[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
BUILDING A SUSTAINABLE HOUSING
FINANCE SYSTEM: EXAMINING REGULATORY
IMPEDIMENTS TO PRIVATE INVESTMENT CAPITAL
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
APRIL 24, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-16
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80-882 WASHINGTON : 2013
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
C O N T E N T S
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Page
Hearing held on:
April 24, 2013............................................... 1
Appendix:
April 24, 2013............................................... 49
WITNESSES
Wednesday, April 24, 2013
Hughes, Martin S., Chief Executive Officer, Redwood Trust, Inc... 10
Katopis, Chris J., Executive Director, Association of Mortgage
Investors (AMI)................................................ 8
Kling, Arnold, member, Mercatus Center Financial Markets Working
Group.......................................................... 13
Millstein, James E., Chief Executive Officer, Millstein & Co..... 11
APPENDIX
Prepared statements:
Hughes, Martin S............................................. 50
Katopis, Chris J............................................. 61
Kling, Arnold................................................ 80
Millstein, James E........................................... 85
Additional Material Submitted for the Record
Foster, Hon. Bill:
Written responses to questions submitted to Martin S. Hughes. 113
Written responses to questions submitted to Chris J. Katopis. 114
Written responses to questions submitted to Arnold Kling..... 116
Written responses to questions submitted to James E.
Millstein.................................................. 118
Hurt, Hon. Robert:
Written statement of the Securities Industry and Financial
Markets Association (SIFMA)................................ 120
Stivers, Hon. Steve:
Study by Douglas Holtz-Eakin, Cameron Smith, and Andrew
Winkler of the American Action Forum entitled, ``Regulatory
Reform and Housing Finance: Putting the `Cost' Back in
Benefit-Cost,'' dated October 2012......................... 130
BUILDING A SUSTAINABLE HOUSING
FINANCE SYSTEM: EXAMINING
REGULATORY IMPEDIMENTS TO
PRIVATE INVESTMENT CAPITAL
----------
Wednesday, April 24, 2013
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:04 a.m., in
room 2128, Rayburn House Office Building, Hon. Jeb Hensarling
[chairman of the committee] presiding.
Members present: Representatives Hensarling, Royce, Capito,
Garrett, Neugebauer, McHenry, Campbell, Pearce, Posey,
Fitzpatrick, Luetkemeyer, Huizenga, Duffy, Hurt, Grimm,
Stivers, Fincher, Stutzman, Mulvaney, Hultgren, Ross,
Pittenger, Wagner, Barr, Cotton, Rothfus; Waters, Maloney,
Velazquez, Watt, Sherman, Meeks, Capuano, Clay, Scott, Green,
Cleaver, Himes, Peters, Carney, Sewell, Foster, Kildee, Murphy,
Delaney, Sinema, Beatty, and Heck.
Chairman Hensarling. The committee will come to order.
Without objection, the Chair is authorized to declare a
recess of the committee at any time.
Before we begin our hearing, I would like to take a moment
to introduce the newest member of our committee. Keith Rothfus
is a freshman Member representing the 12th District of
Pennsylvania. He is an attorney with a law degree from the
Notre Dame Law School, and a background in business law. He
worked for the Department of Homeland Security from 2006 to
2007, and earned his BA from SUNY Buffalo. We are very happy to
have him officially join our committee today.
And I am sorry you won't get recognized today to speak at
your first hearing.
We will now turn to opening remarks. The Chair will
recognize himself for 4\1/2\ minutes. This is the 7th full or
subcommittee hearing that we have had on the topic of forging a
new sustainable housing policy for America, one that is
sustainable for homeowners, taxpayers, and our economy.
Clearly, all Americans want a healthier economy. They want
a fair opportunity for all Americans to be able to buy a home
that they can actually afford to keep. It is clearly time to
displace the false hopes and broken dreams which have arisen
from a system of misdirected government policies that
regrettably incented, browbeat or mandated financial
institutions to loan money to people to buy homes that all too
often they could not afford to keep.
Regrettably, on this topic there have recently been a
couple of disturbing press reports concerning actions of the
Administration.
On April 2nd, The Washington Post had the headline, ``Obama
Administration Pushes Banks to Make Home Loans to People With
Weaker Credit.'' Had the story been posted on April 1st, I
might have thought it was an April Fool's joke. I ask the
question, have we as a Nation learned nothing?
The article went on to say that the Obama Housing officials
were urging Obama Justice officials to offer banks the
equivalent of get-out-of-jail-free cards if they would lend
money to folks with weaker credit.
Ed Pinto, the former top Fannie Mae executive and a recent
witness before our committee, said in response, ``That would
open the floodgates to highly excessive risk and would send us
right back on the same path we are just trying to recover
from.''
The other disturbing headlines came from the L.A. Times and
many other major publications on April 10th. The L.A. Times
headline was, ``Obama budget projects $943-million bailout for
key housing agency.'' Regrettably, the President's budget does
indeed call for a bailout of FHA. That institution has
abandoned its historical mission, endangered the future of the
agency, and regrettably put taxpayers at risk.
Many of us believe that there are three steps to a
sustainable housing policy for our Nation: one, to gradually
reduce and eventually eliminate the government guarantee of
Fannie Mae and Freddie Mac; two, to reform the FHA so that its
mission is explicit, targeted, and paid for; and three, to
remove the artificial barriers to private capital coming into
the market, which is the subject of today's hearing.
Now, it may be a challenge for members of this committee to
come to agreement on all the provisions of the first two steps,
but surely, surely, we can find some way to come together on
the third, and that is removing barriers to entry of private
capital coming into this market. After all, the Administration
has clearly been on the record urging us to do just that. This
is a quote from the Administration's housing White Paper: ``We
need to scale back the role of government in the mortgage
market and promote the return of private capital to a
healthier, more robust mortgage market.'' Again, that was in
the Administration's White Paper, which regrettably has been
left to gather dust for about 2 years.
Then-Secretary of the Treasury, Secretary Geithner, on
behalf of the Administration, said, ``The administration is
committed to a system in which the private market, subject to
strong oversight and strong consumer investor protections, is
the primary source of mortgage credit. We are committed to a
system in which the private market, not American taxpayers,
bears the burden for losses.''
HUD Secretary Donovan, ``As we have made clear, this
administration believes that private capital needs to come back
and that the government's footprint in the housing market needs
to be much smaller. In order to do this, some provisions of the
Dodd-Frank Act, particularly QM and QRM, will have to be
carefully examined given their potential impact on the mortgage
market.''
I know that many of my friends on the other side of the
aisle have much invested in the Dodd-Frank Act and its brand,
and I respect this, but if you agree that private capital and
not taxpayer capital should be the foundation of our housing
finance system, then I hope you will have open minds that
perhaps some limited number of provisions of the Dodd-Frank law
perhaps could be refined and improved upon at this time.
At this time, I yield to the ranking member for 5 minutes.
Ms. Waters. Thank you, Mr. Chairman, for holding this
hearing.
Today, we are examining regulatory impediments to private
capital coming back to the housing markets, even as we have
very fresh memories of a largely unregulated shadow mortgage
industry selling billions of dollars of toxic securities to
investors and devastating millions of American families.
Interestingly, we are not examining the private sector
impediments to private capital returning. For example, how many
investors have confidence that the institution selling new
mortgage-backed securities won't try to swindle them again?
Have banks fixed their servicing practices that harmed both
borrowers and investors, and do we really think investors have
forgotten that?
According to the GAO, the financial crisis reduced the
wealth of Americans by $9 trillion. This is not to say that I
think that our current predicament in which the taxpayer is
backstopping 90 percent of all mortgages is sustainable. Nearly
everyone on both sides of the aisle agrees that we must reduce
the taxpayers' current exposure. However, it was FHA, Fannie
Mae, and Freddie Mac that stepped up to ensure housing finance
continued when the private market disappeared.
Congress passed the Dodd-Frank Act to help restore investor
confidence in the housing finance markets by providing clear
rules of the road. To name a few, the Act provides legal
certainty to banks only when underwriting safe and sound
mortgages. Congress also requires issuers to have skin in the
game by retaining some of the risks, thus aligning their
incentives with investors. To provide investors with better
information, Dodd-Frank improves securities disclosures,
including requiring better data on the underlying assets as
well as reforming and imposing liability on the credit rating
agencies when analyzing those securities.
Even if these changes are implemented, we are still a long
way from restoring the level of investor confidence necessary
to restart the private label security markets. I continue to
support proposals, including aspects of Mr. Garrett's
securitization bill from last year that recognized the
government's role in encouraging further standardization in
these markets. I also think the government can work with the
private sector in other areas, like helping to establish a
model purchase and sale agreement, eliminating the conflicts of
interest some banks have that service first liens while also
owning the second lien on the same property or transferring
servicing generally to institutions that have much higher
levels of personal contact with borrowers.
But if we are really looking for impediments to bringing
back private capital, we need look no further than this
committee. While the GSEs are incrementally taking steps to
reduce their market presence, it is Congress that must pass
comprehensive housing finance legislation to bring about real
reform. This legislation will only be successful if it ensures
a continuance of stable products such as the 30-year fixed-rate
mortgage, provides all eligible borrowers with access to
credit, and supports affordable rental housing options.
Two weeks ago, I hosted a roundtable of experts, the first
in a series to discuss housing finance reform and a path
forward. I think participants found the forum conducive to
digging deeper into the issues to understand policy choices.
One conclusion from this roundtable, for example, was that the
objectives I just outlined must be met or can be met only if
the government backstops some level of credit risk. I am told
that there are now over a dozen different comprehensive
proposals to reform our housing finance system, many with
bipartisan support. I find it disappointing that while we have
convened more than 20 hearings on FHA and the GSEs over the
last 3 years, we have not considered any of these ideas. I hope
that our witnesses will explain to my colleagues the need as
well as the opportunity we have to build a stable mortgage
market for generations to come.
Thank you, Mr. Chairman. I yield back.
Chairman Hensarling. The Chair now recognizes the gentleman
from Texas, Mr. Neugebauer, for 2 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman, and I appreciate
you holding this hearing as we examine the regulatory
impediments to private capital returning to the housing market.
One of the things we know is that sometimes what government
does when they are trying to fix one problem is they create
another one, and a lot of the legislation that was passed in
the last few years was to try to address what happened in 2008,
but basically, what we have done in trying to ``fix'' the
mortgage market in this country is we have nationalized the
mortgage market in this country.
As the chairman mentioned, 9 out of every 10 mortgages in
this country have some Federal backing, FHA and the GSEs
continue to dominate the markets, and while there is some
private activity, it is a very nominal amount of private
activity, and the other thing that we have done is, I think
most people who are investors in those securities, debt
securities are interested in credit risk, identifying what is
the credit risk, what is the interest rate risk, but what we
have done with some of the new regulations is we created a new
category of risk called regulatory risk. And as we talk to a
lot of the market participants, they are having a difficult
time trying to price what this regulatory risk is because there
is so much uncertainty and so many unanswered questions
because, as we speak, rules continue to change, rules continue
to come out, and so I am looking forward to hearing today about
some ways that we can remove some of the impediments, bring
private capital back in because the big beneficiary will, if we
have a robust housing finance market, everybody wins, but more
importantly, the American taxpayers have already put $200
billion into the mortgage finance entities. And our ultimate
goal is to have a robust market but also to make sure that we
get the taxpayers out of the business of guaranteeing their
neighbors' home loan in the future.
And with that, Mr. Chairman, I yield back.
Chairman Hensarling. The Chair now recognizes the
gentlelady from New York, Mrs. Maloney, for 2 minutes.
Mrs. Maloney. Thank you, Mr. Chairman, and Madam Ranking
Member.
I welcome all the panelists, particularly those from the
district which I am honored to represent: Mr. Chris Katopis,
who is also a leader in the Greek-American community; and Mr.
James Millstein, who successfully restructured AIG into a form
which was making a profit.
The current homeownership rate in the United States is 65
percent, and for every percentage point that drops, another 3
million Americans exit the homeownership market, and I believe,
going forward, we have to look at answers that help the middle
class have access to financing and homeownership.
The Wall Street Journal 2 days ago wrote that existing home
sales are down as inventories tighten. So getting the housing
finance structure right is tremendously important to our
economy going forward. Some economists estimate that it is as
much as 25 percent. So it is very, very important. And with
Fannie and Freddie still in conservatorship and the Federal
Government guaranteeing 90 percent of the mortgage
originations, I think we all agree that changes are needed. But
with $6.5 trillion of the $10 trillion guaranteed by the
government, in my opinion, we need a transition period, and we
need to be very careful how we move forward. We need the
private sector to play more of a role, but at the same time, we
need the middle class to have access to credit, the 30-year
mortgage, and others that have built the stability in our
economy.
My main question today is, how do we protect the taxpayers
from bearing the risk of housing finance in the future? None of
us want to see another government bailout, and I am also
interested how any changes would impact homeownership and
interest rates as we move forward in the future. I look forward
to the testimony today. Thank you for being here.
Chairman Hensarling. The Chair now recognizes the
gentlelady from West Virginia, Mrs. Capito, for 2 minutes.
Mrs. Capito. Thank you.
I would like to thank the chairman and the ranking member
for holding this morning's hearing as we continue to look to
the future of housing finance. As you can tell from our opening
statements, I think we have a lot of consensus here. As our
Nation's housing finance system slowly recovers, the current
imbalance between private sector and government in our markets
remains clear. While we might have consensus and it sounds
fixable, it is not as easy as it sounds. We know this from the
many hearings that we have had.
Although what a suitable mortgage market will look like
remains unknown, there is an agreement that the current
environment of government dominance is not reasonable nor is it
a long-term solution, so I would encourage that we work toward
a sustainable housing finance system which promotes a broader
private marketplace where creditworthy customers can find
affordable credit in a safe and sound system which protects
taxpayers from future losses.
This starts with applying smarter regulations and not
adding new regulations on top of the old. Unfortunately, with
the implementation of Dodd-Frank, the current regulatory
structure does not foster this type of environment, and
expansive regulations being implemented only add to uncertainty
and impose more time and resources on private institutions
trying to deploy their capital.
These regulations especially impact those who cannot bear
the weight of the new and restricting rules, further
restricting credit availability. Rather, the impediments to
private capital should be addressed through consistent
regulations that coincide with efforts to restore an
appropriate balance between the private market and government.
While I hope to return government's occupancy and housing
finance to the private market as quickly as possible, I would
reiterate that these efforts need to be made towards the
attention to the customer or the consumer. Withdrawing
government's presence should at the same time correspond with
facilitating opportunities in the private market so we can
defend market stability and create growth.
Again, I thank the chairman for holding the hearing, and I
look forward to the testimony of our witnesses and thank them
for coming.
Chairman Hensarling. The Chair now recognizes the gentleman
from Georgia, Mr. Scott, for 3 minutes.
