U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

86–803 PDF 2014

S. HRG. 113–187 

HOUSING FINANCE REFORM: POWERS AND 

STRUCTURE OF A STRONG REGULATOR 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING THE CURRENT REGULATORY STRUCTURE RELATED TO THE 

SECONDARY MORTGAGE MARKET AND EXAMINING ISSUES RELATED 

TO PROPOSED REGULATORY STRUCTURES 

NOVEMBER 21, 2013 

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

( 

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

LAURA SWANSON, Deputy Staff Director 

ERIN BARRY FUHER, Professional Staff Member 

GLEN SEARS, Deputy Policy Director 

KARI JOHNSON, Legislative Assistant 

GREG DEAN, Republican Chief Counsel 

JELENA MCWILLIAMS, Republican Senior Counsel 

CHAD DAVIS, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

TAYLOR REED, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

THURSDAY, NOVEMBER 21, 2013 

Page 

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

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 2 

WITNESSES 

Alfred M. Pollard, General Counsel, Federal Housing Finance Agency ............. 4 

Prepared statement .......................................................................................... 26 

Responses to written questions of: 

Senator Reed .............................................................................................. 67 

Diane Ellis, Director, Division of Insurance and Research, Federal Deposit 

Insurance Corporation ......................................................................................... 6 

Prepared statement .......................................................................................... 29 

Responses to written questions of: 

Chairman Johnson .................................................................................... 69 

Senator Warren ......................................................................................... 70 

Senator Kirk .............................................................................................. 72 

Kurt Regner, Assistant Director, Arizona Department of Insurance, on behalf 

of the National Association of Insurance Commissioners ................................. 7 

Prepared statement .......................................................................................... 34 

Responses to written questions of: 

Chairman Johnson .................................................................................... 76 

Senator Kirk .............................................................................................. 77 

Senator Coburn ......................................................................................... 125 

Bart Dzivi, Chief Executive Officer, The Dzivi Law Firm, P.C. .......................... 9 

Prepared statement .......................................................................................... 49 

Responses to written questions of: 

Chairman Johnson .................................................................................... 127 

Robert M. Couch, Counsel, Bradley Arant Boult Cummings, LLP, on behalf 

of the Bipartisan Policy Center Housing Commission ...................................... 11 

Prepared statement .......................................................................................... 58 

Responses to written questions of: 

Chairman Johnson .................................................................................... 130 

Paul Leonard, Senior Vice President of Government Affairs, The Housing 

Policy Council of the Financial Services Roundtable ........................................ 13 

Prepared statement .......................................................................................... 61 

Responses to written questions of: 

Chairman Johnson .................................................................................... 133 

(III)

(1) 

HOUSING FINANCE REFORM: POWERS AND 

STRUCTURE OF A STRONG REGULATOR 

THURSDAY, NOVEMBER 21, 2013 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:12 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I call this hearing to order. 

This hearing continues the Committee’s effort to examine housing finance reform proposals. Today we will explore the current 

regulatory structure related to the secondary mortgage market and 

survey the issues related to the proposed regulatory structure in 

legislation. 

S.1217 creates a new regulator: the Federal Mortgage Insurance 

Corporation, or FMIC. The new regulator would wear many hats, 

as the operator of the insurance fund, the regulator of the home 

loan banks, mutual organization, and Common Securitization Platform; and authorizer of issuers, servicers, and guarantors with regard to guaranteed mortgages. 

Because the structure of the housing finance system is complex 

with a wide range of market participants taking part, it is critical 

that we have a strong, effective regulator. Any piece of legislation 

will need to clearly detail the structure, functions, and powers of 

the new regulator. This regulator will need to coordinate closely 

with a variety of other Federal and State regulators to be effective 

and have flexibility to set appropriate standards and rules. In addition, we need to consider whether the new regulator should regulate for safety and soundness, conduct exams, set capital standards, 

play a countercyclical role, crack down on bad actors through enforcement actions, and resolve failed institutions it regulates. 

We should not forget that we have experience with a weak secondary mortgage market regulator. OFHEO was widely viewed as 

weak, which contributed to the problems at Fannie and Freddie, 

and Congress created FHFA in 2008 in response. We cannot afford 

to return to the days of weak regulatory oversight of the secondary 

mortgage market, so Congress should be clear and explicit about 

the responsibilities and range of tools any new regulator should 

have. 

Today’s witnesses bring a wealth of experience to this important 

conversation. They will outline essential tools needed by the new 

2 

regulator, as well as important lessons they have learned as regulators of the Deposit Insurance Fund, insurance companies, and the 

secondary mortgage market. 

We are all aware that housing is a key part of our Nation’s economy. A well-equipped, appropriately structured regulator will provide certainty to market participants and ensure a strong and stable housing finance system that provides mortgage credit to Americans across this country. 

With that, I turn to Ranking Member Crapo for his opening 

statement. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you, Mr. Chairman. 

Today the Committee will discuss how to best structure a strong, 

independent regulator with appropriate checks and balances as 

part of the new housing finance system. We have a broad panel of 

witnesses, and I thank you all for coming. 

In past hearings, I have highlighted the mistakes of Fannie Mae 

and Freddie Mac before they were placed into conservatorship. Not 

only did they operate as undercapitalized companies holding just 

45 cents in capital for every $100 in mortgages they guaranteed, 

but they acted like highly leveraged hedge funds, purchasing nearly 40 percent of the private label subprime securities at the peak 

of the housing bubble. 

These forces culminated in a perfect storm whose cleanup cost 

taxpayers billions of dollars in bailouts, crushing our economy and 

undermining America’s international standing. We must learn from 

these mistakes. When considering reform, we must address three 

pivotal issues about the new regulator. 

First, how can it appropriately balance its dual role as regulator 

and reinsurer in a highly complex market with diverse stakeholders? 

Second, what authorities and powers should be vested in the new 

agency to ensure it is effective without duplicating existing efforts? 

Third, how should we structure the governing board so that the 

agency is well equipped to carry out its responsibilities on day one? 

S.1217 would create the Federal Mortgage Insurance Corporation, or FMIC, as the primary regulator for taxpayer-backed mortgages. The FMIC would provide catastrophic loss insurance funded 

by premiums and guarantee fees on eligible mortgage 

securitizations. As such, it would be a hybrid between the Federal 

Deposit Insurance Corporation and the Federal Housing Finance 

Agency. 

The FDIC was created as an independent Federal agency in response to the bank failures of the 1920s and early 1930s. It is comprised of a five-person board of directors with no more than three 

directors from the same political party. 

The FDIC has survive 80 years without depositors losing a single 

cent of insured funds, in large part because its board is designed 

for long-term stability and continuity, without sudden movements 

or extreme policy shifts. 

As the guaranteed mortgage industry will need similar stability 

and continuity, the new regulator should have a similar balance of 

views. In addition, the new regulator will serve as the principal 

3 

line of defense for the taxpayers and should have a strong, clearly 

defined purpose. Its activities and the activities of those it regulates must result in strong underwriting standards and responsible 

homeownership. Any reinsurance fund, industry participant, and 

ensuring or mortgage or financial product must be well capitalized 

to insulate the taxpayers from unwarranted risk. And to adequately oversee a diverse industry and to coordinate with State and 

other regulators, the new agency will need superb technical expertise. 

In order to accomplish all these goals, we ought to reach consensus on key principles. The new regulator should be an independent agency, resolute in its mandated and unwavering to political whims. Its leadership has to be balanced out to ensure true political independence. Its safeguards and underwriting standards 

must be based on qualifying standards to provide mortgages but to 

protect taxpayers. Its finances must be frequently examined to ensure accountability and transparency, including appropriate stress 

tests. And, last, the agency cannot exist in a regulatory vacuum. 

It must coordinate with other agencies in a holistic approach to 

achieve sensible regulation. Any new regulator must avoid regulatory duplication that leads to increase paperwork and regulatory 

burdens which increase the cost of credit while creating legal nightmares. 

Adopting these principles is crucial because the agency will be 

tested immediately upon its creation. Some of the immediate tasks 

it will have to undertake include to establish rules for the structure 

and use of a federally insured mortgage market within perimeters 

set by Congress, determine approval criteria and guidelines for 

market participants, and set up a cooperative to ensure access for 

small participants in a manner that also maintains adequate taxpayer protections. Today’s hearing is a good platform to discuss 

how best to enable this new agency to succeed. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Crapo. 

