary to the solvency regulation of mortgage guaranty
    insurers. The NAIC's Mortgage Guaranty Insurance (E) Working Group was
    formed by the Financial Condition (E) Committee in late 2012. This
    Working Group is assessing what changes should be made to the Model
    Act, and each of the previously mentioned potential changes have been
    developed by this NAIC group.
        In February 2013, the Working Group released a list of potential
    regulatory changes in which it identified the issues with mortgage
    guaranty insurance as it exists now. The primary problems are
    threefold:

      1.  The overconcentration of mortgage originations in only a few
            banks has increased the pressure on mortgage insurers to accept
            everything given to them by any single bank or risk losing all
            the business from that bank.

      2.  The cyclical nature of mortgage insurance means that periods of
            high profitability are followed by periods of varying duration
            of catastrophic loss.

      3.  The lack of incentives to continue adhering to strict
            underwriting standards during booming periods when there is no
            threat of discontinued business.

        In addition to the previously mentioned potential changes to the
    NAIC model and a new Risk Based Capital formula specific to Mortgage
    Insurance, the following additional potential changes are being
    considered:

        The need for new reporting requirements that break out
            mortgage insurers' exposures to different levels of risk and
            are used as partial input into the minimum capital
            requirements.

        The need to prohibit captive reinsurance agreements between
            mortgage insurers and originating banks.

        The need to refer potential accounting issues to the NAIC's
            Statutory Accounting Principles (E) Working Group for further
            consideration as a longer-term project than what the Working
            Group is focused on currently.

        The Working Group's next steps are to expose a concept draft of a
    new model for public comment and debate.
    Financial Guaranty Insurance
        I understand that you are also interested in bond insurers (also
    known as ``Financial Guarantors''). Since Arizona is not a domestic
    regulator for a financial guarantor, I have limited expertise in the
    area and encourage the Committee to discuss the regulation of these
    insurers with a State that regulates one of the remaining financial
    guarantors. Nevertheless, as an experienced insurance regulator, I do
    have some thoughts on the state of the industry. Bond insurers are
    distinct from other property casualty insurers. Their business is based
    almost exclusively on selling their credit rating to other parties.
    This niche industry developed in the early 1970s and initially focused
    on wrapping AAA ratings around lower-rated municipal obligations for a
    small fee. Bond insurance benefited municipalities by both increasing
    the market for their bonds and lowering their net costs. In the 1990s,
    bond insurers expanded their business into structured products like
    Asset Backed Securities, Credit Default Swaps, and Collateralized Debt
    Obligations. These more complicated investment vehicles, some of which
    were tied to subprime-backed mortgages, exposed bond-insurers to
    greater risk, which became painfully evident during the financial
    crisis.
        Since the crisis, the structured bond insurance market has
    basically dried up. The bond industry struggled to remain relevant
    following the 2008 economic crisis and ensuing housing crash. The
    industry declined to only two affiliated active writers, who are only
    writing coverage on traditional municipal business, and are rated AA--
    by Standard and Poor's.
        Gross written premiums for monoline financial guarantors have
    steadily fallen over the past 5-year period, from $4.4 billion in 2007
    to $1.2 billion at year-end 2011. Gross paid losses peaked in 2009 at
    $10.8 billion (mostly due to the four large insurers), compared to
    $110.6 million for 2007, with reported losses of $3.4 billion at year-
    end 2011. Contingency reserves totaled $6.1 billion at year-end 2011
    compared to $8.7 billion for 2007, before the financial crisis started.
        On a positive note, this has opened the door for new participants,
    as newly established insurers and surviving players compete to meet the
    continued demand for bond insurance for municipal obligations. There
    have been two recent entrants who have written $8 million in
    traditional municipal business as of mid-year 2013--one is rated AA--
    and the other is rated AA by Standard and Poor's. The 2008 crisis
    dramatically illustrated the risk inherent to many of the structured
    products linked to the mortgage market that financial guarantors were
    seeking to insure.
    Current Legislative Proposals
        State regulators working through the NAIC recognize the important
    role that PMI continues to play in the housing market and the role that
    recent legislative proposals contemplate the PMIs and the financial
    guarantors playing in that market. While, at this time, the NAIC has
    not taken a position on any of these legislative proposals including
    S.1217, the bipartisan Housing Reform bill introduced by Senators
    Corker and Warner, we certainly appreciate the need for and the efforts
    by Congress to address the issues that arose during the financial
    crisis with the housing finance system and the GSEs. We recognize that
    there are many who would like a more prominent role for the private
    market in housing finance markets and less reliance on the GSEs, and
    insurance regulators remain committed to helping Congress shape such
    proposals.
        However, any effective proposal needs to take into account the
    existing regulatory regime and the lessons State insurance regulators
    learned during the crisis. In this regard, we caution against solutions
    that solely or substantially rely on the use of private mortgage
    insurers and financial guarantors as the lubricant for the housing
    market engine. Private mortgage insurers appropriately insure
    individual loans and, to date, there has been little experience with
    their insuring securities. Indeed, there may be regulatory concerns
    with expansion into this business as they could in some cases take on
    risks in the same loan or type of loan as both a guarantor of the
    securities and the insurer of the individual loan. Conversely,
    financial guarantors have substantial experience in the area but failed
    to live up to expectations during financial crisis and, given our
    experience to date, insurance regulators remain skeptical of their
    capability of insuring anything other than municipal debt--particularly
    if the underlying financial instrument they seek to insure is not
    appropriately capitalized and secure. Reliance on these entities should
    not be considered the ``magic bullet'' that will fix the housing
    finance market. Moreover, throughout this process, neither PMI nor
    financial guaranty insurance should be seen as a substitute for due
    diligence or sound underwriting by mortgage servicers or bond issuers.
        The NAIC is concerned with proposals for a new Federal regulator
    with the authority to develop, adopt, and publish standards for the
    approval of insurers that provide first loss coverage for individual
    loans (such as the PMIs) or provide coverage for eligible bonds. While
    insurance regulators recognize that any new Federal entity charged with
    establishing and maintaining the requirements surrounding a Government
    guarantee has a strong interest in ensuring that taxpayers are not left
    with the bill, appropriate deference should be given to existing State
    insurance regulatory requirements such as capital and reserving
    requirements that are designed with the dual purpose of protecting
    policyholders and ensuring competitive insurance markets. The incentive
    is simply too great for a regulator charged with maintaining the
    viability of a Government guarantee to overshoot this regulatory
    objective and put in place standards, particularly solvency standards
    such as capital requirements, that are more stringent than necessary.
    This would ultimately threaten the availability of coverage and
    undermine the objective of a private market solution to support a
    vibrant housing market for the future.
        We would propose that any new Federal entity defer to the State
    regulators' supervision of the companies within their purview, which
    are designed to protect policyholders and ensure availability of
    coverage. Instead, the focus should be on establishing standards for
    any unregulated entities that may participate in the housing finance
    framework and create standards relating to the establishment and
    administration of any new Government guarantee. If there are issues of
    common concern that arise, Federal regulators should work hand in hand
    with the insurance regulators to address them, as is done today with
    the Federal Housing Finance Administration, the Federal Reserve, and
    the other Federal financial regulatory agencies.
    Conclusion
        As the GAO recently affirmed, U.S. insurance regulators have a
    strong track record of effective supervision of insurers, even in the
    face of the worst financial crisis since the Great Depression. \7\ The
    NAIC and State regulators are committed to working alongside Congress
    and Federal banking regulators to help ensure open, competitive, and
    stable housing and mortgage insurance markets that promote investment
    in home ownership while protecting both lenders and borrowers.
    ---------------------------------------------------------------------------
         \7\ GAO Report 13-583: ``Insurance Markets: Impacts of and
    Regulatory Response to the 2007-2009 Financial Crisis''. June 2013.
    ---------------------------------------------------------------------------
        The NAIC looks forward to contributing meaningful input as
    insurers, lenders, borrowers, policyholders, and the Federal Government
    work together to develop a new framework for housing regulatory
    structure in the U.S. Together, we will meet any new challenges posed
    by a dynamic housing market. We remain committed to effective
    regulation of the PMI and financial guaranty industries, and to making
    changes to our regulatory structure where necessary. We continue to
    believe that well-regulated markets make for competitive markets and
    well-protected policyholders.
        Thank you again for the opportunity to be here on behalf of the
    NAIC, and I look forward to your questions.
    APPENDIX

                        PREPARED STATEMENT OF BART DZIVI
               Chief Executive Officer, The Dzivi Law Firm, P.C.
                               November 21, 2013
        Chairman Johnson, Ranking Member Crapo, and Members of the
    Committee, thank you for inviting me to testify on the proposed powers
    of the regulator and the regulatory structure for the secondary market
    for housing loans. I have represented many clients in the private
    sector and the public sector in the nearly 30 years that I have worked
    on housing finance issues, but my comments today are my own views and
    are not intended to reflect the views of any of my current or former
    clients. My views expressed today draw upon my experience with
    financial institution regulatory agencies, both as a lawyer exposed to
    the savings and loan crisis two decades ago (where I was involved by
    first representing the regulators as they pursued various wrongdoing in
    the western United States and then as counsel to this Committee) and
    then my recent experience as counsel to the Financial Crisis Inquiry
    Commission and its review of the housing finance problems at our
    largest financial institutions.
        I commend the Committee for undertaking this hearing, and the other
    hearings related to the permanent replacement of Fannie Mae (Fannie)
    and Freddie Mac (Freddie) with a new structure to support housing
    finance through a vibrant secondary market that relies more on private
    capital, and presents less risk to the American taxpayer. The prior
    model of Fannie and Freddie, investor owned companies where the senior
    managers were given financial incentives to take outsized risks, was
    deeply flawed public policy. The fact that Fannie and Freddie operated
    for almost their entire existences without a regulator with the strong
    supervisory powers like the Federal Housing Finance Agency (FHFA) only
    exacerbated those flaws. However, uniform standardization in home loans
    and a national platform for issuing securities provided an efficient
    means for millions of American homeowners to access affordable credit.
    Before the advent of what effectively became a national market for
    mortgage loans, there was a lasting and sustained rate differential on
    mortgage loans in various regions across the country. \1\ The
    development of a national mortgage market was a significant improvement
    for rural States that were located far from the centers of capital in
    the United States.
    ---------------------------------------------------------------------------
         \1\ Indeed, in 1982 the rate differential between the State with
    the highest mortgage rate and the lowest mortgage rate spiked up to 600
    basis points. ``The Future of Housing Finance: Who Will Qualify?'',
    Rosen Consulting Group and Ranieri Partners, October 25, 2013, p.5.
    Available at http://www.ranieripartners.com/latest-news.
    ---------------------------------------------------------------------------
        The Committee should analyze both what was good about Fannie and
    Freddie for American homeowners, and what was bad about Fannie and
    Freddie for American taxpayers. I urge the Committee to continue its
    thoughtful and deliberate approach to this problem because the issues
    involved are complicated, and the outcomes could have a profound impact
    on the U.S. economy for generations to come. In the fall of 2008,
    Congress was faced with a crisis and immediate action was needed to
    stabilize the financial system. As a result of the efforts of the FHFA
    to stabilize the operations of the conservatorships of Fannie and
    Freddie, currently we are not in a crisis, and Congress has the luxury
    of time. Finding the right solution is more important than getting a
    quick solution.
        In framing my remarks today, I will use S.1217 as a point of
    departure. The introduction of S.1217 by Senator Corker and Senator
    Warner and their bipartisan cosponsors represents an important first
    step in raising the issue of creating a permanent replacement for
    Fannie and Freddie. I do, however, believe there are ways in which the
    structure proposed in that legislation, especially the regulatory
    structure, could be improved.
        Today, I will present my views with respect to the legislation's
    impact on safety and soundness supervision of the newly proposed
    Federal Mortgage Insurance Corporations (FMIC), and the various private
    entities and businesses in the housing finance sector that could be
    involved in the securitization process. In looking at S.1217, I see two
    primary structural issues for the Committee to consider regarding the
    regulatory agency:

            First, and most importantly, what is the appropriate level of
            safety and soundness supervision of the various private
            entities, such as the mortgage originators, mortgage servicers,
            and private mortgage insurers, that will be in business with
            the FMIC?

