[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
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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
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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
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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
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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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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\
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\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
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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\
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\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''.
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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.
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\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.
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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.
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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.
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\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.
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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.
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\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.
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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.
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\7\ 12 U.S.C. 481. The relevant criminal code provisions in Title
18 of the United States Code should also be amended.
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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\
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\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.
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\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.
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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\
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\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.
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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).
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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.
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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.
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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\
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\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.
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\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\
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\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.
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\2\ Section 205.
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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.
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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.
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\6\ See, Section 203.
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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.
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\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.
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\8\ Section 103(a)(1)(B)(i) through (iv).
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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\
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\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.
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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.
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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.
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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.
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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.