Are there any other Members who would like to give brief opening statements? 

[No response.] 

Chairman JOHNSON. I would like to remind my colleagues that 

the record will be open for the next 7 days for additional statements and other materials. I will now introduce the witnesses that 

are here with us today. 

First, Mr. Alfred Pollard is General Counsel for the Federal 

Housing Finance Agency. 

Ms. Diane Ellis is Director of the Division of Insurance and Research at the Federal Deposit Insurance Corporation. 

Mr. Kurt Regner is assistant director of the Arizona Department 

of Insurance, testifying on behalf of the National Association of Insurance Commissioners. 

Mr. Bart Dzivi—am I pronouncing that correctly? 

Mr. DZIVI. Yes, Senator. 

Chairman JOHNSON. He is chief executive officer of the Dzivi 

Law Firm. 

4 

Mr. Robert Couch is counsel at Bradley Arant Boult Cummings, 

LLP, testifying on behalf of the Bipartisan Policy Center Housing 

Commission. 

And Mr. Paul Leonard is senior vice president of Government affairs, Housing Policy Council of the Financial Services Roundtable. 

We welcome you all here today and thank you for your time. Mr. 

Pollard, you may begin your testimony. 

STATEMENT OF ALFRED M. POLLARD, GENERAL COUNSEL, 

FEDERAL HOUSING FINANCE AGENCY 

Mr. POLLARD. Thank you, Mr. Chairman, Ranking Member 

Crapo, and Members of the Committee. I appreciate the invitation 

to testify on the powers and structure of a regulator for a revised 

housing finance system. 

As you know, I work at the Federal Housing Finance Agency, the 

safety and soundness regulator for the Federal Home Loan Bank 

System and Fannie Mae and Freddie Mac. As the Chairman noted, 

the enactment of the Housing and Economic Recovery Act of 2008, 

creating this new agency, represented a major step by Congress 

similar to the task that you now have before you: empowering an 

agency with a full array of supervisory tools, including explicit authority to impose and enforce prudential standards, including capital standards; obtaining reports from parties on a regular and on 

an as-requested basis; conducting examinations; requiring remedial 

actions and authorities to undertake enforcement actions necessary 

to oversee the housing finance market. 

Here are reflected lessons learned about a regulator that lacked 

a full array of authorities to deal with an increasingly complex financial market. FHFA has deployed a broad supervisory team and 

has administrative enforcement powers regarding the regulated entities and the ability to access judicial relief if necessary to address 

third parties through independent litigation authority. 

For emergency situations, the agency does not possess a fund 

such as the Deposit Insurance Fund to cover specified losses. It 

does maintain a working capital fund and has the ability to make 

special assessments. Temporary emergency funding was provided 

in the form of a support agreement with the Treasury Department 

in 2008. 

Including lessons learned from the current financial crisis, I will 

comment on the structures of S.1217 and what may be improved 

per the request of the Committee. 

S.1217 would establish a new model for a secondary mortgage 

market and a new supervisory agency, the Federal Mortgage Insurance Corporation, or FMIC. The range of its duties and responsibilities represents a movement away from traditional examinationand enforcement-based supervision to a multifaceted construct that 

covers availability and transparency of information, standard setting to enter and participate in the market, and supervision of participants. Implementation of these varied elements will require 

careful planning over the 5-year transition period. It must be 

noted, however, that a key lesson learned during the financial crisis is that, even with adequate powers, regulators will not always 

get it right. If taxpayers are going to be exposed to risk of losses, 

5 

sufficient private capital must be available in front of taxpayers, as 

contemplated in S.1217. 

The bill provides FMIC with limited explicit regulatory authority, though additional tools may be implied and, importantly, an incidental privilege provision is included. Making regulatory authority clear and explicit, including establishing prudential standards, 

setting capital requirements, and taking enforcement actions, will 

provide a higher degree of confidence to market participants. These 

powers are familiar to current participants in the housing finance 

market and, to the extent they have not been provided to FMIC or 

are only implied in the bill, they should be made explicit. 

As noted, greater sharing of supervisory information among regulators has been a lesson learned; greater cooperation among regulators and greater transparency for markets is essential. 

The Committee has posed two key questions: Does the legislation 

get the right structural pieces in place for the new market to function smoothly? And does it provide for an effective transition from 

the current system? We have identified some areas where the bill 

could more fully answer these questions. 

The bill authorizes consultation of FMIC with other regulators, 

but really does not strike an appropriate balance of a two-way 

street of consultation and cooperation. We recommend that to the 

Committee. 

FMIC and FHFA roles in the Financial Stability Oversight Council should be clarified, and FMIC should have an appropriate and 

explicit place on the Federal Financial Institutions Examination 

Council. 

There are gaps to be filled, such as oversight of nonbank mortgage servicers, who may not be subject to prudential oversight. 

As to funding, the bill provides for FMIC to be funded exclusively 

by insurance fees. Relying exclusively on such fees as a funding 

base, particularly as the new market is developing, may present 

certain challenges. Growing the insurance reserve could require 

rather large insurance fees in FMIC’s early years. These challenges 

may be addressed by expanding FMIC’s sources of funding to include other fees and assessments, such as application fees, which 

are not explicit, and restoring assessments on the home loan banks 

for their supervision. 

Now, transition to the new agency involves a simultaneous wind 

down of the enterprises and the transfer of functions and employees from FHFA to FMIC. 

FHFA’s experience in standing up a new agency argues in favor 

of immediate transfer of all FHFA personnel and responsibilities to 

FMIC, thus permitting a smooth integration, a focus on meeting 

the bill’s 5-year goal of full implementation, and maintaining the 

congressional direction to wind down Fannie Mae and Freddie Mac. 

Funding in a transition will also be critical so that there is a 

smooth start for FMIC with a solid capitalized reserve fund, systems and technology in place, and resources to address challenges 

that may arise. 

I will end. FHFA supports early congressional action to make 

clear for its regulated entities, for borrowers, and for financial markets the directions you believe most appropriate to protect taxpayers, maintain access to housing finance products and services, 

6 

and the strongest regulatory structure that is credible, empowered, 

clearly defined with needed flexibility, and transparent to carry out 

your directions. While all of this has complexities, that should not 

deter prudent actions. The certainty that can come from such efforts will benefit homeowners, investors, and taxpayers. 

Thank you for your efforts in this direction. 

Chairman JOHNSON. Thank you. 

Ms. Ellis, you may proceed. 

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

Ms. ELLIS. Chairman Johnson, Senator Crapo, and Members of 

the Committee, I appreciate the opportunity to testify before you 

today regarding the elements of the deposit insurance system that 

the Federal Deposit Insurance Corporation has found to be the 

most important in achieving its mission. 

Drawing from lessons learned over the deposit insurance system’s 80 years of operation, both Congress and the FDIC have 

made a number of improvements. My remarks will focus on the importance of certain authorities and regulatory tools through the 

lens of the FDIC’s experience. These include clear and explicit statutory authority, ongoing monitoring to assess risk exposure and to 

take action when necessary, appropriate pricing of insurance, and 

adequate funding arrangements. 

Congress has given the FDIC a clear mandate: to protect depositors and maintain financial stability. Congress has clearly defined 

by statute the amount of deposits covered under the FDIC’s deposit 

guarantee and the condition—that is, bank failure—that triggers 

the exercise of that guarantee. At the same time, Congress has allowed the FDIC flexibility to craft specific regulations to cover the 

many details of its operations. 

Clear statutory authority also has been critical to both our supervisory program and our resolution activities. Examination authority and reporting requirements enable us to monitor and control for 

the risk posed to the Deposit Insurance Fund, or DIF. 

For our resolution activities, authorizing statutes delineate the 

priority of claims and impose general requirements on the way the 

FDIC resolves failed banks. These statutes enable the FDIC to 

mitigate losses to the DIF and help maintain financial stability 

through the timely resolution of failed banks and payment of depositor claims. 

An effective insurance program also must include tools to identify and manage risk exposure, not only when insurance is granted 

but while it stays in force. The FDIC assesses the risk of an institution when it applies for insurance and engages in ongoing monitoring to identify new risks in the banking sector as they emerge. 

Importantly, explicit statutory authorities allow us to take action 

when an institution is engaging in potentially unsafe and unsound 

practices. 