            Second, is it sufficient that the FMIC be run by a board of
            Government appointees, or should the FMIC's business of
            granting a Government guarantee on mortgage securities be
            subject to safety and soundness oversight by a separate Federal
            agency?
    Safety and Soundness Supervision of Private Business Partners of the
            FMIC
        Under S.1217, the FMIC would be created with multiple
    responsibilities, including the power to establish a Mortgage Insurance
    Fund to charge fees to be deposited in a fund, and to issue a full
    faith and credit Federal guarantee to cover losses on securities
    insured by private parties, after application of a first loss position
    by either investors or a guarantor. The FMIC would be governed by a
    five member board of presidential appointees, subject to Senate
    confirmation. The FHFA, which has enforcement powers similar to the
    Federal banking agencies, would be abolished.
        Given that a Federal credit guarantee is involved, it is critical
    that any supervision of the private entities participating in the
    securitization be in the hands of a strong, independent Federal
    regulator. During the savings and loan crisis of the 1980s, the country
    learned the hard way that when providing access to Federal guarantees,
    it may not be prudent to rely on State legislatures and State
    regulatory officials, with weak Federal oversight. In the 1980s,
    Congress allowed States wide authority to set the investment rules for
    State chartered savings and loans, but allowed them to have access to
    Federal guarantees for deposit insurance. \2\ Before Congress slammed
    that door shut in 1989, \3\ weak State supervisors in just a few States
    loosened the rules and let a torrent of new operators acquire charters,
    or buy up existing companies, and then the American taxpayer eventually
    picked up the tab for $124 billion of losses. \4\ State regulators may
    be appropriate for certain entities, such as companies involved in the
    life insurance business that are supported by State guarantee funds,
    but when the fund backing any losses is a Federal fund, and the
    American taxpayer has exposure, prudence demands that a strong Federal
    regulator be in charge.
    ---------------------------------------------------------------------------
         \2\ Pub. L. No. 97-320 (Oct. 15, 1982).
         \3\ Pub. L. No. 101-73 (Aug. 9, 1989).
         \4\ ``Fuzzy Numbers Lead to Prickly Politics'', Steve Sloan,
    Congressional Quarterly Weekly, (Oct. 30, 2010).
    ---------------------------------------------------------------------------
        The legislation establishes a process for the FMIC to establish
    standards for approving private parties doing business with the FMIC.
    The private parties participating in the securitization process and
    subject to Government oversight are limited in the legislation to
    private mortgage insurers, mortgage servicers, bond issuers, and bond
    guarantors that do business facilitated by the FMIC. The FMIC is given
    the power to suspend or revoke the authority of those entities to do
    business with the FMIC, and the power to adopt a civil money penalty
    process.
        I believe this portion of the legislation can be improved
    substantially by allowing a Federal agency with safety and soundness
    duties more like the Federal banking agencies to supervise the
    activities of the private parties participating in the securitization
    process. \5\ I recommend that three specific changes be considered by
    the Committee.
    ---------------------------------------------------------------------------
         \5\ In my view, the abolition of the FHFA is unnecessary and would
    add further complications to the transition to a system where Fannie
    and Freddie are replaced permanently with a new organization. My
    references to a Federal agency in this section could mean the FHFA if
    the Committee determined its abolition was unnecessary and made it the
    safety and soundness supervisor for both the FMIC and the Federal Home
    Loan Banks. If the Committee determines not to abolish the FHFA, it
    also could consider whether the single director should be replaced with
    a three person board.
    ---------------------------------------------------------------------------
        First, I would broaden the definition of the private parties in the
    securitization process that are subject to Government oversight, and
    increase the flexibility of the Federal agency to define by regulation
    the key mortgage securitization participants that are subject to its
    authority. The specified entities in the legislation--private mortgage
    insurers, mortgage servicers, issuers \6\ and bond guarantors--should
    be expanded in the statutory language, and the statute should expressly
    grant that Federal agency the authority to adopt regulations in the
    future further expanding the list. For example, it is my view that
    mortgage originators, due diligence firms, and trustees of the
    securitization trusts holding the mortgages that are underlying the
    guaranteed securities should be subject to oversight by the Federal
    agency. Securitization trustees occupy a key position from which they
    could protect investors, but often have little accountability for their
    actions, and in the past have not shown great vigor in exercising their
    potential powers. The Federal agency should have the power to take
    actions that can influence all the key participants in the mortgage
    securitization market place.
    ---------------------------------------------------------------------------
         \6\ I believe the Committee should consider an alternative
    structure where the FMIC itself is the sole issuer of mortgage backed
    securities. The primary goal in issuing these securities with a Federal
    guarantee is to have a low cost of funds that is passed onto
    individuals with home mortgages at a low markup. The structure of the
    system proposed in the bill would have multiple issuers, and because of
    the liquidity premium for smaller outstanding issues, such bonds would
    undoubtedly have a higher interest rates, and a larger bid ask spread,
    than bonds issued by one large issuer. The FMIC could act as the sole
    conduit for entities that desire to issue securities, much as the
    Office of Finance acts as the sole issuer for all the Federal Home Loan
    Banks. 12 CFR 1273.
    ---------------------------------------------------------------------------
        If this new secondary market structure is meant to last, then the
    Federal agency must be given the power to adapt to changing times and
    changing financial markets. Otherwise, over time, the agency will be
    left writing rules applicable to horse drawn buggies as Google-powered
    self-driving cars cruise the freeways.
        Second, I would grant the Federal agency the express power to
    examine and inspect the books and records of all the entities that
    participate in the mortgage securitization, and afford the agency
    examiners who do that inspection the same powers and protections that
    are afforded to national bank examiners. \7\ Federal bank examiners
    today essentially have unfettered access to all the materials and
    documents available to the senior managers of the banks they inspect,
    even materials that are subject to litigation privileges. The Federal
    examiners need access to this information, which is often in the form
    of confidential reviews and reports, to fully inform their views, and
    the private parties need to know that divulging such information does
    not impair existing litigation privileges.
    ---------------------------------------------------------------------------
         \7\ 12 U.S.C. 481. The relevant criminal code provisions in Title
    18 of the United States Code should also be amended.
    ---------------------------------------------------------------------------
        Third, the proposed legislation grants the FMIC the power to set
    standards for private parties and suspend them from doing business with
    the FMIC if they violate those standards. That is a blunt weapon.
    Instead of relying upon a concept of program suspension for private
    parties that violate the agency's standards, supplemented with a
    general grant of power to create a civil money penalty system, I would
    create an express enforcement system modeled after the Federal banking
    laws, with the power to take action for violations of law and
    regulation, and also for engaging in unsafe and unsound practices. That
    final phrase, ``unsafe and unsound practices'', is a key weapon in the
    arsenal of the bank regulatory agencies. It was added to the Federal
    banking laws in 1966 at the request of the Federal banking regulators
    and allows them to address developing practices and conditions. \8\ The
    remedies available to the Federal agency in enforcing its authority
    should include cease and desist powers, \9\ temporary cease and desist
    powers, \10\ the power to take action against individuals (referred to
    as institution affiliated parties) to prohibit such individuals from
    engaging in further business related to the Mortgage Insurance Fund,
    \11\ and a civil money penalty system with express amounts and tiers
    similar to those of the Federal banking agencies. \12\
    ---------------------------------------------------------------------------
         \8\ The broad context of this term was set forth in testimony
    during legislative hearings that has been accepted by courts as a
    guiding principle. ``Generally speaking, an `unsafe or unsound
    practice' embraces any action, or lack of action, which is contrary to
    generally accepted standards of prudent operation, the possible
    consequences of which, if continued, would be abnormal risk of loss or
    damage to an institution, its shareholders, or the agencies
    administering the insurance fund.'' Financial Institutions Supervisory
    Act of 1966, Hearings on S.3158 before the House Committee on Banking
    and Currency, 89th Cong., 2d Sess. At 49-50 (1966) (statement of
    Federal Home Loan Bank Board Chairman Horne).
         \9\ 12 U.S.C. 1818(b).
         \10\ 12 U.S.C. 1818(c).
         \11\ 12 U.S.C. 1818(e), (f), and (g).
         \12\ 12 U.S.C. 1818(i)(2).
    ---------------------------------------------------------------------------
        Cease and desist authority allows a Federal regulator to take more
    precise action than relying upon the blunt action of causing the
    private business to be barred from doing any further work on mortgage
    securitizations that have the benefit of a Federal guarantee. Certainly
    there would be instances in which the offenses do not warrant causing
    the private entity to be barred from all further work, but nonetheless
    call for remediation. And, as is the common practice with the Federal
    banking regulators, instead of actually using the statutory power to
    issue a cease and desist order, in most instances a consent agreement
    would be negotiated between the private business and the Federal agency
    setting forth the scope of the appropriate remedial action. This is a
    much more effective tool than relying upon the brinksmanship of
    threatening to bar the private party from engaging in business with the
    entity providing the Federal guarantee.
    Separation of the Business of Guaranteeing the Securities and
            Supervising the Entity That Makes Guarantees
        S.1217 grants the FMIC the power to issue the guarantee of mortgage
    securities and does not subject the FMIC to supervision by a separate
    safety and soundness regulator. Instead, the legislation creates a
    board of directors composed of Presidential appointees, and relies upon
    them to be self policing when extending a Government guarantee on
    mortgage securities. I am troubled by this framework.
        A review of the history of the housing finance system shows why
    this proposed approach might be troublesome. The recent crisis is not
    the first time that the housing GSEs have faced significant financial
    troubles. By 1981, Fannie Mae, which had a Chief Executive Officer that
    was a presidential appointee, and presidentially appointed members
    serving on its board of directors, was insolvent on a market value
    basis. \13\ Fannie Mae continued to generate cumulative net losses in
    1981, 1982, 1984, and 1985. \14\ At that time, Fannie Mae had no
    independent safety and soundness supervisor with strong enforcement
    tools; its operations were subject to ``light touch'' supervision by
    HUD until Congress created the Office of Federal Housing Enterprise
    Oversight in 1992. \15\ While the specific manner in which Fannie Mae
    blew a hole in its balance sheet back in the 1980s (holding long term
    assets in portfolio that it financed with short term debt) would not be
    available to the proposed FMIC, the similar structural incentives are
    in place for excessive risk taking. History has shown that merely
    having a presidentially appointed executive and some presidentially
    appointed directors did not restrain that organization's push to
    zealously expand its business.
    ---------------------------------------------------------------------------
         \13\ ``Regulating Housing GSEs: Thoughts on Institutional
    Structures and Authorities'', Lawrence J. White and Scott W. Frame,
    Federal Reserve Bank of Atlanta Economic Review, April 2004, fn. 6.
         \14\ ``Government-Sponsored Enterprises: The Government's Exposure
    to Risks'', General Accounting Office, GGD90-97 (Aug. 1990), p.9.
    Freddie Mac, which in the early 1980s was a subsidiary of the Federal
    Home Loan Banks and was not investor owned like Fannie Mae was at that
    time, and Freddie ``was consistently profitable throughout the 1980s .
    . . [avoiding] most interest rate risk . . . and . . . [with] credit
    losses . . . lower than industry average.'' Id. at 8. However, Freddie
    Mac was not subject to stringent safety and soundness standards, and
    operated with razor thin capital (0.62 percent of its assets and
    outstanding MBS at the end of 1989). Id.
         \15\ Federal Housing Enterprises Financial Safety and Soundness
    Act of 1992, Pub. L. No. 102-550 (Oct. 28, 1992) Title XIII. Even then,
    this new agency was hobbled with statutory restrictions giving it far
    less authority (compared to the Federal banking regulators) to
    supervise the safety and soundness of Fannie Mae and Freddie Mac.
    ---------------------------------------------------------------------------
        In the 1980s, there was no strong independent Federal regulator to
    restrain the Freddie or Fannie business managers' zealous push to
    expand their book of business. As the GAO said in the early 1990s, the
    multiple roles given to HUD created an inherent conflict of interest.
    \16\ HUD was a promoter of housing, yet it had a role as safety and
    soundness regulator of Fannie and Freddie. Multiple conflicts arise in
    this scenario. HUD's conflict at that time is evidenced by its response
    to the 1990 GAO report, in which it argued that Fannie's and Freddie's
    minuscule then existing capital (each had less than 1 percent of
    capital to back its assets and outstanding mortgage backed securities)
    was more than enough to meet any stringent capital standards. \17\
    ---------------------------------------------------------------------------
         \16\ ``Government-Sponsored Enterprises: The Government's Exposure
    to Risks'', General Accounting Office, GGD90-97 (Aug. 1990), p.11.
         \17\ ``Government-Sponsored Enterprises: The Government's Exposure
    to Risks'', General Accounting Office, GGD90-97 (Aug. 1990), p.152.
    ---------------------------------------------------------------------------
        In another context, the GAO has previously noted that making
    operational business decisions and being an arms' length safety and
    soundness supervisor are incompatible. In 1993, GAO issued a report
    noting that the Federal Housing Finance Board still had several
    governance functions with respect to the operations of the Federal Home
    Loan Banks (such as approving budgets and dividends), and was also
    charged with being the safety and soundness supervisor of the Federal
    Home Loan Banks. \18\ GAO recommended that safety and soundness
    supervision should be done by a single independent regulator, and that
    the governance decisions should be given to the Federal Home Loan Banks
    and their shareholders. \19\ Congress wisely followed the advice of
    GAO, and later eliminated the governance powers that the FHFB had
    previously held. \20\
    ---------------------------------------------------------------------------
         \18\ ``Federal Home Loan Bank System: Reforms Needed To Promote
    Its Safety, Soundness, and Effectiveness'', General Accounting Office,
    GGD-94-38 (Dec. 1993).
         \19\ Id. at 4-5. Although my testimony today focuses on the FMIC
    and the supervision of the various private parties with which it will
    do business, I also would suggest that having the FMIC be responsible
    for running the Mortgage Insurance Fund, and being the safety and
    soundness supervisor of the Federal Home Loan Banks raises some
    conflicts that are parallel to the conflict that were in place when the
    Federal Home Loan Bank Board was responsible for running the FSLIC
    insurance fund (that insured savings and loans deposits), and
    supervising the Federal Home Loan Banks. When the FSLIC was running low
    on funds to close troubled savings and loans, it lowered collateral
    standards applicable to FHLBank loans to savings and loans, and
    pressured them to make loans that they would not otherwise make. I
    believe the Committee should consider allowing the FHFA to continue to
    exist, and act as the safety and soundness supervisor for the FMIC, the
    private parties involved in FMIC securitization, the Federal Home Loan
    Banks, and its Office of Finance. The Office of Finance issues bonds on
    behalf of all the Federal Home Loan Banks, and is subject to FHFA
    enforcement actions because Congress defined it as an entity affiliated
    party. 12 U.S.C. 4502(11). A graphic depiction of the current
    regulatory system, the system proposed by S.1217, and an alternative
    structure are set forth in Exhibits A, B, and C to this testimony.
        If the Committee were to adopt the alternative approach, it could
    consider whether the best way to structure the FMIC's guarantee
    operations would be as a Government corporation (the GNMA model), or as
    a member owned cooperative (the FHLBank model). The primary benefit of
    the industry cooperative model is that it requires the industry to have
    ``skin in the game'' in the form of stock purchased in the cooperative
    in order to do business with the cooperative. It is not clear to me
    that there would be enough critical mass of business for the mutual
    securitization company for small companies envisioned by section 215 of
    the proposed bill to ever begin operation.
         \20\ Pub. L. No. 106-102 (Nov. 12, 1999).
    ---------------------------------------------------------------------------
        In the current context, an organization charged with ensuring the
    availability of mortgage credit to the maximum extent possible will
    want looser underwriting standards so more families can have access to
    housing; a safety and soundness regulator will want tighter
    underwriting standards to prevent losses during economic downturns.
    This proposed structure puts the FMIC in an inherent conflict of
    interest. In running the business of guaranteeing securities and
    setting the standards for the private parties involved in the
    securitization, they would naturally want the business to expand as
    much as possible to provide as many benefits to as many American
    households as possible; a safety and soundness regulator, on the other
    hand, should want the standards to provide protection to prevent losses
    when an economic downturn occurs. This fundamental tension is why I
    believe the roles should be separated into separate organizations.
        Some have suggested that the deposit insurance model, with a
    special purpose Government backed corporation providing a guarantee of
    insured deposits should provide comfort to those considering the
    proposed model of the FMIC operating without independent oversight from
    a separate safety and soundness supervisor. To this I say please
    examine the results of such specialized deposit insurance systems that
    have been run by special purpose corporations in the housing finance
    system: there are some rather spectacular failures. The most famous of
    these, of course, is the Federal Savings and Loan Insurance
    Corporation, which collapsed for good in 1989, and caused an enormous
    loss for the taxpayers.
        But the FSLIC failure was not an isolated incident. Into the mid-
    1980s there were several States that had State laws creating deposit
    insurance programs funded by assessments on State chartered housing
    lenders. By 1985, all but one of these programs had failed, or were
    closed before they failed. \21\ Some of these were operated exclusively
    with State chartered thrift members on the board of directors, \22\ and
    some had directors appointed by the State government. \23\ But because
    none of them charged their members enough for their deposit insurance,
    they all failed.
    ---------------------------------------------------------------------------
         \21\ ``Mass. Thrifts To Seek U.S. Insurance'', Laurie Cohen,
    Chicago Tribune (May 24, 1985), p.C1 (Ohio, Maryland, North Carolina,
    and Massachusetts deposit insurance systems were closed in 1985, and
    only the Pennsylvania Savings Association Insurance Corp. remained
    open). The Nebraska Depository Insurance Guaranty Corporation had
    declared bankruptcy in 1983. ``After the Ohio bank run, extend Federal
    insurance to all banks'', R. Richardson Pettit, N.Y. Times (March 24,
    1985), p.2.
         \22\ The fund established by Ohio had all its directors elected by
    State thrifts. ``The Ohio Deposit Guarantee Fund--The Ohio Alternative
    to FSLIC'', Ronald Alexander, 15 Akron L. Rev. 431, 436 (1982).
         \23\ The ineffectual Maryland Savings-Share Insurance Corp., for
    example, had three of its board members appointed by the Governor of
    Maryland. ``Toothless Watchdog Shares Blame'', R.H. Melton and John
    Mintz, Washington Post, (Dec. 26, 1985) p.A1.
    ---------------------------------------------------------------------------
        Even the fiscal history of the FDIC should not give great comfort
    to those saying putting Government appointed directors on the board of
    a governmental entity giving credit guarantees is sufficient protection
    in all contexts. At the end of 2009, the Deposit Insurance Fund managed
    by the FDIC had a negative balance of $20.9 billion. \24\ One must
    question whether that negative balance would have been substantially
    larger but for the extraordinary steps taken in 2008 by Congress, the
    Federal Reserve, and the FDIC to pump hundreds of billions of dollars
    into the financial system. Although the FDIC system of deposit
    insurance has been a dramatic success in protecting small savers and
    stabilizing the American banking system, there are issues that should
    cause the Committee to be careful in exporting that model into other
    areas. In the years leading up to the recent crisis, from 1996 to 2006,
    the overwhelming majority of banks paid nothing for their deposit
    insurance from the FDIC. \25\ A former FDIC Chairperson noted in
    testimony before this Committee over a decade ago that the statutory
    model then in effect did not allow the FDIC to ``price risk
    appropriately,'' and that underpriced deposit insurance premiums had a
    number of negative effects. \26\
    ---------------------------------------------------------------------------
         \24\ ``FDIC insurance premiums not likely to change soon,
    Gruenberg says'', Ken McCarthy, SNL Bank and Thrift Daily (Oct. 9,
    2013).
         \25\ In 2006, the FDIC adopted a premium for 2007 in which banks
    had to pay at least 5 basis points. ``FDIC Fees: A 5-BP Floor and Most
    To Pay More'', Joe Adler, American Banker (Nov. 3, 2006), p.1.
         \26\ Prepared Testimony of FDIC Chairperson Tanoue, United States
    Senate Committee on Banking, Housing, and Urban Affairs, June 20, 2001.
    The FDIC Chairperson also noted that the FDIC's system was procyclical,
    exacerbating downturns, because ``premiums are volatile and are likely
    to rise substantially during an economic downturn when financial
    institutions can least afford to pay higher premiums.'' Subsequent
    legislation and actions by the FDIC have reduced, but not eliminated,
    those distortions.
    ---------------------------------------------------------------------------
        The proposed legislation partially addresses this problem by
    setting reserve ratios for the new Mortgage Insurance Fund that appear
    to be floors, not caps, but I would go further and direct the Federal
    agency to establish a meaningful minimum nonzero charge for the fees
    charged to purely private parties for the Federal guarantee that
    applies even after the targeted reserve ratios have been met.
    Conclusion
        Because of the stability of the marketplace resulting from the
    conservatorships of Fannie and Freddie being overseen by the FHFA,
    Congress has the luxury of taking its time to get these issues right.
    In 1982, Congress first attempted to fix the problems of a broken
    housing finance system, and the struggling FSLIC, by expanding the
    powers of savings and loans. While accepted portfolio theory recognizes
    that diversification of investment classes can lower risk, the
    realities of the marketplace often steam roll theory. If those expanded
    powers had been limited by requiring them to be exercised only through
    acquisitions by existing commercial banks with experience in making
    those types of investments it might have worked. Instead, the law
    expanding savings and loan powers was exploited by a group of real
    estate developers who seized control of traditional savings and loans,
    operated under light touch supervision, and used them to fund their
    risky ventures. Congress back then certainly did not intend to invite
    rogue agents into the system, but flawed reliance on weak supervision
    created a perfect storm. The ``cure'' created by Congress in 1982
    exacerbated the problem several fold, and the final cost to the Federal
    Government to make good on the insured deposits of failed savings and
    loans far exceeded the final cost to the Federal Government of the
    extraordinary measures taken under TARP. \27\
    ---------------------------------------------------------------------------
         \27\ Recent calculations indicate that net TARP outflows have been
    approximately $40 billion. See, http://www.projects.propublica.org/
    bailout/. In constant dollars, in 2009 the cost of the savings and loan
    crisis was estimated at $293 billion. http://www.propublica.org/
    special/government-bailouts
    ---------------------------------------------------------------------------
        I am very concerned about the potential for a similar exacerbation
    of current problems. Certainly the existing problems that created
    insolvencies at Fannie and Freddie are significant and demand a
    permanent solution, but let the cure not be worse than the disease.
    Some type of Federal backing of the mortgage market appears to be a
    necessity if Congress desires American homeowners to have continued
    access to 30-year fixed-rate mortgages at an affordable cost. \28\ But
    great care must be taken in designing a system where as yet unknown
    private parties will have access to a Federal guarantee. Whatever you
    design will be a huge magnet for those trying to exploit the system to
    make a quick profit and leave the taxpayers holding the bag.
    ---------------------------------------------------------------------------
         \28\ The 30-year fixed-rate mortgage was first introduced by the
    FHA. ``Private Risk, Public Risk: Public Policy, Market Development,
    and the Mortgage Crisis'', Daniel Immergluck, 36 Fordham Urb. L. J.
    447, 456 (April 2009). By 1970, FHA still accounted for 30 percent of
    single family loans. Id. at 457.