Mr. Scott. Thank you very much, Mr. Chairman.
This is a very interesting topic on which I have quite a
bit of interest, and I think that the title of this hearing is
examining regulatory impediments to private investment capital.
I think it is important, but the fundamental issue here that we
must first address is whether or not the current health of the
private mortgage market is strong enough to bear the risk of
bringing back private investment capital.
This is particularly true, for we know that the
displacement of private sector competition is now so large that
roughly 90 percent of all residential mortgage originations are
securitized into government-backed, mortgage-backed securities.
So is there sufficient capital in the private market to
make up for what the GSEs are doing and to make sure that we
still have the guarantee of the 30-year mortgage situation? If
our secondary mortgage market were entirely privatized, does
sufficient capacity exist among both bank and non-bank lenders
to absorb loans on balance sheets until they can be securitized
or sold?
Then, there is a cascading number of questions. To what
extent, for example, do guaranteed fees charged by Fannie Mae
and Freddie Mac still need to rise in order for private label
securitizations to compete in the market? And do we know the
capacity of the private market to step in and provide credit if
Fannie and Freddie were to raise their prices? Will the supply
of mortgage credit expand as a reaction to additional price
increases? Will it have the effect of simply limiting access to
qualified borrowers or both? And then is there a concern that
raising the guarantee fees further without also reforming the
Enterprises will not break the GSEs duopoly over securitization
but instead bring in enormous profits. So, we have some very
perplexing issues here.
Fundamentally the issue should be, is the private market
really capable? Can they handle the risk, and can they do what
the GSEs do? They were put here for a reason, and the reason
was because the private sector wasn't doing this, so we have to
make sure, before we throw the baby out with the bath water
here, that we protect the baby.
Thank you, Mr. Chairman.
Chairman Hensarling. The Chair now recognizes the gentleman
from California, Mr. Campbell, for 1\1/2\ minutes.
Mr. Campbell. Thank you, Mr. Chairman, and good morning to
the panel.
Today in this hearing, we are going to look at, as the
title says, impediments that exist in the structure or
regulatory structure, impediments to bringing private
investment capital back into the housing market, but the one
thing I think we should all agree on is that we don't want to
create some new impediments to private capital, and right now,
there is an idea out there about using eminent domain to seize
mortgages, which is gaining a little traction with some cities
in my home State, and actually across the country, and we will
discuss this more during the hearing, and about the issues, but
for the purposes of this hearing, it has a lot of problems. It
is hard to convince private capital to come in when their
security could be at risk with the idea that a municipality
could just arbitrarily decide, okay, we are going to seize your
mortgage, and write down your security. And by the way, we are
going to put a bunch of that money in our pocket and a bunch of
it in the pocket of the private company which is pushing this
idea.
So it seems to me, and this is a bipartisan issue--Chicago
Mayor Rahm Emanuel, when this was brought up in front of
Chicago, said, ``The idea of using eminent domain is not one
that I support because I don't think it is the right way to
address the problem.''
So I look forward to hearing from the panel, and I yield
back. Thank you.
Chairman Hensarling. That concludes the opening statements.
I will now welcome our distinguished panel of witnesses and
introduce them. First, Mr. Chris Katopis is the executive
director of the Association of Mortgage Investors (AMI).
According to its Web site, AMI was formed ``to serve as the
industry voice for institutional investors and investment
professionals with interest in mortgage securities.''
Previously, Mr. Katopis has served on the Hill as a
legislative staffer.
Mr. Martin Hughes is the CEO of Redwood Trust, which I
believe may be one of the few, if not the only securitizer of
private label mortgage-backed securities at the moment. He has
over 15 years of senior management experience in the financial
services industry. He is a CPA, and holds a bachelor's degree
in accounting from Villanova.
Mr. James Millstein is the CEO of Millstein & Co. He
previously served as the Chief Restructuring Officer at the
Treasury Department where he oversaw AIG's restructuring
efforts. He has a JD from Columbia, a master's from UC
Berkeley, and a BA from Princeton.
Finally, Dr. Arnold Kling is a senior scholar and a member
of the Financial Markets Working Group at the Mercatus Center
at George Mason University. He has previously served as a
Senior Economist at Freddie Mac and a Senior Economist at the
Federal Reserve. He has a Ph.D. in economics from MIT.
Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony.
Without objection, each of your written statements will be
made a part of the record. Some of you have testified before,
so you are familiar with our light system. The green light will
be on for 4 minutes. When it turns yellow, you have 1 minute to
sum up. When it turns red, I think you know what that means.
After all of you have finished presenting your testimony,
each member of the committee will have 5 minutes in which to
ask any or all of you questions.
Mr. Katopis, you are now recognized for 5 minutes.
STATEMENT OF CHRIS J. KATOPIS, EXECUTIVE DIRECTOR, ASSOCIATION
OF MORTGAGE INVESTORS (AMI)
Mr. Katopis. Good morning, Mr. Chairman, Ranking Member
Waters, and distinguished members of the committee. We
appreciate the opportunity to testify this morning. The
Association of Mortgage Investors was formed as a primary
unconflicted trade association for investors and residential
mortgage-backed securities. We, along with investors from life
insurance companies, State pensions, State retirement systems,
and university endowments invest in the U.S. mortgage market. A
key goal of the system today is to move credit and mortgage
capital from investors to borrowers and then back again. The
more private capital that is in the system, the more
opportunities there are for borrowers and the more housing
opportunities exist. At essence, securitization today is
broken, limiting the availability of housing credit and the
reach of the American dream of homeownership.
Mortgage investors share your frustration with the slow
restoration of the housing market and the need to assist
homeowners who are truly hurting. In fact, the market for
residential mortgage-backed securities today has virtually
ground to a halt since the financial crisis for the reasons we
describe in detail in our written statement.
Today, Members of Congress have said mortgage investors are
on strike. We assure you, Mr. Chairman, that we are on strike,
but we would like to get back to work, and with your help,
perhaps that will be possible in the near future.
So what do we do? For example, we are hopeful that
meaningful solutions can be implemented more quickly, and we
believe that our interests are aligned with responsible
homeowners. As difficult as it may be to believe, many of the
most sophisticated investors in the market were as victimized
and abused by big bank servicers as many consumers. Investor-
managed funds are essential to rebuilding the private mortgage
market.
However, Mr. Chairman, investors will only return to a
mortgage market which is transparent, has data on the
underlying mortgages backed by enforceable reps and warranties,
addresses servicer conflicts of interest, and provides
protection through law and regulation.
The current mortgage market suffers from a thorough lack of
transparency as well as a number of other items outlined in my
testimony: poor underwriting standards; a lack of
standardization concerning mortgage documents; numerous
conflicts of interest; defective and improper mortgage service
practices; an absence of effective legal remedies for
contractual violations; and unwarranted State and Federal
interventions in the mortgage market, for example the proposed
use of eminent domain as a foreclosure mitigation tool.
In terms of competition, private investors in the mortgage-
backed securities space right now are crowded out by the
government to a large degree. Mr. Chairman, the playing field
is not level for investors, and even if FHFA, as conservator of
the GSEs, were to raise g-fees to market levels by regulatory
order, this would not solve the problem in itself. Fannie Mae
and Freddie Mac are in the same business as private mortgage
investors and mortgage insurers, bearing credit risk in
exchange for financial compensation. And going forward, the
Enterprises should not have their costs subsidized by the
advantages of government sponsorship. Congress should prepare a
transition plan to end the government sponsorship and have the
credit risk-bearing functions of these entities fully
privatized to ensure a competitive level playing field.
Mr. Chairman, the return to private capital requires
several steps. There is no one silver bullet. There is no
``easy button'' like we see on TV. What can we do? Congress has
already acted in a way that could be exemplary. They solved a
problem very similar to this in the 1920s with the stock market
crash of the corporate bond market. The Trust Indenture Act was
enacted by Congress in the 1930s to restore the corporate bond
market, and it works so well today that most corporate bond
market traders have it work without even knowing it is in
existence.
It creates a number of responsibilities and obligations for
trustees, resolves intercreditor rights, and creates certain
standards, structures, and systems that help the market go
forward. We hope these can be emulated for RMBS to bring
private capital back into the space.
Beyond that, we hope that Congress can consider the
following: facilitating a single national Internet database of
mortgages; mortgage servicing standards that address the needs
of investors as well as borrowers; and a single national
uniform foreclosure law.
So we thank you very much for this opportunity to testify.
AMI is pleased to be a resource for the committee as you
continue your efforts to bring private capital back to the U.S.
mortgage market for generations to come. Thank you.
[The prepared statement of Mr. Katopis can be found on page
61 of the appendix.]
Chairman Hensarling. Mr. Hughes, you are now recognized for
5 minutes.
STATEMENT OF MARTIN S. HUGHES, CHIEF EXECUTIVE OFFICER, REDWOOD
TRUST, INC.
Mr. Hughes. Good morning, Chairman Hensarling, Ranking
Member Waters, and members of the committee. I appreciate the
opportunity to testify here today on what could be done to
accelerate the return of the private secondary market.
My testimony is singularly focused on the perspective of
the institutional investors that are the buyers of senior
classes of securities backed by mortgage backs. Those investors
are the single most critical variable to consider as you take
steps to produce a robust mortgage-backed, private mortgage-
backed market. Simply put, these investors have the money, and
without their participation, there is no market.
In the wake of the financial crisis, investors in private
mortgage securities lost confidence that their rights and
interests in the securities they own would be respected and,
consequently, that their investments were safe and secure. In
response, some large senior MBS investors who previously had
significant capital obligations to the private MBS space now
have little or no participation.
It doesn't add up. In today's financial world awash with
liquidity, with senior investors searching for safe, attractive
yield, the private MBS market should play a much larger role as
an attractive investment asset, as it was in the past.
So in terms of recommendations on how we can get there, it
will take a combination of efforts by market participants,
Congress, and regulators. My recommendations are threefold:
first, meet investors' demands for stronger structural
protections, increase transparency, and align interest through
the entire mortgage chain; second, give the private MBS market
room to develop and grow by having the government reduce its
market share on a safe and measured basis--this can be
accomplished through further increases in guarantee fees and
reductions in loan limits; and third, remove the overhang of
unfinished regulation by requiring that unfinished rules that
are past deadline to be issued within 4 months are subject to a
4-year moratorium. My written testimony contains detailed
recommendations for each of these three categories.
In the interest of time, I would like to single out one
issue for special mention because it has not received the
attention equal to the harm it has caused, and that is the need
to control the systemic threat that second liens, otherwise
known as home equity loans, pose to first lienholders. We can
do this by giving first lienholders the ability to require
their consent to a second lien if the combined loan to value
with all other liens will exceed 80 percent. During the housing
bubble, homeowners used home equity lines to extract record
levels of equity from their homes and also as a substitute for
a cash downpayment. The rise in home equity lending increased
monthly payment obligations for borrowers and reduced the
amount of equity remaining in their homes, leaving borrowers
vulnerable to price decline. As a result, 38 percent of
borrowers who used these loans found themselves underwater
compared to only 18 percent who did not, and from a delinquency
standpoint, even for prime borrowers, the delinquency rate was
114 percent for borrowers who had taken out seconds. This
proposal would allow borrowers to tap into their equity while
preserving a level of protection for first lien investors.
If we move back to Redwood, the success of Redwood's
private securitizations proves that this market can be fixed
and that it is ready to assume a larger role in our housing
finance system. Since we restarted securitization in 2010,
Redwood has securitized $5.6 billion of jumbo loans in 14
transactions. We plan to securitize $7 billion in transactions
this year, and we have already completed 5 transactions to
date. Our success didn't happen by accident. We listened to
investors, and worked hard to meet the new requirements by
putting together transactions that included more comprehensive
disclosures, better and simpler structures, and new enforcement
mechanisms for representations and warranty. Currently, our
primary focus has been on the prime jumbo market. We are
limited to the prime jumbo market at this point because we
cannot compete with the price and market advantages the
government has conferred to the GSEs. Once the playing field is
level, we stand by ready to securitize prime loans of any size,
and we are not that far off. For example, today the rate on a
Redwood jumbo mortgage is 3.875 percent, on a Wells Fargo
mortgage on an agency conforming it is 3.65 percent, and on an
agency conforming completely it is 3.5 percent.
In conclusion, Mr. Chairman, I commend you for focusing
this hearing on investors. I firmly believe that the private
secondary mortgage market can grow quickly to provide liquidity
to a very large share of the mortgage market without the need
of a government guarantee if the needs of investors are met and
the government gives the private markets an opportunity to
grow. Thank you for the opportunity.
[The prepared statement of Mr. Hughes can be found on page
50 of the appendix.]
Chairman Hensarling. Thank you.
The Chair now recognizes Mr. Millstein for 5 minutes.
STATEMENT OF JAMES E. MILLSTEIN, CHIEF EXECUTIVE OFFICER,
MILLSTEIN & CO.
Mr. Millstein. Thank you. Chairman Hensarling, Ranking
Member Waters, and members of the committee, thank you for the
opportunity to testify today.
Chairman Hensarling. I'm sorry, could you pull the
microphone a little closer, please? Thank you.
Mr. Millstein. I am losing precious time.
Chairman Hensarling. We will give you 5 seconds.
Mr. Millstein. The question we now face, 5 years into the
conservatorship over Fannie and Freddie, and a market in which
90 percent of all new mortgage originations are ending up on
the balance sheet of the Federal Government, is how to back the
government out of a market it now dominates without triggering
another credit contraction and downturn in house prices? How do
we design a transition plan to a market where private capital
plays the leading role in credit formation but which also
protects the economy and ensures access to credit?
During my recent tenure as the Chief Restructuring Officer
at the Treasury Department, I had primary responsibility for
the restructuring and recovery of the government's funding
commitments to AIG, commitments which rivaled in size the
amount of capital today invested in Fannie and Freddie. In
downsizing AIG and recovering the taxpayers' investments in it
without destabilizing the broader financial markets in which it
operated, we faced a problem similar to the problem facing
Congress today: how to reduce the systemic importance of Fannie
and Freddie without undermining stable credit formation in the
mortgage markets.
Although housing reform is more complex in several respects
than the AIG restructuring, I believe that a similar corporate
finance and restructuring solution to that which we employed
with AIG, combined with a broader housing finance reform of the
sort you have just heard, could accomplish three important
goals for which I believe there is broad bipartisan support:
one, ending the conservatorships and the creeping
nationalization of the mortgage markets; two, fully recovering
the taxpayers' substantial investments in Fannie and Freddie;
and three, creating conditions under which private investment
capital will return to a market now almost completely dominated
by the Federal Government. Any credible transition plan to
reduce the government's footprint needs to ensure that private
capital will, in fact, substitute for what the government is
providing through Fannie and Freddie today.