Strong capital requirements are one of the most effective means 

for controlling risk taking by participants in the system, and the 

FDIC has found explicit capital standards to be an important tool 

to protect the DIF. 

7 

The pricing of insurance also is a key element of a successful insurance system. The FDIC has had experience with both flat-rate 

and risk-based pricing. Initially, Congress directed the FDIC to 

charge all banks the same assessment rate. This flat-rate system 

resulted in less risky banks subsidizing riskier banks and did nothing to reduce the incentives for banks to take excessive risk. 

In response to the banking crisis of the late 1980s, Congress 

ended the flat-rate system and directed the FDIC to adopt a riskbased system. Since 1993, the FDIC has had a pricing system 

where banks that take on more risk pay more in assessments. 

Finally, funding arrangements play a critical role in the success 

of an insurance system. A well-designed system ensures that adequate funds are readily available to respond to problems as they 

arise and to avoid delays in closing failed banks or paying insured 

depositors. Those arrangements also determine the amount and 

timing of the industry’s contributions toward the cost of insurance 

and the degree of taxpayer exposure. 

The FDIC has always had an explicit, ex ante fund paid for by 

the banking industry to satisfy claims as they arise. Alternative arrangements, such as pay-as-you-go or ex post assessments, increase 

the risk that bank closings will be delayed, increasing the ultimate 

cost of failure and undermining confidence in the banking system 

more generally. 

Prefunding for future losses is also more equitable and can be 

less procyclical. With other arrangements, surviving banks pay the 

costs generated by those that have already failed, which penalizes 

those banks that are less risky and imposes costs in the wake of 

failures when banks can often least afford it. 

A more difficult question is that of optimal fund size, which involves balancing significant tradeoffs. The Dodd-Frank Act increased the minimum reserve ratio to 1.35 percent and removed a 

hard cap, which had required the FDIC to rebate all amounts in 

excess of 1.5 percent. This new authority gives the FDIC the flexibility to determine the optimal target, so long as it is at least 1.35 

percent of estimated insured deposits. This flexibility should allow 

us to maintain a positive fund balance without having to raise 

rates sharply when failures spike and banks can least afford to pay 

for insurance. 

Again, thank you for the opportunity to share with the Committee the FDIC’s experience and insights. I would be happy to answer any questions. 

Chairman JOHNSON. Thank you. 

Mr. Regner, you may proceed. 

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

Mr. REGNER. Thank you for the opportunity to testify today. My 

name is Kurt Regner. I serve as the assistant director for the Arizona Department of Insurance. Arizona sits on the NAIC’s Mortgage Guarantee Insurance Working Group, and it is on behalf of 

the NAIC that I present testimony today. 

State regulators have a responsibility to protect policy holders 

and ensure competitive markets. As insurance markets evolve, we 

8 

are engaged with all stakeholders to promote an optimal regulatory 

framework. We carefully balance solvency standards with the availability of coverage in the mortgage insurance market. We appreciate the desire in Congress to address issues arising from the 

mortgage transaction, but any legislation must carefully consider 

the existing regulatory regime. 

At its most basic level, mortgage insurance underwrites the risk 

of borrowers defaulting on their loans. The borrower pays the premiums, and the lender is the beneficiary. Through the most recent 

financial crisis, the financial sector’s collective assumptions about 

the housing market were proven wrong. This found PMIs exposed 

on the front lines. After all, they were the ones directly underwriting the risk of borrowers defaulting on their loans. While the 

main players in the PMI space survived the crisis, they are still recovering. 

PMIs are regulated by States in which they do business, with the 

State of domicile providing primary oversight. State laws and regulations that are specifically tailored for mortgage insurance control 

the risk PMIs can assume through a variety of limitations, including strict reserve requirements to protect against economic shock, 

25:1 risk-to-capital requirements, investment in geographic risk 

concentration restrictions, and restrictions on nonmortgage insurance-related activities. 

The NAIC has a mortgage guarantee model act, and it has been 

adopted in substantial form by most States primarily responsible 

for the regulation of PMIs. We have spent the last year considering 

adjustments to regulatory requirements to address the risks uncovered by the crisis and identified three main problems: overconcentration of originations in a few banks, the cyclical nature of the 

mortgage insurance product, and the lack of incentives for strict 

underwriting during boom periods. 

I understand you are also interested in financial guarantors. 

Since Arizona does not serve as a domestic regulator for a financial 

guarantor, I have limited experience in this area. Nevertheless, I 

am an experienced insurance regulator. I have some thoughts on 

the state of the industry. 

Bond insurers base their business almost exclusively on selling 

their credit rating to other parties, initially focused on wrapping 

AAA ratings around lower rated municipal obligations. In the 

1990s, bond insurers expanded their business into structured products. These more complicated investment vehicles, tied to 

subprime-backed mortgages, exposed bond insurers to greater risk, 

which became painfully evident during the financial crisis. Since 

then, the structured bond insurance market has basically dried up. 

On a positive note, this has created opportunities for surviving insurers and new entrants into the traditional municipal business. 

The NAIC has not taken a position on any housing finance reform bills, including Senate bill 1217, but we caution against legislative solutions that solely or substantially rely on the use of PMIs 

and financial guarantors as the lubricant for the housing market 

engine. 

PMIs appropriately insure individual loans, and there has been 

little experience with their insuring securities. There may be regulatory concerns with expansion into this business as they could in 

9 

some cases take on risks in the same loan or type of loan as both 

a guarantor of the securities and the insurer of the individual loan. 

Conversely, financial guarantors have substantial experience in the 

area but failed to live up to their expectations during the crisis. 

Given our experience, we remain skeptical of their capability of insuring anything other than municipal debt, particularly if the underlying financial instrument they seek to insure itself is not appropriately capitalized and secure. Reliance on these entities 

should not be considered the panacea which will fix the housing finance market. 

Moreover, neither PMI nor financial guaranty insurance should 

be seen as a substitute for due diligence or sound underwriting by 

servicers or issuers. The NAIC is concerned with proposals for the 

creation of a new regulator charged with administering of a Federal guarantee that would have the authority to establish standards for the approval of insurers. Those responsible for a Government guarantee has a strong interest in protecting taxpayer dollars, but appropriate deference should be given to existing State requirements. The incentive is simply too great for a regulator 

charged with maintaining the viability of a Government guarantee 

to overshoot the regulatory objective and put in place overly stringent standards that threaten the availability of coverage. Instead, 

this new regulator should focus on establishing standards for the 

unregulated entities that may participate in the new housing finance framework and create standards for the administration of 

the new Government guarantee. As issues of common concern 

arise, any new regulator should work hand in hand with us to address them, as is done today with other regulatory agencies. 

In conclusion, State regulators are committed to working with 

Congress and other regulators to help ensure competitive, stable 

housing and mortgage insurance markets. We remain committed to 

effective regulation of the PMI and financial guaranty industries 

and to enhancing our regulatory structure where necessary. Good 

regulation makes for competitive markets and well-protected policy 

holders. 

Thank you again for the opportunity to be here. 

Chairman JOHNSON. Thank you. 

All Members are now required to report to the Senate floor. I ask 

the witnesses to stay here until we can determine if we can resume. If not, we will reconvene at a date and time to be determined. 

This hearing is in recess. 

[Recess.] 

Chairman JOHNSON. I call this hearing to order. Thank you all 

for your patience today. 

Mr. Dzivi, I believe you are next in line. You may begin your testimony. 

STATEMENT OF BART DZIVI, CHIEF EXECUTIVE OFFICER, THE 

DZIVI LAW FIRM, P.C. 

Mr. DZIVI. Mr. Chairman, Ranking Member Crapo, thank you for 

continuing this hearing this afternoon, especially on behalf of us 

panelists from outside of the District. I do want to note for the 

10 

record, being a former Senate staffer, I had the foresight to book 

a flight to return tomorrow instead of today. 

[Laughter.] 

Mr. DZIVI. My testimony is based on my own views and is not 

intended to reflect the views of any current or former clients of my 

firm. I commend the Committee for undertaking this hearing and 

the other hearings related to replacing Fannie and Freddie with a 

new structure to support housing finance through a vibrant secondary market that relies more on private capital and presents less 

risk to the American taxpayer. In so doing, the Committee should 

analyze both what was good about Fannie and Freddie for American homeowners and what was bad about Fannie and Freddie for 

American taxpayers. I urge the Committee to continue its thoughtful and deliberate approach to this issue. 

