[Senate Hearing 116-66]
[From the U.S. Government Publishing Office]


                                                     S. Hrg. 116-66


                   SHOULD FANNIE MAE AND FREDDIE MAC
      BE DESIGNATED SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS

=======================================================================

                                HEARING

                               BEFORE THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED SIXTEENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINING THE CRITERIA THE FSOC CONSIDERS WHEN DETERMINING WHETHER 
MATERIAL FINANCIAL DISTRESS AT A NONBANK FINANCIAL COMPANY COULD POSE A 
      THREAT TO THE FINANCIAL STABILITY OF THE UNITED STATES; THE 
  APPLICABILITY OF THESE CONSIDERATIONS TO FANNIE MAE AND FREDDIE MAC 
  RESPECTIVELY; AND ANY OTHER RELEVANT POLICY CONSIDERATIONS THAT THE 
                       COMMITTEE SHOULD CONSIDER

                               __________

                             JUNE 25, 2019

                               __________

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


                Available at: https: //www.govinfo.gov /

                               __________
                                

                    U.S. GOVERNMENT PUBLISHING OFFICE                    
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      MIKE CRAPO, Idaho, Chairman

RICHARD C. SHELBY, Alabama           SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania      JACK REED, Rhode Island
TIM SCOTT, South Carolina            ROBERT MENENDEZ, New Jersey
BEN SASSE, Nebraska                  JON TESTER, Montana
TOM COTTON, Arkansas                 MARK R. WARNER, Virginia
MIKE ROUNDS, South Dakota            ELIZABETH WARREN, Massachusetts
DAVID PERDUE, Georgia                BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina          CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana              CATHERINE CORTEZ MASTO, Nevada
MARTHA MCSALLY, Arizona              DOUG JONES, Alabama
JERRY MORAN, Kansas                  TINA SMITH, Minnesota
KEVIN CRAMER, North Dakota           KYRSTEN SINEMA, Arizona

                     Gregg Richard, Staff Director

                Laura Swanson, Democratic Staff Director

                      Joe Carapiet, Chief Counsel

                 Matt Jones, Professional Staff Member

           Corey Frayer, Democratic Professional Staff Member

           Beth Cooper, Democratic Professional Staff Member

           Megan Cheney, Democratic Professional Staff Member

                      Cameron Ricker, Chief Clerk

                      Shelvin Simmons, IT Director

                    Charles J. Moffat, Hearing Clerk

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                         TUESDAY, JUNE 25, 2019

                                                                   Page

Opening statement of Chairman Crapo..............................     1
    Prepared statement...........................................    25

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     3
        Prepared statement.......................................    26

                               WITNESSES

Alex J. Pollock, Distinguished Senior Fellow, R Street Institute.     4
    Prepared statement...........................................    27
    Responses to written questions of:
        Senator Warren...........................................    37
Douglas Holtz-Eakin, President, American Action Forum............     6
    Prepared statement...........................................    31
    Responses to written questions of:
        Senator Warren...........................................    38
Susan M. Wachter, Sussman Professor of Real Estate and Professor 
  of Finance, The Wharton School of the University of 
  Pennsylvania...................................................     7
    Prepared statement...........................................    34
    Responses to written questions of:
        Senator Warren...........................................    40
        Senator Sinema...........................................    41

              Additional Material Supplied for the Record

Letter submitted by the American Land Title Association..........    42
Letter submitted by the National Association of Federally-Insured 
  Credit Unions..................................................    44
Statement submitted by Thomas H. Stanton.........................    52
Letter submitted by the U.S. Mortgage Insurers...................    57
Letter submitted by the the Center for American Progress.........    59

                                 (iii)

 
SHOULD FANNIE MAE AND FREDDIE MAC BE DESIGNATED SYSTEMICALLY IMPORTANT 
                         FINANCIAL INSTITUTIONS

                              ----------                              


                         TUESDAY, JUNE 25, 2019

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:02 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mike Crapo, Chairman of the 
Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN MIKE CRAPO

    Chairman Crapo. The hearing will come to order.
    Today the Committee returns its focus once again to the 
state of our housing finance system.
    We are quickly approaching the 11-year mark since the 
Government asserted control of the GSEs, Fannie Mae and Freddie 
Mac. After all that time, Fannie and Freddie continue to 
dominate the mortgage market, and taxpayers remain on the hook 
in the event of the next market turndown.
    In recent weeks, FHFA Director Mark Calabria has repeatedly 
stated, quoting President Kennedy, that ``The time to repair 
the roof is not in the middle of a downpour but when the sun is 
shining.''
    I agree with this sentiment. We have a key opportunity 
right now while the sun shines on our economy and mortgage 
markets are healthy to put our housing finance system on a 
durable, sustainable course that can withstand any market 
cycle.
    My strong preference is for comprehensive legislation. 
However, we are also interested in analyzing some of the 
options currently available to the Administration to protect 
taxpayers and put our housing finance system on stronger 
financial footing.
    One of those options is for the Financial Stability 
Oversight Council, or FSOC, to designate Fannie and/or Freddie 
as a systemically important financial institutions, or SIFIs, 
under Title I of Dodd-Frank, thus, subjecting them to 
supervision by the Federal Reserve and enhanced prudential 
standards.
    Title I of Dodd-Frank authorizes FSOC to subject nonbank 
financial companies to such supervision if it determines that 
material financial distress at a particular company could pose 
a threat to the financial stability of the United States.
    Once a designation is made, the additional tools available 
to the Fed include, but are not limited to, enhanced risk-based 
and leverage capital requirements; liquidity; risk management 
and risk committee requirements; stress test requirements; and 
for institutions that pose a grave threat to financial 
stability, a debt-to-equity limit.
    Section 120 of the Dodd-Frank Act also authorizes the FSOC 
to make recommendations to primary financial regulatory 
agencies to apply new or heightened standards and safeguards 
for a financial activity or practice conducted by nonbank 
financial companies if the FSOC determines that the conduct, 
scope, nature, size, scale, concentration, or 
interconnectedness of such activity or practice could create or 
increase the risk of significant liquidity, credit, or other 
problems spreading among bank-holding companies and nonbank 
financial companies, U.S. financial markets, or low-income, 
minority, or underserved communities.
    Fannie and Freddie are clearly too big to fail. We all know 
it, and the 2008 bailout proved it.
    Today Fannie Mae has a larger balance sheet than any 
financial institution in the United States and the second 
largest balance sheet of any public company in the world. 
Freddie Mac is not far behind.
    Collectively they hold $5.48 trillion in assets. That is 
$5,000 billion.
    Additionally, both companies hold far less capital and are 
far more leveraged than any other currently designated SIFI.
    As FHFA Director Calabria recently said, ``With a leverage 
ratio of nearly a thousand to one, their balance-sheet capital 
cushion is razor thin.''
    Trillions of dollars of Fannie and Freddie obligations are 
held by central banks across the world, and the GSEs' economies 
of scale, proprietary underwriting engines, intellectual 
property, special congressional charters, and unique role in 
the marketplace would be nearly impossible to immediately 
substitute in the event of a market turndown.
    In a 2017 speech, Federal Reserve Chairman Jerome Powell 
publicly referred to Fannie and Freddie as ``systemically 
important.''
    Despite these considerations, Fannie and Freddie have never 
formally been designated as SIFIs under Title I of Dodd-Frank 
by FSOC.
    Today we are interested in assessing the viability of a 
formal designation of the GSEs under Title I of Dodd-Frank, 
whether in conservatorship or in the event that they someday 
return to the private market as reformed entities.
    In particular, I am interested in determining to what 
extent a SIFI designation under Title I of Dodd-Frank would 
result in increased capital levels at the GSEs that can shield 
taxpayers from liability in the event of a future market 
turndown, how the Fed and FHFA would coordinate their oversight 
efforts in the event of a designation under Title I of Dodd-
Frank, and the impact a designation under Title I of Dodd-
Frank--that such a designation would have on all participants 
in the broader mortgage market.
    I look forward to continuing to work with Members of this 
Committee, the Administration, and other stakeholders to 
finally put our housing system on durable, sustainable footing.
    Senator Brown.

           OPENING STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman, and thanks to the 
three witnesses.
    Home is the center of everything we do. Whether you rent or 
own, home is where you raise your kids, throw birthday parties, 
do homework, relax after a hard day's work. It also determines 
so much else about your life, what school your kids go to, how 
long it takes to get to work, your access to parks and 
community resources, whether you are exposed to lead in your 
walls or in your drinking water.
    For many Americans, owning a home is so essential that it 
has become synonymous with the American dream, but rent and 
housing costs are rising faster than wages. More than a quarter 
of renters spend over half their income on housing. It is 
getting harder for working families to make that dream a 
reality.
    Without the stability and affordability of a long-term 
fixed-rate mortgage, far fewer families would have a home of 
their own. That is why Congress chartered Fannie Mae more than 
80 years at the height of the Great Depression to make home 
ownership more accessible and affordable for all American 
families.
    That is why Congress reaffirmed Fannie and Freddie's public 
purpose in 2008 with the Housing and Economic Recovery Act. In 
addition to enhancing accountability, that law strengthened 
Fannie and Freddie's affordable housing missions and duty-to-
serve communities that have not been given a fair shot. People 
of color were systematically excluded from sharing in this 
Country's housing wealth for most of our history.
    I suggest any in the audience and the three at the witness 
table, if you have not, to read ``The Color of Law'' by Richard 
Rothstein. We know Americans of many backgrounds still face 
housing discrimination. Congress made clear that Fannie and 
Freddie must address inequities in our housing finance markets.
    Today's hearing asks whether Fannie and Freddie should be 
systematically important financial institutions. They play an 
important role in the economy today, to be sure. There is not a 
single person in this room who would disagree with that.
    Last year Fannie and Freddie helped more than 3 million 
families buy or refinance their homes. They made it possible 
for another million-and-a-half to find an apartment, including 
nearly 900,000 low- and very low-income renters.
    But before we decide how to regulate these important 
institutions, we should answer a fundamental question: Which 
Fannie and Freddie are we talking about? Are we talking about 
the Fannie and Freddie of the early 2000s, which under a weak 
regulator had spent years focusing too much on making profits 
for shareholders and too little on stable home ownership for 
hardworking families? Or are we talking about the Fannie and 
Freddie of today managed by a strong Federal regulator and 
which pay all but a modest capital buffer back to taxpayers? Or 
are we talking about the reformed entities Congress may create 
for the future, which will have to continue Fannie and 
Freddie's role addressing the affordable housing crisis we face 
across the country?
    This Committee held two hearings in March where we heard 
from small lenders and consumer groups and civil rights 
organizations and lenders and builders and realtors. We 
received written statements from other critical participants in 
the housing system.
    Across those 2 days, we heard many of these folks 
coalescing around a few foundational principles for reform. I 
would like to outline what those were from those hearings.
    They told us that any reform should protect access to 
affordable 30-year fixed-rate mortgages. They should provide a 
catastrophic Government guarantee. Any reform should structure 
loan guarantors like public utilities providing a regulated 
rate of return. Any reform should serve a broad national 
market. It should serve lenders of all types and sizes 
equitably. It should maintain a duty to serve all markets and 
all borrowers. It should maintain affordable housing goals and 
metrics. It should expand investment in affordable housing, and 
it should maintain the GSEs' successful multifamily business 
models and ensure continued or better access for financing of 
affordable rental housing.
    This would reorient Freddie and Fannie to serve the housing 
needs of families in Cleveland and Boise and Billings and 
Richmond, rather than maximize profits. It would also require a 
different type of oversight than we have for the megabanks and 
shadow banks that poisoned the mortgage market and infected our 
economy, different than we have for financial interests that 
are obsessed with stock buybacks and that believe they have no 
obligation to serve the Nation that bailed them out.
    No matter how much money you make or what State you live 
in, housing is essential. That means our housing market and the 
entities that make it work are essential. We need a housing 
system that is built to last, so that it can continue to serve 
all families across the Country in times good and bad.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Brown.
    We are joined today by Mr. Alex Pollock, Distinguished 
Senior Fellow at the R Street Institute; Dr. Douglas Holtz-
Eakin, president of the American Action Forum; and the 
Honorable Susan Wachter, Sussman Professor of Real Estate and 
Professor of Finance at The Wharton School of the University of 
Pennsylvania.
    I want to thank each of the witnesses for joining us this 
morning. We appreciate your bringing your expertise and 
knowledge to the Committee on this critical issue.
    We would like to hear from each of you in the order I 
introduced you. Again, I would like to remind you to try to 
keep your introductory remarks to 5 minutes so that we will 
have time to get through all of our questions.
    Mr. Pollock, you may proceed.