                     PREPARED STATEMENT OF ROBERT M. COUCH
    Counsel, Bradley Arant Boult Cummings, LLP, on behalf of the Bipartisan
                        Policy Center Housing Commission
                               November 21, 2013
        Chairman Johnson, Ranking Member Crapo, and Members of the
    Committee, thank you for the opportunity to be here today to discuss
    housing finance reform.
        Before I get into the substance of my remarks, I want to commend
    the Committee for the deliberate, bipartisan approach it has taken in
    examining this very complicated subject, one of immense importance to
    the American people and our Nation's economy. The series of hearings
    that the Committee has convened have done an excellent job in
    illuminating the key decision points in designing a new, more
    sustainable housing finance system. These hearings, in turn, have
    performed a vital service by helping educate the public.
        This past March, the Committee heard from my good friend and
    colleague Senator Mel Martinez, who outlined the housing finance reform
    recommendations of the Bipartisan Policy Center Housing Commission.
        Founded in 2007 by former Senate Majority Leaders Howard Baker, Tom
    Daschle, Bob Dole, and George Mitchell, the Bipartisan Policy Center is
    a Washington-based think tank that actively seeks bipartisan solutions
    to some of the most complex policy issues facing our country. The
    Housing Commission was launched in October 2011 with the financial
    support of the John D. and Catherine T. MacArthur Foundation. The
    commission has 21 members from both political parties who bring to the
    table a wide variety of professional experiences. Former Senators
    George Mitchell, Kit Bond, and Mel Martinez, and former HUD Secretary
    Henry Cisneros, serve as commission cochairs.
        Suffice it to say that the commission strongly supports the
    objectives of S.1217, the Housing Finance Reform and Taxpayer
    Protection Act, and I am pleased that many of the bill's provisions
    reflect our own recommendations. Like S.1217, the commission proposes
    the wind down of Fannie Mae and Freddie Mac over a multiyear transition
    period; a greater role for private capital in assuming mortgage credit
    risk; and a continued Government presence through a limited
    ``catastrophic'' guarantee of mortgage-backed securities that is funded
    through the collection of actuarially sound fees charged to borrowers.
    The commission believes that a limited Government guarantee in the
    secondary market is essential to ensure widespread access to long-term
    and fixed-rate mortgage financing, in particular the 30-year fixed-rate
    amortizing single-family mortgage.
    The Powers of the New Regulator
        The new housing finance system envisioned by the commission and
    outlined in S.1217 will only work with a strong regulator at the
    system's center. This regulator will function as ``Mission Control''
    for the new system and will be charged with fulfilling two
    responsibilities that are admittedly in tension: promoting a widely
    accessible mortgage market, while protecting the wallets of the
    American taxpayers.
        The commission calls its proposed regulator the Public Guarantor,
    while S.1217 establishes the Federal Mortgage Insurance Corporation
    (FMIC) to assume the regulatory and guarantee functions currently
    performed by the Federal Housing Finance Agency (FHFA), Fannie Mae, and
    Freddie Mac.
        Under the system envisioned by the commission and outlined in
    S.1217, the new regulator would have significant powers and
    responsibilities, including (a) guaranteeing investors the timely
    payment of principal and interest on covered mortgage-backed securities
    (MBS); (b) collecting fees in exchange for providing this insurance as
    well as to cover operational costs; (c) establishing and maintaining a
    catastrophic risk fund; (d) developing credit risk-sharing mechanisms
    for private entities to assume the first-loss position; (e) qualifying
    private institutions to serve as issuers of securities, servicers,
    private mortgage insurers, bond guarantors, and other types of credit
    enhancers; and (f) overseeing and supervising the common securitization
    platform developed by the FHFA.
        S.1217 also commendably seeks to promote transparency and
    standardization in the market by directing the FMIC to maintain a
    database of uniform loan level information on eligible mortgages,
    establish an electronic registry for eligible mortgages that
    collateralize covered securities, and develop standardized
    securitization agreements. Greater transparency and standardization
    should encourage more risk-bearing private capital to enter the
    mortgage system.
        As the former president of a savings bank in Alabama, I
    particularly appreciate the provisions of S.1217 that require the FMIC
    to facilitate access to the secondary market by small, midsize, and
    community banks, many of whom may lack securitization capabilities.
    Ensuring access to the Government-guaranteed secondary market on full
    and equal terms to lenders of all sizes and types was a major objective
    of the commission.
        Looking at S.1217, let me highlight five areas where the Committee
    can strengthen the FMIC's role in the new housing finance system while
    promoting mortgage liquidity:
        1. The Ginnie Mae Model. The commission examined a variety of
    models around which to design a new housing finance system. We
    concluded that the Ginnie Mae model offers a number of distinct
    advantages that can be successfully reproduced in the segment of the
    mortgage market now dominated by Fannie Mae and Freddie Mac. This model
    has a proven track record of promoting broad access to affordable
    mortgage credit while posing minimal risk to the taxpayers.
        An important advantage of a Ginnie Mae-like approach is that it
    allows for a greater number of financial institutions to be issuers of
    MBS. As applied to the FMIC, the Ginnie Mae model would carefully align
    the interests of all the parties in the mortgage chain and allocate
    risk among them: (1) the borrowers (who have downpayment and home
    equity risk and, in some States, face the risk of a deficiency
    judgment); (2) the MBS issuers (who maintain the risk associated with
    ``representations and warranties'') and the mortgage servicers (who
    have risk for the timely payment of principal and interest); and (3) a
    credit-enhancement facility that assumes ``first-loss'' credit risk.
    Like Ginnie Mae, the Public Guarantor would stand in the fourth-loss
    position (behind borrowers, MBS issuers and mortgage servicers, and
    private credit enhancers) with a significant buffer of protection for
    the taxpayers. \1\
    ---------------------------------------------------------------------------
         \1\ Ginnie Mae in its current form might not have sufficient
    capacity to become the Public Guarantor, but might be a suitable
    vehicle if given greater authorities and flexibilities.
    ---------------------------------------------------------------------------
        As you revisit S.1217, we urge you to consider legislative language
    that would allow the FMIC to replicate the Ginnie Mae model as a part
    of its ongoing operations.
        2. Common Securitization Shelf. The commission felt strongly that
    the portion of any new housing finance system guaranteed by the Public
    Guarantor must have a single security or ``common shelf'' for single-
    family mortgages in order to ensure the system's liquidity, interact
    effectively with the To-Be-Announced (TBA) market, and establish an
    equal playing field for lenders of all sizes. A common shelf also
    allows mortgages with different terms, interest rates, and other
    attributes to be pooled into a single security.
        In our proposal, the Public Guarantor is specifically directed to
    provide a common shelf. Based on our reading, it is unclear whether
    S.1217 contemplates the FMIC guaranteeing a single, common security or
    multiple securities. We recommend that the FMIC be explicitly directed
    to provide a common shelf for the segment of the market it backstops
    and to focus its efforts on promoting the liquidity of the new
    mortgage-backed securities.
        3. Resolution Authority. Under the commission's proposal, the
    Public Guarantor would have the authority to temporarily take over the
    business of issuers, servicers, and/or private credit enhancers that
    happen to fail and to transfer that business to other private
    participants in the mortgage system. S.1217 does not appear to give the
    FMIC the same type of resolution authority. With resolution authority,
    the FMIC can help preserve liquidity and ensure a fully functioning
    market, particularly during periods of economic stress.
        4. Emergency Authority. The commission also proposed that the
    Public Guarantor be given the authority to price and absorb first-loss
    credit risk for limited periods during times of severe economic stress
    in order to ensure the continued flow of mortgage credit. Under these
    circumstances, the Public Guarantor would be required to notify the
    Treasury Department, the Federal Reserve, and the chairs of the
    appropriate congressional committees before taking any such action.
        S.1217 provides the FMIC with similar emergency authority, but this
    authority is subject to a number of more stringent conditions. First,
    the authority may only be exercised upon the written agreement of the
    Chairman of the Federal Reserve Board and the Treasury Secretary, in
    consultation with the HUD Secretary. Second, it may only be exercised
    for a period of 6 months. Third, the authority may not be exercised
    more than once in any given 3-year period. \2\ While these safeguards
    are understandable, the Committee may wish to consider empowering the
    FMIC with the flexibility to respond more quickly to emergency
    conditions in the mortgage market.
    ---------------------------------------------------------------------------
         \2\ Section 205.
    ---------------------------------------------------------------------------
        5. Wind Down of Fannie Mae and Freddie Mac. The hard and fast 5-
    year deadline that S.1217 proposes for transitioning from the current
    Government-dominated housing finance system to one in which private
    capital plays a larger role in bearing credit risk may not allow for
    sufficient flexibility and adjustments during this critical period. The
    commission adopts a more flexible approach by suggesting that a
    transition period of 5 to 10 years be built into the legislation.
    Structure and Governance of the New Regulator
        The FMIC and the Public Guarantor are similar in that both would be
    self-supporting institutions that do not rely on Federal appropriations
    but rather finance their catastrophic risk funds and operational
    expenses through the collection of guarantee fees. The primary purpose
    here is to protect the taxpayers from unnecessary risk, but operating
    largely outside the appropriations process also gives the institutions
    some insulation from political interference.
        S.1217 describes the FMIC as an ``independent agency of the Federal
    Government,'' \3\ whereas the commission proposes that the Public
    Guarantor be established as an independent, ``wholly-owned'' Government
    corporation under the Government Corporation Control Act of 1945. \4\
    The commission concluded that establishing the Public Guarantor as a
    wholly-owned Government corporation would provide it with an additional
    layer of protection from political influence while subjecting it to
    well-established budgetary and fiscal controls. \5\ We encourage you to
    examine whether this type of organizational structure is appropriate
    for the FMIC.
    ---------------------------------------------------------------------------
         \3\ Section 101(c).
         \4\ Examples of wholly-owned Government corporations include
    Ginnie Mae, the Export-Import Bank of the United States, the Overseas
    Private Investment Corporation, and the Pension Benefit Guaranty
    Corporation.
         \5\ While there is no general incorporation statute at the Federal
    level, the Government Corporation Control Act of 1945, as amended
    (GCCA), does provide for standardized budget, auditing, debt
    management, and depository practices for most Government corporations.
    Under the GCCA, ``wholly-owned'' Government corporations are required
    to submit annual ``business type'' budgets to the President. See, Kevin
    R. Kosar, ``Federal Government Corporations: An Overview'',
    Congressional Research Service (June 8, 2011). Among a number of items,
    these budgets must (a) contain estimates of the financial condition and
    operations of the corporation for the current and following fiscal
    year, (b) contain estimates of operations by major activities,
    administrative expenses, borrowings, and any appropriations that may be
    needed to restore capital impairments, and (c) provide for emergencies
    and contingencies. Budgets submitted to the President by the Government
    corporation become part of the budgets submitted by the President to
    Congress.
    ---------------------------------------------------------------------------
        S.1217 appropriately specifies that the multifamily businesses of
    Fannie Mae and Freddie Mac must be transferred to the FMIC, and it
    appears that the Mortgage Insurance Fund would cover both single-family
    and multifamily mortgage-backed securities. \6\ The commission, on the
    other hand, concluded it was best to establish separate single-family
    and multifamily catastrophic risk funds since single-family and
    multifamily lending are fundamentally different businesses with
    different underwriting approaches. I encourage the Committee to take a
    second look at this issue.
    ---------------------------------------------------------------------------
         \6\ See, Section 203.
    ---------------------------------------------------------------------------
    Governance
        With respect to the governance of the new regulator, the commission
    ultimately recommended vesting authority in a single individual
    appointed by the President of the United States and subject to Senate
    confirmation. In reaching this judgment, we recognized that the
    regulator of the new system would have an enormous set of
    responsibilities, particularly in the early stages of the new system's
    build out. Our view was that putting a single person in charge would
    promote accountability and ease of decision making.
        Ginnie Mae does not operate under a Board of Directors with
    management oversight responsibilities. \7\ In my view, and speaking as
    a former President of the organization, Ginnie Mae has consistently
    been one of the best-run organizations within the Federal Government.
    But I certainly understand that its governance model is somewhat unique
    among Federal agencies and there are logical reasons for establishing a
    Board of Directors for the FMIC.
    ---------------------------------------------------------------------------
         \7\ The President of Ginnie Mae is responsible to the Secretary of
    HUD and, ultimately, to the President of the United States.
    ---------------------------------------------------------------------------
        The most compelling reason is that rebooting our Nation's housing
    finance system and running the FMIC is a huge undertaking requiring a
    deep bench of experience. An engaged, experienced Board of Directors
    can be an enormously valuable asset to the Director of the FMIC. While
    the Director should have demonstrated experience in financial
    management and a broad understanding of the capital markets, he or she
    must also be someone who can draw upon and utilize the skills of
    others, including the members of the FMIC Board, and inspire the
    members of the FMIC staff to work at a high level of proficiency.
    Having these personal qualities is essential for the FMIC Director to
    be effective.
        If, as contemplated by S.1217, the FMIC is to be managed by a Board
    of Directors, I encourage the Committee to amend the legislation to
    ensure that members of both political parties are represented on the
    Board. Bipartisan representation on the FMIC Board will provide some
    assurance to the public and Congress that the Board is making decisions
    for sound operational and risk-management reasons, and not because of
    political considerations. Building public confidence in the new housing
    finance system will be particularly critical in the early stages of its
    development.
        There is plenty of precedent for this bipartisan approach: Critical
    financial regulatory agencies like the Securities Exchange Commission
    and the Commodities Futures Trading Commission are required to have
    political balance. Likewise, no more than three members of the five-
    member Board of Directors of the Federal Deposit Insurance Corporation
    may have the same political affiliation. While there have been
    occasions when these and other similarly governed Boards and
    commissions have descended into partisan bickering, the totality of the
    evidence over the years suggests they have worked reasonably well.
        I strongly support S.1217's requirement that members of the FMIC
    Board have significant experience in at least one of the following
    fields: asset management, mortgage insurance, community banking, and
    multifamily housing. \8\ This requirement will help ensure that
    relevant experience is represented on the Board. There is also
    precedent for this approach. For example, one of the members of the
    FDIC Board is required by statute to possess a background in State bank
    supervision.
    ---------------------------------------------------------------------------
         \8\ Section 103(a)(1)(B)(i) through (iv).
    ---------------------------------------------------------------------------
        During my career in the mortgage banking industry, I have seen
    first-hand how duplicative and overlapping examination and reporting
    requirements can increase expenses and raise mortgage costs. To improve
    coordination among our Nation's financial regulators, as well as to
    facilitate information sharing about market developments and potential
    risks to the stability of the financial system, I support S.1217's
    decision to make the Chairperson of the FMIC a member of the Financial
    Stability Oversight Board (FSOC). \9\ As we build a new housing finance
    system, FSOC should promote regulatory streamlining and harmonization
    and, when appropriate, encourage regulators to rely on the work and
    conclusions of their counterparts to avoid unnecessary duplication.
    ---------------------------------------------------------------------------
         \9\ Section 102(c).
    ---------------------------------------------------------------------------
        Finally, I support the establishment of an Office of Inspector
    General (IG) within the FMIC to promote the efficient operations of its
    programs and detect and deter fraud and other forms of corruption. \10\
    I also support the additional requirement established in S.1217 that
    the FMIC IG conduct periodic audits of the adequacy of the private
    capital assuming the first-loss position in the new housing finance
    system and make recommendations for addressing any deficiencies. \11\
    By requiring the IG, as well as an independent actuary, to issue annual
    reports to Congress on the adequacy of the guarantee fees charged by
    the FMIC and the Mortgage Insurance Fund itself, S.1217 provides an
    important mechanism to assist Congress in performing its oversight
    responsibilities. \12\
    ---------------------------------------------------------------------------
         \10\ Section 104.
         \11\ Section 104(a)(2)(A)(i).
         \12\ Section 104 (a)(3)(A) and (B). S.1217 also requires the
    Comptroller General of the United States to conduct an annual audit of
    the financial transactions of the FMIC. These audits, too, should
    assist Congress in performing its oversight responsibilities. Section
    106(c).
    ---------------------------------------------------------------------------
        Thank you for your attention. I look forward to your questions.
                                     ______