In framing my remarks today, I will use S.1217 as a point of departure. The introduction of S.1217 by Senator Corker and Senator 

Warner and their bipartisan cosponsors represents an important 

first step in raising the issue of creating a permanent replacement 

for Fannie and Freddie. I do, however, believe there are ways in 

which the structure proposed in that legislation, especially the regulatory structure, could be improved. 

I see two primary regulatory issues: 

First, what is the appropriate level of safety and soundness supervision of the various private entities that will be involved in the 

securitization process of Federal guaranteed mortgage securities? 

Second, should the Federal Mortgage Insurance Corporation 

itself, which will grant Federal guarantees on mortgage securities, 

be subject to safety and soundness oversight by a separate Federal 

agency? 

When examining the appropriate level of supervision of private 

entities, given that a Federal credit guarantee is involved, it is critical that any supervision of the private entities participating in the 

securitization be in the hands of a strong, independent Federal regulator. During the savings and loan crisis of the 1980s, the country 

learned the hard way that when providing access to Federal guarantees, it may not be prudent to rely on State legislatures and 

State regulatory officials with weak Federal oversight. 

In the 1980s, Congress allowed States wide authority to set the 

investment rules for State-chartered savings and loans, but allowed 

these companies to have access to Federal guarantees for deposit 

insurance. Before Congress slammed that door shut in 1989, weak 

State supervisors in just a few States loosened the rules and let a 

group of rogue operators acquire companies and ring up losses on 

the tab of the American taxpayer in the amount of $124 billion. 

Congress should be mindful of that history. 

I believe this legislation can be improved in three ways: 

First, Congress should expand the scope of the private parties 

who are subject to the Federal agency’s authority. 

Second, Congress should expressly grant the Federal agency the 

same powers that bank examiners have to inspect the books and 

records of entities that participate in the mortgage securitization. 

Third, Congress should create an express enforcement system 

modeled after the Federal banking laws, including the power to 

issue cease-and-desist orders and prohibition and removal orders 

11 

for violations of law and also for engaging in unsafe and unsound 

practices. 

If this new secondary market structure is meant to last, then the 

law must be drawn in a manner to give the Federal agency flexibility with the ability to adapt its rules to changing times and 

changing financial markets. Otherwise, over time, the agency will 

be left writing rules applicable to horse-drawn buggies as Googlepowered self-driving cars cruise the freeways. 

S.1217 grants the FMIC itself the power to issue guarantees of 

mortgage securities. It does not subject the FMIC to supervision by 

a separate safety and soundness regulator. I think the sounder approach is to have a separate Federal agency, either a newly created 

one or the Federal Housing Finance Agency, exercise safety and 

soundness supervision over all the mortgage securitization participants, both the FMIC itself and the purely private parties doing 

business with it. 

In conclusion, Mr. Chairman, great care must be taken in designing a system where as yet unknown private parties will have access to a Federal guarantee in peddling their wares. Whatever you 

design will be a huge magnet for those trying to exploit the system 

to make a quick buck and leave the taxpayers holding the bag. 

Thank you, and I look forward to any questions you may have. 

Chairman JOHNSON. Thank you. 

Mr. Couch, you may proceed. 

STATEMENT OF ROBERT M. COUCH, COUNSEL, BRADLEY 

ARANT BOULT CUMMINGS, LLP, ON BEHALF OF THE BIPARTISAN POLICY CENTER HOUSING COMMISSION 

Mr. COUCH. Chairman Johnson, Ranking Member Crapo, and 

Members of the Committee, thank you for the opportunity to be 

here today to discuss housing finance reform. 

Before I get into the substance of my remarks, I want to commend the Committee for the deliberative, bipartisan approach it 

has taken in examining this complicated but tremendously important subject. 

This past March, the Committee heard from my good friend Senator Mel Martinez, who outlined the recommendations of the Bipartisan Policy Center Housing Commission. As Senator Martinez laid 

out in his testimony, the commission strongly supports the objectives of S.1217, including a multiyear wind down of Fannie Mae 

and Freddie Mac, a greater role for private capital in assuming 

mortgage credit risk, and a continued Government presence 

through a limited catastrophic guarantee of mortgage-backed securities that is funded through the collection of actuarially sound 

fees. The commission believes that a limited Government guarantee in the secondary market is essential to ensuring widespread 

access to long-term, fixed-rate, single-family mortgage financing. 

The new system envisioned by the commission and outlined in 

S.1217 will only work with a strong regulator at the system’s center. This regulator will function as ‘‘Mission Control’’ for the new 

system and will be charged with fulfilling two responsibilities that 

are admittedly in tension: promoting a widely accessible mortgage 

market, while protecting the wallets of American taxpayers. 

12 

Looking at S.1217, let me highlight four areas where I believe 

the Committee can strengthen the FMIC’s role while promoting 

mortgage liquidity. 

First, the commission examined a variety of models around 

which to design a new housing finance system. We concluded that 

the Ginnie Mae model offers several distinct advantages, including 

allowing for a greater number of financial institutions to be issuers 

of mortgage-backed securities. As applied to the FMIC, it would assure the alignment of interests among all the parties in the mortgage chain and allocate risk among them. As you revisit S.1217, I 

urge you to consider legislative language allowing the FMIC to replicate the Ginnie Mae model as a part of its ongoing operations. 

Second, the commission felt that developing a single security or 

‘‘common shelf’’ for single-family mortgages was necessary to ensure the new system’s liquidity, interact effectively with the TBA 

market, and establish an equal playing field for lenders of all sizes. 

A common shelf also allows mortgages with different terms, interest rates, and other attributes to be pooled into a single security. 

Based on our reading, it is unclear whether S.1217 contemplates 

the FMIC guaranteeing a single, common security or multiple securities. We recommend explicitly directing the FMIC to provide a 

common shelf for the single-family segment of the market it backstops. 

Third, under the commission’s proposal, the new regulator would 

have the authority to temporarily take over the business of issuers, 

servicers, and private credit enhancers that happen to fail and to 

transfer that business to other private participants in the mortgage 

system. S.1217 does not appear to give the FMIC the same type of 

resolution authority. With resolution authority, the FMIC can help 

preserve liquidity and ensure a fully functioning market. 

Finally, S.1217 provides the FMIC with emergency authority to 

absorb first-loss credit risk during periods of severe economic 

stress. But this authority is subject to a number of stringent conditions, including obtaining the written agreement of both the Chairman of the Federal Reserve Board and the Treasury Secretary. The 

Committee may wish to consider empowering the FMIC with the 

flexibility to respond more quickly to emergency conditions in the 

mortgage market. 

With respect to the governance of the new regulator, the commission recommended vesting authority in a single individual appointed by the President and subject to Senate confirmation. We 

concluded that putting a single person in charge of the new system 

would promote accountability and ease of decision making. 

Ginnie Mae does not operate under a board of directors, and in 

my view, as a former Ginnie Mae president, it has consistently 

been one of the best-run organizations within the Federal Government. But I certainly understand that the Ginnie Mae governance 

model is somewhat unique among Federal agencies, and there are 

logical reasons for establishing a board for the FMIC. The most 

compelling reason is that rebooting our Nation’s housing finance 

system and running the FMIC is a huge undertaking requiring a 

deep bench of experience. An engaged, experienced board of directors can be a valuable asset to the FMIC Director. 

13 

If, as contemplated by S.1217, the FMIC is to be managed by a 

board of Directors, then I encourage the Committee to amend the 

legislation to ensure that members of both political parties are represented on the board. Bipartisan representation on the FMIC 

board will provide some assurance that the board is making decisions for sound operational and risk management reasons, and not 

because of political considerations. 

Finally, I strongly support S.1217’s requirement that members of 

the FMIC board have significant experience in various specified 

areas of housing finance. This requirement will help ensure that a 

full range of experience is represented. 

Thank you for your attention, and I look forward to your questions. 

Chairman JOHNSON. Thank you. 

Mr. Leonard, you may proceed. 