To ensure that outcome, there are four key features of the
proposal. First, we need to wind down the government-sponsored
hedge funds that Fannie and Freddie ran. We need to terminate
the government charters that created an implied guarantee of
their debt and recapitalize and sell their mortgage guarantee
businesses to private investors.
Second, to be able to continue to tap the broad and deep
pool of capital that the government guarantee permits, however,
until private markets fully heal, we need to provide government
reinsurance for qualified MBS in exchange for a fee properly
calibrated to protect taxpayers against the risk of loss. This
would be similar to the FDIC's Deposit Insurance Program and
would represent a dramatic shift in structure and substance
from the pre-crisis model of a free implicit guarantee of
undercapitalized government-sponsored entities.
Third, remove structural impediments to PLS issuance. Along
those lines, I am in agreement with much of what you have just
heard from both of these gentlemen.
Fourth, fund affordability initiatives in a transparent
fashion by assessing a fee on all MBS issued with this
government reinsurance.
For better or for worse, the truth is that Fannie and
Freddie play a central role in credit formation of the mortgage
markets today, a role too big for banks, too big for private
mortgage insurers or private institutional investors to
displace overnight or even over the next decade, particularly
in the aftermath of the greatest credit crisis in 4 generations
from which these investors are still reeling. So, in light of
the continued weakness in the appetites of banks, private
insurers, and private investors for taking mortgage credit
risks, our plan calls for the recapitalization and
privatization of Fannie and Freddie's mortgage guarantee
business and the creation of a separate independent agency to
provide reinsurance on qualified mortgage-backed securities,
which reinsurance would be behind in the first instance the
substantial capital then owned by the newly privatized
guarantee businesses. We think this is a practical and
executable transaction and transition out of the
conservatorships to a new market structure in which well-
regulated private insurers put substantial private capital
ahead of the government on its guarantee.
In the interest of full disclosure, my firm owns certain of
the junior preferred securities issued by Fannie and Freddie.
These securities are only entitled to a recovery if the
government is repaid in full on its investments. The merits of
my proposal for ending the conservatorships, however, do not
rise and fall on whether those securities are entitled to a
recovery. The primary objective of the proposal is to ensure
that mortgage credit remains broadly available in the
transition from a system dominated by the government today to a
system in which private capital takes the lead in mortgage
formation in the future.
Thank you.
[The prepared statement of Mr. Millstein can be found on
page 85 of the appendix.]
Chairman Hensarling. The Chair now recognizes Dr. Kling for
5 minutes.
STATEMENT OF ARNOLD KLING, MEMBER, MERCATUS CENTER FINANCIAL
MARKETS WORKING GROUP
Mr. Kling. Thank you, Chairman Hensarling, and Ranking
Member Waters.
My fellow panel members are much more familiar than I am
with current practices. I have spent the last 12 years teaching
at a high school.
And I am going to be a bit pedantic today and say that
technically all of the capital for mortgages today comes from
private capital. It is private capital. It is now, always has
been, and always will be the savings of the private sector that
gets channeled into mortgages.
The difference is what kind of intermediary and what kind
of intermediation takes place to translate that private capital
into mortgages, and so the purpose of this hearing is quite
correct, and several people have stated it: The issue is, how
can that intermediation take place without taxpayers taking so
much of the risk? That is kind of the fundamental question
here.
I want to start out by pointing out, and maybe we can
discuss this more later, that a major form of risk that we
should be concerned with that the taxpayer is taking is
interest rate risk. There is a real potential, while everyone
focuses on credit risk, for taxpayers to end up taking interest
rate risk in ways people haven't anticipated.
The other point to make about this intermediation is that
it does not necessarily require securitization. I am old enough
to remember when savings and loans were the intermediaries that
supplied most of the capital to the mortgage market, and there
are some pros and cons to going back to that model, and we
shouldn't close ourselves off to that model.
With that said, I have seven recommendations to run through
for improving the intermediation of private capital. And the
first is to stop demonizing mortgage originators. Mortgage
originators were told after Dodd-Frank that they should not
originate any loans that violated the rules. And then they were
told if they asked what the rules are, ``We are not going to
tell you yet.'' That is not a sustainable way of dealing with
mortgage originators.
Second, stop demonizing mortgage servicers. Mortgage
servicing is an industry that, until recently, was kind of
shaving nickels off of its cost of doing business and has been
basically beaten up to the tune of having to spend thousands
and thousands of dollars per loan because other people are
telling them that they should be able to cure loans. And it has
just completely thrown that business apart. So the net result
is that there are fewer originators today and fewer people want
to do servicing on anything other than a squeaky clean loan
today. And, the joke I have heard recently is that if you want
a loan, you can either go to Wells Fargo or Wells Fargo, and
mortgage rates are high because the origination market and the
servicing market have been beaten up.
As far as phasing out Freddie Mac, Fannie Mae, and FHA, I
think that is a simple matter of phasing down their maximum
loan sizes. I think you should consider, if you at all want any
kind of national market in mortgages, to have a national title
system. The fragmented title system doesn't work, and you can
also get rid of the cost of title insurance by switching to
something called a Torrens title. I think that a national model
for loan servicing agreements, and people have already spoken
about this, would be useful as well.
I would say continue to develop a national standard for
conforming loan for mortgage securities. Again, that is a
constructive step.
And finally, continue to support consumer protection,
financial literacy, and programs to help families save for
downpayments. It frightens me, frankly, when people complain
that 65 percent homeownership is too low. Buying a home is a
complex transaction. In the United States, when you are putting
10 percent down, that is way more than we allow people to
borrow to buy stock. We require 50 percent margin to buy stock.
So we are putting people into very complex transactions, and I
think we need to make sure that they have the savings to deal
with it and the financial literacy to understand what they are
doing. Thank you very much.
[The prepared statement of Dr. Kling can be found on page
80 of the appendix.]
Chairman Hensarling. Thank you, Dr. Kling.
And thank you to all the panelists.
The Chair now recognizes himself for 5 minutes. I think I
hear a concurrence among the panel and hopefully among many
Members who gave opening statements that we all want a system
with more private capital, but some have begged the question,
is there enough private capital, and will it come back in?
I think it was you, Mr. Hughes, who said presently the
system is ``awash in liquidity.'' Was that your phrase?
Mr. Hughes. That was my phrase.
Chairman Hensarling. And just how much liquidity do you see
awashing around?
Mr. Hughes. In fixed income funds, there is $3.5 trillion,
and that is not counting banks' balance sheets or what is
available on insurance companies' balance sheets. So
personally, I don't think it is a money problem.
Chairman Hensarling. I believe if I have the right
statistic in front of me, the current size of the U.S.
residential mortgage market is roughly $10 trillion. I have
heard some concern from many that private capital could not
backfill a market of this size, so I guess a question, what is
the optimum size of the U.S. mortgage market? Is it $8
trillion? Is it $10 trillion? Is it $12 trillion? Who is
qualified to tell me what the optimum size of the U.S. mortgage
market should be? No takers?
We have one taker.
Mr. Millstein?
Mr. Millstein. I will say this: In 2000, at the turn of the
century, the size of that market was $4.5 trillion of
outstanding mortgage indebtedness. In the 7 years between 2000
and 2007, we more than doubled the aggregate debt on the
housing stock of the United States to $11 trillion. It is off a
trillion now with foreclosures and debt repayment, but we are
clearly at a very inflated size of the mortgage market.
Chairman Hensarling. That does beg the question of what the
optimum size of this market ought to be. I myself don't know
the answer to that question. But I do believe also, maybe it
was in your testimony, Mr. Hughes, you noted that the auto
loans, credit card loans, and commercial real estate loans are
up and functioning while the private residential mortgage-
backed securities market is barely developed. So is there
something about the residential mortgage market that makes it
immune to the laws of supply and demand, and won't they
ultimately determine the size of capital for the market?
Mr. Hughes. There is no shortage of money. The problem is
the risk that investors see in that market, from being burned
and waiting to see that steps have been taken to improve
investor protection mechanism, servicing, and a number of
factors that we both have talked about.
Chairman Hensarling. Dr. Kling, you didn't discuss it in
your oral testimony, but I found in your written testimony an
interesting discussion of, I guess the Canadian model, their
version of a 30-year amortized model. We have heard some
Members say they are concerned that we might end up with a
model where the 30-year fixed no longer exists. I am under the
impression that it exists in jumbo now where the GSEs do not
operate. Does anybody wish to offer a contrary opinion?
If not, let me ask about this model, because I know we had
testimony when FHA Director Ed DeMarco came and testified
before us regarding the 30-year fixed, ``It is not necessarily
the best mortgage product for a home buyer, especially a first-
time home buyer.'' I can see a system where anybody who wanted
it, I would hope it would appear in the market, I observe it
appears in the market, but I am also curious in the Canadian
model, as I understand it, you have a 5-year reset on the
interest rate, yet it amortizes over 30 years, which means a
number of our constituents have found that they were underwater
with their mortgages, had challenges engaging in refinancing,
then also the refinancing costs, the closing costs kept many
from doing it. Had they had access to this model, many of them
would have seen their monthly payments go down and might have
been able to keep their home. Is that correct?
Mr. Kling. I don't--I guess I wouldn't champion the 5-year
rollover as something that would have done a whole lot in this
crisis. I think a lot of these people were underwater almost
from day one. Maybe a few of them who took out really crazy
adjustable rate mortgages would not have taken them out and
would have taken out a 5-year loan.
The main thing is that we don't know where the risk on the
30-year product resides. We don't know where it resided when
Freddie Mac and Fannie Mae were at their peak. We just didn't
observe the kind of spike in interest rates that would have
shown us what happened. My guess is that either Freddie Mac or
Fannie Mae would have gone bankrupt because of the interest
rate they took or the derivatives that--
Chairman Hensarling. Regrettably, I need to cut you off and
attempt to set a better example for the committee. I am over my
time.
I now yield 5 minutes to the ranking member.
Ms. Waters. Thank you very much, Mr. Chairman.
I would like to thank all of our panelists who are here
today. It seems as if there is a consensus on some things. It
appears that everybody agrees that there is a lack of
confidence and that there needs to be transparency and some
other kinds of things.
I would like to particularly thank Mr. Millstein for his
participation in the discussion, not just here today, but the
fact that you have come up with some real live proposals, and
have been helpful to me and to others.
[Dogs barking].
Ms. Waters. That is the servicers.
Chairman Hensarling. Are they German Shepherds?
Ms. Waters. I have a question for Mr. Katopis. Do you agree
that mortgage servicers have been demonized and that the
``gotcha'' regulators Mr. Kling references have been unfair to
servicers?
Mr. Katopis. With all due respect, Congresswoman, we
disagree. We think that the servicing model that has existed
for decades is not sufficient for the economic environment we
are in now. We have a lot of distressed borrowers who should be
helped, who may need some special touch, and we have seen a lot
of reforms in this space, but still we think more needs to be
done. And in particular, for the topic of this hearing,
bringing private capital back into the markets, we need
servicer reform that not only addresses the needs of distressed
borrowers but of investors. And remember when I speak of
investors, I am talking about all the limited partners we have,
whether it is CalPERS, retirement systems, or university
endowments, because returns for those investors are harmed by
the servicing practices we are seeing today.
Ms. Waters. Absolutely. And despite the fact that some of
us are real advocates for our consumers and we want to make
sure that they have available to them the kind of mortgages
that are fair, we also are concerned about investors. And I
have been concerned about the fact that various servicing
settlements from regulators and State attorneys general allow
servicers to meet the terms of the settlements by writing down
the loans that are owned by investors. Do you think that is
fair?
Mr. Katopis. That is an absolutely keen observation. We are
very concerned, and my testimony touches on what I call
unwarranted Federal and State interventions in the market. A
lot of these settlements are extremely troubling for mortgage
investors because they are having some of these institutions,
these too-big-to-fail institutions settle with other people's
money, the first lien investors, so we really appreciate your
attention to these matters.
And we have asked for more transparency. We have contacted
a number of Administration officials, including the National
Mortgage Settlement Administrator, for more transparency, and
we hope that there is action taken on that front. And as an
aside, I talk about who are mortgage investors. I was a Hill
staffer. I had a TSP. I was in the G or C fund, I would like to
think anyone who has a TSP is a mortgage investor, too, on one
level, so I claim as many as I can.
Ms. Waters. I want to get to Mr. Millstein. In your
testimony, you describe some of the private label mortgage
securitization deals that have occurred since the 2008
financial crisis, and you note that they are structured to
provide immense protection for investors. This includes both
high downpayments for the loans, underlying the
securitizations, the high FICO scores for borrowers. This also
includes the fact that the issuers of these new private label
mortgage securitizations retain the subordinated tranches in
these deals, meaning that the issuers take losses before other
investors take losses. Given the extremely conservative nature
of these issuances, is it reasonable to expect that private
investors are willing to absorb all of the credit risk
currently borne by Fannie Mae and Freddie Mac?
Mr. Millstein. In my testimony, I described the deal done
by Mr. Hughes. And I think this is important for the committee
to understand, that while Redwood is really pioneering now this
private label securitization market, they are doing it with
enormous equity cushions and subordinated tranche cushions to
protect the senior investor. You could have a downturn as
severe as we had in 2007 and 2008 and the investors in the
Redwood Trust recent issuances would not lose a dime because of
the enormous cushion. So there is not a lot of credit risk
being taken by the private market today. And that is for good
and valid reasons. The Government of the United States has two
of the largest funding sources for mortgages in
conservatorship. Until you guys clarify what is the fate of
those, the fate of the housing market will remain uncertain for
private investors.
Chairman Hensarling. The time of the gentlelady has
expired.
The Chair now recognizes the gentlemen from Texas, Mr.
Neugebauer, for 5 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman.
I would like to continue along this line because one of the
keys to getting private securitization going again is making
sure the government is pricing its risk appropriately. And what
we have seen by the fact that we had to put $200 billion in
Fannie and Freddie is that they weren't pricing that risk
appropriately.
So, Mr. Hughes, would you comment on the fact that--I think
Redwood bonds are trading at about a 2.6 percent yield and MBS
agency are trading around 2.2; I understand that there could be
some differences. But that is a 40-basis point spread. And in
this market, 40 basis points is real money. I would like to be
getting 40 basis points on my savings. But would you kind of
expand on that a little bit for us?
Mr. Hughes. Sure. Actually, the historical average was
approximately 25 basis points between those numbers. And if you
rolled back the increases and guarantee fees, the actual spread
today is closer to 60 basis points. What that spread was
intended for was to cover three potential risks to the extent
you are holding a private security: one was faster prepayments;
the second was not as much liquidity; and the real biggie was
the credit risk. So with the agency security didn't have that.
And where the premium is today is investors needing more for
that credit side, which isn't necessarily borrower credit, but
it is everything that goes with the process to make sure that
their investments are safe and secure.