                       PREPARED STATEMENT OF PAUL LEONARD
    Senior Vice President of Government Affairs, The Housing Policy Council
                      of The Financial Services Roundtable
                               November 21, 2013
        Chairman Johnson, Ranking Member Crapo, and Members of the
    Committee, thank you for the opportunity to appear before you today.
        My name is Paul Leonard and I am the Senior Vice President of
    Government Affairs of the Housing Policy Council of the Financial
    Services Roundtable. The 31 members of the Housing Policy Council
    originate, service, securitize, trade, invest in, and insure mortgages.
    We estimate that our member companies originate three quarters of all
    residential mortgages in the U.S. and service about two-thirds of those
    mortgages.
        The Housing Policy Council strongly supports reform of our Nation's
    housing finance system. Our members appreciate the time and attention
    Chairman Johnson, Ranking Member Crapo, and the Committee are devoting
    to housing finance reform. We also want to thank Senators Corker and
    Warner and their cosponsors for their thoughtful and significant
    contribution to advancing housing finance reform.
        For many years, consumers, lenders, the housing industry, and the
    broader economy benefited from the secondary mortgage market that was
    facilitated by Fannie Mae and Freddie Mac, the housing GSEs. At the
    height of the financial crisis, however, fundamental flaws in the
    design and operation of the GSEs were exposed. Those flaws included
    insufficient capital requirements and an inherent tension between the
    interests of private shareholders and the public mission of the GSEs.
    The GSEs also were subject to a certain amount of ``moral hazard''
    since they operated under a special congressional charter that shielded
    them from traditional market forces.
        A new model is needed for the secondary market in conventional
    mortgage loans that preserves the availability of stable mortgage
    credit for qualified homebuyers, retains key operations, systems, and
    people critical to the current system, and corrects the flaws in the
    existing GSE model by requiring more private capital and better
    protection for taxpayers.
        The structure and duties of the Federal agency charged with
    overseeing the successors to the GSEs is equally important. Just as the
    structure of the GSEs contributed to the crisis, so too, did the
    structure and the limits on some of the powers of the Office of Federal
    Housing Enterprise Oversight (OFHEO).
        Congress corrected many of those problems with the passage of the
    Housing and Economic Recovery Act of 2008 (HERA). Unfortunately, those
    reforms came just as the financial crisis was cresting and could not
    prevent the collapse of the GSEs. Given that history, the members of
    the Housing Policy Council support a strong and effective regulatory
    structure for the entities that will replace the GSEs.
        In the balance of my statement, I will highlight what we believe
    are the more important features of that structure, how those features
    compare to some of the provisions in the Corker-Warner bill, and how
    they mesh with our vision of housing finance reform.
    The Structure of the Federal Regulator
        First, as Senators Corker and Warner have proposed, we support the
    creation of an independent Federal agency to oversee the transition
    from the current GSE system to a new structure for housing finance. We
    also agree that the independence of this agency is enhanced by a
    funding structure that is based upon assessments and fees as opposed to
    Congressional appropriations. While we appreciate the checks and
    balance that are provided by the appropriations process, insufficient
    funding of OFHEO inhibited that agency's ability to properly supervise
    the GSEs.
        Like the Corker-Warner bill, we support the creation of a board to
    govern the agency, the members of which would be appointed for
    staggered multiyear terms. Multiyear terms remove the members of the
    board from the shifting winds of politics. And a board, rather than a
    single director, ensures a greater continuity of policies and
    sufficient consideration of alternative perspectives. Care needs to be
    taken, however, not to micromanage the qualifications for membership on
    the board. The goal should be to ensure that board members have
    sufficient experience and judgment to oversee the agency.
        The Corker-Warner bill proposes different divisions to handle key
    duties of the agency. It calls for a division on underwriting, a
    securitization division, and a division to oversee the Federal Home
    Loan Banks. Creating separate divisions to focus on the unique issues
    within each of these areas is appropriate.
        The Corker-Warner bill also proposes the establishment of advisory
    committees. We support the creation of advisory committees to help
    ensure regular contact with stakeholders to enhance the knowledge base
    of the agency and the quality of its activities. Indeed, we would
    recommend that the creation of advisory committees be mandated, since
    discretionary authorities can be ignored. FSOC provides an example of
    such a neglected authority.
        We agree with the requirement in the Corker-Warner bill that the
    new regulatory agency have its own Inspector General. It is appropriate
    to provide for this oversight and prevent fraud and abuse. At the same
    time, care needs to be taken not to have the Inspector General become a
    ``shadow'' regulator by giving the Inspector General authority to
    review and second guess policy decisions of the board. The additional
    powers the Corker-Warner bill gives the Inspector General may tilt in
    that direction.
    The Duties of the Federal Regulator
        Let me now turn to the duties of this agency. We believe that the
    fundamental duty of the agency should be to ensure that the secondary
    mortgage market operates in a safe and sound manner. In other words,
    the new agency should be, at its core, a prudential regulator that
    ensures the integrity of the market and the solvency of the reserve
    fund that stands before a Federal guarantee. If the agency performs
    this basic duty properly consumers, and the economy as whole, should
    enjoy a steady flow of reasonably priced conventional mortgage credit
    in all economic cycles.
        As a prudential regulator, the agency should have the authority to
    set standards for the segment of the secondary market that is linked to
    a Federal guarantee. That should include setting the boundaries of the
    acceptable credit terms associated with federally guaranteed mortgage
    securities. These boundaries, alone, should prevent the types of
    problems experienced by the GSEs. Also, to enhance the liquidity of
    federally guaranteed mortgage securities, the agency should establish
    the terms and conditions governing pooling and servicing agreements and
    should establish common terms and conditions for guaranteed mortgage
    securities. In other words, the agency should provide for the creation
    of a single form of guaranteed security that promotes a simple, liquid
    and transparent market. On the other hand, the agency should not have
    authority to set standards for the private label market. That market
    will not be supported by any form of Federal guarantee and should be
    able to evolve independently. Indeed, effective operations in that
    market can serve as a signal on the health of the overall market to the
    new agency.
        In exercising its standard setting authority, the agency should be
    required to seek public comment. While we give FHFA high marks for the
    manner in which the conservatorship has been conducted, many of the
    policy actions taken under the conservatorship have fallen outside the
    scope of the normal notice and comment process. Going forward, the
    basic standards and policy actions taken by the new agency should be
    subject to public notice and comment. This process will give all market
    participants and the public the opportunity to comment on proposals and
    decisions by the regulator and will increase confidence in the process
    and the decisions made by the regulator.
        This Federal regulatory agency also should have the power to
    federally charter, or otherwise certify, the key participants in the
    market for guarantee securities. In other words, the Congressional
    charters granted to the GSEs should be repealed and the entities that
    take their place should be subject to a chartering process similar to
    the chartering of a national bank or a Federal thrift. This new
    regulatory chartering process will also eliminate the perception of the
    special status that the GSEs experienced through their unique charters.
        The agency should have examination and enforcement powers,
    including resolution powers. Congress did give such authorities to FHFA
    in HERA, and those authorities should be extended to the new agency.
    Congress should also require the agency to have a concrete resolution
    plan for the successors to the GSEs so that all market participants can
    understand how they would be resolved, if necessary.
        The agency should have rulemaking powers, including the power to
    set appropriate capital standards and the power to adjust conforming
    loan limits. Congress should resist hardcoding some standards,
    including capital standards, in law. Setting appropriate capital
    standards requires a complex analysis and detailed consideration of
    market conditions, as well as consumer impact. Moreover, setting
    specific standards into the statute could have unintended consequences
    in different economic cycles. Congress has long deferred to the
    expertise of the Federal banking agencies to set the specific capital
    standards for banking firms. We believe that a similar approach should
    be applied to the firms that replace the GSEs. This discretionary
    authority also would permit the agency to adjust capital in periods of
    severe economic downturns to ensure that the market continues to
    function.
        Likewise, Congress should give the new agency some flexibility to
    determine the point at which the Federal guarantee on qualifying
    mortgage securities is triggered. This trigger point may differ for
    different structures. In other words, the trigger point for securities
    backed by a federally chartered guarantor may not be the same as the
    trigger point for a securities structure in which investors assume some
    first loss risk on those securities. However, whatever the triggering
    point is should be clearly disclosed to investors, and it should be
    clearly understood that the Government guarantee stands behind private
    capital and a reserve fund that is funded by industry.
        In those cases in which the agency is given some flexibility to set
    prudential standards, the agency should be required to explain its
    rationale for the standards and justify them. This could be achieved
    through regular reports to Congress.
        The agency should have responsibility for the reserve fund that
    stands in front of the Federal guarantee. This should include setting
    the price for the guarantee and the premiums to be paid into the
    reserve fund to ensure that private capital stands before the
    taxpayers. We strongly disagree with the assertion by some that such a
    fee structure cannot be priced to protect taxpayers. The FDIC's bank
    insurance fund serves as an example of a Federal guarantee program that
    has never imposed a cost on taxpayers.
        The agency should be authorized to oversee the establishment of a
    securitization platform for federally guaranteed securities. This
    platform should be used as the basis to securitize and manage a single
    agency security created by multiple participants. Such a platform would
    likely influence the private label market, but the issuers of private
    label securities should not be required to use the platform. While some
    issuers may choose to do so, it would be preferable to have separate
    and distinct platforms to maintain a clear distinction between
    guaranteed and nonguaranteed securities.
        Finally, the agency should not be burdened with too many
    responsibilities that would detract from its basic prudential mandate.
    For example, we do not see the need for the agency to oversee a Mutual
    Securitization Corporation for smaller firms as long as a cash window
    is available for such firms The cash windows operated by the GSEs have
    provided smaller firms with full access to the secondary market, and
    the GSEs should continue to provide this function during the transition
    period. We would not, however, oppose the creation of a Mutual
    Securitization Corporation or similar facility it is deemed necessary.
        More importantly, the agency should not have antitrust and market
    pricing powers, as implied by section 216 of the Corker-Warner bill.
    Other agencies already have sufficient antitrust powers, and pricing
    controls would only have a market distorting impact. Nor do we believe
    that the agency should be responsible for overseeing an electronic
    mortgage registry, as proposed in the Corker-Warner bill. This may be
    needed, but this authority would detract from what should be the
    prudential mandate of the new agency.
    Our Vision of Reform
        The model for the secondary market that we favor is a guarantor
    structure built around several privately capitalized companies that
    would be chartered and regulated by the new agency. Under this model,
    lenders of all sizes and business models would originate mortgage loans
    that meet certain minimum standards and sell those loans to the
    guarantors in exchange for mortgage securities or cash. The federally
    chartered guarantor then would assume the credit risk on the
    securities.
        The Corker-Warner bill also envisions a capital markets structure,
    in which any entity could issue Government guaranteed mortgage
    securities provided the entity met appropriate standards, including the
    assumption of a first loss position. We have no objection to the
    inclusion of such an option in the legislation. However, we believe
    that there are significant impediments to its effective implementation,
    not the least of which is the ability for investors to assess the
    credit risk of the securities.
        The Corker-Warner bill also provides that guarantors and issuers
    could be separate entities. Again, we have no objection to this option,
    but would note that separate entities would require separate capital
    structures and there are limits on the amount of private capital to
    support housing finance. Moreover, there are market efficiencies
    associated with the combination of the guarantor and issuance
    functions. Such a structure provides a single point of contact for
    lenders in the securitization process. Additionally, to the extent that
    the separation of these functions is based upon concerns related to
    market concentration, we would note that current accounting and capital
    rules would prevent an originator from controlling a guarantor since it
    is unlikely that the originator could gain ``true sale'' treatment for
    the mortgages it acquirers.
        The securities issued under this model should carry an explicit
    ``backstop'' Federal guarantee that ensures payments to investors in
    the event a guarantor could not perform on its guarantee. Guarantors
    would pay a fee for the Federal guarantee and part of that fee would be
    placed into a reserve fund, administered by the Federal agency.
    Guarantors also should be able to transfer the credit risk that they
    assume to other parties through reinsurance and capital markets
    structures. Additionally, as I previously noted, guarantors should
    maintain a ``cash window'' to purchase and to aggregate whole loans for
    smaller lenders. On the other hand, guarantors should not be permitted
    to engage in loan origination, mortgage servicing or speculate in
    mortgages or mortgage backed securities.
        The securities created by guarantors would be run through a shared
    securitization platform. This shared platform would provide common
    administrative and systems support for the guarantors and would ensure
    that the securities have a single form with common terms and
    conditions.
        While this model has some similarities to the existing GSE model,
    it differs in several key respects:

        Market Distortions Created by ``Implicit'' Federal Support
            for the GSEs Eliminated--Guarantors would not be granted any of
            the special privileges currently given to the GSEs under their
            Congressional charters (e.g., exemption from State taxation,
            line of credit with Treasury). The guarantors would be
            chartered by the Federal agency, and the ``explicit'' Federal
            guarantee provided under this model would apply only to the
            securities, not to any other debt or equity of the guarantors;

        Systemic Risks Reduced Through More Limited Role in
            Securitization Process--The role of the guarantors would be
            limited to credit enhancement and securities issuance. Other
            key processes associated with securitization would be performed
            by a shared securitization platform. This limitation on the
            functions of the guarantors reduces systemic risks and reduces
            barriers to entry.

        Systemic Risks Reduced Through Limitations on Activities--
            Unlike the GSEs, guarantors could not establish portfolios to
            speculate in mortgages or mortgage securities;

        Tensions Between Competing Missions Eliminated--Guarantors
            would not be subject to specific housing goals, thereby
            avoiding the conflict that existed between the shareholders of
            the GSEs and the public mission of the GSEs;

        Competition Enhanced Through Multiple Guarantors--This
            model envisions more than just two guarantors. The mandatory
            use of a common securitization platform would reduce barriers
            to entry for entities seeking to act as guarantors since it
            would reduce the costs associated with designing and
            implementing key administrative functions associated with
            securitization. The new Federal agency also should be
            encouraged to promote the development of multiple guarantors.

        Prudential Regulation and Supervision Enhanced--Guarantors
            would be subject to more stringent regulation and supervision
            than the GSEs, including heightened capital standards set by
            the new agency.
    Some Transitional Steps
        The transition to any new model for the secondary market will take
    some time. We commend FHFA for the key steps that it has taken in that
    process, including new risk sharing arrangements, adjustments to
    guarantee fees and proposed adjustments to conforming loan limits. We
    commend FHFA for the steps it has taken, and suggest the following
    additional actions during the transition to a new system:

        Single Security--FHFA could increase the liquidity in the
            current agency market and reduce taxpayer costs by creating a
            unified agency security that can be substituted for Fannie Mae
            MBS and Freddie Mac PCs (the terms and conditions applicable to
            this new security would then serve as a foundation for the
            standard securitization agreements applicable to guaranteed
            securities issued under our proposed new system);

        Reps and Warranties--FHFA has made some progress toward
            reforming representations and warranties applicable to
            mortgages sold to the GSEs. However, the rep and warranty
            framework continues to inhibit new loan generation, and
            requires additional reforms;

        Risk-Sharing Structures--FHFA should continue to develop
            risk-sharing arrangements with GSE securities to increase the
            level of private sector capital in front of the Federal
            Government. These structures could then be adopted by
            guarantors following the transition from the GSEs to the new
            model;

        Data Disclosure--FHFA has facilitated some greater data
            disclosure, but additional data on credit performance and loan
            loss severity is needed to attract investors to new risk
            sharing arrangements;

        Guarantee Fees--FHFA's efforts to induce or ``crowd''
            private capital back to the market by increasing guarantee fees
            are not the only steps needed to entice additional private
            capital into the market. The obstacle to a more vibrant private
            market is not only price, but a more efficient securitization
            process. Additional increases in guarantee fees may only
            increase costs for consumers and profits for the GSEs; and

        Conforming Loan Limits--Gradually reducing the existing
            conforming loan limits and aligning the limits applicable to
            the GSEs and FHA. The reduction in the loan limits should be
            done with careful consideration of current market conditions.
    Conclusion
        The Housing Policy Council supports reform of the secondary
    mortgage market system. These reforms should create a system that can
    provide consistent availability of stable products like the 30-year
    fixed-rate mortgage to American consumers by requiring more private
    capital and stronger protections for the taxpayer. A reformed system
    should include a Government backstop behind layers of private capital
    and a strong prudential regulator to set standards and oversee the
    participants in a new secondary mortgage market system.
        We look forward to working with the Committee in its efforts to
    produce bipartisan housing finance reform legislation. Thank you.
             RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
                         FROM ALFRED M. POLLARD

    Q.1. On what date will the entire Common Securitization
    Platform be ready to perform all of its functions?

    A.1. The Enterprises are currently developing the Common
    Securitization Platform (CSP), and have built the core
    functionality and the related infrastructure components.
    Preliminary testing is underway. The CSP's design and its
    development have necessarily evolved over time, and a
    significant amount of work remains with regard to both the CSP
    itself and the business entity that will own it. The
    Enterprises are engaged in developing and implementing
    operational and business processes for the CSP and the joint
    venture entity, and they are developing their integration plans
    critical to the success of the CSP. Fannie Mae and Freddie Mac
    are conducting this work under FHFA's guidance and with
    industry input. Consequently, plans for this project will
    continue to evolve as the Enterprises take into account the
    many factors that will drive project success. The project plans
    will not be finalized until the Enterprises, under FHFA's
    oversight, are in a position to do so. As a result, we do not
    yet have a date by which the Common Securitization Platform
    will be operational.

    Q.2. When the Common Securitization Platform is finally ready
    to perform all of its functions, how much money, all in, will
    have been spent in total by FHFA, each GSE, and Common
    Securitization Solutions, LLC, including contracting costs?
    Does this cost include the cost of any adjustments and upgrades
    that may be necessary so that Fannie and Freddie can take
    advantage of the Common Securitization Platform? If not, what
    is this additional cost expected to be?

    A.2. As discussed above, the Common Securitization Platform
    project plans, inclusive of the design, build and testing of
    the technology and the Enterprises' system and process changes,
    are being finalized. As a result, we have neither final plans
    nor specific budgets assigned to these still-in-development
    projects. To date, the following funds have been spent:

        CSP and CSS: $65 million (1/21/2012-12/31/2013)

        Fannie Mae Integration: $20 million (1/1/2013-12/
            31/2013)

        Freddie Mac Integration: $7 million (1/1/2013-12/
            31/2013)

    Q.3. FHFA staff has stated that FHFA ``has not prepared a
    formal valuation analysis regarding the platform,'' which I
    find disturbing, especially since taxpayer funds are
    essentially at stake here and are in the process of being
    spent. Should we be worried by the fact that FHFA is making
    financial decisions with taxpayer funds without any ``formal
    valuation analysis regarding the platform?''

    A.3. FHFA understands your concern but believes that the
    approach to the project has been prudent and well considered.
    The project is consistent and aligned with many other projects
    undertaken by the Enterprises, at the direction of the agency,
    to achieve uniformity in areas essential to achieving an
    effective mortgage securitization system. The Servicer
    Alignment Initiative, Common Appraisal Data Portal, and Uniform
    Mortgage Data Program are some of the projects that have
    established common and uniform standards and practices in the
    Nation's housing finance system, providing benefits not just to
    the Enterprises, but also to other market participants.
        The decision to engage the Enterprises in this project is
    neither solely nor even principally a financial decision,
    although the financial costs associated with it are very
    important and being monitored. Rather, the decision is rooted
    in FHFA's legal obligations, both as conservator and regulator.
    The decision is based on achieving market efficiencies and
    providing policy makers with options as they determine the
    future of the U.S. housing finance system. The agency has
    determined that the building and operation of the CSP would
    also achieve many supervisory goals and realize other
    significant benefits.

    Q.4. Fannie and Freddie are still two distinct legal entities,
    and FHFA acts as conservator for each GSE. Given how valuable
    the Common Securitization Platform would be to each GSE on its
    own, how did FHFA, as conservator for each GSE, determine that
    a 50/50 joint venture was the right decision for each GSE? In
    preserving and conserving the assets of Fannie with a view
    towards putting it in a sound and solvent condition, why would
    FHFA, as conservator for Fannie, give Freddie a 50-percent
    stake in such a valuable asset?

    A.4. As Conservator, FHFA decided that it was most beneficial
    to establish common securitization technology, which would be
    available to Fannie Mae and Freddie Mac and ultimately to all
    market participants, rather than have each Enterprise
    separately undertake extensive and proprietary infrastructure
    projects. FHFA believes that building the CSP functionality
    once, through the joint and collaborative efforts of, and its
    use by, both Enterprises, will be more cost-effective than
    having each Enterprise independently rebuild its core
    securitization and servicing systems. Neither of the
    Enterprises' existing systems would allow for relatively quick,
    effective and efficient access by the industry either in the
    near or medium term. Furthermore, independent and proprietary
    Enterprise systems would not allow for uniformity across the
    mortgage finance industry, thereby exacerbating the current
    disarray within the industry and complicating the already
    difficult task before policy makers. FHFA believes that two
    different systems rather than common technology could seriously
    delay or complicate attempts to reform the Nation's housing
    finance system. Independent technology provides policymakers
    with greater options for reforming the system than would a
    rebuilding of the Enterprises' individual systems. FHFA and the
    Enterprises have established a process to ensure that each
    Enterprise's contribution to the joint venture is equitable and
    fair retroactively and prospectively.

    Q.5. Please provide all formation documents prepared in
    conjunction with the formation of Common Securitization
    Solutions, LLC (CSS), including but not limited to the
    operating agreement, all legal opinions, all resolutions from
    the Board of Directors for each of Fannie Mae and Freddie Mac
    duly authorizing the formation of CSS, and documentation of all
    costs incurred thus far and expected costs associated with CSS.

    A.5. We would be happy to provide you and your staff an
    opportunity to review the documents noted above at the FHFA
    offices. Please contact Peter Brereton, Associate Director for
    Congressional Affairs, if you would like to schedule such a
    review, and if you require additional information or have
    additional questions.
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                   CHAIRMAN JOHNSON FROM DIANE ELLIS

    Q.1. S.1217 proposes the regulator have, with the consent of
    other officials, emergency powers in a crisis that only lasts 6
    months. Should we consider expanding that authority, or
    providing other countercyclical tools that a regulator may need
    in a future crisis?

    A.1. Since the length, depth, and frequency of financial crises
    are hard to predict, any emergency systemic risk authority
    should allow some flexibility in the frequency or duration of
    the use of that authority.
        The FDIC has found it important to have sufficient
    authority and flexibility to respond to crises promptly in a
    way that maintains public confidence and financial stability.
    The FDIC has always been funded by the banking industry. Under
    section 7 of the Federal Deposit Insurance Act (FDI Act), 12
    U.S.C. 1817, the FDIC has the specific authority to raise
    assessment rates and charge special assessments and broad
    authority to require prepayment of assessments. The FDIC has
    used this authority to cover losses and maintain liquidity
    during periods marked by a high volume of bank failures. The
    FDIC also has lines of credit with the U.S. Treasury and the
    Treasury's Federal Financing Bank, and can borrow from the
    banking industry and from the Federal Home Loan Banks.
        The FDIC's ability to access these lines of credit coupled
    with the U.S. Government's full faith and credit backing of the
    FDIC's deposit insurance system reassures the public that the
    FDIC can pay its depositors promptly in the event of a bank
    failure, eliminating the risk of bank runs and panic. The lines
    of credit also reduce the likelihood of having to charge highly
    procyclical assessments. Ultimately, though, the banking
    industry would bear the costs of deposit insurance by repaying
    any emergency lines of credit were they to be drawn upon.