STATEMENT OF PAUL LEONARD, SENIOR VICE PRESIDENT OF 

GOVERNMENT AFFAIRS, THE HOUSING POLICY COUNCIL OF 

THE FINANCIAL SERVICES ROUNDTABLE 

Mr. LEONARD. Thank you, Mr. Chairman. Mr. Chairman and 

Ranking Member Crapo, thanks for the opportunity to testify here 

today. 

The Housing Policy Council of the Financial Services Roundtable 

strongly supports reform of our Nation’s housing finance system. 

Like others have said today, we truly appreciate the time and attention the Committee is devoting to developing bipartisan reform 

legislation, and we thank Senator Corker, Senator Warner, and 

their cosponsors for their major contribution to this effort through 

S.1217. 

As others have said, for many years consumers and the housing 

market benefited from the role that GSEs played in facilitating a 

secondary mortgage market. However, the financial crisis exposed 

fundamental flaws in the design and operation of the GSEs. A new 

model was needed for the secondary market that preserves the 

availability of stable mortgage credit for qualified homebuyers, retains key operations, systems, and people critical to the current 

system, but corrects the flaws in the GSE model by requiring more 

private capital and better protection for the taxpayers. 

A critical aspect of a new system is the structure and authority 

of the Federal agency that will oversee the successors to the GSEs. 

We support a strong prudential regulator to oversee the private 

participants and the solvency of a reserve fund that stands in front 

of any taxpayer backing. 

On the structure of a new regulator, the Housing Policy Council 

supports the structure of the independent agency as proposed in 

Corker-Warner S.1217, including a governing board, funding 

through assessments from industry participants, and different divisions to handle key duties such as underwriting and credit risk, as 

well as advisory committees to allow market stakeholders to provide input to the agency. 

On the duties of a new regulatory agency, fundamentally the priority duty of the agency should be to ensure the secondary mortgage market operates in a safe and sound manner. The agency 

should have the authority to federally charter the key participants 

14 

in the guarantee securities market and have authorities set standards for that market, including credit terms. To enhance liquidity, 

the agency should establish the terms and conditions of pooling and 

servicing agreements and provide for the creation of a single form 

of guaranteed security. These standards and platforms should 

apply to the securities that carry the Federal guarantee, not the 

private label market. 

The agency should oversee the establishment of a securitization 

platform for federally guaranteed securities. The agency must have 

rulemaking authority, including the discretion to adjust conforming 

loan limits and set appropriate capital standards, much like Federal banking agencies. 

The agency should be required to seek public comment as it exercises its standard-setting authority. Public notice and comment is 

essential to ensure the understanding of and confidence in the 

agency’s regulatory action. 

Where the agency has discretion, it should be required to explain 

the rationale behind its decisions through regular reports to Congress. 

It is important that the agency have examination and enforcement powers, including resolution powers for entities that may fail. 

The agency should have responsibility for the reserve fund that 

should stand in front of the Federal guarantee, much like the 

FDIC’s authority over the Deposit Insurance Fund. 

Finally, as detailed in my written testimony on our vision for 

housing finance reform, the Housing Policy Council supports a 

guarantor structure built around privately capitalized companies 

chartered and regulated by this new agency. Lenders of all sizes 

and business models would originate mortgages that meet certain 

standards and sell those to the guarantors in exchange for mortgage securities or cash. The guarantor would then assume the credit risk on the securities. The securities issued should carry an explicit Federal backstop, and guarantors would pay a fee for that 

guarantee, part of which would be placed into a reserve fund. 

My written testimony also details some important transitional 

steps we have recommended that FHFA take as a way to move toward this new model such as the securitization platform, additional 

progress toward a single security, and additional clarity on representations and warranty standards. 

We believe the work of this Committee is vital to creating a 

housing finance system that works for the future, and we encourage you to continue this effort. 

Thanks for your time, and I will try to respond to any questions. 

Thanks, Mr. Chairman. 

Chairman JOHNSON. Thank you. Thank you all for your testimony. 

As we begin questions, I will ask the clerk to put 5 minutes on 

the clock for each Member. 

Ms. Ellis, based on your experiences at the FDIC, what tools and 

authorities does a strong regulator need to protect the fund from 

losses of bad actors? 

Ms. ELLIS. Mr. Chairman, over the FDIC’s history, we have 

found it very important for the FDIC to have the ability to identify, 

and monitor risk posed to the Deposit Insurance Fund, and to take 

15 

action where necessary. And we do this in a number of ways. We 

do this at the outset. We have the ability to deny or approve deposit insurance applications. We have the ability to collect information from members. We have the ability to set minimum capital 

standards. We have the ability to engage in ongoing monitoring 

and also, when needed, to take action if risks are escalating. 

Some of these authorities are explicit in a statute, and some 

come from more broad authorities, and we have found both very effective. 

Chairman JOHNSON. Mr. Pollard, in your testimony you raise 

concerns that the implied powers provided to FMIC in S.1217 could 

undermine the operation of a national housing market. Do you believe that the legislation should be explicit about the supervisory 

and enforcement authorities that FMIC has? 

Mr. POLLARD. Mr. Chairman, the view that we have is that 

S.1217 is a very strong start. We do believe, as the FDIC commented, that explicit authorities avoid litigation and other problems that can impair action. So that is really where we just believe 

an elaboration was appropriate. 

I would note we believe that the best model is strong and clear 

legislation, but with the flexibility on implementation to adjust to 

changing circumstances. 

Chairman JOHNSON. Mr. Dzivi, what do you think? 

Mr. DZIVI. I concur, and I think the legislation should have express inspection and examination powers and express enforcement 

powers modeled after the Federal banking laws. 

Chairman JOHNSON. Mr. Leonard, what elements of the regulatory structure are needed in legislation in order to provide certainty for market participants? What is flexibility needed? For example, should capital requirements be set in statute or set by the 

regulator? 

Mr. LEONARD. Mr. Chairman, as others have said, I think the 

regulator should have some flexibility to set capital standards. I 

think the goal of S.1217, the ability of the system to withstand a 

significant market downturn is very important, but particularly as 

in S.1217, if you are allowing different types of credit enhancement, I think the regulator would need the flexibility to set different capital requirements for either an insurer guarantor or a 

capital markets credit enhancement process. So I think as others 

have said, I think the regulator needs some flexibility to be able 

to increase capital and respond to different situations. 

Chairman JOHNSON. Mr. Couch, do you agree or have anything 

to add? 

Mr. COUCH. Generally I agree with Mr. Leonard, Mr. Chairman, 

and we approached it the same way at the commission. We backed 

into the capital requirements by asking, What would it take in 

terms of capital to protect the American taxpayer from having to 

pay on that backstop guarantee, that catastrophic guarantee? And 

we looked at it by saying what kind of downturn in the market 

should the system be prepared to withstand, and we said, well, it 

ought to be something worse than the Great Recession but not as 

bad as the Great Depression, and we came up with 30- to 35-percent housing price index deflation. And taking that into consideration, we thought that the capital requirement would be someVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
16 

where in the 4- to 5-percent range. I know S.1217 talks about 10 

percent. But the devil is somewhat in the details on that, and that 

is where the regulator probably needs some discretion to determine 

what kind of capital we are talking about. Is it leveraged? Is it nonleveraged? You know, exactly how does it work? 

So, yes, I would probably agree with Mr. Leonard at a general 

level but we might disagree on some details. 

Chairman JOHNSON. Mr. Regner, the mortgage insurance industry went through difficult times during the crisis. What changes 

have been made or are under consideration through the regulation 

of PMI to strengthen this industry? 

Mr. REGNER. Chairman Johnson, I am a member of the Mortgage 

Guarantee Working Group through the NAIC. The working group 

has been working together for about a little bit over a year now. 

We are in the process of putting in changes to the Model Act, and 

included in that Model Act are additional provisions that we feel 

necessary to protect the mortgage guarantee industry and policyholders. 

A number of things that we have included in our model are additional capital surplus standards, revisions to the contingency reserve standards. We have introduced some additional language on 

the geographical concentration. We have also put some provisions 

in there in regards to quality assurance. We have put standards in 

there for underwriting criteria, higher restrictions on dividend releases, higher restrictions on contingency reserve releases. We have 

put in provisions for rescissions, just to mention a few. But overall 

we are tackling just about every area that we could think of in 

order to cover any of the shortfalls that we have felt were needed 

during the crisis. 