Mr. Neugebauer. Another issue that has been talked about a
little bit is the fact that the agencies aren't subject to all
of the same rules that the private securitizers are. And you
heard me say in my opening statement about this new risk that
we have in the marketplace today, this regulatory risk. How is
the pricing--in other words, if the agencies today had to play
by the same rules, what would be the pricing premium that would
be in the marketplace for regulatory?
Mr. Hughes. Are you referring to QM?
Mr. Neugebauer. Yes.
Mr. Hughes. Today, the pricing difference between the two
markets, again, we are about three-eights of a point. To the
extent that the same regulations--I think it would close the
gap some, maybe an 8th of a point. But I think the bigger
difference is going to have to come over time through increased
guarantee fees and spreads coming in as we invite more and more
investors in to the investor side.
Mr. Neugebauer. Mr. Katopis?
Mr. Katopis. I just wanted to add an observation,
Congressman, that for some of our investors, when they look at
the issue you have raised very wisely, what they deem is what
is the political risk premium surrounding some of the
transactions in this space. Depending on the nature of the
political activity, the severity that it entails, they will
not--there is no premium they will pay if a 30-year contract
becomes a 30-minute contract. So it depends on the nature of
the activity, and it can really steer private capital out of
the market.
Mr. Neugebauer. I am glad you made that point. Because I
think one of the things that we are hearing is, okay, even if
you increase the g-fees, reduce the loan limits, create this
space up there, until you bring some certainty into investor
rights and servicers' responsibilities, a lot of market
participants still would not be comfortable until we resolve
some of the Dodd-Frank requirements--capital requirements, risk
retention requirements. Does anybody disagree with that
statement?
Mr. Hughes. I totally agree with that statement.
Mr. Neugebauer. What do you think would be two or three of
the top impediments to us doing something quickly in that area?
What would those be?
Mr. Millstein. Congressman, Representative Garrett has done
a lot of work around this. And I think there are many aspects
of that bill that all of us on this panel would agree with.
Mr. Neugebauer. Mr. Katopis?
Mr. Katopis. I invite everyone to look at our testimony
describing the Trust Indenture Act as an exemplary model that
saved the corporate bond market in the 1930s and has worked
flawlessly for the last 70 years.
Mr. Neugebauer. Mr. Chairman, I yield back.
Chairman Hensarling. The Chair now recognizes the gentleman
from North Carolina, Mr. Watt, for 5 minutes.
Mr. Watt. Thank you, Mr. Chairman. Thank you for convening
this hearing.
Mr. Katopis, I am fascinated by some points that you made
on page 11 of your written testimony in which you suggest that
if we did four things--limit the charter to high-quality
guarantees; ensure sound regulation with appropriate equity
capital; sever government sponsorship and entity level
backstops; and impose appropriate political limitations--the
core mortgage guarantee business can be sold into the private
markets with no government backstop and the funds realized can
repay the government for sustenance, as was done with AIG. That
is what you said.
I envision, then, kind of a government IPO spinning off
these things, Fannie and Freddie, or at least parts of Fannie
and Freddie into the private sector. And correct me if I am
wrong in that vision. I would then want to know what would
happen--first of all, whether that wouldn't create entities in
the private sector that were too-big-to-fail and how we could
guard against that?
Second, since you would be limiting this to high-quality
guarantees, which is what Mr. Hughes' business sounds like it
is, what, then, would you do about average-quality guarantees?
And whether this could still be done with 30-year mortgages as
opposed to what Dr. Kling is saying, how would you hedge
against the risks that are associated with 30-year mortgages?
If you could just answer that series of questions, I probably
won't have enough time to ask another one.
Mr. Katopis. Thank you, Congressman, for the opportunity to
address that issue.
I will try to answer in the time. And if we need to follow
up in writing, we are happy to do so. AMI stands for a number
of goals broadly, including housing finance reform, increasing
housing opportunities, and bringing private capital back to the
market. We believe that the GSEs can be restructured in a way
where you take the ``GS'' off, and they are no longer
government-sponsored entities and create housing opportunities.
We do not promise we can do what Redwood has done with these
super prime, immaculate kind of high net value homes.
Mr. Watt. You are getting me off the subject there. What I
am really interested in is, it seems to me that the primary
thing that the government has to sell, if we did an IPO, would
be the government guarantee. And if you take that away, then
you are back into a private sector with a much, much higher
interest rate, I would think. Am I missing something there?
Mr. Katopis. Broadly speaking, and we can follow up on
this, we know that the backstop creates certain characteristics
for a mortgage. Those characteristics would change under this.
I think it is a question of what pricing, what type of product
you want to have in the market. And we certainly believe that
the 30-year mortgage is valuable and is important--
Mr. Watt. For the high-end market?
Mr. Katopis. No.
Mr. Watt. What about for any market?
Mr. Katopis. For any market. It is just a matter of the
characteristics would change.
Mr. Watt. One of those characteristics would be that
interest rates would go up?
Mr. Katopis. Possibly. But, again, I think it is a question
of calibrating the risk, the perceived risk by investors with
the price.
Mr. Watt. And what would the government's role be at the
end of the day in that process?
Mr. Katopis. I think the government's role, looking at the
testimony of the others and our internal thinking, although we
do not have an official position how to structure it, it would
be very much like the FDIC, some type of insurance vehicle,
just like we have for savings.
Mr. Watt. Mr. Millstein, if you can use the rest of the
time analyzing what we just talked about, that would be
helpful.
Mr. Millstein. Yes. I think in my materials, in an
appendix, there is a chart on page 4 of the--if any of you have
it, which I would just point you to, which shows you who bears
mortgage credit risk today and the evolution of who bears
mortgage credit risk over the last 40 years. And what you will
see in the middle is a huge yellow swath where 50 percent of
that credit risk has been residing with the government.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from California, Mr.
Campbell, for 5 minutes.
Mr. Campbell. Thank you, Mr. Chairman. Do you want to
finish that thought, Mr. Millstein?
Mr. Millstein. I do. My point is that I think we can evolve
to a market where less than 50 percent of the credit risk is
borne by the Federal Government. But for the last 20 years, we
have had a system in which the Federal Government has borne 50
percent of the credit risk in the market. It is going to take
time to bring private capital back into taking credit risks.
And if you look at, on this chart, who has borne credit risk,
it is the banking system, which, as we all know, was the most
recent beneficiary of the massive bailout from the Federal
Government when its mortgage assets were impaired.
So I think the notion that the Federal Government is just
going to walk away and private investors are going to bear all
the credit risks in the system is a dangerous notion. It is
going to take time to evolve this. And the market--just to
finish the thought--what we had suggested as a way to protect
taxpayers for its guarantee is not to do it as it has been
done, on an implicit basis without a fee, but to do it with
lots of private capital ahead of the government as a reinsurer
for an explicit fee that is well-priced.
Mr. Campbell. Let me ask two questions following up on
that. One is, we have been talking about the g-fee, and I keep
hearing that FHA is close to market. And I guess market would
be--everyone defines what is market for a government guarantee.
But I guess it would be where at some point, there are some
investors that say, you know what, for that margin, I will take
that risk. I don't want to pay the government to do that. How
close is the FHA's current g-fee to that, and also for the
GSEs?
Mr. Millstein. I will let Mr. Hughes answer that. My answer
to that is, today, the government is not required--there is no
hurdle rate on the government's equity support for the GSE. So
there is no built-in return on equity. And as a result, that
margin is missing at least in the g-fee. I would say that other
15 basis points. They are an average today of about 50 basis
points for the newly issued MBS. It has to get closer to 65, 75
basis points to be a market fee for that risk.
Mr. Campbell. Mr. Hughes?
Mr. Hughes. I would agree with that. And two things need to
happen. One is the g-fee going up. But we also need active
investors coming in, such that that spread we talked about
comes in.
Mr. Campbell. Right.
Mr. Hughes. The combination of those two, and I would
agree, probably 15 basis points and a combination of investors
coming in would make the private sector--
Mr. Campbell. Let me ask you another question about phasing
the government involvement out. If you were to do it by
reducing how much LTV, if you will, loan to value, that the
government will guarantee--arguably, right now, FHA will
guarantee up to 97 percent. Right? If you reduce that and it
got--at what point does it become effectively no guarantee? In
other words, if it was 65 percent, then you are talking about a
2007, 2008 crash really--the government doesn't even step in
then. What is the point that you reduce and say, all right, the
government will guarantee 80 percent, 75 percent, at what point
does it become, as far as the market is concerned, not of any
value?
Mr. Millstein. Mr. Hughes is doing deals today without a
government guarantee with a 40 percent equity cushion ahead of
the senior note.
Mr. Campbell. Okay. So is that where it is, then, 60--if
the government says, hey, we will guarantee up to 60 percent,
that is--markets won't care.
Okay. In my last minute, I do want to get back to the
eminent domain issue. Because in the proposals that I have in
front of me, the investors take a huge haircut. The government
guarantee takes a hit. And when we say investors, remember, we
are talking about a lot of pension funds, 401Ks, life
insurance, stuff like that. The city gets a 5 percent cut. So
they get a nice 5 percent cut, and then it is refinanced with
FHA. So the Federal taxpayer basically guarantees so the city
can get a 5 percent cut, and then the venture capital fund that
is involved with this gets $4,500, which is why they are
pushing the heck out of this thing. Does anybody on this panel
think that is a good idea?
Mr. Hughes. No.
Mr. Campbell. Let the record show nobody thinks it is a
good idea.
If cities start doing this, what effect is that going to
have in the mortgage market on private capital, on even
government involvement with mortgages that exist today?
Mr. Katopis. Again, the political risk of having this
further nationalization from local communities and cities would
chill private investment and could lead to a stop of lending in
certain areas, certain States. It is very troubling, and we are
happy to follow up offline about any questions that any of you
or your colleagues have.
Mr. Campbell. Mr. Hughes?
Mr. Hughes. I think it would be catastrophic if en masse,
we were going through eminent domain. I lose sleep over a lot
of things, but that is not one of them. I think there is an
easy solution for that. And that would be through SIFMA, that
to the extent a city decided to go ahead with eminent domain,
they could stop accepting loans from that city that would fall
into securities. And I think that would take care of it. Thank
you.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes and apologizes to the gentlelady
from New York, who, on the front row, is out of sight but never
out of mind. She is recognized for 5 minutes.
Mrs. Maloney. Thank you very much, Mr. Chairman.
And I thank all of you for your excellent testimony. But
all of us listen to our constituents. And what I am hearing
from my constituents is that even if they have an excellent
credit rating and scores, they can't get a mortgage or have
tremendous difficulty getting a mortgage, or have tremendous
difficulty refinancing. And so, I think that the role that
Fannie and Freddie has played during this crisis under
government conservatorship is that they have played a role in
getting the system moving.
So my question to all of you, and I would like to just go
down the line, starting with you, Mr. Chris Katopis, do you
think that the private market is ready to take the credit risk
in the size that Fannie and Freddie are bearing? And I would
like a detailed answer from each of you. Because that is the
critical issue that is before us today.
Mr. Katopis. Congresswoman, I think that investors are very
good at pricing risk when they have the information. For them
to step into the situation you have described, they would need
a lot more transparency, a lot more effective remedies, and the
other issues that I have outlined in testimony where they could
step in. Ultimately, as has been described, there is a lot of
liquidity in the market. But there would be an incremental
process if those legal protections and transparency are
available for investors.
Mr. Hughes. Certainly, the private sector today is not
ready to step in and replace Fannie Mae and Freddie Mac. What
we do think the private sector could do is provide on a risk-
sharing basis, take the credit risk on a number of pools today.
In terms of the private sector, one of the things we are
looking for, we had to start with the best of credit to get
investors back. But we would look to expand that box over time,
where it would be people who are good credit for exactly the
reasons that you are saying to provide and widen the box today.
Mr. Millstein. At its height, the private label
securitization market in 2006 did $750 billion of issuance that
year. This last year, 2012, we did $1.9 trillion of issuance of
new mortgage originations or refinancings. So at its height, it
was about 40 percent of the market today. I think credit
investors will come back. But the idea that they can replace
Fannie and Freddie any time soon, I think is fanciful.
Mr. Kling. I guess my hope is actually that old-fashioned
banks and savings and loans could replace Freddie Mac and
Fannie Mae. It might take them awhile to gear up operationally,
and the regulators might have to make it reasonably attractive
for them to hold mortgage loans, not penalize them, as they
have in the past, for holding mortgage loans. But there is a
lot to be said for it. As I hear the problems of investors and
servicers, I think if you hold the mortgage the way that
savings and loans used to hold it, you don't have to worry
about your contractual relationship between the investor and
the servicer. It is the same person, the same institution. So
just consider that as one possible way of bringing private
capital--of getting the credit risks into the private sector
might be the old-fashioned banks and savings and loans.
Mr. Millstein. Can I respond to that? One of the great
financial innovations in America in the 1980s was the creation
of securitization markets. It enabled pension funds and
insurance companies which have long-term liabilities they need
to fund to access the long-term mortgage market. And it was a
proper matching of assets and liabilities in the system, and it
helped, as you see from that chart on page 4, take mortgage
credit risk out of the banking system, which collapsed in the
1930s as a result of the risk that it bore.
There is something fundamentally really good about the
securitization business because it diversifies credit risk. The
question is how to do it in a sensible, rational way that
protects taxpayers. Because right now, and for the last 20
years, 50 percent of the credit risk in the security--that the
securitization market is bearing is really in the Federal
Government, and it is going to take time to wean the market off
that.
Mrs. Maloney. All of the Congress, Mr. Chairman, and my
colleagues have testified that the private market is not ready
to come in and assume this role, which is critical to our
overall financial stability and the growth of our economy. My
time has expired.
Chairman Hensarling. The time of the gentlelady has
expired. The Chair now recognizes the gentleman from Missouri,
Mr. Luetkemeyer, for 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Mr. Millstein, in your--there is an article we have access
to that you had in the Washington Post on October 12, 2012. And
in there, you made a statement something to the effect of we
are transforming Fannie and Freddie into more of an insurance
company versus the entities that they are now, at least that is
kind of the way I take it. Am I misreading that?
Mr. Millstein. They are insurers today. They basically
provide a guarantee of principal and interest on mortgage-
backed securities. But they do it with--it used to be an
implied government guarantee. Now, it is an express guarantee.
Mr. Luetkemeyer. But you are going to basically transform
them into a different entity?
Mr. Millstein. That is right. We are going to take the--
what we propose to do is to take the private--sorry--the
mortgage guarantee business that provides that insurance to
investors and privatize it and privatize it with an appropriate
level of capital to back those guarantees.
Mr. Luetkemeyer. And that would be a private entity, then,
or is it going to be a government entity?
Mr. Millstein. There would be private entities, and they
would be able to buy reinsurance from the government for a fee.
Mr. Luetkemeyer. Okay. I just want to follow up on the
eminent domain question that the gentleman from California had.