 STATEMENT OF ALEX J. POLLOCK, DISTINGUISHED SENIOR FELLOW, R 
                        STREET INSTITUTE

    Mr. Pollock. Thank you, Mr. Chairman and Ranking Member 
Brown. It is an honor to be here with the Committee.
    To begin with the essence of today's question, ``Are Fannie 
and Freddie Mac systemically important?'' They guarantee half 
the credit risk of the massive U.S. housing finance sector. 
They have combined assets, as the Chairman said, of $5.5 
trillion. They are systemically important, quite obviously. Are 
they financial companies? Of course, they are. They are 
systemically important financial institutions as a simple fact, 
and, Senator Brown, I think that includes the past, present, 
and future, Fannie Mae and Freddie Mac.
    Now, it is true that they are systemically important if you 
consider them as two of the largest and most highly leveraged 
financial institutions in the world, but it is equally true if 
you consider them as an activity that generates systemic risk. 
Leveraged real estate is and has been throughout financial 
history a common source of credit collapses and crises.
    Fannie and Freddie are giant credit-risk takers on a super-
leveraged basis, not just operating intermediaries. Being 
leveraged credit-risk takers, could they, to use the words of 
the Dodd-Frank Act, ``pose a threat to the financial stability 
of the United States''? They have already demonstrated that 
they can.
    As Secretary of the Treasury Henry Paulson correctly judged 
in 2008, a default on Fannie and Freddie's obligations would 
have dramatically exacerbated the financial crisis on a global 
basis. I just note that today such a default would also impose 
credit losses on the Federal Reserve.
    As the Chairman said, Fannie and Freddie are, without 
question, too big to fail. They are systemically important, as 
my old friend, Susan Wachter agrees, and indeed, no reasonable 
person would dispute. Yet so far the Financial Stability 
Oversight Council has not designated them as SIFIs, as the 
Chairman said.
    How should FSOC deal with the fact of Fannie and Freddie's 
systemic importance? Should they recognize the reality or keep 
ignoring the issue? I believe FSOC should formally designate 
Fannie and Freddie as SIFIs under Title I of the Dodd-Frank Act 
and strongly recommend that action.
    My written testimony considers the qualifying factors for 
SIFIs of size, interconnectedness, substitutability, leverage, 
maturity mismatch and liquidity risk, and existing regulation.
    To mention a few key points, they are enormous in size, as 
we have already heard. Their systemic role is critical and 
cannot be replaced in the short or medium term. They are hyper-
leveraged at over 500 to 1 as of March 31st but more like a 
thousand, as the Chairman said, on other dates. They are 100 
percent concentrated in leveraged real estate. Their primary 
regulator is devoted only to housing finance.
    Such a regulator always faces the temptation to become a 
cheerleader and a promoter of housing and its regulated 
entities. Good historical examples of this are the Federal Home 
Loan Bank Board, abolished in 1989, and the OTS, abolished in 
2010.
    In sum, Fannie and Freddie meet the criteria specified by 
the Dodd-Frank Act and its implementing regulations for 
designation as a SIFI, both as institutions and as a 
systemically risky activity.
    Designating them a SIFI should not be delayed because they 
are in conservatorship. They are just as systemically important 
in conservatorship as out of it. When they are designated as 
SIFIs, as I hope, the Federal Reserve will become an additional 
systematic risk regulator for them. This seems to me a good 
idea.
    The Fed is well placed to consider under systemic risk, for 
example, whether Fannie and Freddie's capital requirements and 
super-leverage cause capital arbitrage and therefore increased 
risk in the financial system as a whole. Of course, there are 
many other important systemic questions.
    I believe the Fed as systemic risk regulator of Fannie and 
Freddie would be a force for sound and well-capitalized housing 
finance, which would be better understood in the context of its 
interaction with the rest of the financial system, which we 
greatly need.
    In conclusion: Are Fannie and Freddie SIFIs? Yes, without a 
doubt.
    Do Fannie and Freddie cause systemic financial risk? Yes.
    Is the Federal Reserve a reasonable place to try to 
understand and address the systemic risk? Yes.
    Should FSOC recognize these facts by formally designating 
Fannie and Freddie and SIFIs under Title I? Yes.
    When? The sooner the better.
    And thank you for the chance to share these views.
    Chairman Crapo. Thank you very much.
    Dr. Holtz-Eakin.

 STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION 
                             FORUM

    Mr. Holtz-Eakin. Chairman Crapo, Ranking Member Brown, and 
Members of the Committee, it is a privilege to be here today. 
Thank you very much.
    As the Chairman noted, there has been increased discussion 
of housing market reforms, the housing finance reforms, notably 
the outline the Chairman produced earlier this year.
    The President has issued a memo to Housing and Urban 
Development and Department of Treasury to deliver to him 
administrative plans to reform Fannie Mae and Freddie Mac, and 
both of these efforts presumably would lead to the exit of the 
GSEs from conservatorship. And at that point, I think it is 
imperative that they be designated as SIFIs. For many of the 
reasons that have been laid out so beautifully by Alex, I think 
this is the only sensible way to go.
    Their core activity is the thing that has historically been 
the most systemically risky activity in the financial system--
leveraged lending for real estate. If you just follow the trail 
from Woodward & Company to Continental Illinois to the savings 
and loan crisis to the subprime crisis, you find the same 
activity as the core of financial and banking crises in our 
history. Not only are Fannie Mae and Freddie Mac engaged in 
that activity, they dominate that activity. They have 
extraordinary market presence, are currently buying at 48 
percent of all originations. They are responsible for 61 
percent of all mortgage-backed security issuances, and all of 
these are up from their precrisis footprint. I think there is 
simply no question that their activities are systemically 
dangerous.
    And they have the other characteristics that one associates 
with SIFIs. They have enormous leverage. I have no idea what 
the right number is, but it is beyond any reasonable measure of 
leverage. And they are heavily interconnected. Fannie and 
Freddie are buying mortgages from over a thousand other 
financial institutions in the most recent report.
    So, given the criteria that the FSOC is currently using for 
designation, I think there is no question that they should be 
designated as SIFIs at the moment they exit conservatorship.
    Despite that, there are some who have argued against the 
idea of designation with the notion that perhaps the Federal 
Reserve might face a conflict of interest, being both a 
regulator of housing markets and also in setting interest rates 
for monetary policy, or some would argue that they did not 
display themselves to be outstanding insurance regulators. They 
might not be outstanding prudential regulators of a housing 
finance entity.
    And if one were to go down that path and decide against 
designation, under Title I of Dodd-Frank, it seems to me it is 
imperative that the FHFA use the powers that it have to create 
an alternative regime that insulates the housing markets and 
the broader economy from the threat posed by the GSEs.
    They would need to hold SIFI-like amounts of capital, and 
the FHFA is about to finalize a capital rule for the GSEs. That 
is an opportunity to display to the FSOC that they have an 
interest in insulating the financial system against the 
collapse of these entities by holding more capital.
    They are subject to a stress test. Those stress tests 
should look like the stress tests that the 18 large banks just 
passed. Those stress tests are done by the Federal Reserve, and 
they included declines of 25 percent in housing prices and 35 
percent in commercial real estate prices. We ought to see the 
capacity to survive those things.
    They should be precluded entirely from holding the 
portfolios that essentially made them monoline hedge funds and 
extremely risks prior to the crisis, and they should be de-
risked as much as possible through aggressive use of up-front 
credit-risk transfers, something they have done a modest amount 
of but which there is a lot more opportunity to.
    In short, it may be the case--I am not sure I am convinced, 
but it may be the case that FHFA could put in place a regime of 
capital and other provisions that are enough to have the FSOC 
deem them and avoid designation. So one way or another, the 
future of Fannie Mae and Freddie Mac cannot look like the ones 
that we saw prior to the crisis, and the financial system has 
to be safe from the implications of any distress that they 
might suffer.
    I thank you for the chance to be here today, and I would be 
happy to answer your questions.
    Chairman Crapo. Thank you.
    Ms. Wachter.

STATEMENT OF SUSAN M. WACHTER, SUSSMAN PROFESSOR OF REAL ESTATE 
AND PROFESSOR OF FINANCE, THE WHARTON SCHOOL OF THE UNIVERSITY 
                        OF PENNSYLVANIA