    Q.2. What is needed in legislation to ensure that Federal and
    State regulators coordinate on supervision and resolution?

    A.2. The FDIC has found its supervisory and resolution
    authorities essential to fulfilling its mission of protecting
    depositors and maintaining financial stability. The FDIC
    coordinates with Federal and State regulators under authorities
    provided by the FDI Act. These authorities include coordination
    and information sharing with other agencies, the ability to
    review examination findings for banks we do not supervise
    directly, and the ability to conduct backup examinations and
    reviews of those institutions as necessary.
        The FDIC's most important tools in regulating entities
    primarily supervised by another agency are: (1) ongoing
    communications with the primary Federal regulators and State
    supervisors, (2) maintaining clear standards for sharing
    information and examination reports, (3) coordinating
    examination schedules, and (4) working together on interagency
    issues through the Federal Financial Institutions Examination
    Council. The FDIC has maintained a Memorandum of Understanding
    (MOU) with the other primary Federal regulators (Office of the
    Comptroller of the Currency [OCC], Board of Governors of the
    Federal Reserve System [FRB], and the former Office of Thrift
    Supervision [OTS]) on Special Examinations for many years, the
    most recent version updated in 2010. In addition, the FDIC,
    FRB, OCC, and National Credit Union Administration entered into
    a MOU with the Consumer Financial Protection Bureau in May 2012
    to implement supervisory coordination and information-sharing
    requirements in the Dodd-Frank Wall Street Reform and Consumer
    Protection Act (Dodd-Frank Act).
        With respect to the proposed legislation, it is possible
    that many guarantors would already be subject to a regime of
    Federal or State regulation and supervision, which also may
    include a process to handle insolvency. This underscores the
    need for clearly defined roles and rules for cooperation and
    coordination between the FMIC and the various Federal and State
    regulators with authority over the guarantors. Where entities
    subject to the legislation are subject to oversight by other
    Federal or State agencies, the legislation could clarify
    requirements for coordination of examination activities and
    information sharing agreements.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                            FROM DIANE ELLIS

    Q.1. Fannie Mae and Freddie Mac's duty to serve the entire
    primary market is an important aspect of our current housing
    finance policy. The duty to serve ensures that creditworthy
    people in all parts of the country can get access to mortgages
    with reasonable rates and terms. Without a duty to serve,
    people in rural areas, lower-income neighborhoods, and
    primarily immigrant or minority neighborhoods might find that
    mortgages are no longer readily available.
        S.1217 envisions a secondary market with many issuers of
    Government-guaranteed securities. Unlike Fannie and Freddie,
    which serve the entire Nation, certain issuers in the S.1217
    model may purchase loans only from certain parts of the country
    or may specialize in targeted loan profiles. Assuming there is
    a secondary market with several issuers, do you have views on
    how we could structure and enforce a duty to serve?

    A.1. While a ``duty to serve'' for individual issuers could be
    created by establishing and enforcing obligations similar to
    those in the Community Reinvestment Act, bringing affordable
    rate mortgages to some communities that would otherwise not be
    served by the marketplace, eliminating the nationwide scope of
    the territory Fannie and Freddie occupy with respect to their
    issuance of securities almost certainly means that many
    hundreds of communities in this country would see a drastic
    increase in mortgage rates, and a significant decrease in the
    availability of mortgage credit. I do not believe that there is
    any other mechanism for addressing this issue other than having
    an issuer with a nationwide scope.

    Q.2. It's critically important that regulators of the housing
    finance market have the authority to take countercyclical
    action--to slow things down when the market is heating up too
    rapidly, and to open the flow of credit when the market slumps
    too low. As we've seen, the housing market is naturally
    procyclical, and regulators must be able to temper those boom-
    bust cycles to ensure availability of credit and to protect
    taxpayers.
        One way to exert countercyclical pressure is to raise
    Government guarantee fees during boom periods and lower the
    fees during declines in the market. But that won't work unless
    regulators have the authority to exert countercyclical pressure
    on the private-label market as well--otherwise, when guarantee
    fees go up during a boom period, it will just drive
    securitization from the guaranteed market to the private label
    market.
        Do you have any ideas on how regulators can exert
    countercyclical pressure on the private-label market?

    A.2. Neither a regulatory agency nor a Government credit
    facility has particularly powerful tools to dampen a boom that
    occurs during bouts of irrational exuberance.
        A Government credit facility, such as a Federal Home Loan
    Bank, can expand its balance sheet and provide needed credit
    during a bust; but during a boom, private sources of funding
    will displace it.
        If you grant a regulatory agency the power to set safety
    and soundness standards in the private-label market that must
    be met before any issuer can sell securities to the public, the
    regulatory agency could exert some countercyclical pressure on
    the market through enforcing those standards. The most
    important thing a regulatory agency could do during a boom
    period is to avoid relaxing its standards, and continue
    rigorous enforcement of existing standards in the private-label
    market. For example, when the OTS relaxed its standards on what
    constituted a safe lending program, and allowed savings and
    loans to offer riskier loan products with teaser rates and
    negative amortization during the boom period in the last decade
    it added further fuel to the bonfire. Theoretically, a
    regulatory agency could increase the safety and soundness
    standards applicable to private market participants during a
    boom period. If the threshold for a safe mortgage loan is a
    twenty (20) percent downpayment during ordinary times, a
    regulatory agency could increase the standard to twenty-five
    (25) percent during a boom time to protect against the
    potential for a larger fall in prices. That is somewhat similar
    to what certain exchanges do to margin requirements for
    particular securities or commodities that have a sudden and
    significant increase in price. However, in the nearly 30 years
    in which I have practiced law in the housing finance sector, I
    have not witnessed any regulator of housing lenders make a
    meaningful increase in safety and soundness standards during
    the boom times; it is only after the losses accrue that
    regulators take note and increase safety standards.
        In addition to maintaining rigorous enforcement of safety
    and soundness standards, imposing requirements for transparency
    and accountability is also important. Having meaningful claw
    back provisions on compensation of senior management of private
    lenders ensures that managers who profit during the boom times,
    and then depart, are held accountable for their actions. If
    such managers know that claw backs with real teeth are in
    place, they will have an incentive to act with more prudence
    during the boom times because they will be accountable during
    the bust. Transparency, and full disclosure of all material
    lending criteria to investors, is important so that
    participants can judge whether other parties are acting
    prudently, and steer their own business away from those who act
    imprudently during a boom time. Warren Buffet famously has said
    it is only when the tide goes out during the bad times that we
    can see who is wearing a bathing suit; if the water were less
    murky during the good times we could see who is wearing a
    bathing suit before the tide went out. In my view, the most
    important thing Congress can do is acknowledge that housing is
    a very procyclical industry, and build in significant
    safeguards that will lessen the damage when the inevitable bust
    occurs.
                                    ------

             RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
                            FROM DIANE ELLIS

    Q.1. The FDIC's mandate is made very clear as you note in your
    written testimony--``to protect depositors and maintain
    financial stability.'' The new FMIC will have both a
    supervisory role and a role to oversee the insurance fund. What
    do you think the mandate of the FMIC should be?

    A.1. Congress has given the FDIC a clear mandate: protect
    depositors and maintain financial stability. Congress has
    explicitly defined the amount of deposits covered under the
    FDIC deposit guarantee, and when insurance coverage is
    triggered (that is, when a bank fails). Clarity is important
    not just because it enables the FDIC to do its job, but because
    it establishes credibility in the eyes of depositors. The
    FDIC's explicit statutory authority assists in accomplishing
    our mission, and we rely on this authority along with
    supervisory tools to identify risk and take action to mitigate
    such risk.
        The bill the Committee is considering clearly states two
    purposes of the FMIC: (1) to provide liquidity, transparency,
    and access to mortgage credit by supporting a robust secondary
    mortgage market and the production of residential mortgage-
    backed securities, and (2) to protect the taxpayer from having
    to absorb losses incurred in the secondary mortgage market
    during periods of economic stress. How to best balance these
    policy priorities is a question properly reserved for Congress.

    Q.2. Do you think that the FMIC will need two separate
    divisions--one for supervision and one for the insurance fund?

    A.2. Congress has consistently provided the FDIC with clear and
    explicit statutory responsibility and authority for creating a
    risk-based assessment system, maintaining a viable deposit
    insurance fund, supervising State nonmember banks, acting as
    backup supervisor for all insured banks, and resolving failed
    institutions. Congress has not mandated that the FDIC establish
    separate divisions for its insurance and supervision functions
    and, in general, Congress has left the FDIC's internal
    organization to the FDIC, although there are exceptions. For
    example, the FDIC is required to have a separate asset
    disposition division. While FMIC's internal structure is
    important, consideration also should be given to ensuring that
    FMIC has clear statutory responsibilities and authorities and
    sufficient discretion to respond to varying circumstances.

    Q.3. The FDIC currently manages exposure risk to the deposit
    insurance fund (DIF) at the time when insurance is granted to
    an institution but also while the insurance stays in force. In
    determining membership eligibility, the FDIC considers factors
    including financial history and condition of an institution,
    adequacy of the institution's capital structure, and a number
    of other factors. If there is one thing that Community Banks do
    not need it is one more Federal agency requesting information,
    doing examinations, and layering additional standards and
    requirements onto them, which is time consuming and costly to
    the institution. To this end, do you think that institutions
    that are approved for FDIC insurance should be approved with
    far less rigor to have access to the FMIC insurance fund? Do
    you think that there could be coordination between the FDIC and
    the FMIC on the FDIC's ongoing monitoring and reporting
    requirements?

    A.3. As the primary Federal regulator of most community banks,
    the FDIC understands the crucial role that community banks play
    in the American financial system. The FDIC has an ongoing
    responsibility to better understand the challenges facing
    community banks, and in early 2012 we launched a series of
    initiatives focusing on confronting those challenges. These
    initiatives remain an ongoing priority and include outreach
    programs, research, and improvements to make the supervisory
    process for community banks more efficient, consistent, and
    transparent.
        Under the bill the Committee is considering, the FMIC would
    have to consider various factors before approving participation
    by four types of companies: private mortgage insurers,
    servicers, issuers, and bond guarantors. The factors for
    approving each of these companies are similar to, but not the
    same as, the statutory factors found in section 6 of the FDI
    Act, 12 U.S.C. 1816, which the FDIC uses to determine
    eligibility for Federal deposit insurance. The FDI Act factors
    include the financial history and condition of the institution,
    adequacy of the capital structure, future earnings prospects,
    general character and fitness of management, risk presented to
    the DIF, convenience and needs of the community to be served,
    and the consistency of the institution's corporate powers with
    the purposes of the FDI Act.
        However, a bank's condition can change over time. For
    example, a change in ownership or business model can alter a
    bank's risk profile. Some banks are mismanaged or take on
    excessive risk, which can cause problems for the bank. If
    problems are severe enough, they can result in the bank's
    failure. Because a bank's condition can change over time, the
    FDIC and the other Federal banking regulators are statutorily
    required to continue to monitor the condition of every bank
    after the bank receives deposit insurance. For example, every
    bank must file a quarterly report of condition and income. The
    FDIC and other banking regulators conduct periodic on-site
    examinations and require banks to take remedial action when
    deficiencies are noted.
        The FMIC would be tasked with assessing potential risks of
    market participants in the secondary mortgage market, which is
    a different assessment than the FDIC makes for members of the
    deposit insurance system. Congress may wish to give the FMIC
    the authority to make the final determination on whether an
    institution has access to the FMIC insurance fund. Of course,
    to the extent there is overlap in the supervisory authority or
    requirements for granting admission to the deposit insurance
    system and for participation in the FMIC mortgage insurance
    system, it will be important for the FDIC, other banking
    regulators, and the FMIC to coordinate their efforts to avoid
    undue burden on participants of both systems. Under the FDI
    Act, the FDIC coordinates with other Federal and State
    regulators, and the FDIC works on interagency issues through
    the Federal Financial Institutions Examination Council.
    Additionally, the FDIC has a longstanding Memorandum of
    Understanding with the other banking regulators (OCC, FRB, and
    the former OTS) to facilitate a coordinated approach to
    supervision. Where entities subject to the legislation are
    subject to oversight by other Federal or State agencies, the
    legislation could clarify requirements for coordination of
    examination activities and information sharing agreements.

    Q.4. The new FMIC will oversee a deposit-like insurance fund.
    Since it will have to be at least partially funded from day-1
    of the new operation, how do you suggest that we consider
    getting initial capital for the fund? Do you recommend a
    gradual increase in premiums over time?

    A.4. The FMIC guarantee will cover an insurance exposure that
    generally rises with the volume of mortgages securitized under
    the FMIC. In recognition of this fact, the draft legislation
    mandates certain target levels for the size of the Mortgage
    Insurance Fund (MIF) in terms of a percentage of outstanding
    balances. This is analogous to the statutory reserve targets
    mandated for the FDIC Deposit Insurance Fund (DIF), which are
    expressed as a percent of estimated insured deposits.
        While the proposed legislation suggests that FMIC would
    assess participants only at issuance (similar to the manner in
    which the Government-sponsored mortgage enterprises (GSEs)
    currently impose guarantee fees), as opposed to an ongoing
    basis like the FDIC, it does not state so unambiguously.
        Whichever assessment model the legislation or FMIC
    ultimately adopts, the FDIC's experience suggests that
    maintaining relatively consistent assessment rates over time
    will be important in avoiding procyclicality in insurance
    assessments and in providing for a stable competitive landscape
    between insured and noninsured financial activities. In that
    regard, the FDIC has learned from its experience that the
    flexibility to determine the proper fund size is important and
    that a hard target for a fund (that is, a particular size that
    a fund must remain) poses problems. During the 1990s through
    2006, when Congress required a hard target for the size of the
    FDIC's insurance fund, a number of problems resulted, including
    a decade where at least 90 percent of the industry paid nothing
    for deposit insurance, a free-rider problem where new entrants
    and fast growers diluted the fund but paid nothing, and
    potentially volatile and procyclical premiums.
        Also, as our experience during the recent crisis shows, the
    net worth of the insurance fund at any given time is less
    important than the availability of cash, or working capital, to
    meet anticipated near-term insurance obligations. As such,
    there are a wide range of potential options for providing
    initial working capital to the FMIC, including an entrance fee
    for participating institutions, or loans from the Federal
    Government or the participating institutions themselves.

    Q.5. Also, you note that while a risk-based pricing system that
    is forward looking works much better than the former flat-rate
    system for the FDIC, you also note that this is not analogous
    with the Federal mortgage insurance which might have
    alternative means of mitigating risk through underwriting
    standards, etc. Do you, however think that there should be a
    graduated scale for insurance premiums, where larger users of
    the system pay more for the insurance--perhaps based on asset
    size or loan origination?