Mr. Katopis, in your testimony, there is quite a bit of
discussion about that. Would you like to elaborate on that? I
think that is something a lot of us on the committee probably
haven't had a lot of exposure to, but I have had one of my
major cities in my district, just outside my district actually
go through this exercise, and it was rejected by the citizens
of the city. But it certainly scared the financial community in
my State because of the potential that could happen with this.
Mr. Katopis. It is a proposal, as we understand, being
developed by an investment company. It is not a charitable
organization. And the idea is to do a short--massive short refi
in a way that would take performing underwater mortgages,
refinance them, and give the local community a cut of the
action. We think that it is an idea that has--it is untried.
Its constitutionality is dubious. I know that different
communities, in response to the Kelo decision a number of years
ago, have changed their laws. So it really can't be implemented
in a lot of jurisdictions. But it is troubling. We don't really
know the contours of the proposal. The company that is pursuing
this, it is like, ``Let's Make a Deal.'' They are constantly
changing, upping the fee for the community to entice them. And
it raises a lot of issues, including the liability to the
community or the State should the valuations be off.
So I think at the end of the day, we have to ask, is it a
solution to a real problem. And when we look at some of these
underwater performing mortgages, we have people who have been
paying their mortgage for the last 12 to 72 months. So we
understand that they may have some anxiety, but they are not
necessarily at risk. And a number of them, when you do the
research, they are underwater because they did cashout refi's.
We did analysis with an analyst for one of the California
communities, and 50 percent of his mortgages were cashout
refi's. So they really weren't underwater; the equity was
recapitalized--reconstituted in some way. So that is troubling.
Are you bailing out people who--while your neighbor paid
their mortgage diligently for the last 72 months, you did a
refi, cash out, bought a BMW, bought a plasma TV, did something
else? So I think you really have to look at what is trying to
be achieved as part of this process, where are the consequences
to the community if the legality--
Mr. Luetkemeyer. Do they undermine the lienholder position
of the financial institution here with what they are doing?
Mr. Katopis. It certainly poses a risk to institutions
because it--again, who owns a lot of these securities and
mortgages, some of them are by community banks; some are them
are by State pension funds. So, there really are a lot of
questions.
Mr. Luetkemeyer. That is where the concern is, that there
is a gray line that has been established there, which is like,
holy smokes, this goes against the--
Mr. Katopis. The fundamental question seems to be how to
help responsible homeowners who are hurting. And there are a
number of tools that are available. I think that eminent domain
is a drastic solution, and it is not something that should be
pursued.
Mr. Luetkemeyer. I just have a few seconds left. I want to
follow up on a couple of questions. I know that one of the
other panelists asked about the QM, QRM securitization
problems. Does that--are those rules going to impact you? Basel
III, how is that going to affect to be able to securitize loans
and the options of going to the market, private market folks?
Mr. Hughes. Clearly, one of the key things under Dodd-Frank
that needs to get done is the definition of QRM, which I think
is a good starting point, for it would be QM. But I think if we
go through look the eyes of investors, QM alone is not enough
to find a safe mortgage for investors.
Mr. Luetkemeyer. Is that a deal-breaker if we don't do
that?
Mr. Hughes. If you--the same--to me, QM, if you are
protecting investors, needs to go beyond just--it needs full
documentation. It needs loan to value. There needs to be a
downpayment requirement of some size.
Chairman Hensarling. Regrettably, the time of the gentleman
has expired.
The Chair recognizes the gentleman from New York, Mr.
Meeks, for 5 minutes.
Mr. Meeks. Thank you, Mr. Chairman.
There are a number of issues, so much to try to get through
in 5 minutes. I am concerned also about QRM and 20 percent and
seeing whether or not that would make it almost impossible for
some average American citizens to own a home, whether that is
too high. You are taking into consideration the whole
individual and their ability to pay, which I think is very
important. So that debate--I know that we need to have some
finalization in what the rule will be. But the question is, is
it 20 percent? Is it 10 percent? Is it 5 percent? What is best,
as far as making sure of being as sure as you possibly can that
an individual--that we are not closing out a whole segment of
the American people from the possibility of owning a home. But
I heard, Mr. Hughes, you saying 20 percent, you thought that 20
percent is where it should be. And so, therefore, a number of
Americans should not be eligible to buy a home. Is that what
you said?
Mr. Hughes. No, that is not what I said or not what I
intended to say. I would say for the part of the market that is
going to be financed through the private sector, yes, I think
they are going to need a downpayment. And whether that is 10
percent or 20 percent, it is going to need something. I think
that is why we are going to have other parts of the mortgage
finance market that will be at the discretion of the government
here to provide financing. But, again, my lens today is what is
it going to take to get the one segment out there back, which
is the private sector side of it?
Mr. Meeks. Mr. Millstein, would you comment on that?
Mr. Millstein. Yes. I think the risk potential
requirements--right now, the QM effectively carves out the
government sector for a limited period of time. Because I think
the regulators themselves need to know where FHA and where
Fannie and Freddie are going in order to actually create a
comprehensive regulation here. So I think the concern you
express is one that is real, but I don't think the regulators
yet have come down in a way that is definitively something that
you would oppose because, in fact, I think they are all waiting
for Congress and the Administration to tell them what is the
fate of the FHA and Fannie and Freddie, who are currently
carved out?
Mr. Meeks. I have a question, but I wanted to get to
another area really quick, because I have real concerns during
the lead up to the 2008 financial crisis, and that was dealing
with the credit rating agencies. We know that a significant
number of investors relied exclusively on the rating agencies'
evaluation of private label securities to inform the investors
of their decision, and later, those ratings turned out to be
completely inaccurate and the Wall Street Reform Act included
several provisions aimed at improving the investor's ability to
understand how the rating agencies reviewed securities as well
as provide a specific private right of action against rating
agencies. So, given the failure to perform due diligence in its
review of private label securities prior to the financial
crisis, what role, if any, do you think that the credit
agencies will play in the market going forward?
Mr. Hughes. Right now, most of the financial system and
major investment firms as part of their asset criteria on what
you can buy, the incentive is on the private side which
requires a rating agency AAA rating. In many cases, it is two.
So I think for the time being, and we are dealing with the
rating agencies now, it is going to be required on the private
side so there is a benchmark that the rating agencies' AAA
rating would be very important.
Mr. Meeks. Do you think that the credit rating agency
reforms that were included in Dodd-Frank, the Wall Street
Reform Act, restore any confidence in the use of these credit
ratings? Do you think there are any additional reforms that are
needed to improve the ratings industry?
Mr. Millstein. Dodd-Frank is one of the great unresolved
problems from the crisis--what to do with the rating agencies?
We all want something other than them embedded in the system.
But insurance company asset rating--I am sorry--capital ratios
are still dependent on rating, as are banks. We haven't gotten
rid of them. What we can do and what the reforms that we have
talked about on the panel today and that a number of bills that
have been introduced address is create much greater
transparency in the pools so investors could do their home
work.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Ohio, Mr.
Stivers, for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman.
I appreciate you holding this important hearing. And I
appreciate all the witnesses for being here.
I was struck by something the gentlelady from New York said
earlier about how the market is not ready for privatization.
And clearly, that is true. But if Congress does nothing, the
market will never be ready. I was struck by the things that Mr.
Hughes and Mr. Millstein both said about a plan for a gradual
transition to a private market. Assuming Congress does some of
the things that were in both of your testimonies, how long
would it be before we could get to a private market? I will let
both Mr. Hughes and Mr. Millstein answer that one.
Mr. Millstein. So, again, I would direct you to page 4.
Just that slide. It took 20 years for the government sector to
get this big as the savings and loans effectively went out of
this business, in large part. I think this transition could be
at least that long. That doesn't mean you don't start. But it
means you have to be prudent in--
Mr. Stivers. If you don't start, how long will it take?
Mr. Millstein. It will never happen.
Mr. Stivers. Exactly.
Mr. Hughes?
Mr. Hughes. Markets need room to grow. Markets grow when
there are active buyers and sellers, when there is a need.
Unless you create a need and break the status quo, I don't see
how the markets are going to come back, given the opportunity,
and just do it on a safe and measured basis.
Mr. Stivers. Thank you.
And to something Mr. Millstein said, Mr. Kling, because you
talked about it earlier. We all talk about community banks and
how important they are to our communities. Do you think that
allowing and encouraging community banks to have an originate
and hold strategy, what my grandfather did before--my father
ran a community bank and they started securitizing. But my
grandfather originated and held those loans to term until they
were paid off. Do you think that helps create a role for
community banks in leveraging the capital that is in community
banks to help transition to a private market?
Mr. Kling?
Mr. Kling. Let me repeat, all the money in the mortgage
market today comes from the private sector. It is just that the
risk, the credit risk is being absorbed by taxpayers. As
taxpayers absorb less credit risk, then the prices will adjust,
the suppliers will adjust, the intermediaries will adjust.
Community banks can be suppliers, and so can national banks.
The money is sitting out there. As an investor, I don't care
whether my money goes to a money market fund or a mutual fund
that invests in mortgage securities or whether my money goes
into a bank CD. That is not the issue.
The issue is, who is going to bear the credit risk? And if
the taxpayers gradually back off of bearing the credit risk,
other intermediaries--and we can't necessarily dictate which
ones, although some people would like to--will come in to take
that credit risk.
Mr. Millstein. A little comment on the community banks:
When you think about a small bank, the question is, where does
it get funding? Deposits are the clear primary source. But if
you don't give these banks access to the secondary market, they
are significantly disadvantaged in competition with the large
banks. And one of the really great features of the Fannies and
Freddies of the world is their ability to give community banks
access to funding sources in the secondary market. So, again,
if you take that away, if that is no longer part of the--
Mr. Stivers. Although most of our community banks use the
Federal home loan model ahead of the GSE model.
Mr. Millstein. Ahead of it, but not in full replacement of
it. Because, ultimately, the GSEs provide these guys funding
that the big banks have access to. They can float bonds, they
have access to the capital markets directly. The community
banks rely on these intermediaries, Fannie and Freddie.
Mr. Stivers. Sure.
Mr. Hughes, Mr. Luetkemeyer talked originally about Basel
III, but I don't think you got a chance to answer what the
impact of that will be on the future of private capital return
to the market.
Mr. Hughes. I am not the right guy to ask about Basel III.
Mr. Stivers. Sorry. Maybe Mr. Millstein?
Mr. Millstein. It is going to force all banking entities to
hold more capital against these assets. Again, one of the great
lessons of the crisis was that almost everybody--banks,
community banks, Fannie and Freddie--who held mortgage risk did
not have enough capital against it. So from a point of view of
financial stability, making sure the system is not
undercapitalized is a key feature of reform.
Mr. Stivers. Mr. Chairman, I would like to enter into the
record a couple of pieces of documentation. One is from the
former CBO Director, Douglas Holtz-Eakin, that is a study about
Basel III and DFA rules and what they would mean. And it
suggests it would mean 3.9 percent fewer jobs and 1.1 percent--
Chairman Hensarling. Without objection, it is so ordered.
Mr. Stivers. Thank you. I yield back the balance of my
nonexistent time.
Chairman Hensarling. There is no time to yield back.
The Chair recognizes the gentleman from Georgia, Mr. Scott,
for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman.
I have to tell you, I am worried about the little fellow in
this. And it seems to me that is the undercurrent of the
question we need to raise here in terms of impact. There is a
reason, as I said in my opening statement, for the GSEs. There
clearly are certain things that the private sector is not going
to respond to. And it is very important for the private sector
to examine these. So as we examine the regulatory impediments
to the private investment capital coming in, we also need to
examine the culture of the private sector. There is a reason
for both here.
Let me give you an example. I have home foreclosure events
in my area. I come out of Georgia, the metro area of Atlanta,
which has one of the highest foreclosure rates; they are
underwater. And every time I have one of these events, we have
representatives of Federal programs there to assist some of
these homeowners. One was HAMP. And the only--when I talk to
the banks, when I talk to those homeowners, and I say, why
won't you use HAMP for this? They say, we will only use HAMP if
that mortgage is backed by Fannie or Freddie. So the question
becomes, if we phase Fannie and Freddie out, what happens
there?
And so I think that what we have here is sort of like a
square peg we are trying to fit into a round hole.
I believe that having 90 percent of these mortgages backed
by the government is not healthy for us, no doubt about it. But
I think as we go forward, it shouldn't be this or that, but
maybe a combination here. And I think it is very important that
each of the four of you have come to the conclusion, I believe,
that you are aware that the private capital and the private
investors cannot come in and replace Fannie.
Can we agree that is a statement here?
All right. Moving forward, what I understand we should do
here is to come up with a way in which we could deal with this.
And I think you mentioned, Mr. Katopis, something called the
Trust Indenture Act as a model that was done back then that we
need to work to.
And, Mr. Millstein, I think you dealt with the guarantee
fee, of how we can manipulate that to--as two levers.
So can each of you kind of explain going forward how that
would work as a way of easing in private capital and yet being
sensitive to the safety net value of Fannie and Freddie?
Mr. Katopis. Thank you, Congressman.
I just want to make some brief observations. And I invite
you to see the testimony where we say that since the financial
crisis, the amount of capital available in the system is at an
all-time low. So I think the conversation has to be about not
only the people who need assistance, who are hurting and are
looking to HAMP and HARP as vehicles for assistance, as well as
the other dozen Federal programs and other State assistance
programs, but how do we help the first-time homeowner, the
person coming into the system, maybe just graduating from a
college in Georgia, who are looking to buy their first home, or
the veteran, how do we help them?
We need to have a system where private capital comes into
the market. Because as I mentioned in my opening statement, the
mortgage system is about private capital investors to borrowers
and back. So the Trust and Indenture Act is a system--you know
what it is? It is an investor bill of rights and a bank
originator quality control measure. And it is detailed in our
testimony. We think that it will set the rules of the road,
create standards in the systems that will allow that private
capital to come back for both people who need refinancing and
new homeowners.
Mr. Scott. Mr. Millstein, very quickly, could you tell us
about the guarantee fees? To what extent do guarantee fees that
are charged by Fannie and Freddie need to rise in order to
bring in private capital?
Mr. Millstein. As I said earlier today, Fannie and Freddie
are not being required to earn a return on capital. Government
is providing its capital effectively without requiring the
entities to earn a return on it. If they were to have private
enterprise-like capital return on equity hurdles, they would
probably have to raise the g-fees another 15 basis points.
Mr. Garrett [presiding]. I thank the gentleman for the
answer.
The gentleman from South Carolina, Mr. Mulvaney, is
recognized now for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman. I have enjoyed the
opportunity to have this hearing. So thank you for calling it.
Thank you for coming, gentlemen.
I want to focus on some smaller steps. I know we have had
some discussion about some large ideas and some large plans for
possibly reforming these entities. I want to start with
something relatively simple that I can get my hands around,
which is the fees.