    Ms. Wachter. Chairman Crapo, Ranking Member Brown, and 
other Members of the Committee, thank you for the invitation to 
testify at today's hearing, ``Should Fannie Mae and Freddie Mac 
Be Designated as Systematically Important Financial 
Institutions?''
    I am the Sussman Professor of Real Estate and Professor of 
Finance at The Wharton School of the University of Pennsylvania 
and have addressed related questions in my research.
    It is an honor to be here today to discuss the role of the 
Financial Stability Oversight Council in the prevention of 
systemic crises derived from the mortgage market.
    The Financial Stability Oversight Council, FSOC, has a 
statutory mandate to identify risk and respond to threats to 
financial stability. As is evident from the severe financial 
crisis that led to the Great Recession of 2009, mortgage 
markets can disrupt stability and have done so. Regulatory 
oversight and the structure of the housing finance system may 
be instrumental in determining whether we have a repeat of the 
crisis.
    My comments today will address why there is a need for 
systemwide oversight of the mortgage market. I will also 
address the specific question: ``Should Fannie Mae and Freddie 
Mac be designated as SIFIs?'' I believe, for reasons that I 
will explain, that the correct designation for the GSEs--is 
SIFMUs, Systemically Important Financial Market Utilities.
    Under Title X of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, Dodd-Frank, FSOC is authorized to 
designate nonbank financial institutions as systemically 
important.
    In addition, under Section 204 of Dodd-Frank, FSOC is 
responsible for the designation of financial market utilities 
that the council determines are, or are likely to become, 
systemically important; that is, SIFMUs.
    Section 803 of Dodd-Frank clarifies a disruption to a SIFMU 
as a situation where the failure of a functioning financial 
market utility could create or increase the risk of significant 
liquidity or credit problems spreading across financial 
institutions and markets and thereby threatening the stability 
of the financial system of the United States.
    I believe a SIFMU designation is correct because the GSEs 
provide a structural foundation to the secondary mortgage 
market.
    The GSEs are characterized by the considerations already 
established for the SIFMU designation, which are the aggregate 
value of transactions processed by the financial market 
utility, the aggregate exposure of the financial market 
utility, the relationship, interdependencies, or other 
interactions of the utility, and the effect that the failure or 
disruption of the utility would have on critical markets, 
financial institutions, or the broader financial system. This 
characterizes the GSEs.
    In the years after the crisis, under the direction of the 
FHFA, the GSEs have made major improvements. They have wound 
down their portfolios. They have increased transparency. They 
have de-risked through higher credit standards and risk 
sharing.
    In 2012, the FHFA called for the GSEs to implement credit-
risk transfer programs, which they have and which now cover 
approximately $80 billion worth of risk.
    Additionally, the GSEs have developed a common security 
platform to ensure liquidity for the trading of MBS and 
interest rate risk.
    While the GSEs are now less risky, the lack of equity 
capital, private capital, to absorb losses still leaves 
taxpayers at risk. In order to address the need for equity 
capital, so-called recap and release proposals have been put 
forth which would enable the GSEs to raise private capital and 
to reduce risk and to end the conservatorship. At this point, 
in contemplation of this, the GSEs should become SIFMUs.
    Various plans have been proposed for the GSEs' 
restructuring, including multiple guarantors. The risk of the 
future GSEs depends upon whether they remain as currently 
structured or whether there are additional and perhaps many 
additional guarantors.
    Moody's recently opined that increasing the number of GSEs 
could lead to weaker underwriting standards or price 
competition, both credit negatives for the GSEs and ultimately 
for the taxpayer. In this situation particularly, it would be 
extremely important to have the oversight that a SIFMU 
designation provides.
    The key functions of the GSEs are to set standards and to 
provide transparency for the secondary mortgage market. The 
source of the crisis was the undermining of these standards and 
the underpricing of risk, which led to an unsustainable 
expansion of bad credit.
    With the oversight of the FHFA and the enhanced oversight 
of a SIFMU along particularly with the role of the Federal 
Reserve, the GSEs are in a position to maintain their 
functions, providing stability to the mortgage market going 
forward.
    But the FHFA alone cannot provide the collective oversight 
of the entities that comprise the mortgage market. Here, the 
Federal Reserve is critically important.
    Therefore, I respectfully propose that the FSOC consider 
the designation of Fannie Mae and Freddie Mac as SIFMUs. The 
SIFMU designation can support macrostability while enabling the 
GSEs to provide access to sustainable mortgage credit over the 
long term.
    I thank you for the opportunity to testify today. I welcome 
your questions.
    Chairman Crapo. Thank you very much.
    I would like to start with a question for each of you, and 
I would like you, if you could, to just make this yes or no 
answers because I want to get on to some further questions.
    It seems to me, based on the testimony you have given, that 
each of you agree that whether based on size or activity, 
Fannie and Freddie are too big to fail. Agree?
    Mr. Pollock. Yes.
    Mr. Holtz-Eakin. Yes.
    Chairman Crapo. All right. Second----
    Ms. Wachter. I did not say yes.
    Chairman Crapo. So you do not?
    Ms. Wachter. No. I think that under conservatorship, they 
are not too big to fail. They are under direct Government 
oversight.
    Chairman Crapo. OK. Then I guess the second part of my 
question--again, hopefully, a yes or no--is do you believe--
whether it is the designation under Title I or Title VIII, do 
you believe that they should be designated as systemically 
important institutions?
    Mr. Pollock. Yes.
    Chairman Crapo. I did not hear a yes from either of the 
other two of you.
    Mr. Holtz-Eakin. Yes.
    Chairman Crapo. OK. And again?
    Ms. Wachter. The systemically important SIFMUs.
    Chairman Crapo. Yes, I understand that, under Title VIII.
    Ms. Wachter. Yes, absolutely.
    Chairman Crapo. SO let me go back--and this would be just 
for Mr. Pollock and Mr. Holtz-Eakin because you both, I think, 
agree that a Title I designation would be the preference.
    In that context, do you believe that Fannie and Freddie 
today are adequately capitalized?
    Mr. Pollock. No. Clearly no.
    Chairman Crapo. Mr. Holtz-Eakin.
    Mr. Holtz-Eakin. No, not at all.
    Chairman Crapo. That would mean that a designation should 
at least require that there be a greater level of capital at 
Fannie and Freddie?
    Mr. Holtz-Eakin. Yeah. I think that is the advantage of a 
Title I designation over Title VIII. There is no obligation for 
greater capital under Title VIII.
    Chairman Crapo. Well, that was going to be my next 
question, and I would like to ask each of you to then comment 
on why you prefer Title I. And then, Ms. Wachter, I will give 
you the opportunity to respond as to why that should not be the 
case.
    And, Mr. Pollock, could you go ahead?
    Mr. Pollock. Thanks, Mr. Chairman.
    I think Susan's SIFMU argument is very creative but is 
misdirected and misinterprets Fannie and Freddie.
    If we look at Title VIII, it is directed at exchanges and 
clearinghouses. The formal title of Section VIII is ``Payment, 
Clearings, and Settlement Supervision''. The more appropriate 
point about Fannie and Freddie, as we have said, is that they 
are hyper-leveraged credit-risk takers of an amazing scale and 
thereby systemically risky, taking credit risk as principals on 
a super-leverage basis. That is a Title I issue, I believe, and 
so I think they definitely need to be designated and under 
Title I.
    Chairman Crapo. Thank you.
    Dr. Holtz-Eakin.
    Mr. Holtz-Eakin. I prefer Title I to Title VIII for two 
reasons. First, the one thing that it does do, which is to 
require the holding of greater capital cushions, I think that 
is an imperative.
    The second is that one of the things that it does do under 
Title VIII is to give those designated access to the discount 
window at the Fed.
    I will just quote former FDIC Chair Sheila Bair in 
discussing giving them access to discount window. She says, 
``Not only does it give these firms a real advantage over other 
nonsystemic competitors, it opens up taxpayers to potential 
losses and creates moral hazard. Title VIII financial market 
utilities will very likely become the new GSEs and a new source 
of system instability.'' Taking the GSEs and turning them into 
GSEs on steroids is a bad idea.
    Chairman Crapo. Thank you.
    So, Ms. Wachter, would you like to respond to that?
    Ms. Wachter. Yes, I would. Thank you.
    The GSEs are not banks. The GSEs are financial utilities. 
In the sense that they establish standards, they are similar to 
a clearinghouse in that the standards are critical for the 
common security platform and the TBA market, in which there are 
thousands of participants. This is their critical function.
    I do not disagree in any way with the two other witnesses 
on the importance of private capital, and it is, indeed, the 
function of the FHFA to make sure, along with Treasury, prior 
to privatization that there be sufficient capital.
    And in my proposal that they be considered as SIFMUs, there 
would be additional enhanced oversight by the Federal Reserve 
Board on the issue of capital and sufficiency of capital. That 
absolutely is key. It is just not the only function.
    Chairman Crapo. So do you think that a designation under 
Title VIII would bring with it a mandate for increased capital?
    Ms. Wachter. Well, the mandate for sufficient capital is 
already there under FHFA's mandate, but the oversight of the 
systemic implications and the need for capital varies not only 
with the GSEs specifically but the interconnectedness of the 
GSEs with the entire mortgage system, including Ginnie Mae and 
FHA, including the banking system. This interconnectedness can 
only be in the vision of the FSOC, and particularly the 
function of the FSOC as our macroprudential agency. Many 
countries have such an agency. That is the function of the 
FSOC.
    In the absence of that oversight, the particular agencies 
that provide the underpinnings will not have the expertise of 
the other important regulators of the mortgage market at hand.
    Chairman Crapo. Thank you.
    Senator Brown.
    Senator Brown. Thank you, Dr. Wachter. Thanks to all three 
of you.
    During hearings the Committee held on housing finance 
reform in March, a number of witnesses talked about 
restructuring the GSEs as utilities providing regulated rates 
of return. The support for the utility model, I think, 
surprised most of us in both parties, the strong, strong 
support for it.
    The witnesses said that this would stabilize the secondary 
market and avoid a race to the bottom in Wall Street's 
underwriting that contributed to the crisis.
    My question is, if GSEs were structured as utility with a 
mission of serving the housing market, how would the risk be 
different from the risks of private banks and nonbanks?
    Ms. Wachter. As a utility, their mission would be to 
stabilize the market and to provide access to credit over the 
long run. It would not be simply to maximize profits, as for 
private entities, of course, with their shareholders rightfully 
directing them.
    The problem is maximizing profits in the short run often 
comes at the expense of long-run stability, and particularly, 
these entities, their purpose, their goal, their mission should 
be long-run stability.
    Senator Brown. Some have suggested that everything from the 
Federal Reserve banks and the FOMC and SBA loans should be 
regulated as SIFIs.
    Dr. Wachter, should Government-chartered entities and 
agencies which serve public purposes be supervised using the 
same tools as for-profit megabanks operating to serve their 
shareholders?
    Ms. Wachter. Absolutely not. The purpose of Government is 
to provide regulation, why would we double up the regulation? 
That would just be additional bureaucracy. I see no purpose to 
that.
    Senator Brown. As I mentioned in the first question, most 
of the witnesses we have had talking about this seem to support 
or do support the utility model, but some witnesses say that 
having more entities playing the same role as Fannie and 
Freddie and guaranteeing mortgage credit risk would help 
reduce--they argue it would help reduce risk to the system, but 
during the crisis, we know that we saw every company with ties 
to the housing market suffer large losses.
    So would you expect, Dr. Wachter, having more guarantors 
would increase or reduce risk in the system?
    Ms. Wachter. It would increase risk, and the reason it 
would increase risk is that there would be races to the bottom. 
And also, it would be very difficult to regulate these entities 
for standards. The more entities you have, the harder it is to 
regulate for standards, and it is the erosion of standards that 
led to the crisis.
    Senator Brown. But just sort of intuitive--I am sorry to 
interrupt.
    Ms. Wachter. Yes.
    Senator Brown. Intuitively, should not more participants 
mean a better working system?
    Ms. Wachter. No, absolutely not.
    If you have more, they are going to look at their share of 
the market, and that is what they are going to maximize. And 
they are going to go for increasing their share of the market, 
and they are going to underprice. They are going to reduce 
standards. This race to the bottom is exactly how we got where 
we are.
    The competition needs to be for interest rate risk and for 
credit risk, and we need a utility to set up the mechanism for 
competition for the pricing of those two risks. And that then 
gives us the pricing in the secondary market at competitive 
levels.
    The problem with a so-called multi-guarantor system is the 
competition would only last for the short run, and then we 
would have underpricing of risk. We would have standards that 
would be eroded.
    If you had a few, that is not a problem, but if you had 
many, that is a problem, and besides, five or six do not get 
you to competition. What gets you to competition is a number 
more like 30 or 100. How would we regulate 30 or 100 entities 
for standard setting and for rate setting?
    Senator Brown. Last question. During hearings, again, in 
March, we heard repeatedly, it was essential for every company 
guaranteeing mortgage risk to serve a broad national market. 
Would you expect, Dr. Wachter, an entity serving just part of 
the country to be more risky or less risky than an entity that 
is required to serve the whole market?
    Ms. Wachter. Absolutely. A small part of the market is far 
riskier. It is diversification that comes from providing 
mortgages to the entire market that provides insurance to 
regions which are far more volatile than the Nation as a whole.
    Senator Brown. Thank you, Mr. Chairman.
    Chairman Crapo. Thank you.
    Senator Moran.
    Senator Moran. Mr. Chairman, thank you.
    Thank you all for sharing your expertise and intellect this 
morning.
    A commonly held concern with FHFA continuing to serve as 
the sole regulator of Fannie and Freddie is that they will 
control their regulator and hold a high degree of influence.
    Having said that, one of the key points on the ongoing GSE 
reform debate centers around the consensus on the need for caps 
on market share control for current and future federally 
chartered guarantors.
    This is a bit of what you were talking about with Senator 
Brown. Do you see a multiple guarantor model as sufficient to 
ensure that Freddie and Fannie do not control FHFA as their 
sole regulator, and that regulatory decisions will be made 
best--in the best interest of the secondary mortgage market as 
a whole?
    Ms. Wachter. Thank you.
    Right now, it appears that FHFA is not at the behest of 
Fannie and Freddie.
    Senator Moran. OK.
    Ms. Wachter. We cannot say what the future will be, but I 
do believe that the SIFMU designation helps address that 
problem.
    Senator Moran. Thank you.
    Anyone else? Mr. Pollock
    Mr. Pollock. Thank you, Senator.
    As I said in my testimony, I think a danger of a 
specialized housing regulator is that it becomes captured by 
the idea of----
    Senator Moran. You did say that.
    Mr. Pollock ----promoting and cheerleading for housing or 
be captured by its regulated entities, and therefore, the 
notion of a systemic level of regulation is also a key, I 
think. It is quite clear the FHFA is neither empowered nor able 
to be a systemic risk regulator for the systemic risk created 
by Fannie and Freddie. That is according to the statute 
assigned to the Fed.
    I will say this, Susan. If you will agree to make Fannie 
and Freddie SIFIs under Title I, I think we could make them 
SIFMUs under Title VIII, too----
    Ms. Wachter. OK.
    Mr. Pollock ----and make them both be SIFIs and SIFMUs.
    Senator Moran. Who says that compromise cannot be found in 
the U.S. Senate?
    [Laughter.]
    Mr. Holtz-Eakin. How can I sit between two such reasonable 
people?
    Ms. Wachter. And you have already said you are not so 
sure----
    Mr. Holtz-Eakin. Yeah.
    Ms. Wachter ----that they should be SIFIs.
    Mr. Holtz-Eakin. So I think a couple of things. There is 
broad agreement that designation is appropriate, and that is a 
unique position for me. I have been pretty vocal in my concerns 
about the existence of the FSOC and its inability to actually 
identity systemic risk, measure it, control it, and so it is on 
a mission that it may not be equipped to pursue.
    This is the one place where systemic risk is historically 
present. This is the one place I am very comfortable with the 
designation, and the details of it, I think, are left to be 
determined.
    The second thing I would mention, if there are going to be 
more entities--and there will be more competition somehow 
defined among these guarantors--the key issue is how much 
capital those guarantors are going to hold.
    If you have a downturn and you have these sort of large 
leveraged entities, the number is not going to matter. You are 
going to have a systemic problem coming out of real estate. We 
have seen that in history.
    If you have a lot of equity behind things, you can have a 
big downtown and survive it. The best example of that is the 
dot-com bubble. The collapse of the dot-com bubble was a loss 
and wealth comparable to the collapse in the housing market. It 
produced a mild recession in the early 2000s. The collapse of 
the housing bubble produced the Great Recession. The difference 
is leverage and debt, and you have to control that. And if you 
control that, you will control the problem.
    Senator Moran. Thank you.
    Mr. Pollock, you impressed me. I noticed the degrees in 
philosophy. I have never met a philosopher who answered the 
questions presented as testimony in a way that was so 
understandable for me by outlining the question and providing a 
yes answer following each question, so thank you.