Chairman JOHNSON. Mr. Pollard, when Acting Director DeMarco 

was before the Committee in April, he testified that FHFA was updating master policies and eligibility guidelines for private mortgage insurers. Can you detail the progress on those efforts and how 

these changes will better protect taxpayers? 

Mr. POLLARD. The major point that I can tell you as general 

counsel is that I have been working with the team working on that. 

We do expect something to be made public shortly. The whole goal 

there is to undertake efforts that, first of all, have input that are 

measured and gradual. And that is what I would tell you today— 

any phase-in that the Director has ever supported has had those 

attributes. So right now it is still under review and discussion with 

the industry. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman, and before I begin 

asking questions, I want to also thank the members of the panel. 

You managed to be scheduled just moments before the detonation 

of the nuclear option on the Senate floor, and we all had to interrupt you and go down for a series of—what was it?—eight or nine 

votes while we had an unfortunate skirmish. 

That being said, you were very polite to remain here with us and 

continue to be available, and I appreciate that. 

Mr. Leonard, I want to start with you, but I would encourage all 

the witnesses to listen to the question because I would be interested in thoughts that any of you have on this issue. The issue that 

17 

I want to discuss with you, Mr. Leonard, is the scope and authorities of the new regulator that we are contemplating establishing in 

this legislation. Each of you in one way or another, and many others who have commented to us, have talked about how important 

it is to be sure that certain authorities and powers are given to 

FMIC if FMIC is established as this legislation contemplates. And 

as you sit back and look at what we are poised to do here, it is, 

as I see it, the creation of yet another very big, powerful, comprehensive regulator in our financial system. And I see the need 

for that. 

The question that I have is: How do we assure that we establish 

this new regulator with the appropriate authorities, powers, and 

scope but avoid the duplication with the existing regulators in this 

space and avoid what I consider to be serious potential for increased regulatory cost and burden, inefficiencies, which will then 

play out in the marketplace as a higher cost of credit and so forth? 

So I know it is a broad question, but I think it is a very critical 

question that we have got to answer. Mr. Leonard. 

Mr. LEONARD. Senator Crapo, that is a very good question. I 

think this is such an important—normally, as a representative of 

industry, you know, we have—you know, obviously we do not want 

to be regulated too much. But having said that, this is such an important part of the economy and it is so important to get this right 

that, you know, significant regulatory authority for this new regulator is necessary. 

I think FHFA, through what the Congress did through HERA in 

2008, obviously at that time it was too late to save Fannie and 

Freddie, but FHFA has a lot of the authority now that the new regulator would need. I think it would have to be clarified and added 

to, since I think the prudential authority to essentially act like a 

bank regulator, look at their—you know, be able to go in, look at 

their practice of the guarantors of these new entities that would be 

providing the private credit enhancement. I think the regulator 

needs the kind of authority much of which FHFA has now, but I 

think as others said, it needs to be refined and added to in some 

respects so that the regulator can understand what is happening 

in each of these companies, are they following the practices on the 

types of steps that they should be taking as they do their own due 

diligence on the mortgages that they are guaranteeing? 

I think the point that you make is very true in that there is a 

lot of mortgage regulation that has already been put into effect 

through Dodd-Frank, and it is really not now having an effect. You 

know, I think as we envision it—and others can comment—obviously anything getting the Government guarantee would be a 

qualified mortgage. I think that a lot—we would ask that the new 

regulator—and, you know, I think the kind of legal authority has 

to be carefully considered in terms of is it consultation or coordination or mandated joint rulemaking with either CFPB or some type 

of coordination on the consumer-facing aspect of mortgage regulation and what originators and the insurers have to do. 

So I think we are leery of, you know, too much overlapping regulation, but I think for the most part, for the new entities that 

would be doing credit enhancement, the new regulator, FHFA Plus 

or FMIC, would have to have some pretty significant authority. 

18 

Senator CRAPO. Mr. Pollard, your thoughts? 

Mr. POLLARD. Yes, I think the concern is valid, but I also think 

we have lessons learned and experience coming from this crisis. 

First, many of the participants in this market are already regulated. There needs to be respect for that. I do not think S.1217 disrupts that. 

We at FHFA have both formal and informal relationships. As I 

stressed in my testimony, cooperation and consultation is a very 

good thing. Many of the rules in Dodd-Frank have required people 

to work together—sometimes challenging, but I think it has been 

a good experience in terms of that. 

Also, FMIC could employ what now exists similar to the Fed, the 

FDIC, and the States, which is a State and Federal working group, 

which can help smooth and make sure things work effectively. I 

would note that CSBS has been made part of the FFIEC, so the 

State bank examiners have been incorporated to facilitate that. 

I think what Mr. Leonard said is very important. I think markets do want active regulation, appropriate regulation. There is a 

fear of contagion. We do not want another systemic event. And I 

believe that making explicit authorities but having some flexibility, 

as S.1217 proposes, is a course to take. None of us wants overlap 

or additional burden. 

Senator CRAPO. Thank you. And to the other witnesses, my time 

is up, but if I do not get to come back to you on that, I would welcome your written responses as well. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. It is lonely here 

today. 

Chairman JOHNSON. Yes. 

[Laughter.] 

Senator CORKER. So we thank you guys for being here, more witnesses than Senators, but I know the record will benefit from your 

testimony, and thank you all for the patience you have had. 

Ms. Ellis, one of the things that people have talked about in the 

1217 bill that is generating a lot of discussion—and I know the 

Committee itself is looking at obviously reforms relative to housing 

finance—is the issue of hard wiring capital. And some people say, 

in other words, in the 1217 bill we hard-wire the amount of capital 

that is necessary in advance of any kind of Government guarantee. 

And some people have said that is unprecedented, but isn’t it true 

that Section 38 of the FDI Act actually hard-wires capital relative 

to what your institution is governed by? 

Ms. ELLIS. Right, well, Senator, you are referring to what we 

refer to as the ‘‘prompt corrective action rules,’’ and, yes, Congress 

did define several capital categories, and it also defined restrictions 

that would occur as you breached different capital categories. And 

Congress in the law did define the threshold for the worst capital 

category, if you will, critically undercapitalized. It said that a bank 

essentially has to have a 2-percent capital ratio in order to stay 

open. 

Above that threshold, for the other capital categories, it left it to 

the regulators to define what those thresholds would be, but then 

as I said, it prescribed what the restrictions would be if you 

19 

breached those. So I would say it is a combination of hard-wired 

and flexible, and it has served us well. 

Senator CORKER. And to Mr. Pollard and to yourself, I guess 

what we see around here is a watering down of things over time. 

Could the two of you speak to the benefits of having capital hardwired in that manner? 

Mr. POLLARD. We could consult first, as your bill calls for. 

[Laughter.] 

Mr. POLLARD. But I think—if I can go first? OK. First of all, we 

agree with the 10-percent first loss position. It must be real, it 

must be sustained, and it must create a credible private sector role. 

The bill does talk about the ability to lower it in a crisis. I think 

that what I have heard from the private sector a lot, though, is certainty, and what they refer to as the value proposition. They need 

to know what the rules of the road are. 

Putting this in place and, as your bill does, tying it to safer mortgages should not make this a burden. Indeed, it reinforced prudent 

underwriting. And as I said in my written testimony, and oral, if 

we are going to put Federal taxpayer dollars on the line, it seems 

to me that the regulators serve a valuable role, but the private sector needs to be there as well for a sustained participation. 

Senator CORKER. Thank you. 

Ms. ELLIS. And, yes, as I indicated, we think the capital framework that we have has served us well. Having hard-wired minimums is helpful. It is also helpful to have the flexibility to impose 

higher capital standards as circumstances warrant, as risks develop in the system or an individual institution. 

I would echo the idea that one of the lessons we learned during 

the crisis is that not only is the amount important, not only should 

it be sufficient, capital should be of high quality, and it should be 

there when losses occur. It should not be something that can flee 

in a time of stress. 

Senator CORKER. Thank you. Thank you very much. 

Mr. Pollard, one of the things we also sought to do in this bill, 

especially, again, after we saw what had happened, as Ms. Ellis 

was referring to, during the crisis and what led up to is, is to also 

have some underwriting standards, some minimum underwriting 

standards. They do not address everything, but we have in the bill, 

one of the bills that is being discussed, 1217, QM plus 5, and I am 

just wondering if you might respond to something like that being 

in a bill like this. 