Mr. Millstein, you had mentioned in your testimony, I
think, that you had encouraged a program whereby fees would be
properly calibrated to cover taxpayers against risk of loss. I
guess my question to you is, is that really possible? If, so
what, would it look like?
Mr. Millstein. Just because individuals go into the
government, it doesn't mean they lose their ability to do
credit ratings and credit analysis. In this last crisis,
obviously, everyone in the private sector got it wrong. Banks
took it on the chin; private investors took it on the chin.
There was lots of bad underwriting and credit analysis that
went on, not only in the government in its oversight of Fannie
and Freddie but in all of the major financial institutions. So
the point is, is that we can impose on the government-sponsored
entity or the government reinsured entity, in my universe, a
requirement to charge fees that are proper to the risk they are
taking and for a government reinsurer to charge fees calibrated
to the risk they are taking. And I will tell you that we have
done some modeling with some of our friends on Wall Street, and
we think that the government needs to charge for a reinsurance;
it needs to charge 6 to 10 basis points for the privilege of
providing that catastrophic guarantee. But you don't--and it
doesn't have to charge more than that because you need to have
a well-capitalized first-loss insurer ahead of you. If you
don't have somebody who is well-capitalized ahead of you, you
have to charge an awful lot more.
Mr. Mulvaney. Mr. Katopis took the position that fees by
themselves are probably not enough to level the playing field
to encourage private capital into the market.
Mr. Millstein, would you agree with that?
Mr. Millstein. I'm sorry, sir?
Mr. Mulvaney. Mr. Katopis stated in his testimony that he
thought raising the fees might be something we should look at
and should encourage. But that by itself would not be enough.
Do you agree with that?
Mr. Millstein. No. I agree with that for the reasons that
he cited, which is that when you look back at private label
securitization market and the period 2007-2008 and then the
aftermath of the crisis, it was clear that the legal
protections of investors were inadequate to protect them
against conflicts with second lienholders, inadequate to
protect them against conflict with servicers, and inadequate to
get their trustees in these trusts to actually enforce their
rights.
Mr. Mulvaney. Let's talk about another tool, then, if fees
aren't enough, and we all agree that fees are not enough. Let's
look at the lending limits. I was struck by something that my
colleague from Georgia just said, which is he is interested in
how we treat the little fellow. I happen to agree with that. In
fact, that is one of the original missions of these entities.
The lending limit in Chester County, South Carolina, is
$417,000. I have news for you; I don't think you can buy a
house in Chester County, South Carolina, for $417,000. We are
covering much more than just the little fellow.
What I am hearing from you, Mr. Hughes, is that there is a
functioning private market above jumbo, or in the jumbo realm
right now. And if we slowly were to lower those lending limits
below $417,000, we may well still be able to deal with the
folks that Mr. Scott and I are so interested in, but still
allow private capital to enter the market below $417,000. Am I
wrong about that? What am I missing?
Mr. Hughes. I would agree. If we look back and went back to
the OFHEO model, which was calibrated based on changes in home
prices, if we went back to what the loan limit would have been
under those models, where Fannie and Freddie would transact,
the loan limit would be about $330,000 today. So, yes, I think
on a safe basis, one of the ways to bring the private sector in
would be to guarantee fees and give an opportunity to open up
more of the market to the private sector.
Mr. Millstein. But don't go there too fast, because if you
lowered it in your county to 3--whatever it is--30, the people
between $330,000 and above would have to have a 40 percent
downpayment for Mr. Hughes' firm to actually finance them.
Mr. Hughes. It is not 40 percent, for the record.
Mr. Millstein. Thirty-five.
Mr. Hughes. It is not 35 percent.
Mr. Millstein. Isn't that the average LTV?
Mr. Mulvaney. Thank you for that, gentlemen.
One unrelated question, because I heard something from you,
Dr. Kling, that grabbed my attention. And I don't know the
answer. At the risk of asking a question I don't know the
answer to, you said that taxpayers were taking interest rate
risk in ways that no one anticipated. What type of interest
rate are we taking that we didn't anticipate?
Mr. Kling. Freddie and Fannie used a huge book of
derivatives to hedge their risk. We don't know ultimately who
is holding those derivatives, just as we didn't know that AIG
was holding a lot of the credit risk before. So if there had
been an interest rate spike, there would have somewhere in the
shadow banking system, somebody who would have taken a big hit
and we could have faced that problem.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Missouri, Mr.
Cleaver, for 5 minutes.
Mr. Cleaver. Thank you, Mr. Chairman.
I think it was Warren Buffett, I am not sure--I don't think
I missed a single meeting when we were dealing with Dodd-Frank.
So I think people began to quote Warren Buffett with the whole
deal of declaring that we needed to--in Section 941, need to
make sure that people had ``skin in the game,'' in terms of
securitization, because where I grew up, we said, ``dog in the
fight.'' But we don't have as much money as Mr. Buffett, so we
said ``dogs.''
But my concern is, in this Section 941 of Dodd-Frank, the
skin in the game requirement would require that securitizers
retain 5 percent interest in the securitization. And given that
the risk retention proposal provides significant flexibility,
how does the proposal impact the asset-backed security market,
or does it?
Mr. Millstein?
Mr. Millstein. Interestingly, Mr. Hughes will tell you that
his investors require him to have skin in the game. And he had
skin in the game, actually greater than 5 percent. He is taking
that subordinated tranche in his pools to himself. Right?
Mr. Hughes. Correct.
Mr. Millstein. So the market has sort of--at least as the
market is today, a very small private label securitization
market but growing, has actually adopted this requirement and
requires the securitizer to have the junior tranche taking
first loss ahead of the senior creditors.
Mr. Cleaver. Now, Fannie and Freddie, 100 percent. Correct?
Mr. Millstein. Yes, that is right. They have skin in the
game, but they don't have any capital to back it.
Mr. Cleaver. So they don't have to retain 5 percent,
correct?
Mr. Millstein. They have been carved out by Congress--
sorry, by the regulators, not by Congress.
Mr. Cleaver. Do you think that will limit the private
security market?
Mr. Millstein. Yes.
Mr. Cleaver. How so?
Mr. Millstein. I think if Fannie and Freddie are to
persist, either in government-sponsored form or in privatized
form, we are going to have to build into--we are going to have
to let them have capital, first, to protect taxpayers against
loss in either system, a cushion to absorb losses, and they are
going to have to have skin in the game.
Mr. Cleaver. Yes--anybody else? Mr. Hughes?
Mr. Hughes. Yes. I would just like to clarify a couple of
things. One, investors haven't sat there and pounded the table,
Redwood, you need to hold 5 percent. We hold it as part of our
business model to show alignment of interests with investors.
And second, in terms of the GSEs, I think another
interesting model underfoot, rather than the GSEs having dollar
one of loss through dollar 100 is to sell to the private
sector, have them invest in the first tranche or the first
credit loss of the securities that they are issuing, I think is
a very interesting model.
Mr. Cleaver. Yes, sir.
Mr. Katopis. Congressman, AMI's position is that the best
skin in the game is effective reps and warranties that can be
followed up in court. Certainly, if you buy anything in
America, you buy an iPod, you buy a car, you get a warranty. If
your State, your union is investing in mortgage-backed
securities, they should have some recourse. So we would hope
that effective reps and warranties are part of any future
system.
Mr. Cleaver. Mr. Kling, do you agree with everyone else?
Mr. Kling. I am just not sure that the best place to design
the allocation of risk is with a government agency. When I was
with Freddie Mac, we had all sorts of systems in place for
dealing with what we thought were ultimately scum bags as
lenders. And--
Mr. Cleaver. Let's not get technical, sir.
Mr. Kling. And some of it was saying, well, since we don't
trust you, you are going to have to sell your loan through
somebody else. There are all these issues. I just think that if
you try to have a government agency dictate the process by
which you manage the whole loan origination to securitization
process, there are going to be mistakes of both kinds, mistakes
of allowing risky processes that you shouldn't allow and maybe
adding to costs unnecessarily.
Mr. Cleaver. Thank you.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from New Jersey, Mr.
Garrett, for 5 minutes.
Mr. Garrett. Thank you, Mr. Chairman, and thank you to the
panel.
When we talk about private securitization and you talk
about investors, the investors class, all investors, I guess,
are not created equal or are not similarly situated. Is that
correct, in the sense that some are looking for long-term
investment and some are looking for short term? I see, Mr.
Hughes, you are on the button.
Mr. Hughes. Correct.
Mr. Garrett. Okay. So, then, if that is the case, going
back to you, can you tell us, were you able to structure some
of your deals in a way that you are cognizant of the fact that
investors are looking for either short or long term, and so you
are able to adjust or modify the cash flow in accordance with
that? Yes, exactly. For some of our transactions, one of the
things you can do is to take the AAA tranche, which is a one
set series of cash flows, and be able to divide that cash flow
up to meet the needs of different investors. So you could be an
investor. And it is a zero-sum game, but you could be an
investor that has a short duration that says, I am willing to
accept a lower yield, but I would like my money first. You can
trade somebody in the middle, and you may have an insurance
company on the back end that says, fine, I want the highest
yield, I feel comfortable with this, and take their money last.
But, yes.
Mr. Garrett. Okay. And so, there is a lot of talk about
trying to make sure that whatever we do, we end up, at the end
of the day, with a 30-year instrument that is out there. Right?
So is there a--well, let's turn it around. By barring
prepayment penalties, is that something that gets in the way of
providing for a 30-year fixed without a wrapper on it?
Mr. Hughes. Excuse me. I didn't quite understand.
Mr. Garrett. All right. So if you want to establish a 30-
year fixed in the market, in the private sector, without a
wrap, without a guarantee, if that is the goal, do prepayment
penalties help or hurt the situation?
Mr. Hughes. I think prepayment penalties would help the
situation, knowing that the duration of the cash flows would be
longer.
Mr. Garrett. Right.
Mr. Hughes. 3 or 5 years.
Mr. Garrett. Spend 30 seconds explaining why prepayment
penalties or the borrower on prepayment penalties is adverse to
an investor's interest, or could be adverse to an investor's
interest?
Mr. Hughes. It could be on the agency side as well as the
private side, to the extent that you pay a premium for a
security and a yield, to the extent that you paid, not par but
you paid 102, with an expectation that you are going to get a
higher yield, and that higher yield will last for a longer
period of time. To the extent that it gets prepaid in 6 months,
you are going to end up losing money on that investment. So
matching the duration of the expectations for what premiums you
are paying and your expectation.
Mr. Garrett. But those are interest rate risk variations
that you have, there. That if you thought you had--as an
investor, you thought you had a 30-year instrument there and
all of a sudden, like I say, 6 months later, because the
markets have changed and now I can refinance my mortgage, I am
going to do that, it is good for the homeowner, but may not be
good for the investor. Right?
Mr. Hughes. Correct.
Mr. Garrett. So if we can adjust that and allow that to be
a variable, it could actually help getting a 30-year fixed in
this market.
Mr. Hughes. Yes, it could.
Mr. Garrett. Are there other factors that we could look at,
standardization, as such, to get a TBA market and a forward-
looking market to make sure that we end up with a 30-year
fixed?
Mr. Hughes. Yes. And I think your bill would go a long way
toward trying to get us there.
Mr. Garrett. That is nice to hear, sir.
Mr. Hughes. I would say that standardization, at least as a
guide, one of the things I think would be very helpful for
private investors is one of the things, and this has happened
over the last month-and-a-half, going through documents that
are incredibly dense to try and figure out differences in
private deals. I think one thing that would be very helpful is
to have an industry best practices, top to bottom from seconds,
whatever, and make that clearly identifiable in a prospectus so
an investor can clearly see which ones agree with best
practices and which ones have deviations.
Mr. Garrett. That is pretty neat. So what would happen
today or tomorrow, for example, if FHFA said, we are going to
issue two pools of securities for sale, right? One over here is
just what have all the standardization that you just described
which FHA currently does, right, and has the wrap or the
guarantee around it and another pool identical to it in all
ways that you can. Would there be--obviously, there is interest
in the first. Is there any interest if that were to happen
tomorrow by some investors depending on the price? The price
would be different, correct?
Mr. Hughes. The price would be different.
Mr. Garrett. Okay. So there would be--for some investors,
they may find an interest in that. Do you know, could anybody--
Mr. Hughes. I think the key thing is that what investors
want is clear transparency so they know what they are buying,
and if the expectations of PSA look this way and if there are
deviations to it, what they just don't want to have to do is go
to page 130 to figure it out. They would like on the front page
to know, here are the deviations, and make true transparency
and make it simple.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from California, Mr.
Sherman, for 5 minutes.
Mr. Sherman. Thank you, Mr. Chairman.
It was interesting hearing from Mr. Mulvaney. When he used
the phrase, ``You couldn't find a home in Chester County for
$417,000,'' I thought his area was like mine, that you couldn't
find a home in that county for as little as $417,000. It took
Mr. Watt's translation ability to tell me that, no, you
couldn't find a home in his county that sold for as much as
$417,000, and I think this illustrates why we need some
differential in the conforming loan limit between high-cost
areas and areas where homes sell for different prices.
Over the last year or so, the guarantee fees of Fannie and
Freddie, the g-fees, have been raised in an attempt, among
other things, to level the playing field for private capital. I
wonder if the gentlemen could tell the committee if the
increased g-fees have spurred your members, your organizations
or others that you focus on to take the first step back into
the market below the jumbo level, and if the folks are still on
the sidelines when we have the guarantee fee at 50 basis
points, how much higher does that guarantee fee have to go to
get private capital involved below the jumbo level? It looks
like Mr. Hughes is interested.
Mr. Hughes. Yes. I would say an increase of somewhere in
the neighborhood of 15 to 20 basis points would begin to get
private capital back, but as I said, that has to work in
concert with all the other recommendations around safety so
investors know that there is safety in the investments so that
the prices they are willing to pay begins to tighten, and I
think the combination of investors paying at slightly tighter
spreads together with higher guarantee fees would bring much
more capital into the market.
Mr. Sherman. Now, what is stopping particularly the large
banks from originating and then keeping and not even
securitizing the mortgage loans? They don't have the cost of
securitization. They don't have to hire a lawyer to tell them
whether they have to keep 5 percent of it or not because they
would be keeping the whole thing; they are not paying. There is
no guarantee fee to pay, and banks have the lowest cost of
capital in, certainly in my memory. So what is keeping banks
from just doing what they used to do in ancient times, and that
is loan money and collect payments from the borrower?
Mr. Hughes. There are many banks today, some of the major
banks with larger balance sheets that are actually holding
their jumbo loans today. One of the risks out there that Dr.
Kling mentioned is that the 30-year fixed, bad things happened
in the S&L crisis so that people hold on their books 30-year
fixed rate mortgages and their funding comes from deposits or
shorter terms, you can get kind of upside down, and we had a
bad chapter in our history.
