[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\
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     \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.
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     \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).
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    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.
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     \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).
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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.
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     \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.
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     \1\ NAIC Model Act #630-1. Attached as Appendix A.
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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.
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     \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.
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     \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.
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    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).
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    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.
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     \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).
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    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\
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     \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.

                              
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