Mr. POLLARD. We are very comfortable with that approach. 

Senator CORKER. That is not much of a filibuster. 

[Laughter.] 

Senator CORKER. I am not accustomed to answers like that, but 

I thank you for that. 

Mr. POLLARD. Senator, most of the people that know me are tickled pink that I gave a short answer. 

[Laughter.] 

Senator CORKER. Mr. Leonard and Mr. Couch, I wonder if—I 

know you all have looked at 1217. I know that we have had discussions about it in the past. But, generally speaking, do you think 

that it does a good job of preserving the good things that exist in 

20 

our housing finance system and eliminating those bad things that 

exist? 

Mr. COUCH. Yes, Senator, I do. Following Alfred Pollard’s model 

for brevity—yes. 

Senator CORKER. Very good. Thank you. That is about as clear 

as it could be. 

Mr. Leonard. 

Mr. LEONARD. Senator, we agree. I think S.1217 goes a long way 

toward correcting those problems, and obviously capital is one, regulation is another, and, you know, we are talking about not FHFA 

but OFHEO, the types of authorities that OFHEO had at the time. 

And issues like portfolio—you know, there should not be—and I 

think it has been well discussed in the Committee, and you have 

made the point. You know, you should not have a portfolio for arbitrage purposes. The portfolio should be for developing or maintaining a market, and it is obviously different from the single-family 

to the multifamily, but we agree there. 

So I think the short answer, not to filibuster, is that we think 

the bill has most of the things needed for reform. 

Senator CORKER. Thank you all for your testimony, and, Mr. 

Chairman, for having the hearing. 

Mr. COUCH. Senator, can I amend my statement with just one 

short sentence? With respect to your question about capital, the Bipartisan Policy Center is going to host on December 11th a daylong session that will bring in private marketplace participants, as 

well as Senators Johnson and Crapo, to address that very issue. So 

we hope you will send some representatives to hear what our folks 

have to say. Thank you. 

Senator CORKER. I am sure they will be there. Thank you. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman, and I appreciate 

all of your testimony. I was at a hearing on a disability treaty, so 

I had a chance to glance through some of the written testimony, 

and I appreciate it on this subject matter. But I want to direct my 

questions to Mr. Pollard since I do not always have the opportunity 

to have you before the Committee. With reference to Director 

DeMarco’s intentions to unilaterally reduce the maximum size of 

mortgage loans that Fannie and Freddie can finance, families in 

my home States of New Jersey, like many other families in States 

throughout the country, can face particularly high housing costs, 

and I am concerned that the reductions to the conforming loan limits can disproportionately harm them. 

So we, meaning a group of bipartisan Senators, including Senator Isakson as well as several Members of this Committee, sent 

a letter to Mr. DeMarco basically urging him not to take unilateral 

actions and questioning whether or not he had the authority to do 

so. 

Now, I would like to know from you as the agency’s counsel, is 

the agency taking the position that Congress has expressly delegated authority to it to reduce the maximum size of loans financed 

by Fannie and Freddie or is it interpreting the scope of its conservatorship powers to include that authority? 

Mr. POLLARD. Senator, let me address both legal and policy, if I 

might—— 

21 

Senator MENENDEZ. Well, if you can just address the legal—— 

Mr. POLLARD. I will address the legal then. The statute for well 

over 50 years has provided that the GSEs set limits; that is the 

first part; second, that the limit may not exceed a maximum, which 

is set through a formula. Thus, the maximum is not a mandate nor 

a floor. The Director in—so the enterprises at any time could have 

set a lower limit. They did not have to go to what is called the 

maximum. 

In the conservatorship, where the Director stands in the shoes of 

the board and management, he then has the same authorities and 

may set that limit. 

Senator MENENDEZ. So your response to me is then saying you 

have both the legal authority and to the conservatorship powers 

you can do it either way. Is that what you are saying to the Committee? 

Mr. POLLARD. Yes. 

Senator MENENDEZ. Well, in 2011, the Director told the House 

Financial Services Committee, and I quote, ‘‘I do not intend to act 

unilaterally in lowering the loan limits because the Congress of the 

United States has been so active in repeatedly involved in adjusting the conforming loan limits that I really and truly believe that 

the Congress of the United States is the body that should make the 

determinations about the future path of the loan limit if it is going 

to be something other than what current law provides.’’ 

Mr. POLLARD. Right. That quote was in part of a response to a 

broader question on loan limits in general. But what I would note 

is he indicated talking about Congress and the maximum loan 

limit. The ability within that loan limit has never been altered by 

Congress, including when they adjusted the loan limit. They have 

not—— 

Senator MENENDEZ. So you are suggesting that if Congress does 

not want the Director to arbitrarily and capriciously on his own, 

despite a feel that Congress has repeatedly been engaged in setting, that, in fact, we should change the law to limit what he, in 

fact, can do in decreasing loan limits? 

Mr. POLLARD. All I can say is that the construct that I have to 

analyze every day provides for the GSEs to set the limits, and 

there is a maximum that has been set and calculated, and that was 

set by Congress. 

Senator MENENDEZ. Well, it seems to me that if Congress has actively and repeatedly been involved in adjusting the conforming 

loan limits, it would suggest that Congress has not delegated to the 

FHFA the discretionary authority to adjust the loan limits without 

an express authorize. It just also seems to me, with Congress actively considering housing finance legislation, as demonstrated by 

this hearing, and many other Members of this Committee who have 

had this view held on this topic, why does the FHFA think that 

now is a good time to take unilateral action on an issue in which 

it acknowledges Congress has shown a clear and repeated interest? 

I find the timing puzzling, to say the least. And for some of us, it 

will invoke a reaction that will be far more limiting to your agency’s abilities. 

Mr. POLLARD. What I would say is that the Director has indicated that he is very attentive to the market here and very senVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
22 

sitive to that. He has provided notice about this. He has indicated 

any change would be gradual. It would have a longer phase-in. And 

it is still under review, Senator. 

Senator MENENDEZ. Well, finally, if I may, Mr. Chairman—and 

I am glad that you reconvened so that I could actually get here— 

I hope if the agency has an analysis as it relates to the benefit 

here—because it seems to me that everything I have seen is that 

loans that would be excluded by a reduction in the loan limits actually performed better than the average. And it seems to me that 

even if—or even if they have a positive value, that without ordering the GSEs to stop financing them would be an action that worsens rather than improves the GSEs’ financial position. I would like 

to see all of this analysis that drives this decision, even in the face 

of repeated congressional action in a bipartisan basis. It just boggles my mind. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. We will go with another round. 

Ms. Ellis, the structure of the FDIC Board tries to ensure diversity and independence while also balancing the background of the 

Board members with their duties to protect depositors. In your 

opinion, what are the strengths of this model? Could this model 

work for a new secondary mortgage market regulator? Also, do the 

FDIC’s advisory committees, like the Community Bank Advisory 

Committee, provide a good avenue to consider stakeholders’ views? 

Ms. ELLIS. Mr. Chairman, in my experience in working with various members of the FDIC Board of Directors, they take their jobs 

very seriously. In fact, prior to assuming my current position, I 

worked as deputy to one of our current Board members, so I saw 

this up close. As you indicated, there are certain requirements ensuring some aspects of diversity on our Board of Directors, and it 

has been my view that having people with a broad range of experience and good judgment is important. Also important is to avoid 

conflicts of interest. There are certain rules in place that, for example, prevent the Board of Directors from working for an insured depository institution at the same time, and there are certain postemployment restrictions if they do not serve a full term. Things of 

that nature are very helpful. 

As far as the advisory committees go, yes, we have actually several advisory committees right now. You mentioned one, Community Bank Advisory Committee. We also have one on financial inclusion and another on systemic risk. And it is a very good way to 

get industry and other public views’ input on important policymaking decisions. 

Chairman JOHNSON. Mr. Leonard, S.1217 proposes the regulator 

have, within the consent of other officials, emergency powers in a 

crisis that lasts only 6 months. Should we consider expanding that 

authority of providing other countercyclical tool that a regulator 

may need in a future crisis? 

Mr. LEONARD. Thank you, Mr. Chairman. We have not taken a 

formal position on that, but I think it is worth considering that the 

regulator may need more—you know, as we saw from this last crisis, you know, at different times there were different estimates on 

whether we were recovering or whether it was continuing. So I 

23 

think our initial view is that the regulator may need more flexibility than just 6 months. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you very much, Mr. Chairman, and before 

going back to my first question with the witnesses who did not get 

a shot at it, I do want to try that, but I wanted to follow up quickly, Mr. Pollard, with you on the question of loan limits. 