    Let me ask this one. Expand on the impact of designating 
Fannie and Freddie as SIFIs. What would the impact be on 
getting them out of the balance sheet business and back to the 
guarantee business?
    Mr. Pollock. Thank you, Senator, for your kind comment and 
for the good question.
    The main effect is putting FSOC in a position to look at 
Fannie and Freddie as systemic risks, as systemically 
important, which they obviously are, in my opinion, and to 
bring in the Federal Reserve as systemic risk regulator of 
Fannie and Freddie.
    Now, if you believe in the theory of the Dodd-Frank Act--
and while it may have many shortcomings, I think it is right in 
this--there is a level of analysis and risk control which is 
systemic, which is different from individual entity regulation. 
For that, I think the Federal Reserve relative to Fannie and 
Freddie would be a good choice. Bring the Fed in through 
designation as SIFIs under Title I (and maybe as SIFMUs, too) 
because they then have the systemic view of how Fannie and 
Freddie are affecting the system as a whole. That is the 
fundamental theory of Dodd-Frank and why SIFIs are in there in 
the first place.
    Thank you.
    Senator Moran. Thank you, Mr. Chairman.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Thank you all for your testimony.
    Fannie and Freddie were--are unique entities. Congress 
chartered them for a specific purpose, which is to enable a 
strong national housing market to extend the opportunity of 
home ownership to as many Americans as possible, and it is 
important to note that all the other systemically important 
entities, both banks and nonbanks, were entirely private firms.
    So, as this Committee continues to consider ways to improve 
our housing finance system, it is important that we do not lose 
sight of the critical role that Fannie and Freddie have played 
in helping millions of American actually own their own home.
    In each of your testimonies, you have put forward differing 
views on why and how we should regulate these entities. So I 
want to ask you, as we think about the changes needed to 
preserve housing affordability across the country, can each of 
you explain how your proposal, whether designating the GSEs as 
SIFIs or as market utilities, would impact housing 
affordability in high-cost States like New Jersey as well as 
nationally?
    Mr. Pollock. I will start, Senator, if I may.
    The fact that Fannie Mae and Freddie Mac are SIFIs and that 
they will be SIFIs in any form does not, per se, address the 
affordability question, except that we know that running at 
hyper-leverage tends to escalate credit and pushing excess 
credit at markets tends to escalate housing prices. That makes 
housing less affordable than before, which is one problem with 
organizations which generate excess credit.
    Whatever you do about housing affordability, however, I 
think it is quite clear what you do not want to do is have 
deteriorated credit quality as your strategy for affordability. 
That is just a bad and, indeed, potentially disastrous 
strategy.
    Senator Menendez. I agree, but they are mutually exclusive.
    Mr. Pollock. The SIFI designation is to ensure high-credit 
quality of Fannie and Freddie and proper capitalization of 
their very substantial risks. You do not want to address 
affordability by making them risky and subject to failure.
    Senator Menendez. Anyone else have a quick answer to this?
    Ms. Wachter. Yes, I do. In fact, procyclicality does raise 
risks over time and the cost of risk. If we can reduce 
procyclicality, if we can have more systematic stability, less 
systematic risk, then we will have lower cost of credit, and 
that will mean more affordable credit.
    I believe a SIFMU status with direct oversight of FHFA and 
enhanced oversight by the Fed will achieve this--then credit 
risk will decline and mortgage rates will decline, making 
mortgages more affordable for working families across America.
    Senator Menendez. So would that be your view as well if we 
had the designation without broader housing reform?
    Ms. Wachter. Oh, absolutely. We do not need the designation 
in the current status. In my mind, it would be redundant. It 
would be unnecessary. It is not necessary.
    I am speaking in contemplation of the privatization of 
these entities.
    Senator Menendez. I see. OK.
    Let me just turn a moment, since we have this expertise 
before us, to the broader topic of housing finance reform 
because, fundamentally, I believe the role of this Committee is 
to foster a housing finance system that ensures broad 
affordability and access.
    Without a mandate to serve a national market, will not we 
risk guarantors cherry-picking regions, borrowers, and 
products, inevitably leaving some borrowers without any options 
for mortgage credit?
    Ms. Wachter. That is absolutely correct, Senator, and that 
is why we need a national system, and that is why we need 
utilities. We need securitization utilities that are, in fact, 
underpinning and providing the platform for a national system.
    Senator Menendez. Finally, I want to just follow up on the 
comment you made, Dr. Holtz-Eakin. In your testimony before the 
Committee in March on non-backed SIFI designations, you said 
FSOCs focus on entities that might contribute to systemic risk 
does not pursue the goal of systemic risk itself, and that 
activity-based regulation, quote, ``is substantially better 
than singling out one or a few large firms or funds for 
designation, which create disparities and regulation across 
firms and sectors that could have a very real and unintended 
economic cost.''
    So I am trying to understand that testimony in the context 
of why do you believe that we need to single out Fannie and 
Freddie for designation when you previously argued against that 
type of approach.
    Mr. Holtz-Eakin. Leveraged real estate lending and the 
guarantee of such lending is the systemically risky activity 
historically in the U.S. financial system. That is all they do, 
and the dominate the market in that.
    So using an activity-based designation leads you directly 
to designating them. I see no difficulty with that whatsoever.
    Senator Menendez. Last one, if I may, Mr. Chairman.
    What are the specific activities that the GSEs are 
performing that you believe contribute to that systemic risk?
    Mr. Holtz-Eakin. They have historically done two things. 
They guarantee mortgages, and that is, in and of itself, 
participating in this systemically risky activity on a large 
scale.
    Prior to the crisis, they also held large portfolios of MBS 
and, thus, enhanced their exposure to the systemically risky 
activity.
    And, as I mentioned in my oral remarks, they also have 
other characteristics that people associate with SIFIs. They 
are highly interconnected. They are large and leveraged. The 
combination, I think, makes designation literally a no-brainer, 
and it is unusual for me to be in that position.
    Senator Menendez. Thank you.
    Chairman Crapo. Senator Scott.
    Senator Scott. Thank you, Mr. Chairman.
    Thank you to the panel for being here this morning.
    I want to continue the discussion on the SIFI designation. 
Fannie and Freddie have a public mission to support a national 
market, which includes supporting home ownership and small and 
midsized towns like those in South Carolina as well as 
supporting access to credit after national disasters like 
hurricanes and flooding.
    How would the GSEs' ability to support markets with less 
stable economies or battered by hurricanes be affected by 
adopting a SIFI capital structure?
    Yes, sir.
    Mr. Holtz-Eakin. I think the shared vision of those sitting 
at the table is that they would continue to have that mission, 
but they would be less exposed to downturns and, thus, reliable 
in the performance of that mission across the cycle. Reducing 
that procyclicality, as Dr. Wachter mentioned, is really 
important.
    Mr. Pollock. Senator, I would say that if you are better 
capitalized and managed with an eye to the systemic effect you 
have on the whole economy, that puts you in a better position 
to do all the things you mentioned.
    Ms. Wachter. I agree. I think reducing systemic risk is 
key, and the purpose of the GSEs is to provide national 
capital, particularly to regions under stress. And to the 
extent that the system is more stable going forward, they are 
able to do that.
    Senator Scott. Thank you.
    The GSEs have greatly expanded their programs to share risk 
with the private market through PMIs, reinsurers, capital 
markets. SIFI status is supposed to be designed to protect 
taxpayers by raising capital, but more capital means higher 
rates. If higher costs drive borrowers to the FHA, how does 
this protect taxpayer, especially potentially during 
challenging economies?
    Mr. Pollock, your hand is up already.
    Mr. Pollock. The question of mortgage credit risk and the 
price of overpriced houses, too highly leveraged, guaranteed by 
organizations which are themselves hyper-leveraged, has to be 
seen, in my view, in a systemic way. When the Federal Reserve 
with a SIFI designation is thinking about the systemic risk, 
they will have to, as does the FSOC, also think about FHA.
    The FHA-Ginnie Mae combination is now as big as Freddie Mac 
in terms of its mortgage-backed securities. So you have to also 
think about them, which is another good reason, in my view, to 
put ourselves in a position where we are taking a systemic 
overview of this problem. As I said, This is exactly the theory 
of the Dodd-Frank Act.
    Mr. Holtz-Eakin. I guess what I would say is most of the 
discussion is about FSOC designation and Administration action, 
FHFA regulation, administrative action.
    One reason why I think it is preferable to do housing 
finance reform legislatively is that you can look 
comprehensively at the activities of FHA, Fannie, Freddie, 
Ginnie Mae, and set up appropriate lanes so that if you are 
going to have a low-income supportive agency, it has the powers 
and the duty to serve there and not have competition among 
them.
    Ms. Wachter. Well, I agree that competition will undermine 
the mission of serving all Americans, particularly those who 
are first-time borrowers and are having difficulty becoming 
first-time borrowers.
    In that sense, I think managing the system as a whole to 
prevent future crises is absolutely critical because future 
crises will raise credit risk and increase the cost of credit 
going forward. We must manage procyclicality.
    It is a systemwide problem. That is why I believe we need 
all entities that oversee mortgages, including the Fed, to 
oversee this market together with FHFA, which has now and 
should have in the future the primary role, including the 
requirement of sufficient private capital if and when these 
entities are privatized.
    Senator Scott. Thank you.
    Last question. As it stands, the GSEs use a decades-old 
scoring model that excludes what I consider to be useful data 
from consumers, whether it is the rent payments or the utility 
payments or cell phone bill payments. If we penalize consumers 
for data that reflects negatively on them, I believe we should 
give consumers room for redemption when they have positive 
data.
    In South Carolina alone, only 77 percent of adults can be 
scored under the current model used by the GSEs. An additional 
16 percent of South Carolinians can be scored under newer 
credit-scoring models in the market.
    Mr. Pollock, during the comment period with FHFA, you 
submitted a comment letter on the rule as proposed under then 
Director Watt. In it, you stated, ``The undersigned are pleased 
to comment in favor of the proposed rule, which we believe 
represents a fair and reasonable interpretation of Section 310 
of the Economic Growth, Regulatory Relief, and Consumer 
Protection Act of 2018. Even now, Director Calabria has stated 
that history proves that competition is the best way to serve 
consumers. Competition lowers prices, improves quality, and 
drives innovation.''
    Given your prior statements, Mr. Pollock, do you believe 
that allowing consumer data from alternative sources gives a 
better assessment of a consumer's qualifications for a home 
loan?
    Mr. Pollock. Thank you, Senator. You correctly quote my 
comment letter.
    I believe that the competition for credit score suppliers 
has to be a competition directed toward the credit-risk takers, 
and the credit-risk takers are, in this instance, Fannie and 
Freddie.
    As the bearers of the credit risk, they need to decide what 
best predicts and controls credit risk, taking everything into 
account. We ought to have as much competition as we can. I 
think the new act provides this, of people taking those ideas 
to Fannie and Freddie, but in my view, the decision has to be 
with the credit-risk taker, and that is Fannie and Freddie. 
That is why they are systemically important.
    Senator Scott. Certainly, I will summarize my thoughts on 
our S. 2155 that included my Credit Scoring Competition Act. 
The fact of the matter is using an outdated, perhaps antiquated 
system of scoring creditworthiness is perhaps not in the best 
interest of those folks who find themselves carved out of the 
opportunity for home ownership who are actually qualified based 
on their pattern, their credit-scoring patterns.
    Thank you.
    Chairman Crapo. Senator Warner.
    Senator Warner. Well, thank you, Mr. Chairman.
    Let me start by thanking you and the Ranking Member. As 
somebody who has spent a lot of time on this issue, I 
appreciate the fact that you continue both to hold hearings on 
this. A few more hearings and we may be able to scare away all 
the Members of the Committee.
    [Laughter.]
    Senator Warner. If there is one thing I have learned in 8 
or 9 years of trying to wrestle this to the ground, it is 
extraordinarily complex. There is no simple answers, but do 
very much appreciate you and the Ranking Member's efforts to 
try to get us moving forward on this.
    Before we get to designation, I want to go back to some of 
the comments about recap and release and some of Director 
Calabria's indications. He said that recap and release might be 
appropriate under right conditions, namely that the GSEs have 
adequate capital and they shrink their overall footprint.
    Obviously, it seems to me that the Director also believes 
that in his recap and release scheme that the entities should 
be purely private, with no explicit or implicit guarantee.
    And I want to start with you, Professor Wachter, and then 
hear from all the members of the panel. If we go forward with 
the recap and release plan without any kind of Government 
guarantee, explicit or implicit, what would that do to rates?
    Ms. Wachter. That is really for capital markets to 
determine.
    I do think that the capitalization of these entities is 
absolutely important, as is, their structure. If their 
structure is one that promotes stability going forward, as 
Moody's has already opined, the rates are likely to persist 
where they are with a line of credit, which has, in fact, been 
in place and is likely to be in place going forward.
    The question of explicit credit is an additional question, 
but I will leave my comments there.
    Senator Warner. Mr. Holtz-Eakin.
    Mr. Holtz-Eakin. I do not see how you could not have an 
implicit guarantee. That ship has sailed, and we put them in 
conservatorship once. They have been----
    Senator Warner. It appears the Director's comments----
    Mr. Holtz-Eakin. The Director's----
    Senator Warner ----if he was to do recap and release, he 
would see these with a shrunk enterprise and no explicit or 
implicit guarantee, at least that has been his philosophical 
points prior to this.
    Mr. Holtz-Eakin. I do not disagree.
    So, first of all, there cannot be an explicit guarantee. 
That would require legislation. So the whole question will be, 
How will markets perceive this? Will they, in fact, see 
entities which are so well capitalized, so well supervised, 
that it is impossible to believe that they will ever fail? And 
if so, they will view them as essentially the same as having 
the implicit guarantee that it will be safe.
    If they are less than that, rates will go up.
    Senator Warner. Mr. Pollock.
    Mr. Pollock. Senator, it is a great question, and you are 
right that housing finance reform in general is complex. But I 
think the SIFI issue is really simple.
    On the implicit guarantee, I think there is no way you can 
take the implicit guarantee away from Fannie and Freddie. The 
reason you cannot is because they are too big to fail, just as 
we agreed with the Chairman a little bit ago in this hearing.
    In my written testimony, I quote the wonderful line from 
Secretary of the Treasury Paulson's memoirs of the crisis when 
he talks about how, when Fannie and Freddie were reporting big 
losses, he was having dinner with the Chinese, assuring them 
that everything would be OK. That is a wonderfully compact 
statement of what it means to have the implicit guarantee. So 
we are going to have the implicit guarantee.
    Senator Warner. I guess what I would question, this notion 
that they would be perfectly managed and adequately capitalized 
and all of these other prerequisites. I think the risk would be 
dramatic that rates would go up without that guarantee.
    I also think as someone who believes deeply that part of 
the purpose of the entities is to ensure opportunity for first-
time homebuyers, access for low- and moderate-income 
individuals, a recap and release into purely private entities, 
there would be no guarantee that those functions would 
continue.
    One of the reasons why I am very, very strongly against a 
straightforward recap and release, I think it would move us way 
back from where we have been, put us back into a position where 
both higher rates, no effort to guarantee that kind of access 
to capital, and candidly, a circumstance that I do not think 
would be the goals of many at least on this side of the aisle.
    My time is running out. Can I get an extra 30 seconds since 
we are down to just us chickens?
    [Laughter.]
    Senator Warner. One of the things, as somebody who was 
along with Bob--Senator Corker, an author of Title I and Title 
II, I think this debate back and forth between Title I or Title 
VIII designation, I think both sides make valid points. Could 
you do a dual designation, recognizing that these are entities 
that have such an important purpose that they had been the 
source of past disruption in the market? Could you both do 
SIFMU and systemically important--I think you both make cases, 
I think fairly valid, for your appropriate designations. Why 
not do both?
    Mr. Pollock. I think you could, Senator. I recommended that 
a few minutes ago.
    Senator Warner. I heard you allude to that. I wanted to 
just----
    Mr. Pollock. I think you could, yes.
    Mr. Holtz-Eakin. I do not know if you can, but I see the 
point.
    Ms. Wachter. I think it would be redundant. I think the 
SIFMU status is appropriate. I think the SIFI status is 
redundant because FHFA is already in the position of overseeing 
the amount of capital, and we would have the additional 
prudential oversight of the Fed on top of that.
    Mr. Pollock. Susan, you are wrecking the consensus we are 
building here.
    Ms. Wachter. I am sorry. I feel really bad.
    [Laughter.]
    Mr. Holtz-Eakin. Well, if I could, Senator, I just want to 
be clear.