Mr. Sherman. Yes. Is there--I realize many borrowers aren't
interested in adjustable rate, but those products are still out
there. Is there any real interest in the big banks holding
adjustable rate mortgages?
Mr. Kling. What I heard at a conference last week is that
in the jumbo market, there is a notable price differential
between a 5-year adjustable and a 30-year fixed, and borrowers
are willing to take the 5 year, given that price differential.
Mr. Sherman. Okay. The Basel III rules have raised the
amount of capital banks have to hold, and as to non-government-
backed mortgages with a less than 20 percent downpayment, that
can be almost 50 or 100 percent more of a reserve. What effect
will this have on private investment in non-government-
guaranteed mortgages and mortgage-backed securities?
Mr. Millstein. That is clearly going to raise pricing. It
will have an impact on banks' ability to hold those loans
without higher capital charges, and it is, therefore, going to
have higher pricing.
Mr. Kling. I would also just add--
Mr. Sherman. Yes, Mr. Kling?
Mr. Kling. The Basel agreement is really what got us where
we are today.
Mr. Sherman. What got us--speak louder, please.
Mr. Kling. The original Basel agreement, which made AAA-
rated mortgage securities cheaper for banks to hold, even if
they were backed by total garbage loans, than holding a safe
loan as a whole loan, and unless--so the capital requirements
are a big deal in determining the nature of mortgage finance.
Mr. Sherman. I underlined the words AAA and realize we need
reform with the credit rating agencies. I yield back.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from California, Mr.
Royce, for 5 minutes.
Mr. Royce. Mr. Hughes, you are the only one I know right
now who is involved in the private securitization market, and I
remember in 2011, you made some comments that most borrowers
now qualify for loans backed by government agencies, and you
said one of the reasons that the private securitization market
is not properly functioning is because the government is
crowding out the private market through loan programs that make
90 percent of borrowers eligible for a below-market-rate
government-guaranteed mortgage loan. Private capital simply
cannot compete with government-subsidized mortgage programs.
You mentioned the problems that may arise from the premium
capture cash reserve account provisions also in the proposed
rule on Section 941 of Dodd-Frank, and going through the
comment letters, you notice, we all notice that critics have
noted with respect to the letters to the regulatory agency,
simply speaking, this provision needs to be removed in order to
prevent a material contraction in securitization activity.
Certainly, it is relatively difficult to imagine a contraction
in the private label mortgage market which is already severely
contracted, but we seem to be doubling down here. What will
this do in terms of the future viability of a private mortgage
securitization market, in your opinion, if we don't get this
adjusted?
Mr. Hughes. I think it would tremendously hamper--if
premium capture as written stays in there, it will hamper not
only the RMBS market, it will also be the CMBS market. It is
complex. I can go through it what the provisions are, but it
essentially makes sure that if you are a securitizer, if you
originated loans, that you are going to sell into fair market
value, that you cannot make any money on that transaction.
Mr. Royce. You hinted earlier at interest rate policies.
The Fed's quantitative easing program is having an impact on
mortgage valuations and the ability, I think, for private label
mortgages to be issued, but on top of all of the rest, let's go
to the transparency and standardization in the market, label
market, in the private label market and go to the issue of what
investors are looking for. We have seen a proactive effort led
by the American Securitization Forum with Project RESTART,
which Acting Director DeMarco said will provide a real-time
test of a new standardized contractual framework for
transactions where the private sector is absorbing credit risk.
So this is a good first step, I think, toward standardizing all
loan level information.
How do we ensure that future issuers continue to comply
with the standards--and I would ask that of any members here on
the panel--set by this Project RESTART, and in a similar vein,
is it possible for standardization to include information on
the due diligence process being employed by new private label
issuers where end users will then have full transparency of how
the process works? I think it is also important which vendors
are performing the due diligence. Would that be possible in
terms of this transparency and consistency for investors and
how much would that help?
Mr. Katopis. Congressman, thank you for raising these
issues which are very important to AMI and its members. In
summary, we share the objectives that are being stated by ASF
with this Project RESTART. We are concerned that after 5 years,
there has not been a result of this restart project. That is
one of the reasons why AMI is here to testify today to explain
that all the goals that you have mentioned--enhanced
transparency, greater standardization--are things that we need
the sort of light hand of government to set standards and
systems for the market to move forward and private capital to
return. So I think there is probably a parallel effort that
needs to go on.
Mr. Hughes. I would say also there is a balancing act
because we try--we are completely transparent--to tell
investors whatever we can about the loans, but that is in
conflict at times with privacy, and one of the things that is
in conflict with privacy would be due diligence results, street
address, name, and things like that. So we need to balance
privacy with transparency.
Mr. Royce. Thank you, Mr. Hughes.
Any other observations by other members of the panel?
Thank you, Mr. Chairman.
Chairman Hensarling. The gentleman's time has expired. The
Chair now recognizes the gentleman from Delaware, Mr. Carney,
for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman.
Thank you to the panelists for coming in today. I
appreciate this hearing. This is the second or third hearing we
have had on housing finance reform. It has been very
enlightening and interesting to me. I am not smart enough to
figure out, though, some of the difficulties in transition.
Each of you, I think, has warned us about transitioning to a
very different system. There seems to be an emerging agreement
or consensus around the fact that we need to bring more private
capital in. What that looks like as an end state remains to be
seen, and more importantly, how you transition to that end
state.
Mr. Millstein, I haven't read your whole written statement,
but we have met before, and I have listened to your proposal,
and it seems very interesting and one that we ought to think
about seriously. I have two concerns, or rather a question and
a concern. Are you familiar with what Mr. DeMarco is doing? Are
each of you familiar with what Mr. DeMarco is doing in terms of
setting up a platform, I think he calls it for future
securitization? Are you familiar with that, and is that
consistent with any of the models that we might be moving
toward?
Mr. Millstein, you are shaking your head.
Mr. Millstein. Yes, I am. It is a massive reengineering of
software for both companies. They are doing it on a joint
venture basis to be able to track a loan from origination into
the pooling ultimately the servicing of that. So it is an
important project and could create both greater transparency
and a utility that other market participants could use.
Mr. Carney. So, in that sense, Mr. Katopis, in your piece
you raise a lot of concerns about the legal structure that
again I don't really understand it so much, but do we have that
framework? You talk about the Trust Indenture Act as a model
for what needs to be done now. Do we need to do that so that
Mr. DeMarco is setting up something consistent with the new
legal structure?
Mr. Katopis. Congressman, I think the key is what Mr.
DeMarco appears to be doing is establishing a platform for
agency, and we are private label, so I think his endeavor could
be very valuable, especially if it was open access to all
market participants, and likewise the development of something
along the lines of the Trust Indenture Act provisions would be
a very important complement and help private capital return to
the market.
Mr. Carney. Do you have something specific in terms of what
that model, what that Act might look like modeled after the
Trust Indenture Act?
Mr. Katopis. We have an exemplary draft bill that we are
happy to share with anyone, and come by and spend some time
with you about it, so I would be happy to follow up.
Mr. Carney. That is great.
Mr. Millstein, back to you. This is a great graph here, and
I am wondering if you could explain to us what it might look
like beyond 2011 or what these--how it might transition and
what might be included in the yellow and what the red might
look like, and one of the things I am--the follow-up question
is going to be, there was a time prior to the mid-1980s where
savings and loans and credit unions had a much larger part of
this market, and we know what happened at the end of that
period of time, and what worries me a little bit is as we
change, we invite private capital in, let's assume it all comes
back in, and then something happens where they don't get it
right, and if all that private capital leaves the market, then
what are we left with if we don't have--what is the public role
that could fill in at that point?
Mr. Millstein. Congressman, if you were to actually flip to
page 10 of that, because what I want to do is explain what I
think the yellow on page 4, where that yellow segment is going
or should go, where I would highly recommend to you that it go.
So the old system is on the left side; this is how is the
government guarantee delivered. The old system is on the left
side where you have homeowner equity and Fannie and Freddie
undercapitalized with very little capital required by the
regulator to support the credit risks they were bearing. The
current system is you have homeowner equity and private
mortgage insurance and the Treasury Department is backing, it
basically bears all the credit risk in the Fannie and Freddie
book. The new system we propose is one where homeowner equity
is first in line; then you have effectively the risk retention
either by a guarantor, a private guarantor such as we would
make Fannie and Freddie, or an issuer such as Redwood Trust,
taking the next layer of risk. And only after those two layers
would the government reinsurance kick in, only after those two
layers of risk.
Mr. Carney. So what happens if all of a sudden the red
block in the new system goes away?
Mr. Millstein. The government can tune it up to deal with,
turn up the attachment point.
Mr. Carney. Thanks very much. My time has expired.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Florida, Mr.
Ross, for 5 minutes.
Mr. Ross. Thank you, Mr. Chairman.
Mr. Hughes, I just have to ask you, you spoke of your jumbo
loans, and as I understand it, you have a robust market in the
jumbo loans?
Mr. Hughes. Yes, we do.
Mr. Ross. At a 60 percent loan to value?
Mr. Hughes. We are, just to correct, again, I didn't say 60
percent loan to value. Today, we are offering jumbo loans up to
a million dollars for 80 percent.
Mr. Ross. Okay. Do you put those on the secondary market
afterwards, or do you hold those yourselves?
Mr. Hughes. No, we then take those and securitize those
through private securitization.
Mr. Ross. I understand.
Mr. Katopis, you testified earlier about the inflated
mortgage debt that we have out there. Would you say that there
is enough private capital in terms of capacity to meet a market
if a market were to come back?
Mr. Katopis. There are three sources of mortgage finance:
banks; the Enterprises; and the private markets, PLS. There is
a lot of liquidity, as has been testified about. So it can come
back, provided the systems and safeguards are there, and it
will increase as the Enterprises are wound down.
Mr. Ross. So you feel that over time, there will be
sufficient capacity to meet the demand? And some of the
problems we have that I think you touched on were the cost of
compliance, I mean the cost of regulatory compliance. If Basel
III is implemented, you will have the cost of capital
compliance, so that is going to further suppress any reentry of
the private market, won't it?
Mr. Katopis. As we have testified, regulatory and legal
pressures will be a head wind for private capital coming back.
Mr. Ross. And at one time, I guess back when it was a purer
system, back in the 1970s and 1980s when you had companies that
would originate and hold a mortgage, and they would originate
and hold a mortgage because they managed the risk. And then I
think as the GSEs became more involved, you saw a lowering of
standards to the point where the FICO scores didn't matter, to
the point where employment didn't matter, where there was no
verification of income even, and you moved to a system of, I
think, what is called originate and sell. And it created this
moral hazard, if you will, I think that more and more companies
were trying to just originate a loan and then sell it to the
secondary market, which then led to our collapse. Would you
agree that there is a way maybe we can bring this back if we
had originate and hold for 5 years or just--I say that 5 years
arbitrarily, so that the market in and of itself would have to
have some standards of risk?
Mr. Katopis. Thank you, Congressman.
In response to that, we would offer that effective reps and
warranties as part of a standardized PSA or standardized docs
would achieve the goal I think you are suggesting.
Mr. Ross. Right.
Mr. Katopis. Do you want to weigh in?
Mr. Hughes. Yes. I don't think there would be enough
liquidity in the system if, in fact, people had to hold
mortgages for 5 years. I think going--
Mr. Ross. Is there a magic period of time, though?
Mr. Hughes. I think the most important thing is for the
mortgages that they produce, that they stand behind those
mortgages, so that there are real reps and warrants.
Mr. Ross. I agree. So it is truly risk-based?
Mr. Hughes. Correct.
Mr. Ross. Yes.
Dr. Kling, the chairman had a couple of questions about the
Canadian system and the 30-year amortization with a 5 year
revisiting of the interest rate. You mentioned that and I
understood this to be that had we done something like that it
may have caused Freddie and Fannie to go into bankruptcy. Is
that correct?
Mr. Kling. No. My concern with Freddie and Fannie is that
if--
Mr. Ross. Because they essentially went into bankruptcy
anyway.
Mr. Kling. Yes.
Mr. Ross. They were in receivership, and so--
Mr. Kling. Right. My concern there is that if we go to any
system where the 30-year fixed-rate mortgage is dominant, if we
had--let's say Freddie and Fannie had done fine on credit risk,
but somehow we had had an interest rate spike sometime in the
last 5 years, I am not sure Freddie and Fannie would have been
solvent. And--
Mr. Ross. I appreciate that. I apologize, I only have a
minute left and I have to go to Mr. Millstein for just one
quick second. I would love to explore that with you further.
Mr. Millstein, you hit on something that I think is really
important. You talked about a reinsurance market being there as
the guarantee, and the way I look at capital is that you have
risk-based private capital, you have taxpayer-based capital,
and you have debt-based capital, and the only one that really
works that sends a message as to how to truly actuarially
assess your risk is the private risk-based capital. You
believe, then, that there is a way that reinsurance can be used
to supplant the GSE system that we have today?
Mr. Millstein. I do.
Mr. Ross. And how long do you think that would take? What
incentives would it take? Is it affordable? Is it transitional?
How would you suggest we get there?
Mr. Millstein. I am happy to come back and talk to you. I
have a whole transition plan that we have laid out.
Mr. Ross. I would be very interested in that.
Mr. Millstein. It takes about 3 to 5 years.
Mr. Ross. I appreciate that.
With that, Mr. Chairman, I will yield back.
Chairman Hensarling. The Chair now recognizes the gentleman
from Maryland, Mr. Delaney, for 5 minutes.
Mr. Delaney. Thank you, Mr. Chairman.
And thank you for this very constructive debate here today.
I just had one specific question, but I wanted to set it up a
little bit. It seems to me--and, Mr. Hughes, I think you
touched on this--that for the private market to really get back
in this business, and we should remind ourselves that the
private market is also in the government business, right,
because private investors buy an enormous number of agency
securities, so it is really about migrating an already large
pool of investors to an investment vehicle that doesn't have
explicit or implicit government support, and what we need is a
convergence of credit regulation and pricing to come together
to make that market attractive, and of those three things,
credit is the one we control the least, but unfortunately, it
seems like the environment for that is actually getting pretty
good as we are seeing some recovery in housing. I thought the
testimony on regulations, in other words, creating certainty
around the regulatory environment is critical, and I generally
agree with everything that was said in that regard because I
think that would help, and then finally the guarantee fees if
we can--the good news here is the aspect we control the least,
credit, seems to be going in the right direction. So if we
could actually adjust the guarantee fees and do things with
regulatory changes, it seems like we could get into a pretty
good place in terms of getting the private market active.
Mr. Millstein, I think your proposal lays out a very good
vision for the future of housing finance, something that has
been lacking, and I think this notion of having government
reinsurance that attaches to a mortgage so that mortgage could
be held in any number of institutions, whether it be a bank or
a securitization vehicle, is terrific provided the capital
levels are the same so there is no real capital arbitrage.