    A.5. The FDIC supports a risk-based pricing structure for
    deposit insurance. Under this system, banks that take on more
    risk pay more in deposit insurance, reducing the moral hazard
    problem. A Federal mortgage insurer, however, is likely to have
    a greater ability to mitigate risk at the outset than the FDIC
    has, for example, by setting robust underwriting standards for
    the underlying mortgages.
        In the event that a gradual pricing scale or a system that
    differentiates between large and small FMIC users is adopted,
    it may not serve the same function as a risk-based pricing
    system. Under the FDI Act, the FDIC is permitted to establish
    separate risk-based assessment systems for large and small
    banks. The FDIC has different methods for assessing large and
    small banks, but these separate pricing systems do not usually
    produce dramatically or systematically higher or lower average
    rates for either of these groups of banks. In fact, the range
    of possible assessment rates is the same under both systems.
    Moreover, recent changes to the deposit insurance assessment
    system under the Dodd-Frank Act shifted more of the assessment
    burden from community banks to the largest institutions in
    order to better reflect each group's share of industry assets.
        Whatever pricing system is adopted for Federal mortgage
    insurance, it is important that community banks have fair and
    equitable access to the secondary market for mortgages and to
    FMIC guarantees on terms that are not more expensive than for
    larger issuers. Without the ability for community banks to
    aggregate and securitize their loans, the scale economies in
    origination, servicing, and securitization could well impede
    the ability of community banks to compete in mortgage
    securitization.

    Q.6. It seems apparent that the Federal Government does not
    always price insurance appropriately. You note that through
    prefunding, the FDIC is able to ``smooth the cost'' of
    insurance over time. However, the Designated Reserve Ratio
    (DRR) is truly a ``soft target'' and that it can often
    fluctuate which has led to instances when premiums are required
    to be increased during a crisis. How can we avoid instances
    where the FMIC will need to increase premiums during times of
    economic stress-times when institutions need to hold on to as
    much capital as possible? Doesn't having the ability to change
    rates inherently add the perverse incentive that industry will
    lobby the agency to lower rates during good times only to have
    to rates painfully increased during times of stress?

    A.6. The FDIC faces the problem of procyclical assessments, and
    in fact has charged procyclical assessments in the past, with
    high assessment rates during and immediately after the last two
    major banking crises and low average assessment rates between
    the crises. Under new authorities granted under the Dodd-Frank
    Act, however, the FDIC has adopted a long-term target for the
    fund that should allow us to reduce procyclicality, while
    assuring that the DIP has sufficient funds to remain positive
    even during crises of the magnitude of the last two. In
    meetings between the FDIC and individual bankers and banking
    industry trade groups, the industry has consistently supported
    the idea of avoiding procyclical assessments.
        The FDIC has learned from its experience that the
    flexibility to determine the proper fund size is important and
    that a hard target for a fund (that is, a particular size that
    a fund must remain) poses problems. As discussed above, an
    inherent conflict exists between maintaining constant rates and
    a specific, hard target fund size. During the 1990s and through
    2006, Congress required a hard target for the size of the
    FDIC's insurance fund, which resulted in a decade where at
    least 90 percent of the industry paid nothing for deposit
    insurance. In contrast, allowing the fund to grow during good
    times should reduce premium procyclicality.
        There are some significant differences between how the FDIC
    and the proposed FMIC would generate income, however. The FDIC
    assesses on bank liabilities every quarter, while the FMIC
    would assess transactions. FMIC's transaction-based assessments
    also may increase and decrease procyclically, that is, in line
    with overall economic activity. Congress may wish to consider
    ways to ameliorate this procyclical bias, for example, by
    charging sufficient fees during good times to build a fund
    large enough to withstand losses during a downturn.
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                   CHAIRMAN JOHNSON FROM KURT REGNER

    Q.1. What is needed in legislation to ensure that Federal and
    State regulators coordinate on supervision and resolution?

    A.1. Legislative text should include the requirement that prior
    to taking any action that directly or indirectly affects a
    regulated insurance legal entity, including, but not limited to
    the approvals to work with the GSE's or guarantee covered
    bonds, a Federal regulator, at bare minimum must consult with
    the domestic State insurance regulator or similar official.
    Additionally, the legislation should defer to State regulators
    on any action related to insurance legal entities.
        Attachment B contains recommended changes to S.1217 that
    would ensure coordination and appropriate deference to State
    insurance regulators.

    Q.2. S.1217 proposes the regulator have, with the consent of
    other officials, emergency powers in a crisis that only lasts 6
    months. Should we consider expanding that authority, or
    providing other countercyclical tools that a regulator may need
    in a future crisis?

    A.2. Yes, it would be advisable to permit the exercise of
    emergency powers for up to 2 years. It would be advisable to
    revise Section 205 to provide a reporting mechanism to
    Congress, whereby the Corporation would make a written report
    to Congress within 30 days of exercising the authority provided
    by Section 205 (a) explaining the unusual and exigent
    circumstances and the policies devised or under consideration
    to address the situation.
        The private mortgage insurance regulations that we have in
    place are intended to deal with ups, downs, and sudden shocks,
    not an extended period of intense crisis. Assuming the rare
    occasion of systemic crisis in which regulators have exhausted
    their existing tools to encourage participation in the market,
    the capability of providing capital and liquidity in a time of
    crisis to jumpstart the market could be a useful tool and may
    also encourage entry in normal times. An additional power in
    time of crisis that could be useful would be the ability to
    adjust and lower the first loss percentage position. Requiring
    a reinsurance backstop related to legacy business is also a
    possibility.
        It would be advisable to revise Section 211 to allow the
    Chairman of the Board of Governors of the Federal Reserve
    System and the Secretary of the Treasury in consultation with
    the Director of the Federal Mortgage Insurance Corporation to
    increase or decrease the minimum downpayment requirement for an
    eligible mortgage on a temporary basis of up to 1 year as an
    additional macroeconomic management tool. Continuation of any
    extension of a change in the default downpayment requirement in
    excess of 1 year should require the approval of Congress.
        Section 218 should allow for consultation and information
    sharing with State regulators for private mortgage insurers and
    bond guarantors.
                                    ------

             RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
                            FROM KURT REGNER

    Q.1. You mention that financial guarantors have ``substantial
    experience in the [housing] area but failed to live up to
    expectations during financial crisis and, given our experience
    to date, insurance regulators remain skeptical of their
    capability of insuring anything other than municipal debt.''
    Would you agree that the monoline financial guarantors did not
    even perform well during the financial crisis for municipal
    debt?

    A.1. I respectfully disagree. The most recent crisis saw losses
    paid on nonmunicipal securities increase substantially in 2008
    to over $4 billion and stay at elevated levels since the
    crisis. Meanwhile, losses paid on municipal securities have
    remained below $300 million--an easily manageable amount for an
    industry with a notional exposure of $1.4 trillion--during each
    of these same periods, thus demonstrating the pressure put on
    financial guaranty insurers' capitalization that had been
    caused by the housing market.

    Q.2. The recent financial crisis exposed weaknesses in both
    mortgage insurers as well as monoline bond insurers (most
    notable examples being Ambac and MBIA), yet you also claim that
    the existing regulatory structure works well. If Congress
    enacts legislation that enables Bond Guarantors and/or mortgage
    insurers to have a more robust role in the housing finance
    system, do you not believe that the standards and regulatory
    oversight of that function should be done at the national
    level?

    A.2. State regulators have the necessary tools and authority to
    regulate private mortgage insurers and bond guarantors to the
    level necessary to maintain a stable housing finance system at
    the local level. Although they are different products, the
    Federal Government already relies on State regulators to
    oversee homeowners insurance, renters insurance, and title
    insurance which are every bit as instrumental to ensuring a
    functioning housing market. We would encourage Congress to
    continue to rely on and defer to the century and half of
    experience State regulators have in balancing solvency with
    product availability and affordability. I would encourage
    Federal efforts instead to focus on the activity by the
    institutions they appropriately regulate--ensuring lenders do
    not engage in the underwriting practices that led to the last
    crisis and exposed mortgage and bond insurers to extreme risks.

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR COBURN
                            FROM KURT REGNER

    Q.1. Would you agree S.1217 proposes to give the future Federal
    Mortgage Insurance Corporation approval and oversight authority
    over private mortgage insurers and bond guarantors?

    A.1. The GSE's are currently the largest purchasers of
    mortgages on the secondary market, so it seems the provisions
    set out within S.1217 give FMIC de facto, if not explicit
    approval and oversight authority over private mortgage insurers
    and bond guarantors. In my view this is not necessary, given
    the extensive oversight already performed by State insurance
    regulators.

    Q.2. Would you agree States already have the necessary tools
    and authority to regulate private mortgage insurers and bond
    guarantors to the level necessary to maintain a stable housing-
    finance system?

    A.2. Yes, States already have the necessary tools and authority
    to regulate private-mortgage insurers and bond guarantors to
    the level necessary to maintain a stable housing finance
    system. Moreover, when area for improvement is identified,
    States act collectively together to development enhancements.
    Such is the case today--State regulators are in the process of
    considering targeted revisions to the NAIC's Mortgage Guaranty
    Insurance Model Act (#630-11) through the open and transparent
    NAIC process.
        In 2011, the NAIC Financial Guaranty Insurance Guideline
    (E) Working Group considered the need to change the regulation
    of Financial Guarantors and the NAIC Financial Guaranty Model
    Act. The Working Group concluded that because Financial
    Guaranty Insurers were at the time, and are still today only
    actively writing municipal bond insurance and no company is
    writing guarantees on structured bonds following the losses
    incurred during the financial crisis, there was no need to
    amend the regulation of the Model Act at that time.

    Q.3. Please describe the current activities of State insurance
    commissioners to strengthen the capital requirements and other
    operating procedures of private mortgage insurers and bond
    guarantors to bolster the housing finance system.

    A.3. State insurance regulators are actively studying what
    changes are deemed necessary to the solvency regulation of
    mortgage guaranty insurers. The NAIC's Mortgage Guaranty
    Insurance (E) Working Group was formed by the Financial
    Condition (E) Committee in late 2012. This Working Group is
    assessing what changes should be made to the Model Act.
        In February 2013, the Working Group identified three
    primary problems with mortgage guaranty insurance as it exists
    now:

      1.  The overconcentration of mortgage originations in only a
            few banks has increased the pressure on mortgage
            insurers to accept everything given to them by any
            single bank or risk losing all the business from that
            bank.

      2.  The 2008 crisis dramatically illustrated the cyclical
            nature of the housing market and the potential for
            significant losses if there is a breakdown in mortgage
            underwriting standards. Mortgage insurance is
            derivative of this market, and therefore experiences
            periods of relative stability and high profitability
            potentially followed by periods of varying duration of
            significant loss.

      3.  The lack of incentives to continue adhering to strict
            underwriting standards during booming periods when
            there is no threat of discontinued business.

        In order to address these problems, the Working Group is
    considering a number of potential changes:

        New reporting requirements that break out mortgage
            insurers' exposures to different levels of risk and are
            used as partial input into the minimum capital
            requirements.

        Prohibition of captive reinsurance agreements
            between mortgage insurers and originating banks.

        Referring potential accounting issues to the NAIC's
            Statutory Accounting Principles (E) Working Group.

        A Risked Based Capital formula specific to Mortgage
            Insurers.

        Updating the geographical concentration levels.

        Reevaluating underwriting loan standards.

        Tighter dividend restrictions.

        Reevaluating rescission practices and
            responsibilities.

        The Working Group exposed a concept draft of a new model
    (Attachment A) for public comment and debate, and the comment
    period closed February 17, 2014. We expect the NAIC to pass the
    amendments to the model later this year, and States to begin
    implementing the amendments soon thereafter.
        Where bond guarantors are concerned, at this time, there
    are no initiatives by the State insurance commissioners to
    change regulations, because bond guarantors are not actively
    involved in guaranteeing structured bonds, including
    residential mortgage-backed securities.

    Q.4. Please describe how new Federal oversight functions
    included in S.1217 would duplicate and potentially preempt the
    regulations from State insurance commissioners.

    A.4. S.1217 presents a number of potential duplication concerns
    for State regulators.
        First, there is the notion of an ``approval'' process by
    the new FMIC. There is already an approval process in place for
    private mortgage insurers to do business--it occurs at the
    State insurance departments, when we approve a license. It is
    our job as regulators to monitor the insurer's solvency through
    capital requirements, reserve requirements, coverage,
    investment, and geographic concentration limits, and
    limitations on nonmortgage activities. There is no need for
    FMIC to duplicate the efforts of effective State regulation.
    Instead of duplicating, S.1217 should defer to the licensing
    and other standards that are required by State laws in order to
    write or provide mortgage guaranty or bond insurance coverage,
    just as bank regulators defer to State insurance regulators on
    the oversight of homeowners insurers who, in the event of a
    loss, are relied upon by lenders to be made whole or protected.
        Second, State insurance regulators carefully balance
    solvency concerns with availability of coverage to ensure a
    competitive marketplace. Experience has shown us that the
    incentive is simply too great for a regulator charged with
    maintaining the viability of a Government guarantee, such as
    the FMIC, to overshoot its regulatory objective and put in
    place standards, particularly solvency standards such as
    capital requirements, that are more stringent than necessary.
    This would ultimately threaten the availability of coverage,
    increase cost to the policyholder and undermine the objective
    of a private market solution to support a vibrant housing
    market for the future.
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                    CHAIRMAN JOHNSON FROM BART DZIVI

    Q.1. S.1217 proposes the regulator have, with the consent of
    other officials, emergency powers in a crisis that only lasts 6
    months. Should we consider expanding that authority, or
    providing other countercyclical tools that a regulator may need
    in a future crisis?