    Ms. Wachter. But I am agreeing with you. If I may, I am 
agreeing with both of you on the need for sufficient capital.
    Mr. Holtz-Eakin. Yeah.
    Ms. Wachter. For what reason would the Federal Reserve 
prudential oversight not deliver sufficient capital? I would 
like to understand why that would not happen, but I cannot 
imagine that.
    Senator Warner. Please.
    Mr. Holtz-Eakin. I just want to make sure that I was clear.
    I agree with you. You should question that any recap and 
release of the GSEs would be so fantastic that they would not 
pose some risk. I do not believe that for a second.
    I am deeply concerned of a pure recap and release. These 
were dangerous structures. They did not serve their public 
purpose well. They allowed private entities to profit at the 
taxpayer's backing. Going back to that, to me, is an anathema.
    So pure recap and release without a lot of reforms should 
be a nonstarter. I agree with that.
    Senator Warner. Although they purely are entities, and they 
are financial interests in this country who profited from the 
downturn and upturn in these issues----
    Mr. Holtz-Eakin. I promise you, they write me. I know that.
    Senator Warner ----that still advocate for that simple 
recap and release that would put us frankly back into a 
circumstance where times are good, private shareholders gain. 
Times are bad, taxpayers get stuck with the bill.
    Mr. Holtz-Eakin. I agree. That is why I would prefer to see 
something done legislatively that really does need to do this.
    Senator Warner. Some of us have tried.
    Mr. Holtz-Eakin. I know. I am just encouraging you to 
continue.
    And administratively, one of the reasons for designation is 
we are in a world of second best. What are the things that you 
can do administratively? Well, that is one.
    Senator Warner. The Chairman has given me a lot of time. I 
am just going to close. Professor Wachter, I would love to hear 
back. I understand theoretically why if you are saying if you 
had Title VIII designation, you would not need Title I 
designation. But because you have got a series of experts here 
that have a disagreement, I am not really sure what the harm 
would be of a dual designation to make sure that there was not 
any lack of ambiguity that these are extraordinarily 
significant enterprises and need all the appropriate capital 
and oversight that would be warranted.
    Thank you, Mr. Chairman, for the extra couple minutes.
    Chairman Crapo. I was glad to give you that extra 30 
seconds, Senator.
    [Laughter.]
    Chairman Crapo. Senator Brown----
    Senator Warner. If there were more folks here, I would have 
given up my time earlier.
    Chairman Crapo. I hear you. That is why I was so glad.
    Senator Brown has asked for his extra 30 seconds now too, 
and I may even follow that with my own.
    Senator Brown.
    Senator Brown. Mr. Chairman did not appreciate being called 
a chicken either.
    [Laughter.]
    Senator Brown. The position that Mr. Pollock and Dr. Holtz-
Eakin argue for to many of us, the designation would lead to 
fewer moderate- and low-income people being able to get loans. 
That is what I think a number of us think.
    So my question to the two of you is, Did either of you 
publicly oppose the designation, the de-designation of the huge 
for-profit insurance firms, AIG, Prudential, and MetLife?
    Mr. Pollock.
    Mr. Pollock. I would not, and in fact, I think they were 
not systemically important firms, but Fannie and Freddie, 
Senator, in my view, clearly are.
    Senator Brown. Dr. Holtz-Eakin.
    Mr. Holtz-Eakin. I opposed their designation, and I thought 
it was appropriate to de-designate them.
    Senator Brown. OK.
    Chairman Crapo. All right. I will follow that up with my 30 
seconds now, and I would also like to direct this to Dr. Holtz-
Eakin and Mr. Pollock. And the only reason to focus on them is, 
Ms. Wachter, you have answered this very well, and I want to 
get their perspective on this.
    It is the question about moving toward a utility model 
versus a private-sector model as we move Fannie and Freddie out 
of conservatorship.
    Senator Brown is right. There has been a fair number of 
market participants who have been before us who have 
recommended that. There is a fair number who had not, and 
issues relating to making sure that we have as much competition 
as possible, as we incentivize bringing as much private capital 
into the market as possible raise questions about how and if we 
should move to a more utility-type model. And I would just like 
each of you to comment on this notion of utility versus the 
private sector-type model.
    Mr. Holtz-Eakin. I guess I am not surprised by the support 
for that sentiment, largely because the current construct makes 
no sense.
    These have--well, we have been through this territory. You 
have to get something that is neither fish nor fowl and turn it 
into something useful.
    One of the things that Fannie and Freddie do is this MBS 
issuance and the packaging of that, and their platform is 
tremendous. And that utility function is inside them. So the 
question becomes, Do you take something which has been, quite 
frankly, gold-plated at the taxpayer's expense over the past 10 
years and simply turn it to a poly purpose? That is one route. 
Or do you somehow manage to generate genuine competition in 
that function, the guarantee and origination of these MBS, 
which would require a lot of reforms to get it done? And some 
market participants question whether the playing field would 
ever be level, given the head start that Fannie and Freddie 
have in that activity.
    So that is a tough call, but I think there is nothing, I 
think, that can be effectively done administratively. That is 
one of the reasons, I think, it is important to do a genuine 
overhaul of the housing finance system and decide where you 
want that function and how to deliver it.
    Chairman Crapo. Thank you.
    Mr. Pollock.
    Mr. Pollock. Mr. Chairman, I would say the world is full of 
different models of organization. You have corporations and 
partnerships and mutual organizations and utility structures 
and pure Government agencies like, say, Ginnie Mae, a 
Government corporation, and there are all kinds of pros and 
cons for different organizations.
    But I would say that the essential activity remains 
guaranteeing huge amounts of credit risk and the thing being 
guaranteed is leveraged real estate--as Doug and I have said 
and I think Susan agrees--in fact, the usual mother of all 
credit crises. Whatever the form is, this thing is going to be 
systemically important and systemically risky because issuing 
real estate guarantees in a highly leveraged fashion is risky, 
and there is nothing you can do to be sure that the thing will 
not collapse. That is the history of finance forever.
    So I think looking at these different organizational forms 
can be useful and interesting. Many people have argued for a 
mutual form, for example, like, say, the Federal home loan 
banks have.
    But whatever form this underlying activity takes, it is 
still going to be a systemically important and systemically 
risky thing that you are doing. Therefore, we need this 
designation, in my opinion.
    Chairman Crapo. So Senator Warner has asked for another 30 
seconds, but before I give it to him, I want to follow up on 
that just with one very quick--you can answer this very 
quickly.
    I assume that all of you are saying that whatever the form 
is that we move out of conservatorship with, that there is 
going to need to be a very strong and engaged regulator.
    One of the questions in looking at the utility-type model 
is, Does that regulator need literally the power to move to a 
utility-type model in the sense of, say, for example--and I 
want this to be a really quick answer--regulating or 
controlling the rate of return?
    I think you have already answered that, Ms. Wachter, that 
you agreed yes.
    Ms. Wachter. I have. Thank you.
    Mr. Pollock. And, therefore, you have to set prices, and 
whether anybody knows enough to set the right price is always a 
question.
    Chairman Crapo. So you are saying that that needs to be 
done?
    Mr. Pollock. Yes.
    Ms. Wachter. If I may then take a moment back, I do not 
think you need to set prices because the credit risk transfer 
market sets the price of risk, and the TBA market sets the 
price of interest rates. And when you have those two, that is 
more than 90 percent of the price right there.
    Chairman Crapo. All right.
    Dr. Holtz-Eakin.
    Mr. Holtz-Eakin. I think you have to give them more 
authorities. They do not have that right now.
    Chairman Crapo. Yeah.
    OK. Another 30 seconds, and, Senator Warner, you will be 
the last 30 seconds.
    Senator Warner. It is short. It will be actually a real 30 
seconds.
    I think there is agreement there is an extraordinarily 
important function here. It is explicitly, implicitly very 
risky. You have got to have enough capital.
    If we were to pursue--and I appreciate the Chairman's 
willingness to look at the model--around utility model, the 
notion of a utility, though, I think from an efficiency 
standpoint, you would only need one. You do not need two.
    Comments on that?
    Ms. Wachter. There is sometimes more than one utility in a 
market, and I think it does provide a bit of redundancy. I do 
not think it is harmful to have two. We could even have three. 
I just think it would become a regulatory nightmare to have 
what you really need for competition.
    Senator Warner. But you have said, Professor Wachter, that 
by the very nature, that is not going to provide competition.
    Ms. Wachter. No, no. It is not providing competition, but 
rather execution and servicing. There are alternatives. So it 
is not competition in the setting of rates, but rather 
competition in the setting of standards. We certainly do not 
want competition in rate-setting. But some competition in 
servicing and delivery is useful--borrowers may go to Fannie, 
Freddie, and the banks as alternatives. And they do compete 
from that perspective.
    Mr. Holtz-Eakin. If you go this route, I think you have 
one, and you have a very strong regulator for that, the 
utility.
    Right now it is a very strange situation that Fannie and 
Freddie essentially issuing regulations to their competitors in 
the mortgage insurance industry. This should stop.
    Mr. Pollock. Senator, I would say, in general, we know a 
monopoly is a bad idea, and I think it would be a bad idea in 
this case too. But if it is a monopoly, it is even more a SIFI 
than it was before.
    Chairman Crapo. All right. Well, thank you very much. This 
has been very interesting.
    As has been said by many of them here, we deeply appreciate 
the experience and advice that you have brought to us today, 
and we will be calling on you for further guidance and 
information as we move into this.
    For Senators who wish to submit questions for the record, 
those questions are due to the Committee by Tuesday, July 2nd, 
and as always we ask you as witnesses to respond promptly to 
those questions, as you can.
    Again, we thank you for being here. This hearing is 
adjourned.
    [Whereupon, at 11:17 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
    Today, the Committee returns its focus once again to the state of 
our housing finance system.
    We are quickly approaching the 11-year mark since the Government 
asserted control of the GSEs Fannie Mae and Freddie Mac.
    After all that time, Fannie and Freddie continue to dominate the 
mortgage market, and taxpayers remain on the hook in the event of the 
next market downturn.
    In recent weeks, FHFA Director Mark Calabria has repeatedly stated, 
quoting President Kennedy, that ``the time to repair the roof is not in 
the middle of a downpour but when the sun is shining.''
    I agree with this sentiment. We have a key opportunity right now, 
while the sun shines on our economy and mortgage markets are healthy, 
to put our housing finance system on a durable, sustainable course that 
can withstand any market cycle.
    My strong preference is for comprehensive legislation.
    However, we are also interested in analyzing some of the options 
currently available to the Administration to protect taxpayers and put 
our housing finance system on stronger financial footing.
    One of those options is for the Financial Stability Oversight 
Council, or FSOC, to designate Fannie and/or Freddie as a 
``systemically important financial institution,'' or ``SIFI'' under 
Title I of Dodd-Frank, thus subjecting them to supervision by the 
Federal Reserve and enhanced prudential standards.
    Title I of Dodd-Frank authorizes FSOC to subject nonbank financial 
companies to such supervision if it determines that material financial 
distress at a particular company could pose a threat to the financial 
stability of the United States.
    Once a designation is made, the additional tools available to the 
Fed include but are not limited to: enhanced risk-based and leverage 
capital requirements; liquidity; risk management and risk committee 
requirements; stress test requirements; and, for institutions that pose 
a grave threat to financial stability, a debt-to-equity limit.
    Section 120 of the Dodd-Frank Act also authorizes the FSOC to make 
recommendations to primary financial regulatory agencies to apply new 
or heightened standards and safeguards for a financial activity or 
practice conducted by nonbank financial companies if the FSOC 
determines that the conduct, scope, nature, size, scale, concentration, 
or interconnectedness of such activity or practice could create or 
increase the risk of significant liquidity, credit, or other problems 
spreading among bank holding companies and nonbank financial companies, 
U.S. financial markets, or low-income, minority, or underserved 
communities.
    Fannie and Freddie are clearly too big to fail. We all know it, and 
the 2008 bailout proved it.
    Today, Fannie Mae has a larger balance sheet than any financial 
institution in the United States, and the second largest balance sheet 
of any public company in the world. Freddie Mac is not far behind.
    Collectively, they hold $5.48 trillion in assets. Five thousand 
billion.
    Additionally, both companies hold far less capital, and are far 
more leveraged, than any other currently designated SIFI.
    As FHFA Director Calabria recently said, ``With a leverage ratio of 
nearly a thousand to one, their balance-sheet capital cushion is razor 
thin.''
    Trillions of dollars of Fannie and Freddie obligations are held by 
central banks across the world, and the GSEs' economies of scale, 
proprietary underwriting engines, intellectual property, special 
congressional charters, and unique role in the marketplace would be 
nearly impossible to immediately substitute in the event of a market 
downturn.
    In a 2017 speech, Federal Reserve Chairman Jerome Powell publicly 
referred to Fannie and Freddie as ``systemically important.''
    Despite these considerations, Fannie and Freddie have never 
formally been designated as SIFIs under Title I of Dodd-Frank by FSOC.
    Today we are interested in assessing the viability of a formal 
designation of the GSEs under Title I of Dodd-Frank, whether in 
conservatorship or in the event that they someday return to the private 
market as reformed entities.
    In particular, I am interested in determining: to what extent a 
SIFI designation under Title I of Dodd-Frank would result in increased 
capital levels at the GSEs that can shield taxpayers from liability in 
the event of a future market downturn; how the Fed and FHFA would 
coordinate their oversight efforts in the event of a designation under 
Title I of Dodd-Frank; and the impact a designation under Title I of 
Dodd-Frank would have on all participants in the broader mortgage 
market.
    I look forward to continuing to work with Members of this 
Committee, the Administration, and other stakeholders to finally put 
our housing finance system on durable, sustainable footing.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR SHERROD BROWN
    Thank you, Mr. Chairman, for holding this hearing and thank you to 
our witnesses for being here today.
    Home is at the center of everything we do. Whether you rent it or 
own it, home is where you raise your kids, throw birthday parties, do 
homework, and relax after a hard day's work. It also determines so much 
else about your life--what school your kids go to, how long it takes to 
get to work, your access to parks and community resources, whether 
you're exposed to lead in your walls or in your drinking water.
    For many Americans owning a home is so essential that it's become 
synonymous with the American Dream.
    But rent and housing costs are rising faster than wages. More than 
a quarter of renters spend over half their income on housing, and it's 
getting harder for working families to make that dream a reality.
    Without the stability and affordability of a long-term, fixed-rate 
mortgage, far fewer families would have a home of their own.
    That's why Congress chartered Fannie Mae more than 80 years ago at 
the height of the Great Depression--to make home ownership more 
accessible and affordable for all American families.
    And that's why Congress reaffirmed Fannie and Freddie's public 
purpose in 2008 with the Housing and Economic Recovery Act. In addition 
to enhancing accountability, that law strengthened Fannie and Freddie's 
affordable housing missions and duty to serve communities that haven't 
been given a fair shot. People of color were systematically excluded 
from sharing in this country's housing wealth for most of our history, 
and we know Americans of many backgrounds still face housing 
discrimination. Congress made clear that Fannie and Freddie must 
address inequities in our housing finance markets.
    Today's hearing asks whether Fannie Mae and Freddie Mac should be 
systemically important financial institutions.
    They play an important role in the economy today. I don't think 
there's a single person in this room who would disagree with that.
    Last year, Fannie Mae and Freddie Mac helped more than three 
million families buy or refinance their homes, and made it possible for 
another 1.5 million to find an apartment, including nearly 900,000 low- 
and very-low income renters.
    But before we decide how to regulate these important institutions, 
we should answer a fundamental question: which Fannie and Freddie are 
we talking about?
    Are we talking about the Fannie Mae and Freddie Mac of the early 
2000s, which, under a weak regulator, had spent years focusing too much 
on making profits for shareholders and too little on stable home 
ownership for hardworking families?
    Are we talking about the Fannie Mae and Freddie Mac of today, which 
are managed by a strong Federal regulator and pay all but a modest 
capital buffer back to taxpayers?
    Or are we talking about the reformed entities Congress may create 
for the future, which will have to continue Fannie and Freddie's role 
addressing the affordable housing crisis we face across the country?
    This Committee held two hearings in March where we heard from small 
lenders, consumer groups, the civil rights community, lenders, 
builders, and Realtors. We also received written statements from other 
critical participants in the housing system.
    Across those 2 days, we heard many of these folks coalescing around 
a few foundational principles for reform. They told us that any reform 
should:

    Protect access to affordable 30-year fixed-rate mortgages;

    Provide a catastrophic Government guarantee;

    Structure loan guarantors like public utilities, providing 
        a regulated rate of return;

    Serve a broad, national market;

    Serve lenders of all types and sizes equitably;

    Maintain a duty to serve all markets and all borrowers;

    Maintain affordable housing goals and metrics;

    Expand investment in affordable housing; and

    Maintain the GSEs' successful multifamily business models 
        and ensure continued or better access for financing of 
        affordable rental housing.

    This would reorient Fannie and Freddie to serve the housing needs 
of families in Cleveland and Boise, rather than maximize profits.
    It would also require a different type of oversight than we have 
for the megabanks and shadow banks that poisoned the mortgage market 
and infected our economy. Different than we have for financial 
interests that are obsessed with stock buybacks and that believe they 
have no obligation to serve the Nation that bailed them out.
    No matter how much money you make or what State you live in, 
housing is essential--and that means our housing market and the 
entities that make it work are essential. We need a housing system 
that's built to last, so that it can continue to serve all families 
across the country in good times and bad.
    Thank you, Mr. Chairman.
                                 ______
                                 
                 PREPARED STATEMENT OF ALEX J. POLLOCK
            Distinguished Senior Fellow, R Street Institute
                             June 25, 2019
    Mr. Chairman, Ranking Member Brown, and Members of the Committee, 
thank you for the opportunity to be here today. I am Alex Pollock, a 
senior fellow at the R Street Institute, and these are my personal 
views. I have spent almost five decades working in and on the banking 
and housing finance system. This included serving as President and CEO 
of the Federal Home Loan Bank of Chicago 1991-2004, and as a resident 
fellow of the American Enterprise Institute 2004-2015. I have 
personally experienced and studied numerous financial cycles, crises, 
and their political aftermaths, and have authored many articles, 
presentations, testimony, and two books on related subjects, including 
the nature of systemic financial risk.
    To begin with the essence of today's question: Are Fannie Mae and 
Freddie Mac, which guarantee half the credit risk of the massive U.S. 
housing finance sector, and which have combined assets of $5.5 
trillion, systemically important? Obviously, they are. Are they 
financial companies? Of course. So they are systemically important 
financial institutions as a simple fact.
    This is true if you consider them as two of the largest and most 
highly leveraged financial institutions in the world, but it is equally 
true if you consider them as an activity that generates systemic risk. 
Guaranteeing half the credit risk of the biggest credit market in the 
world (except for U.S. Treasury securities) is a systemically important 
and systemically risky activity. Leveraged real estate is, and has been 
throughout financial history, a key source of credit collapses and 
crises, as it was yet once again in 2007-2009. The activity of Fannie 
and Freddie is 100 percent about leveraging real estate. Moreover, they 
have been historically, and are today, themselves hyper-leveraged.
    To use the words of the Dodd-Frank Act, could Fannie and Freddie 
``pose a threat to the financial stability of the United States''? They 
have already demonstrated that they can.
    The Financial Stability Board has stated this fundamental SIFI 
characteristic: ``the threatened failure of a SIFI--given its size, 
interconnectedness, complexity, cross-border activity or lack of 
substitutability--puts pressure on public authorities to bail it out 
using public funds.''
    Fannie and Freddie displayed at the time of their 2008 failure and 
continue to display the attributes of extremely large size, 
interconnectedness, complexity, cross-border activity and lack of 
substitutability. As we all know, in 2008, U.S. public authorities not 
only felt overwhelming pressure to bail them out, but did in fact bail 
them out, with ultimately $190 billion of public funds. In addition, 
they pledged the credit support from the U.S. Treasury which protected 
and still protects Fannie and Freddie's global creditors.
    Fannie and Freddie continue to represent giant moral hazard, as 
they always have. Since they now have virtually zero capital, they are 
even more dependent on the Treasury's credit support and its implicit 
guarantee than they were before.
    That Fannie and Freddie are SIFIs in financial reality no 
reasonable person would dispute.
    Yet so far, the Financial Stability Oversight Council (FSOC) has 
not designated Fannie and Freddie as official SIFIs. To a nonpolitical 
observer, judging purely on the merits of the case, this would be 
highly surprising. FSOC's historical inaction in this instance has 
certainly not added to its intellectual credibility. To Washington 
observers, naturally, it just seems like ordinary politics.
    This hearing requires us to consider how FSOC should deal with the 
fact of Fannie and Freddie's systemic importance. Should FSOC recognize 
the reality by formally designating Fannie and Freddie as the SIFIs 
they so obviously are? Or should FSOC keep ignoring the issue?
    I believe FSOC should formally designate Fannie and Freddie as 
SIFIs and strongly recommend that action. That would be consistent with 
the clear provisions of the Dodd-Frank Act. In my opinion, the country 
needs Fannie and Freddie to be integrated into the efforts to 
understand and deal with systemic risk. Without including Fannie and 
Freddie, these efforts are woefully incomplete.
    Let us consider the SIFI factors of size, interconnectedness, 
substitutability, leverage, maturity mismatch and liquidity risk, and 
existing regulation.
Size
    In total assets, Fannie is far larger than even the biggest SIFI 
banks. The following table ranks by size the ten largest existing SIFIs 
plus Fannie and Freddie. As it shows, Fannie is bigger in assets than 
JPMorgan Chase and Bank of America, and Freddie is bigger than 
Citigroup and Wells Fargo. On this combined table of twelve huge 
financial institutions, Fannie is number 1 and Freddie is number 4.


Interconnectedness
    The obligations of Fannie Mae and Freddie Mac are widely held 
throughout the U.S. financial system and around the world. U.S. 
depository institutions hold well over $1 trillion of their securities. 
The Federal Reserve itself holds $1.6 trillion in MBS, mostly those of 
Fannie and Freddie. Could Fannie and Freddie be allowed to fail and 
impose credit losses on the Fed? Presumably not. Preferential banking 
regulations promote Fannie and Freddie, including low risk-based 
capital requirements for their MBS and debt, creating an incentive for 
depository institutions to hold large exposures to those securities. 
These low risk-based capital requirements for depository institutions 
compound the hyper-leverage of Fannie and Freddie themselves, and 
amplify their systemic risk.
    Moreover, U.S. banks are allowed to buy the equity, preferred stock 
and subordinated debt of Fannie and Freddie, and fund these investments 
with Government-insured deposits. This combination results in systemic 
double leverage.
    The interconnectedness of Fannie and Freddie's mortgage-backed 
securities and debt with the global financial system became vivid in 
2008. As then-Secretary of the Secretary Henry Paulson correctly 
judged, a default on Fannie and Freddie's obligations would have 
dramatically exacerbated the financial crisis on a global basis.
    As Paulson recounted in his memoir of the crisis, ``On the Brink'':

        ``From the moment the GSEs' problems hit the news, Treasury had 
        been getting nervous calls from officials of foreign countries 
        that were invested heavily with Fannie and Freddie. These calls 
        ratcheted up after the [2008 HERA] legislation. Foreign 
        investors held more than $1 trillion of the debt issued or 
        guaranteed by the GSEs, with big shares held in Japan, China, 
        and Russia. To them, if we let Fannie and Freddie fail and 
        their investments got wiped out, that would be no different 
        from expropriation. . . . They wanted to know if the U.S. would 
        stand behind this implicit guarantee''--and also ``what this 
        would imply for other U.S. obligations, such as Treasury 
        bonds.''

    As Fannie and Freddie reported large losses, Paulson relates that 
he instructed the Treasury staff to ``make sure that to the extent we 
can say it that the U.S. Government is standing behind Fannie Mae and 
Freddie Mac.'' In an even more revealing comment, Paulson added, ``I 
was doing my best, in private meetings and dinners, to assure the 
Chinese that everything would be all right.''
    Thanks to the overwhelming global systemic risk of not bailing them 
out, Paulson's assurance turned out to be true for all of Fannie and 
Freddie's debt and MBS holders. Even those who had bought subordinated 
debt, thereby intentionally taking more risk, were protected.
Substitutability
    Fannie and Freddie's systemic role is critical and cannot be 
replaced in the short- or medium-term--there are no substitutes. They 
play a unique, systemically central role and remain the dominant force 
in the funding of U.S. mortgages. There are no meaningful competitors 
because of their huge, ongoing risk subsidies from the Government. In 
2018, they guaranteed $917 billion in MBS. In the first quarter, 2019 
they had a 63 percent market share of MBS issuance (including Ginnie 
Mae, the Government has a 94 percent market share). Their balance 
sheets represent about half of total U.S. mortgage loans outstanding. 
Thousands of mortgage originators, servicers, domestic and 
international investors and derivatives counterparties depend on their 
continued functioning and Government-dependent solvency. This is one 
reason that the U.S. Congress has been unable to pass any legislation 
to end their conservatorship.
Leverage
    In addition to their massive size, Fannie and Freddie have 
historically displayed extreme leverage and continue to do so. As of 
March 31, 2019, their balance sheets show a combined capital ratio of a 
risible less than 0.2 percent and they are hyper-leveraged at over 500 
to 1. Of course, under the bailout agreement, the Government will not 
let them build retained earnings, but the fact of the hyper-leverage 
remains.
Maturity Mismatch and Liquidity Risk
    The American 30-year fixed-rate, freely prepayable mortgage loan is 
one of the most complex financial instruments in the world to finance 
and hedge. Unlike the fixed-rate mortgages of most other countries, the 
prepayment risk of these mortgages is not offset by prepayment fees. 
This necessitates a complex derivatives market which trades in the 
risks of prepayment behavior. Fannie and Freddie together own about 
$400 billion of mortgages in their own portfolios, on an extremely 
leveraged basis. They are major counterparties in interest rate 
derivatives and options markets. Their MBS spread the complex interest 
rate risks of American 30-year fixed-rate mortgages, while 
concentrating the credit risk of U.S. house prices, now again at an 
all-time high. The liquidity of Fannie and Freddie's securities and of 
Fannie and Freddie themselves completely depends on the implicit 
guarantee of the U.S. Treasury.
Existing Regulation
    Fannie and Freddie of course have an existing regulator, the 
Federal Housing Finance Agency (FHFA). But the FHFA is not, nor is it 
empowered to be, a regulator of the systemic risk created by Fannie and 
Freddie for the banking and financial system.
    U.S. residential mortgages constitute the largest loan market in 
the world, with $10.4 trillion in outstanding loans. The risks of this 
huge market include the holdings by banks of the MBS and debt of Fannie 
and Freddie. There are no limits on the amount of Fannie and Freddie 
obligations which can be owned by banks.
    As discussed above, the risks of Fannie and Freddie also flow into 
the banking system because banks are allowed to invest in Fannie and 
Freddie's equity on a highly leveraged basis, which creates systemic 
double leverage. In the financial crisis of 2007-2009, many banks took 
large losses and a number failed because of their exposure to Fannie 
and Freddie's preferred stock, an exposure which was encouraged by 
regulation. This is an issue the Federal Reserve, as a systemic risk 
regulator, would want to consider.
    A major systemic risk is that Fannie and Freddie are by definition 
100 percent concentrated in the risks of leveraged real estate. Indeed, 
they are by far the largest concentration of mortgage credit risk in 
the world. Leveraged real estate, needless to say, has a long and 
painful record of being at the center of banking collapses and 
financial crises.
    Fannie and Freddie's primary regulator is likewise devoted only to 
housing finance. Such a regulator always faces the temptation to become 
a cheerleader and promoter of housing and housing finance. This brought 
down the old Federal Home Loan Bank Board, abolished in 1989, and 
arguably also the Office of Thrift Supervision, abolished in 2010.
    In sum, Fannie and Freddie are huge in size, huge in risk, close to 
zero in capital, tightly interconnected to thousands of counterparties, 
and force risk on the U.S. Treasury. They meet the criteria specified 
by the Dodd-Frank Act and its implementing regulations for designation 
as a SIFI, both as institutions and considered as a systemically risky 
activity. They also meet the international criteria of the Financial 
Stability Board for designation as a Global SIFI.
    If Fannie and Freddie are not SIFIs, then nobody in the world is a 
SIFI, and if any institution is a SIFI, then so are Fannie and Freddie. 
Addressing their systemic risk through designation as a SIFI would 
logically match their systemically important role and riskiness.
Conservatorship
    In September 2008, as we know, the Federal Housing Finance Agency 
determined that Fannie and Freddie each were ``in an unsafe or unsound 
condition to transact business,'' and ``likely to be unable to pay its 
obligations or meet the demands of its creditors in the normal course 
of business.'' The Government placed them into conservatorship, and 
thus assumed ``all rights, titles, powers, and privileges of the 
regulated entity, and of any stockholder, officer, or director of such 
regulated entity with respect to the regulated entity and the assets of 
the regulated entity.''
    Conservatorship was never intended to be a perpetual status for 
Fannie and Freddie, but it continues in its 11th year, an outcome 
altogether unintended and undesired.
    Should designating Fannie and Freddie as SIFIs be delayed because 
they are in conservatorship? The answer, it seems to me, is clearly No. 
They are just as systemically important and systemically risky in 
conservatorship as out of it. They create just as much or more moral 
hazard. The Conservator cannot manage their systemic risk. Indeed, 
because of the ``net worth sweep'' deal between the Treasury and the 
FHFA as Conservator, Fannie and Freddie are even more highly leveraged 
than before. Meanwhile, under the Conservator, they continue to expand 
mortgages with high debt service to income ratios, another form of 
increased leverage.
The Federal Reserve as Additional Regulator
    If--I hope it is when--Fannie and Freddie are formally designated 
as the SIFIs they economically are, the Federal Reserve will become an 
additional, systemic risk regulator for them. This seems to me a good 
idea, since the Fed is the best placed of all existing regulatory 
agencies to consider the risks Fannie and Freddie pose from the view of 
the financial system as a whole. Of course, the statute assigns this 
responsibility to the Fed for all SIFIs. If you don't like this outcome 
of SIFI designation, should you therefore claim that Fannie and Freddie 
are not SIFIs?
    Suppose we grant that the Fed, like everybody else, has numerous 
shortcomings. That does not mean that Fannie and Freddie are not SIFIs. 
Let us concede that the Fed, like everybody else, is far from perfect. 
It should still take on, as the only available authorized actor, the 
essential task of understanding and addressing what Fannie and Freddie 
are doing to systemic risk.
    Of course, Fannie and Freddie already have a primary regulator, but 
so do all other SIFIs. That the FHFA regulates Fannie and Freddie is no 
more an argument against their being SIFIs than the fact that the 
Comptroller of the Currency regulates national banks would prevent 
banks from being SIFIs.
    The Fed should be able to consider, and should consider, for such 
``large, interconnected financial institutions,'' in the words of the 
Dodd-Frank Act, ``establishment and refinement of prudential standards 
and reporting and disclosure requirements . . . taking into 
consideration their capital structure, riskiness, complexity, financial 
activities . . . size, and any other risk-related factors.''
    For example, the Fed might usefully consider with respect to Fannie 
and Freddie such questions as:

    Whether their capital requirements and their leverage cause 
        capital arbitrage and thereby increased risk in the financial 
        system as a whole.

    Whether the same risks should be capitalized in the same 
        way between private financial institutions and Fannie and 
        Freddie.

    How Fannie and Freddie's concentration in leveraged real 
        estate risk affects the risk of the financial system.

    How or whether Fannie and Freddie's activities contribute 
        to house price inflation and thereby reduce housing 
        affordability.

    Whether their heavy concentration in California mortgages 
        amplifies earthquake risk.

    How much banking regulations which favor Fannie and Freddie 
        increase the riskiness of banks.

    Whether the double leverage in the financial system created 
        by allowing banks to invest in Fannie and Freddie's equity 
        makes sense.

    Whether Fannie and Freddie's market dominance decreases or 
        increases systemic risk.

    How much risk is being pushed on the Treasury and the 
        taxpayers by Fannie and Freddie, at what economic cost.