But the one question I have is you talk about wanting to
take what remains of Fannie and Freddie and privatize those and
start retaining the earnings of those Enterprises, and I
understand why that is good for the preferred stockholders, and
I appreciate your disclosure that you are an investor in the
preferred stock, because it is massively attractive for
preferred stockholders to do that generally speaking--but that
is not my question, and that is fine; that is actually not the
point of my question. I worry about, as we look to privatize
those Enterprises and the government has a stake in those
Enterprises and we all want to do what is best for the
taxpayer, I worry about the conflicts and the incentives to try
to set up those institutions through some form of government
support that makes that number that we sell them for as good as
possible because that will look good and to some extent put in
place some enterprises that permanently have a competitive
advantage going forward as opposed to taking your plan and just
saying we are going to have the mortgage insurance market like
you described, but we are just going to have new infrastructure
manage it and actually wind these things down. So why is one
better than the other?
Mr. Millstein. Okay. I will tell you a cautionary tale from
the 1930s. Under the Federal Housing Administration Act of
1934, they had a very similar idea to this idea, that we should
create a government charter that gave you the right to access
of the secondary market with a specialized government charter.
And the Roosevelt Administration went to Wall Street and said,
you guys should take these charters out because this will
enable you to access mortgage funding cheaply that you can then
provide to the primary mortgage market. No one came. They built
it; nobody came. And so President Roosevelt went to the head of
the Reconstruction Finance Corporation, the TARP of its day,
and asked him to please set up a subsidiary and take one of
these charters out, and who is that today? Fannie Mae. That is
where Fannie Mae came from. So my concern is that we may build
this mortgage reinsurance system, and no one will come.
We have these two entities in our hot little hands today.
We can turn them into private insurers and make sure that we
have someone to come with a big layer of capital ahead of us on
our reinsurance to protect the taxpayers against risk on that
guarantee.
Mr. Delaney. But wouldn't they come, and maybe, Mr. Hughes,
if we create the reinsurance product and have the capital
levels that attach to the guaranteed part be attractive enough,
wouldn't they come to that?
Mr. Hughes. I think they would come to that, on an
individual pool basis, yes, I do. I think, if Fannie and
Freddie were to issue pools--there are various ways under
consideration to sell that. One of the issues right now is
going to be transparency, loan level information, and right
now, I would think that Fannie and Freddie do not--they are
working on it--have the same level of transparency which
private investors would want, but I think you could get there.
Mr. Delaney. I will close by saying, again, I like your
plan quite a bit, Mr. Millstein. I just worry that by launching
these two as private enterprises, we will somehow find
ourselves with monopolistic businesses still in the mortgage
market in some way or form, and it would be better to have that
more dispersed throughout the private markets.
Mr. Millstein. You and I should discuss that.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Illinois, Mr.
Hultgren, for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman.
Thank you all for being here. A few questions. First of
all, Mr. Katopis, I wonder if I could address to you, we heard
testimony back in March about some of the competitive
advantages for the GSEs, and that FHA has compared to their
private competitors. I wonder if you could elaborate on this
for us and how the GSEs and FHA pricing, how are they pricing
investors out of the market?
Mr. Katopis. I will be brief, and I would like to follow up
because what I have said in the testimony that was provided is
that we feel the investors are being crowded out and that there
are a number of economic and noneconomic advantages that the
Enterprises now have. We have discussed the g-fee issue. So, we
have discussed a number of these. Some of these actually also
affect the way the GSEs can impact servicing. They have certain
advantages that do not exist in the private sector. Again, we
would like a level competitive playing field. Our organization
hasn't really looked at some of the FHA issues in detail, but I
am happy to poll my members and get back to you regarding that.
Mr. Hultgren. That would be great if we could follow back
up with you, any suggestions you have.
I will move over to Mr. Hughes. I know you have touched on
this in different questions and also in your own testimony, but
I wonder if you could just get into more specifics on a
recommendation of how we can level the playing field? We talked
a little about the g-fees but tell me more about that as a
potential solution and really as a way to increase investor
interest in the private market.
Mr. Hughes. Yes, I think we have to work on two fronts. I
think the g-fees is one side of it that helps the mass side of
it opening up more opportunity to the market, but quite
frankly, the more important thing is on the structural
protections, transparency, and alignment of interests because
that is what investors are waiting to see. There is plenty of
money out there. If we can get those pieces in place, I think
it would go a long way to bringing the private sector back.
Mr. Hultgren. On the g-fees side, I know you mentioned
there is two, and the structural side is maybe the more
important, but if we were to do something with the g-fee side,
how high do you think that would need to go in order to be an
incentive?
Mr. Hughes. I think, again, with the combination of the
private sector coming in, and spreads tightening, I would say
probably somewhere around 15 to 20 basis points should make it
competitive.
Mr. Hultgren. Dr. Kling, are there other advantages
Congress has given to the GSEs that we should reconsider if our
desire is truly to level the playing field where public capital
has no advantage over private investment?
Mr. Kling. Traditionally, there have been advantages in
terms of not having to register securities, and I can't
remember off the top of my head the litany of advantages that
the GSEs have had, and so my suggestion is to simplify the
problem by just lowering the loan limits gradually and then
opening it up to the private sector that way rather than trying
to figure out which of these--and above all, you have the
implied guarantee and what is that worth, now the explicit
guarantee.
Mr. Hultgren. Okay. One last question, just in the last
minute or a little over a minute that I have, and any of you
who have a thought on this, if you could respond. The Treasury
Department has advocated for gradually reducing conforming loan
limits, as you have mentioned, to bring private capital back in
to certain areas of the market. Is there private sector demand
for loans that would fall into these elevated loan level
limits? What do you think a reasonable time frame for changes
like that, how gradual does it need to be? Could the market
cover these changes very quickly, or would the process need to
be gradual to guard against that market shock? So any thoughts
you have? Again, I know, Dr. Kling, you have talked briefly on
this, but any of the others?
Mr. Hughes. I think the platform that Redwood has set up,
and everything goes with that platform, from structural
protections to transparency all the way through to alignment of
interests, I don't see why the private sector would invest in
prime loans of any size, as long as you get it together, but it
has to come down in stages. But what we have built is
transferrable; it is just not that the only people that we can
lend to are rich people. I think it is a process and a platform
that is transferrable down to lower limits.
Mr. Hultgren. Okay. Again, thank you all. I have just a few
seconds left, so I will yield the few seconds I have back to
the chairman. Thank you.
Chairman Hensarling. The Chair now recognizes the gentleman
from Indiana, Mr. Stutzman, for 5 minutes.
Mr. Stutzman. Thank you, Mr. Chairman, and thank you for
your time today in addressing this issue. I know all of us want
as much capital into the market, I should say, as possible, but
of course to meet the needs that we have for consumers and for
a healthy economy, and I don't care which one of you all want
to touch on this, but could you, with the disparity and the
differences between what the GSEs' standards are--they are held
to different standards since they are in receivership. What do
you see as the disparity between category 1 and 2 loans due to
the incentive to move more capital into the private mortgage
market? Any of you?
Mr. Millstein. I am sorry--
Mr. Hughes. I think all of us are--a definition of category
1 and 2 would be helpful.
Mr. Stutzman. It would be--I am sorry? The difference
between category 1 and 2?
Mr. Hughes. Yes.
Mr. Stutzman. With the higher the requirement for more
capital or less capital with category 1 being backed by GSE and
those who would be in category 2 not being backed by GSE. Does
that make any sense?
Mr. Millstein. I am not getting it.
Mr. Stutzman. You are not getting that, okay. Let me go at
it from a different angle then. As long as they are in
conservatorship, there are differences, right, between what the
GSEs are required to do compared to those in the private
market; is that correct?
Mr. Millstein. Yes, they are serving different markets
right now, and the private market itself is coming back slowly.
Mr. Stutzman. But is that--
Mr. Millstein. It is a much smaller market.
Mr. Stutzman. I guess that is what I am trying to get to.
Are we keeping money out of the market, private money out of
the market because of those differences?
Mr. Millstein. No. Look, there is a debate, I think, on the
two sides of the aisle, are the GSEs crowding private capital
out or is private capital not quite yet ready to take credit
risk after the greatest credit crisis in 4 generations? And I
think it is a little of both. This is a private capital market
that is in need of repair, as you have heard from the two
gentlemen to my right. There needs to be much greater
standardization and transparency, an investor bill of rights in
order to give investors comfort that if they buy into
securitizations, their rights will be protected on the one
hand, but there also needs to be a repair of their own balance
sheets and willingness to take credit risk.
Mr. Stutzman. Okay, so loans with a debt-to-income level
about 43 percent are only allowed transitional QM status if
they are eligible for sale to the GSEs. Are there quality loans
in this space that if they qualified for a QM without a
government backstop, would that attract private capital?
Mr. Hughes. First, go back to the last one because I think
one of the misconceptions is that there is a substantial
difference from the loans other than loan size that Fannie and
Freddie are securitizing today versus what the private sector
has, and if I look at Fannie Mae versus Redwood, aside from
loan size, loan to value for Redwood is 67, for Fannie Mae it
is 75. FICO score for Fannie Mae is 761. It is 770 for those,
for Redwood Trust, and then primary residence is 93 percent and
Fannie Mae is 89 percent. So there isn't a wide disparity for
the majority of what Fannie and Freddie does from what the
private sector would do.
Mr. Stutzman. You say there is not a wide disparity?
Mr. Hughes. In the quality of the loans, no. Other than
loan size, they are similar.
Mr. Stutzman. Okay.
Mr. Katopis. Congressman, I feel the necessity--
Mr. Kling. If I could just add for a second, what that
says, and FHA is the same story, at least in terms of FICO
scores, really high, and what that says is it is the
originators and servicers who are scared of the market right
now. It isn't a matter of which investor is scared; it is the
originators and servicers who don't feel confident that they
can originate or service anything other than a squeaky clean
loan.
Mr. Katopis. Briefly, AMI members would say that we would,
private capital would pursue without a government backstop,
including some type of 30-year mortgage. It would have
different characteristics, but private capital would pursue
something without a backstop.
Mr. Stutzman. Do you think they would be more aggressive if
GSEs and private capital were on the same level playing field?
Mr. Katopis. Absolutely, as we have testified, a level
playing field with certain characteristics would definitely be
a good signal for our investors.
Mr. Stutzman. Okay, thank you. I yield back.
Chairman Hensarling. The Chair now recognizes the gentleman
from North Carolina, Mr. McHenry for 5 minutes.
Mr. McHenry. Thank you, Mr. Chairman, and thank you for
your patience with this long hearing.
Thank you all as well for your patience and fortitude, if
you will, to get through this. This is an important hearing to
understand.
Just to reiterate, and I know you have heard this, but Ed
DeMarco, whose responsibility is to oversee Fannie and Freddie,
said at a hearing a month ago, ``It is possible to rebuild a
secondary mortgage market that is ``deep, liquid, competitive,
and operates without an ongoing reliance on taxpayers or at
least a greatly reduced reliance on taxpayers.'' And he also
talked about just the urgency and the need for this.
So, Mr. Hughes, in terms of private label mortgage
securitization, what percentage of the market are you in? Just
in the last 2 or 3 years?
Mr. Hughes. Redwood? If we hit our goals for what we expect
this year, we will be probably 5 percent of the jumbo market.
Mr. McHenry. Okay. So in terms of securitizations, in terms
of mortgage securitizations outside of government, where are
you? Is that a similar percentage?
Mr. Hughes. Again, we would expect to do about $7 billion.
Mr. McHenry. Okay. So if Fannie and Freddie and the
government went from, what are we, about 90 percent of the
mortgage market roughly? Let's say that pulled back. How much
more business could you do?
Mr. Millstein. I am not--
Mr. McHenry. Again, I am asking you--
Mr. Hughes. If pulling back is done on a safe basis, and
the pulling back happens with increases of guaranteed fees over
time, bringing back loan limits, and again, I can't emphasize
enough, we need to make the structural reforms to bring
investors back because it is not a money problem. There is
plenty of money out there. Historically, of the jumbo market,
50 percent of that market was securitized with the risk. The
difficulty now is the uncertainty of investors who need to wade
back into the water.
Mr. McHenry. So, going back to my question I asked you,
which was could you enhance your business, could you do a lot
more business with less government in the mortgage
securitization marketplace?
Mr. Hughes. Yes, if there was a level playing field.
Mr. McHenry. If there was a level playing field. And is
there currently a level playing field?
Mr. Hughes. Currently, there is not a level playing field,
but we are getting there.
Mr. McHenry. Does anybody on the panel think that there is
a level playing field for private capital and government
capital?
Mr. Millstein, you think there is?
Mr. Millstein. Well, no. What I would say is this, that the
private, the PLS market is broken, these guys are doing a great
job of fixing it, creating transparency, creating structures
that investors will invest in, but it is still rife with
conflicts, rife with confusion about enforcement rights. These
are things you guys can help fix, and if you do fix them, you
will help bring private capital back. But in the last crisis,
what investors in PLS found is that the rights they thought
they had, they didn't have, and as a result, they are very
reluctant to put aside the government's advantages on funding.
As a result, they are very reluctant to step back into these.
Mr. McHenry. Okay. So the title of this hearing is,
``Building a Sustainable Housing Finance System: Examining
Regulatory Impediments to Private Investment Capital.'' That is
the subject matter here today, and removing those impediments,
I think, is a necessary and proper and good thing to the point
where the Minority witness on the panel agrees with that
motivation.
Mr. Millstein. Amazing.
Mr. McHenry. Right? It is amazing. It is fantastic. So
everyone agrees we need to get more private capital into the
mortgage marketplace. Will anybody say they disagree on the
panel?
Mr. Millstein. The question is, how? How?
Mr. McHenry. Thanks. And that is the next thing I was going
to say. You beat me to the punch.
Mr. Millstein. Just trying to help you.
Mr. McHenry. Thank you. So the question is how we get that
back into the marketplace. And I think the agreement here is
that it is not very easy to compete with government when it
comes to this, that you need to have--we talk a lot about
disclosures to those who are getting mortgages, the individual
consumers, but there also needs to be that same level of
clarity for those who are investing or trying to securitize or
are interested in purchasing the securitization. Is that a fair
assessment? You can just say yes.
Mr. Millstein. Yes.
Mr. McHenry. Great, fantastic.
So, with that, I will yield back, and thank you, Mr.
Chairman.
Chairman Hensarling. There are no other Members seeking
recognition, so I would like to thank each of our witnesses for
appearing at this hearing today. Thank you for your testimony.
Prior to adjourning, pursuant to the committee's organizing
resolution, I hereby name the gentleman from Wisconsin, Mr.
Duffy, the vice chairman of the Subcommittee on Financial
Institutions and Consumer Credit.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is adjourned.
[Whereupon, at 12:43 p.m., the hearing was adjourned.]
A P P E N D I X
April 24, 2013
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