    A.1. Section 205 of the legislation provides that during
    exigent circumstances, the Corporation, for a period not to
    exceed 6 months, may continue to sell insurance for covered
    securities regardless of whether the security satisfies the
    first loss position for private market holders and other
    potential requirements developed under Section 202(a) of the
    legislation.
        Providing policy makers with adequate and timely statutory
    tools is critical to allow them to address issues prior to a
    crisis erupting. If policy makers have to wait for Congress to
    respond, the resulting financial shock, and the depth of the
    crisis, will be much more severe. As the recent financial
    crisis has demonstrated, when a severe financial crisis strikes
    the United States again, it is not likely to abate within six
    (6) months. One of the primary responses to the recent
    financial crisis by the Board of Governors of the Federal
    Reserve System (Federal Reserve) has been the purchase of
    mortgage backed securities (MBS) issued by Fannie Mae and
    Freddie Mac. On November 25, 2008, the Federal Reserve
    announced it would undertake the purchase of $500 billion of
    agency MBS. On February 27, 2014, Federal Reserve Chair Yellen
    testified that the Federal Reserve expects to end its agency
    MBS purchases this year. Thus, the Federal Reserve's policy
    response has been to purchase agency MBS for over five (5)
    years. In that context, statutory authority to provide
    extraordinary issuance of insurance to back MBS for only six
    (6) months, and only after an emergency has been declared by
    the Federal Reserve Chair and the Secretary of Treasury, seems
    wholly insufficient to stabilize the economy.
        While the debt markets for private corporations seized up,
    and essentially halted, during the most extreme moments of the
    financial crisis, the Government Sponsored Entities (GSEs) and
    the Federal Home Loan Banks (FHLBs) were able to issue debt to
    fulfill their functions. They were only able to do so because
    the markets perceived that the United States Government stood
    behind that debt. This is the most important countercyclical
    weapon in the arsenal that Federal policy makers have to fight
    a financial crisis. Congress can best equip the country to
    withstand future financial shocks by keeping the FHLBs, and the
    replacements for the GSEs, financially strong and independent,
    so that they can issue unsecured debt that the markets will
    accept, and that the Government can stand behind without
    incurring losses, during future panics.
        I concur with that part of the analysis in the paper
    published by the Center for Responsible Lending, ``A Framework
    for Housing Reform: Fixing What Went Wrong and Building on What
    Works'', (Oct. 28, 2013) that suggests that the replacements
    for the GSEs (for MBS issuer guarantees) should be mutually
    owned cooperatives (not investor owned companies and not a
    Government corporation), and notes that we know this system can
    work because Freddie Mac was a cooperative within the Federal
    Home Loan Bank system when it was founded in 1970. Creating a
    strong mutual cooperative is the best countercyclical tool. See
    also, ``The Capital Structure and Governance of a Mortgage
    Securitization Utility'', Federal Reserve Bank of New York,
    Staff Report No. 644 (Oct. 2013).

    Q.2. What can we put in statute to ensure that the FHLBs
    receive sufficient attention and oversight in a new system,
    given the differences between the FHLBs and the replacements
    for the GSEs?

    A.2. The Federal Housing Finance Board (FHFB) was the
    predecessor-in-interest to the Federal Housing Finance Agency
    (the ``FHFA'' was created in 2008) with respect to the
    prudential supervision and regulation of the Federal Home Loan
    Banks; the Office of Federal Housing Enterprise Oversight
    (OFHEO) was the predecessor-in-interest to the FHFA with
    respect to the prudential supervision and regulation of Fannie
    Mae and Freddie Mac.
        The historical results are clear, the FHFB largely
    succeeded in its mission, and OFHEO largely failed in its
    mission. The results are due to several factors:

        The Federal Home Loan Banks are operated as mutual
            cooperatives, with an incentive to constrain risk
            through conservative lending and investment policies;
            whereas, Fannie Mae and Freddie Mac were investor owned
            enterprises where senior managers had stock options and
            other asymmetric financial incentives that emboldened
            them to take outsized risk on very small capital bases;
            and

        The FHFB had strong supervisory powers; whereas
            OFHEO had been hobbled by Congress with very limited
            statutory supervisory and enforcement powers.

        In 2008, Congress reversed its prior error with OFHEO when
    it created the FHFA and granted it even stronger supervision
    and enforcement tools than the FHFB possessed. Congress needs
    to keep a strong, independent, prudential regulator of both the
    FHLBs and the replacement for the GSEs. There is no basis in
    the historical record for eliminating the FHFA. I urge Congress
    to retain the FHFA as the safety and soundness prudential
    regulator of both the FHLBs and the replacement for the GSEs.
        In order to ensure adequate attention and supervision by
    the Federal regulatory agency for both the FHLBs and the
    replacement for the GSEs, I support the structure currently in
    law of having a dedicated deputy director for each type of
    entity. In addition, I encourage Congress to adopt a statutory
    requirement that both the head of the agency, and the deputy
    director for the relevant entity, appear once a year and
    testify before Congress to report on the safety and soundness
    of the FHLBs, and once a year, at a separate time, to report on
    the safety and soundness of the replacement for the GSEs.

    Q.3. S.1217 gives the new regulator many responsibilities. What
    are the advantages and disadvantages of a structure where a
    single regulator oversees many type of companies, the insurance
    fund, the common securitization platform, and other functions?

    A.3. It would be a significant mistake if Congress created an
    entity that could grant insurance on privately issued mortgage
    backed securities, where the insurance had an explicit Federal
    guarantee, and the entity that issued the insurance was not
    supervised and regulated by a separate, independent Federal
    agency.
        Some proponents of S.1217 have argued that the Federal
    Deposit Insurance Corporation (FDIC) insures deposits at banks,
    and it is an example of how a Government corporation can do
    these many type of tasks at once. Setting up an entity to grant
    insurance on securities, without a separate regulator, creates
    a significant risk of loss for the Government as guarantor. The
    argument being made that the FDIC is an example of how a
    Government corporation can undertake these many tasks without
    serious problems is deeply flawed and understates the prospects
    for substantial future losses for the following reasons:

        All FDIC insured banks are subject to separate
            safety and soundness supervision by their chartering
            entity (the OCC or State agency) that is designed to
            avoid insolvency of the bank;

        The FDIC as receiver has access to all the assets
            of the failed institution to satisfy its claims; an
            issuer of a mortgage backed security is issuing a
            stand-alone security that is not backed by any assets
            of the issuing entity and only by the mortgage loans in
            the pool specific to that security, and perhaps private
            mortgage insurance;

        The FDIC as receiver has extraordinary powers
            designed by Congress to maximize its ability to
            minimize its losses in a receivership proceeding that
            it controls; trying to collect from a busted mortgage-
            backed security, an insolvent private mortgage insurer
            that had provided a guarantee on the MBS, or an
            insolvent seller of loans into the pool would involve
            cumbersome and costly litigation by the Corporation
            resulting in small recoveries for the Government; and

        Notwithstanding the advantages of the FDIC
            described above, the FDIC deposit insurance fund went
            negative during the recent crisis, the prior deposit
            insurance fund operated by the Federal Savings and Loan
            Insurance Corporation went insolvent during the 1990s,
            and various State and private deposit insurance funds
            have gone broke during other financial crisis.

        Having one entity performing many Federal functions, some
    of which conflict with each other, can be a recipe for
    disaster. One of the reasons that the Savings and Loan Crisis
    of the 1980s and early 1990s grew to such a large size was that
    one entity, the Federal Home Loan Bank Board (FHLBB), was
    responsible for chartering Federal savings and loans, insuring
    all savings and loans deposits through the Federal Savings and
    Loan Insurance Corporation (FSLIC), and effectively running the
    Federal Home Loan Banks by appointing directors and setting
    operational rules for the FHLBs. The FHLBB was placed in a
    position of a conflict-of-interest by Congress, and it used its
    powers as head of the FHLBs to order the FHLBs to make loans to
    weak savings and loans to prop them up so the FSLIC could hide
    the extent of its true losses. The multiple functions
    envisioned for the Corporation under S.1217 create the same
    type of conflict of interest. Congress should avoid creating
    another inherently conflicted entity.
        Instead, the legislation should create a privately
    capitalized mutual company to operate a securitization platform
    because neither the insurance of securities nor the issuance of
    securities is a core competence of a Government agency. A
    separate Federal agency should be established and charged by
    Congress with issuing rules, and supervising the enforcement of
    those rules, to keep the entity issuing the guarantee solvent,
    and to keep the market functioning properly by requiring
    adequate transparency of the functions performed by the
    trustees and other participants in mortgage market.

    Q.4. As it relates to the regulatory structure of a new housing
    finance system, what are the most important changes that need
    to be made to S.1217 to ensure a strong, effective regulator?

    A.4. To ensure a strong, effective regulator the legislation
    should:

        Establish an independent agency as a safety and
            soundness regulator, completely separate from any other
            Federal entity, and completely separate from the entity
            issuing the insurance that provides the Federal
            guarantee on the mortgage backed security;

        Provide the regulatory agency with strong
            enforcement and supervision tools equivalent to the
            tools available to the Federal banking agencies, and
            with the same independent litigation authority as the
            Federal banking agencies;

        Grant the regulatory agency independent assessment
            authority, and the ability to set its own budget
            without further action by Congress or any other
            executive branch agency;

        Provide the regulatory agency with the same
            flexibility to set the level of compensation for its
            employees as is provided for the Federal banking
            agencies;

        Require fixed terms for the head of the regulatory
            agency (or the members of the board at the head of the
            agency), subject to removal by the President of the
            United States only for cause (and if there is a board,
            its members should have staggered terms); and

        Mandate that the regulatory agency have an
            independent Inspector General with a budget set by
            Congressional appropriation, not the agency.
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                 CHAIRMAN JOHNSON FROM ROBERT M. COUCH

    Q.1. S.1217 proposes the regulator have, with the consent of
    other officials, emergency powers in a crisis that only lasts 6
    months. Should we consider expanding that authority, or
    providing other countercyclical tools that a regulator may need
    in a future crisis?

    A.1. Any new housing finance system must be resilient enough to
    weather the inevitable periods when the housing market takes a
    downward turn. Even during these countercyclical periods, it is
    critical for the housing finance system to continue to serve as
    a reliable source of mortgage liquidity.
        For most of these periods, the limited Government guarantee
    for catastrophic risk assumed by the FMIC should help provide
    for the continued availability of mortgage credit because the
    Government wrap will assure investors in mortgage-backed
    securities (MBS) that the MBS will be repaid and the Government
    will stand behind the credit risk. If credit-risk protection is
    no longer available through bond guarantors (as envisioned by
    S.1217) and other private credit enhancers, or if the price of
    such credit-risk coverage is too high, the Congress could
    adjust the loan levels for the insurance programs of the
    Federal Housing Administration (FHA) and U.S. Department of
    Veterans Affairs (VA), thus allowing the two institutions to
    expand their activities as they did during the recent crisis.
        The BPC Housing Commission also proposed that its
    Government guarantor (similar to the FMIC) be given the
    authority to price and absorb first-loss credit risk for
    limited periods during times of severe economic stress in order
    to ensure the continued flow of mortgage credit. Under these
    circumstances, the guarantor would be required to notify the
    Treasury Department, the Federal Reserve, and the chairs of the
    appropriate congressional committees before taking any such
    action. S.1217 provides the FMIC with similar authority, but
    this authority is subject to a number of more stringent
    conditions. In addition to the 6-month limitation you cite,
    these conditions include first obtaining the prior written
    consent of both the Chairman of the Federal Reserve Board and
    the Treasury Secretary and a prohibition on using the authority
    more than once in any given 3-year period.
        As I stated in my testimony to the Committee, you may wish
    to consider empowering the FMIC with more flexibility to ensure
    it can respond quickly to emergency conditions in the mortgage
    market. The Committee may also wish to reconsider whether it is
    appropriate to impose specific time limitations on the FMIC's
    ability to exercise its emergency authority. It was the Housing
    Commission's view that prenotification to Congress was a
    critical part of the decision to use emergency powers. We also
    concluded that such notification and ongoing Congressional
    oversight were sufficient to protect against the abuse or
    excessive use of this authority.
        Under the Housing Commission's proposal, neither the
    Government guarantor, FHA, VA, nor Ginnie Mae would be
    permitted to have retained portfolios. Similarly, as proposed
    in S.1217, the FMIC would not have a retained portfolio other
    than to assist in the orderly wind down of Fannie Mae and
    Freddie Mac.
        The absence of retained portfolios raises concerns about
    the availability and liquidity of mortgage credit during
    downturns when demand for MBS or the liquidity with which to
    purchase these securities could fall precipitously, as occurred
    in 2008 to 2009. Therefore, Federal policy should be clear on
    how mortgage liquidity would be managed in such circumstances.
        One alternative is through monetary policy and Federal
    Reserve actions in the market. Such policies should be
    established in advance of any crisis and should be understood
    by all market participants in order to forestall any issues
    that could unnecessarily raise the cost of housing and home
    ownership. By way of reference, during the 45-year history of
    Ginnie Mae in which it had no retained portfolio, the presence
    of a ``full faith and credit'' guarantee as well as Federal
    Reserve and Treasury purchasing authority have preserved ample
    liquidity in Ginnie Mae bonds through numerous credit crises,
    including the most recent one.

    Q.2. How does the source of a regulator's funding affect its
    oversight capabilities?

    A.2. The Government guarantor proposed by the Housing
    Commission is similar to the FMIC in that both are self-
    supporting institutions that do not rely on Federal
    appropriations but rather finance their catastrophic risk funds
    and operational expenses through the collection of guarantee
    fees. While the primary purpose here is to protect the
    taxpayers from unnecessary risk, operating largely outside the
    Federal appropriations process also gives the institutions some
    insulation from undue political interference in oversight
    decisions. The Housing Commission concluded that having this
    independence would allow the guarantor to respond more quickly
    to contingencies in the market and operate with greater
    efficiency in making decisions related to staffing, budgeting,
    procurement, and policy.
        Some may argue that an exclusive reliance on private
    sources to fund its operations raises the prospect that the
    FMIC might be ``captured'' by those entities it regulates.
    S.1217's creation of an Office of Inspector General within
    FMIC, charged with assessing the adequacy of the first-loss
    position held by private institutions as well as providing
    annual reports on the adequacy of the guarantee fees charged by
    the FMIC, is an important safeguard against this possibility.
    Ongoing Congressional oversight is also critical. The
    successful track record of the Federal Deposit Insurance
    Corporation (FDIC), an independent Federal agency that does not
    rely on Federal appropriations but instead is largely funded by
    the insurance premiums it charges to banks and thrift
    institutions, demonstrates that the FMIC can be self-supporting
    and still function effectively.
        S.1217 requires the Mortgage Insurance Fund (MIF) to reach
    a reserve level of 1.25 percent of the guaranteed MBS within 5
    years and 2.50 percent within 10 years. By contrast, the FDIC
    has designated a reserve ratio of 2 percent. To help capitalize
    the MIF in the early stages of the new system as well as signal
    the Federal Government's strong commitment to standing up this
    system, the profits of Fannie Mae and Freddie Mac could be
    tapped as an initial source of MIF funding.
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                   CHAIRMAN JOHNSON FROM PAUL LEONARD

    Q.1. S.1217 proposes the regulator have, with the consent of
    other officials, emergency powers in a crisis that only lasts 6
    months. Should we consider expanding that authority, or
    providing other countercyclical tools that a regulator may need
    in a future crisis?

    A.1. The Housing Policy Council agrees that the Federal
    regulator should retain some flexibility to adjust prudential
    standards during periods of severe economic downturns. That
    authority, if exercised, can reduce economic problems by
    helping to maintain a flow of housing finance. Since the need
    for that authority is based upon economic conditions, we do not
    favor any fixed, statutory deadline on the exercise of the
    authority. A premature reestablishment of normal prudential
    standards could set back a recovery. Instead, we suggest that
    Congress give the Federal regulator some economic markers or
    metrics that the regulator can monitor to determine when it is
    appropriate to reinstate prudential standards. Potential
    markers could be a leveling off of housing price declines and a
    leveling off of foreclosures.