    I believe is that the Fed as systemic risk regulator of Fannie and 
Freddie would be a force for sound and well-capitalized housing 
finance, which would be better understood in the context of its 
interaction with the rest of the banking and financial system. That 
should be everybody's goal.
Concluding Questions and Answers
    Are Fannie and Freddie SIFIs? Yes, without a doubt.
    Do Fannie and Freddie cause systemic financial risk? Yes.
    Is the Federal Reserve a reasonable place to try to understand and 
address the systemic risks? Yes.
    Should FSOC recognize these facts by formally designating Fannie 
and Freddie as SIFIs? Yes.
    When? The sooner, the better.
    Thank you again for the chance to share these views.
                                 ______
                                 
               PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
                    President, American Action Forum
                             June 25, 2019
    Chairman Crapo, Ranking Member Brown, and Members of the Committee, 
thank you for the privilege of appearing today to share my views on 
whether Fannie Mae and Freddie Mac (the housing Government Sponsored 
Enterprises, or GSEs) should be designated as systemically important 
financial institutions (SIFIs). I wish to make three main points:

    There appears to be increased momentum toward reforms that 
        would permit the GSEs to leave conservatorship;

    Fannie Mae and Freddie Mac are engaged solely in an 
        activity--real estate lending--that historically is central to 
        bank failures and financial crises; they are uniquely suited 
        for designation as SIFIs; and

    There may be a regime of administrative reforms involving 
        greater capital, restrictions on portfolio investment, and 
        credit risk transfers (CRTs) that may prove to be a workable 
        substitute for SIFI designation.

    Let me elaborate on each in turn.
    Both Congress and the Trump administration continue to explore GSE 
reform. The Committee Chairman has released an outline of components of 
legislative reform. \1\ In March, the Trump administration formally 
joined the GSE reform conversation. The president issued a memo to the 
Departments of the Treasury and of Housing and Urban Development (HUD) 
directing both to develop plans for GSE reform that is possible without 
congressional action. \2\ In particular, the White House memo lays out 
the goal of ``ending the conservatorships of the GSEs upon the 
completion of specified reforms.'' Treasury and HUD are each expected 
to submit plans to the White House in the near future.
---------------------------------------------------------------------------
     \1\ https://www.banking.senate.gov/imo/media/doc/
Housing%20Reform%20Outline.pdf
     \2\ https://www.whitehouse.gov/presidential-actions/memorandum-
federal-housing-finance-reform/
---------------------------------------------------------------------------
    The goal of ending conservatorship for Fannie Mae and Freddie Mac 
is significant because it is only in this scenario that the question of 
their SIFI status arises. Statements by the Administration, including 
Federal Housing Finance Agency (FHFA) Director Mark Calabria, suggest 
that, contingent upon reforms, the most likely exit strategy will be 
``recap and release,'' whereby the GSEs are appropriately capitalized 
(likely by amending their net profit sweep to Treasury and possibly by 
some form of public offering) and then returning Fannie Mae and Freddie 
Mac to the market as fully private entities.
    As private entities, the GSEs are engaged solely in a very risky 
activity--guaranteeing the performance of real estate loans. Indeed, 
some see real estate lending as the most significant driver--almost the 
definition--of systemic risk itself. As recent papers by Oscar Jorda, 
Moritz Schularick, and Alan Taylor for the National Bureau of Economic 
Research (NBER) have shown, crises can usually be defined as the rising 
leverage of banks concentrated in real estate lending. \3\ Charles 
Calomiris, a professor at the Columbia Business School, has noted since 
well before the previous financial crisis that the use of short-term 
debt with procyclical pricing to finance risky and usually illiquid 
real estate assets is particularly vulnerable to systemwide shock. \4\ 
This relationship was considered so particularly fraught with danger 
that prior to 1913, nationally chartered banks were prohibited from 
holding any real estate at all.
---------------------------------------------------------------------------
     \3\ https://www.nber.org/papers/w16567
     \4\ https://www.aei.org/wp-content/uploads/2018/06/Calomiris-Chen-
2018_September-2018-RFS-Submission-Version.pdf
---------------------------------------------------------------------------
    The GSEs not only participate in a systemically risky activity--
they dominate it. As the chart below shows, during the precrisis years 
(2000-2006) the GSEs accounted for an average of 40 percent of the 
origination market, and closer to 30 percent in the 3 years immediately 
prior to the crisis. During and immediately after the financial crisis 
(2007-2013), the GSEs accounted for, on average, 62 percent of the 
market, at a time when the GSEs and Government loans were the only 
source of credit in the market.
    More worrying, however, this data shows that in recent years GSE 
market share of the origination market has remained near 50 percent, a 
level considerably higher than precrisis levels. In 2018, the GSEs 
acquired 50 percent of all newly originated single-family loans, and 47 
percent of all multifamily loan originations. Prior to conservatorship, 
the GSEs' share of the first lien origination volume was roughly 32 
percent. \5\ Today, that number is closer to 45 percent, and with 
Federal Housing Administration (FHA) and Department of Veterans Affairs 
(VA) loans included, that number is closer to 70 percent. With the 
private-label mortgage-backed securities market largely nonexistent, 
the mortgage market is almost entirely dependent on Government 
agencies.
---------------------------------------------------------------------------
     \5\ https://www.urban.org/research/publication/housing-finance-
glance-monthly-chartbook-may-2019/view/full_report


    Finally, Fannie Mae and Freddie Mac continue to be risky, too-big-
to-fail institutions. By the end of 2007, they had a combined leverage 
ratio of 75 to 1; what the GSEs' leverage ratio will be when they exit 
conservatorship remains to be seen. It seems likely, however, that 
little will be changed from when I wrote my dissenting statement to the 
Financial Crisis Inquiry Commission's report: ``As large financial 
institutions whose failures risked contagion, they were massive and 
multidimensional cases of the too big to fail problem.'' \6\
---------------------------------------------------------------------------
     \6\ http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/
fcic_final_report_hennessey_holtz-eakin_thomas_dissent.pdf
---------------------------------------------------------------------------
    Fannie Mae and Freddie Mac were put into conservatorship because 
they were deemed too big to fail, the very concept that underpinned the 
creation of the SIFI designation. Thus, we would automatically expect 
the GSEs released from conservatorship to be considered SIFIs.
    In the aftermath of the 2007-2008 financial crisis, Congress 
enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank). Title I, Subtitle A, of Dodd-Frank established a new 
body, the Financial Stability Oversight Council (FSOC), with statutory 
responsibilities to ensure the safety and soundness of the financial 
system at large. \7\ The key tool in FSOC's toolbox is the designation 
of financial institutions as SIFIs. Because banking companies with over 
$50 billion in assets are automatically considered SIFIs in Dodd-Frank, 
the key issues involving designation revolved around nonbanks.
---------------------------------------------------------------------------
     \7\ https://www.congress.gov/111/plaws/publ203/PLAW-111publ203.pdf
---------------------------------------------------------------------------
    Specifically, Section 113 of Dodd-Frank gives FSOC the authority by 
two-thirds vote (including the chairperson) to bring a nonbank 
financial company under increased supervision and regulation by the 
Federal Reserve Board (FRB) if FSOC determines that ``material 
financial distress at the U.S. nonbank financial company, or the 
nature, scope, size, scale, concentration, interconnectedness, or mix 
of the activities of the U.S. nonbank financial company, could pose a 
threat to the financial stability of the United States.'' \8\ In making 
that determination, Dodd-Frank lists 10 criteria for FSOC to consider, 
but also allows FSOC to consider ``any other risk-related factors that 
the Council deems appropriate.'' \9\ As such, FSOC has very broad 
statutory authority when evaluating companies for SIFI designation.
---------------------------------------------------------------------------
     \8\ 12 U.S.C. 5323 (a)(1).
     \9\ 12 U.S.C. 5323 (a)(2)(K).
---------------------------------------------------------------------------
    Because Dodd-Frank gives FSOC such expansive authority to set the 
specific determinants of a SIFI designation, FSOC's operational 
procedures have largely been set through the regulatory rulemaking 
process. FSOC announced in March 2019 that it would change its SIFI 
designation criteria to focus on systemically risky activities. This 
policy shift is still at the stage of request for comment from 
stakeholders, and there is little to suggest which activities FSOC will 
identify for consideration first. As noted, however, guaranteeing the 
performance of mortgages should be high on any list.
    Once designated, SIFIs fall under increased supervision and 
regulation by the FRB--with higher capital requirements, liquidity 
requirements and the requirement to undergo annual stress testing. The 
impact of these additional requirements is clear: SIFIs must set aside 
more capital, significantly increase compliance staff, and increase 
technology and data capture processing. As a result, SIFI designation 
is a significant cost.
    In my view, it is difficult to see how the GSEs postconservatorship 
could be anything but SIFIs. For some, however, explicit designation 
has the downside of having FSOC move away from banking, something that 
produced difficulties in as closely related a field as insurance. It 
would require the FRB, with zero housing experience, to become the 
primary regulator. Would the FRB be more effective than the FHFA, 
formed in 2008 for that very purpose? Others have pointed out that the 
conflict of interest inherent in being both central banker that sets 
interest rates and regulator of the banking system would only be 
exacerbated by having the housing finance industry also within the FRB 
purview.
    From this perspective, the question is whether there is a potential 
alternative regime that the FHFA could impose to dissuade FSOC from 
designating the GSEs as SIFIs. This would require important regulatory 
(and/or legislative) reforms in order to ensure they are not the 
housing market force that they were before--and during--
conservatorship.
    Perhaps there is such a regime, although I am not entirely 
confident. At least three elements would seem to be essential to such a 
regime. The first would be SIFI-like capital requirements, above-and-
beyond those that might normally emerge from an FHFA rulemaking 
process, that would absorb the risk and provide the buffer against 
systemic exposures.
    The second would be to ``de-risk'' the basic guarantee business of 
the GSEs dramatically. By process of elimination, the only candidates 
able to absorb additional risk are capital market participants. One 
might imagine an aggressive and effective credit risk transfer regime 
that relieved the GSEs of risk. The FHFA has already established 
guidelines governing single-family credit risk sharing by the GSEs. 
Unfortunately, under the current arrangements, the GSEs retain the 
first-loss position and credit risk transferees participate in a 
mezzanine structure put in place 3-9 months after a loan is acquired. A 
simpler way to have the GSEs reduce their risk exposure could be by 
implementing a policy similar to private mortgage insurance, in which 
the loan-level coverage is put in place at origination. This approach 
would be more effective in transferring risk; it would also have to be 
used more extensively.
    Finally, the GSEs should clearly be prohibited from holding 
portfolios for investment purposes. In 2007-2008 the dangers of the 
guarantee business were compounded by large portfolios of mortgage-
backed securities--essentially large monoline hedge funds with too 
little capital and no public purpose.
    There may be other elements as well. The most important requirement 
is to ensure that any future private-sector GSE bears little structural 
resemblance to the historic Fannie Mae and Freddie Mac that served this 
Nation so poorly.
    Thank you, and I look forward to your questions.
                                 ______
                                 
                 PREPARED STATEMENT OF SUSAN M. WACHTER
Sussman Professor of Real Estate and Professor of Finance, The Wharton 
                School of the University of Pennsylvania
                             June 25, 2019
    Chairman Crapo, Ranking Member Brown, and other distinguished 
Members of the Committee, thank you for the invitation to testify at 
today's hearing, ``Should Fannie Mae and Freddie Mac Be Designated as 
Systemically Important Financial Institutions?'' I am the Sussman 
Professor of Real Estate and Professor of Finance at The Wharton School 
of the University of Pennsylvania. Together with coauthors, I have 
researched and written scholarly papers on the stability of the housing 
finance system. Recent papers, from which this testimony is drawn, are 
listed at the end of this statement. It is an honor to be here today to 
discuss the role of the Federal Stability Oversight Council in the 
prevention of systemic crises derived from the mortgage market.
    The Financial Stability Oversight Council (FSOC) has a statutory 
mandate to identify risks and respond to threats to financial 
stability. As is evident from the severe financial crisis that led to 
the Great Recession of 2009, mortgage markets can disrupt stability and 
have done so in the past. Regulatory oversight and the structure of the 
housing finance system will be instrumental in determining the 
likelihood of a repeat of the crisis. Collective oversight of all 
entities providing mortgages, which the FSOC is uniquely positioned to 
accomplish, is a necessary component of this oversight.
    My comments today, based on my writings in this area, will address 
why there is a need for such a systemwide oversight. I will also 
comment on the specific question: ``Should Fannie Mae and Freddie Mac 
be designated as Systemically Important Financial Institutions?'' What 
is important is that this sector is overseen for its potential to 
undermine macroeconomic stability. I also believe for reasons that I 
will explain that the correct oversight for the GSEs is that they be 
designated, if and when they are privatized, not as SIFIs but as 
Systemically Important Financial Market Utilities (SIFMUs).
    Under Section 113 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank), FSOC is authorized to designate nonbank 
financial institutions as systemically important. In addition, under 
Section 804 of the Dodd-Frank, FSOC is responsible for the designation 
of financial market utilities that the Council determines are, or are 
likely to become, systemically important, that is, SIFMUs.
    In addition, Section 803 of Dodd-Frank clarifies a disruption to a 
SIFMU as being a situation ``where the failure of or a disruption to 
the functioning of a financial market utility . . . could create, or 
increase, the risk of significant liquidity or credit problems 
spreading among financial institutions or markets and thereby threaten 
the stability of the financial system of the United States.''
    I believe a SIFMU designation is the correct designation because 
the GSEs provide a structural foundation to the secondary mortgage 
market. The GSEs are characterized by the considerations established 
for the SIFMU designation--that is, the aggregate value of transactions 
processed by the financial market utility, the aggregate exposure of 
the financial market utility, the relationship, interdependencies, or 
other interactions of the financial market utility, and the effect that 
the failure of or a disruption to the financial market utility would 
have on critical markets, financial institutions, or the broader 
financial system. All four of these characterize the GSEs.
    In the years after the crisis, under the direction of the FHFA (the 
independent Federal agency, established through the Housing and 
Economic Recovery Act--HERA--as the successor to OFHEO, responsible for 
supervision, regulation, and housing mission oversight of the GSEs and 
Federal Home Loan banks), the GSEs have undergone substantial reform. 
They have wound down their portfolios, increased transparency, and de-
risked through tighter credit standards and risk sharing. In 2012, the 
FHFA called for the GSEs to implement, which they have, credit-risk 
transfer (CRT) programs to allocate risk to the private sector, to help 
insure correct pricing of credit risk, and to minimize taxpayer 
exposure. Fannie Mae and Freddie Mac have issued CRTs with returns tied 
to the performance of the GSEs' loan pools, hence enabling a private 
sector pricing of risk, with transparency. Additionally, the GSEs have 
developed a common security platform to ensure liquidity for the 
trading of MBS and interest rate risk. While the GSEs are now less 
risky, the lack of equity capital to absorb losses leaves taxpayers 
still exposed to credit risk. In order to address the need for equity 
capital, so-called recap and release proposals have been put forth 
which would enable the GSEs to raise private capital to reduce further 
taxpayer risk and end the conservatorship of the GSEs.
    Various plans have been proposed for the GSEs' restructuring, 
including multiple guarantors. I have set forth comments, along with 
coauthors Richard Cooperstein, Head of Risk Management at Andrew 
Davidson and Company, and Ken Fears, Senior Policy Representative for 
Banks, Lending, and Housing Finance at the National Association of 
REALTORS, on the increased risk to the system of a multi-guarantor 
model, in part because the regulatory burden of overseeing the safety 
and soundness of multiple guarantors increases tremendously. Moreover, 
as Moody's recently opined, increasing the number of GSEs could lead to 
weaker underwriting standards or price competition, both credit 
negatives for the GSEs and ultimately for the taxpayer.
    The key functions of the GSEs are to set standards and to provide 
transparency for the secondary mortgage market. The source of the 
crisis was the undermining of these standards, and as I have shown 
along with coauthors in a recent paper referenced below, the 
underpricing of risk, which led to an unsustainable expansion of bad 
credit.
    With the oversight of the FHFA and with a SIFMU designation, the 
GSEs are in a position to maintain these functions going forward. In 
particular, the FHFA can provide oversight on the maintenance of 
sufficient capital reserves. But the FHFA alone cannot provide the 
collective oversight of the entities that comprise the mortgage market. 
To this end, I respectfully propose that the FSOC consider the 
designation of Fannie Mae and Freddie Mac as SIFMUs. The SIFMU 
designation can support macrostability while enabling the GSEs to 
provide access to sustainable mortgage credit over the long term.
    I thank you for the opportunity to testify today. I welcome your 
questions.
References
Cooperstein, Richard, Ken Fears, and Susan M. Wachter, ``A Vision for 
    Enduring Housing Finance Reform''. The National Association of 
    REALTORS, February 2019, available at: https://www.nar.realtor/
    sites/default/files/documents/2019-Working-Paper-A-Vision-For-
    Enduring-Housing-Finance-Reform.pdf.
Levitin, Adam J., Desen Lin, and Susan M. Wachter, ``Mortgage Risk 
    Premiums During the Housing Bubble''. Journal of Real Estate 
    Finance and Economics, January 2019, available at: https://
    link.springer.com/article/10.1007/s11146-018-9682-z.
Wachter, Susan M. ``Credit Risk, Informed Markets, and 
    Securitization''. Economic Policy Review, Vol. 24, No. 3, March 
    2019, 5-62, available at: https://www.newyorkfed.org/research/epr/
    2018/epr_2018_crt-informed-markets_wachter.html.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                      FROM ALEX J. POLLOCK

Q.1. As you know, Congress and the Administration are 
determining how to reform the housing finance system. If 
successors to Fannie Mae and Freddie Mac were no longer 
shareholder-owned entities, how would that effect your 
recommendations? What regulatory framework would you recommend 
if the successors were:
    A single Government corporation?
    A shareholder-owned public utility?
    A mutually owned entity?

A.1. In my opinion, Fannie Mae and Freddie Mac would be 
systemically important, systemically risky, and without 
question be SIFIs under Title I of the Dodd-Frank Act, no 
matter what their ownership structure might be. That is true 
with their current ownership in which the Government has the 
majority of the equity and private shareholders a minority, and 
I believe that FSOC should promptly designate them as the SIFIs 
they obviously are. It would also be true if Fannie and Freddie 
were a single Government corporation, a shareholder-owned 
public utility, or a mutually owned entity or entities. They 
would be systemically important financial institutions, 
carrying out an activity which is systemically highly risky, in 
each case.

Q.2. Do you think it's appropriate for Government entities like 
the FDIC, the Federal Home Loan Banks, or the Federal Reserve 
Banks to be designated and regulated as SIFIs?

A.2. If they are systemically important and systemically risky, 
I believe Government entities can be SIFIs, yes. One of the 
hardest things for the Government to do is to address the 
systemic risk created by itself, and the Government creates a 
lot of systemic financial risk. Thinking about whether various 
Government entities qualify as SIFIs would be a productive 
effort.
    In the case of the Federal Home Loan Banks, they are 100 
percent owned by private shareholders, so I would say that the 
category, ``Government entities'' does not apply. They are of 
course, ``Government-sponsored entities.''
    As the question suggests, the FDIC is part of the 
Government. Although it does create major moral hazard, and 
Government insurance corporations can demonstrably become 
insolvent, the FDIC is not an active credit risk taker and I do 
not think it qualifies as a SIFI.
    The Federal Reserve is a special case. Not the individual 
Federal Reserve Banks, but the Federal Reserve System as a 
whole, may fairly be viewed as the biggest SIFI of them all. 
But since being designated a SIFI means your systemic risk 
regulator becomes the Federal Reserve, the designation would 
not achieve anything. As Senator Bunning once asked the 
Chairman of the Federal Reserve, ``How can you regulate 
systemic risk when you are the systemic risk?''

Q.3. In July 2018, the FHFA proposed capital requirements for 
Fannie Mae and Freddie Mac. Would the rule as proposed require 
the Enterprises to maintain enough capital?

A.3. In my opinion, it would not. I believe that Fannie and 
Freddie's minimum capital requirements should be the same for 
taking the same risk as those for every other Too Big To Fail 
SIFI, so there is a single systemic capital standard for 
mortgage credit. For prime mortgage credit risk, the global 
standard capital requirement is 4 percent of assets. I believe 
that 4 percent should be Fannie and Freddie's minimum leverage 
capital requirement.
    Like every other TBTF SIFI, Fannie and Freddie should also 
have a risk-based capital standard, and have to hold the higher 
of the two requirements. If Fannie and Freddie take on large 
amounts of riskier mortgage credit, as they have done in the 
past, their risk-based capital standard should move above 4 
percent, but 4 percent should be the starting point. This means 
their aggregate equity capital requirement, at 4 percent of 
$5.5 trillion, would be about $220 billion. I think this a fair 
and systemically sensible number.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                    FROM DOUGLAS HOLTZ-EAKIN

Q.1. As you know, Congress and the Administration are 
determining how to reform the housing finance system. If 
successors to Fannie Mae and Freddie Mac were no longer 
shareholder-owned entities, how would that effect your 
recommendations? What regulatory framework would you recommend 
if the successors were:
    A single Government corporation?

A.1. For Fannie Mae and Freddie Mac to have successors would 
require that the GSEs be wound-up. Although GSE reform is of 
vital concern it is difficult to envisage a world in which 
Fannie and Freddie do not play a role, such is their market 
penetration. In any event, for a provider of mortgage-backed 
securities to no longer be owned by shareholders (a scenario 
that appears to apply to only one of the three scenarios below) 
imagines a regulatory framework where secondary mortgage market 
activities are performed entirely by Government agencies. To my 
mind this would hardly be the worst reform path for the GSEs. 
For over a decade the GSEs have acted as de facto agencies 
playing an active role in modifying mortgages and other 
policies. Recognizing this fact is preferable to either doing 
nothing or releasing privatized GSEs back into a marketplace 
they have unfairly dominated and would continue to dominate 
with less oversight.
    Insofar as a Government corporation (such as the FDIC, or 
even the U.S. Postal Service) provides market-oriented public 
services with a view to producing revenues that only cover 
expenditures, this model would have several advantages over the 
current status quo. First, it would strip the GSEs of their 
corporate aspects, including presumably shareholder ownership, 
recognizing the GSEs as the public bodies the advantages of 
which they currently enjoy. Second, a pricing structure that 
simply covers cost would presumably eliminate the need for 
either the net profit sweep or the line of credit to Treasury.

Q.2. A shareholder-owned public utility?

A.2. Any entity that is both ``public'' and ``shareholder-
owned'' would appear to have the same murky legal position of 
the GSEs as currently formed. The utility model would allow the 
GSEs to make regulated returns and restore their capital, 
putting them in a better capital position in the event of the 
next financial crisis. Such an entity would however also have a 
legal duty to its shareholders to provide a rate of return. The 
difference between this and full privatization would appear to 
be that full privatization would both allow for and promote 
effective competition in this space; competition which would 
serve to drive down prices and improve services for consumers. 
It is also worth noting that the utility model, something of an 
aberration, sprung from the severe up-front infrastructure 
requirements that would be required to provide the services, an 
argument more difficult to make for the GSEs, particularly with 
a dearth of other financial services utilities.

Q.3. A mutually owned entity?

A.3. The only distinction between a mutually owned company and 
a publicly traded secondary mortgage market participant is that 
a mutually owned company is owned solely by the consumers of 
the services it provides. Given the market penetration of the 
GSEs this would still likely be most Americans. One advantage 
to the mutual structure would be that mutuals are not typically 
profit-maximizing structures. Mutuals however usually have a 
very limited focus or suite of products and operating the GSEs 
as a mutual may provide logistical challenges. Such a structure 
of course would have no statutory obligation to meet Government 
targets including affordable housing.

Q.4. Do you think it's appropriate for Government entities like 
the FDIC, the Federal Home Loan Banks, or the Federal Reserve 
Banks to be designated and regulated as SIFIs?

A.4. Designation by the FSOC as a SIFI of course only applies 
to financial institutions that are publicly traded 
corporations. The system as currently designed does not 
encompass any of the aspects of Government, even those 
providing market-oriented public services. To rebuild the FSOC 
designation process to include such bodies would be a 
significant undertaking that would raise many difficult 
questions including who would regulate the Federal Reserve 
Banks, themselves the regulators of SIFIs. Appropriate 
oversight and control over these bodies is exerted via the 
Federal budgetary and appropriations process.

Q.5. In July 2018, the FHFA proposed capital requirements for 
Fannie Mae and Freddie Mac. Would the rule as proposed require 
the Enterprises to maintain enough capital?

A.5. The proposed Enterprise Capital Rule is in large part a 
hypothetical exercise, as it is impossible to appropriately 
assess the capital requirements of the GSEs postconservatorship 
while they remain in conservatorship. The recapitalized 
Enterprises will presumably have entirely different charters 
and mandates; they will have fundamentally different balance 
sheets and risk appetites, both of which will drive significant 
differences in pricing structures.
    Noting that, I have concerns with both of the proposed 
capital calculations. The 2.5 percent minimum leverage ratio 
put forward by one aspect of the proposal appears low by 
comparison to the 5 percent minimum applied to community banks, 
which have fundamentally less risky business models, let alone 
the capital requirements that apply to the SIFIs, ranging from 
12 to 18 percent. Significant legislative efforts in Congress 
(both the Johnson-Crapo initiative and the Corker-Warner bill) 
fixed on 10 percent as being the appropriate gauge. How then to 
justify 2.5 percent? The second model would require the 
Enterprises to hold capital equal to 1.5 percent of trust 
assets and 4 percent of nontrust assets. Although this would 
require the Enterprises to hold significantly more capital than 
the 45 basis points required by the 1992 Federal Housing 
Enterprises Financial Safety and Soundness Act, it would still 
mean pinning capital requirements to the same law that governed 
the Enterprises going into the financial crisis; in addition, 
such a system would allow the Enterprises to ``game'' the 
system in asset definition.
    More broad concerns remain--Capital requirements are by 
nature procyclical, which is difficult to square with the 
countercyclical mandate of the Enterprises. In addition, the 
FHFA's proposal, does not expressly consider the systemic 
nature of the Enterprises at all. Further, the FHFA presents a 
conflicted message on asset diversification, noting that while 
the monoline nature of the Enterprises' business is, in the 
view of the FHFA, a positive feature with regard to capital 
standard setting, at the same time diversity is attractive when 
it comes to counterparty risk. How can both approaches be 
valid?
    A more extensive answer to this question can be found in my 
comments for the record that I submitted to the FHFA, which can 
be found at the following link: https://
www.americanactionforum.org/comments-for-record/enterprise-
capital-requirements/.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
                     FROM SUSAN M. WACHTER

Q.1. As you know, Congress and the Administration are 
determining how to reform the housing finance system. If 
successors to Fannie Mae and Freddie Mac were no longer 
shareholder-owned entities, how would that effect your 
recommendations? What regulatory framework would you recommend 
if the successors were:
    A single Government corporation?
    A shareholder-owned public utility?
    A mutually owned entity?

A.1. My recommendations would be unchanged in the cases of (b) 
and (c) since I believe a mutually owned utility would operate 
substantially like a shareholder-owned public utility. A single 
Government corporation need not be a SIFMU, as it would be 
directly overseen by the Government and would not have 
shareholders, without regard to the longrun stability of the 
system. It is the profit-maximizing behavior of private 
corporations that serve the shareholder which may undermine the 
future solvency of the entities, to prevent which SIFMU 
oversight would be necessary.

Q.2. Do you think it's appropriate for Government entities like 
the FDIC, the Federal Home Loan Banks, or the Federal Reserve 
Banks to be designated and regulated as SIFIs?

A.2. No, as I indicated in my testimony. \1\
---------------------------------------------------------------------------
     \1\ See Pp. 30-31 of the hearing transcript.

Q.3. In July 2018, the FHFA proposed capital requirements for 
Fannie Mae and Freddie Mac.
    Would the rule as proposed require the Enterprises to 
maintain enough capital?

A.3. Yes, the proposed rule would be sufficient.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA
                     FROM SUSAN M. WACHTER

Q.1. If the Government sponsored enterprises were to be 
designated as systemically important financial institutions 
(SIFIs), what kind of impact would SIFI capital and regulatory 
standards have on Fannie Mae and Freddie Mac's ability to 
provide affordable housing finance for low- and moderate-income 
borrowers?

A.1. While I have not specifically studied this question, a 
higher capital standard would require more reserving and would 
likely impact the G-fee, that is the GSEs' guarantee fee, and 
therefore the rate charged to borrowers. This would especially 
have an impact on borrowers if the GSEs were to impose the 
higher cost of capital onto all borrowers rather than to cross-
subsidize the pool to achieve a socially optimal outcome. In 
the utility approach that I with others have put forth, the 
requisite capital for stability for the GSEs would be less than 
otherwise. \1\
---------------------------------------------------------------------------
     \1\ See Richard Cooperstein, Ken Fears, and Susan Wachter, ``A 
Vision for Enduring Housing Finance Reform'', The National Association 
of REALTORS, February 7, 2019.

Q.2. Do you see a meaningful difference in the overall impact 
on affordability between a Title I and a Title VIII SIFI 
---------------------------------------------------------------------------
designation?

A.2. Yes, I do, because a SIFMU designation would go along with 
a utility, which would substantially reduce the cost of 
capital.
              Additional Material Supplied for the Record
        LETTER SUBMITTED BY THE AMERICAN LAND TITLE ASSOCIATION
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]