As I understand it, your explanation is that there is a loan limit, 

and then there is an authorized maximum amount of loan that will 

be authorized as the entities are managed. And I get that. There 

is, as Senator Menendez indicated, a continuous debate here in 

Congress about what we should set as the loan limits. 

But I wanted to give you an opportunity to get into the policy 

considerations about why we should or should not be setting the 

maximum authorized loans at this point at the highest levels possible or at the current levels that are being discussed. 

Mr. POLLARD. Right. I do not think the issue is whether Congress 

has set them. I think the issue for me, and trying to be the person 

who avoids the Director doing anything arbitrary and capricious, is 

that the maximum—the language in the statute begins with, ‘‘The 

enterprises shall set limits.’’ It says this about three times, and 

then only says that the maximum limit ‘‘should not exceed . . . .’’ 

Senator CRAPO. Right. 

Mr. POLLARD. So the policy behind this right now is—and I 

should have had a chance to say to Senator Menendez, and I apologize for this—that we also have a policy to try and reduce the footprint of the enterprises in the marketplace which stands at 75 percent of the entire domestic mortgage finance market. And this is 

part of an effort of several steps. We are trying to do new credit 

risk transfers that are recognized in S.1217 to share risk. We are 

talking about a 10-percent insurance type approach with a first 

loss. All of this is to bring in more private sector and restore more 

of an equilibrium and reduce the burden on taxpayers. So I think 

that is part of the coordinated effort. 

We certainly have heard the debate on this. The Director is very 

sensitive—he said there would be tons of notice—very sensitive to 

how the market would adapt to any change. And, again, it is under 

review and, you know, it has not occurred yet. 

Senator CRAPO. Thank you. And before I get back to my first 

question, I want to quickly ask you, Mr. Regner, in your role as the 

assistant director for the Arizona Department of Insurance, I am 

sure you have dealt with the myriad of issues affecting mortgage 

insurance from undercapitalized private mortgage insurance companies to regulatory interaction among various entities at both the 

State and Federal levels. 

What specific powers should the new Federal regulator have to 

effectively deal with the private market insurers in a reformed 

housing finance system? 

Mr. REGNER. Well, before, I guess, to answer the question, I 

think from our testimony that I gave today we feel that the powers 

or the guidance that is directed within the bill, that the solvency 

and capital standards should still be maintained and regulated by 

the States in order to maintain a capital level that is adequate to 

allow for new entrants and for the continuation of a competitive 

24 

market. Capital is very expensive. When you get into areas of getting into it being excessive, the possibility of loss of entrants or the 

continuation of that line of business could be lost. That is some 

consideration you may want to think about. And, of course, the 

NAIC staff would be more than happy to work with you in regards 

to maybe coming to some sort of resolution to that type of concern 

that we have. 

Senator CRAPO. All right. Thank you. 

Now I will just get back to the four of you who did not get a 

chance, if you choose, if you would like to, to respond to my first 

question, which was really the broader question of how do we solve 

this issue of creating a very, very, what I see as extensive and powerful new regulator in a field where we already have very significant regulators playing in a number of different positions. And how 

do we make sure that we give appropriate authorities to but assure 

that we do not simply pile on, if you will, the regulatory level of 

burden that we have put on our housing finance system? Would 

any of you like to jump into that? 

Ms. ELLIS. Sure. I would be happy to. 

Senator CRAPO. Ms. Ellis. 

Ms. ELLIS. I would be happy to share some of our experiences at 

the FDIC. Hopefully it will be helpful. The FDIC has a long history 

of working with other regulators, both at the State and Federal 

level. We are primary supervisor for some banks in the U.S., but 

we are a backup supervisor for other banks in the United States. 

And where we are backup supervisor, we have well-established protocols, some facilitated by statute, others facilitated just by informal agreement among the agencies, for things like information 

sharing, the sharing of examination reports, participation on examinations, and even when it comes to disagreeing over the condition of institution, we actually have protocols for how to go about 

disagreeing. All of these are important to reduce the duplication 

that goes on as well as the confusion that it could cause to the regulated entity. 

Senator CRAPO. Mr. Dzivi. 

Mr. DZIVI. Yes, Senator. I think one of the key methods of increasing the efficiency of the regulatory structure is the sharing of 

information, and there are provisions in the draft legislation that 

permit sharing of information, but Congress may consider actually 

requiring sharing of information because sometimes agencies like 

to butt heads a little before they turn over each other’s documents. 

So that might be one thing for Congress to consider. 

Senator CRAPO. Thank you. 

Mr. Couch. 

Mr. COUCH. Senator, I cannot add to—the other witnesses have 

adequately described the cooperative systems that are in place 

now, but I would compliment you for thinking about it because it 

is important, and I think it should be covered. 

Senator CRAPO. Thank you. Mr. Regner. 

Mr. REGNER. Just a quick comment. Information sharing is very 

important to keep that avenue open so that we can learn off each 

other’s experiences and the work that we both have put into the 

efforts of looking at these type of industries. 

Senator CRAPO. Mr. Leonard. 

25 

Mr. LEONARD. Senator, just one more point on your question. For 

example, in the area of mortgage servicing, I think there is more 

that could be done to improve coordination particularly in loss mitigation requirements. And obviously there was a need for improved 

loss mitigation because servicers did not have adequate standards, 

as we found out during the crisis. But now you have multiple 

standards. You have Making Homes Affordable, you have the National Mortgage Settlement, you have the OCC consent agreements, and you have CFPB and GSE guidelines. In some areas, 

many of these are coordinated. In others, the requirements are 

slightly different, so servicers are operating, you know, in times— 

like, for example, times where you have the number of days you 

have to respond to the customer, things like that. 

I think as you look at a bill, like, for example, on servicing standards, additional thought about how the agencies can coordinate, 

and it is moving together but there is still—what we hear from 

servicers, there are a number of different—standards still vary, 

and it causes some confusion. So I think it is an area that still 

needs to be looked at. 

Senator CRAPO. Thank you. Mr. Pollard, you get the last word. 

Mr. POLLARD. Thank you. 

Senator CRAPO. Unless the Chairman wants to give somebody 

the last word. 

Mr. POLLARD. I want to be sure that something is made clear 

that a lot of us have used terms today, and I want to be sure I am 

clear for the Committee on our perspective. We talked a lot about 

setting standards in the market. I think it is very important to recognize that third-party service providers are very important, and 

any regulator that is providing a successful standard like this has 

to be able to look at them. They do pose potential risk. So people 

one step away from the person you are dealing with may be very 

important, and I think that is one of the things we are talking 

about. I do not want to mislead the Committee. We think that ability, that capacity, is needed. 

And, second, when you are putting Federal taxpayer dollars on 

the line, I think there is a challenge to address the reach of the 

Federal authorities here. They need to be broad. We are talking 

about putting Federal tax dollars on the line and the ability of the 

Federal Government to be able to look into, to track, to set standards that may affect all regulated parties. Within this framework, 

not expanding it, but within the very area we are talking about, 

just this area, is part of an interesting point that I do think needs 

to be addressed and confronted. 

Senator CRAPO. Thank you. I am sorry I went a little over there, 

Mr. Chairman. 

Chairman JOHNSON. Thank you to all of our witnesses for being 

here today. I want to thank Senator Crapo and all of my colleagues 

for the time today to discuss the structure of the new secondary 

market regulator. 

This hearing is adjourned. 

[Whereupon, at 3:26 p.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 

26 

PREPARED STATEMENT OF ALFRED M. POLLARD 

GENERAL COUNSEL, FEDERAL HOUSING FINANCE AGENCY

NOVEMBER 21, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, 

thank you for your invitation to testify on the powers and structure of a regulator 

for a revised housing finance system. My name is Alfred M. Pollard and I am General Counsel for the Federal Housing Finance Agency (FHFA), which is the safety 

and soundness regulator of the Federal Home Loan Bank System and Fannie Mae 

and Freddie Mac. The introduction of S.1217 and the work of the cosponsors and 

of the Chairman and Ranking Member in moving forward with housing finance reform are important steps. I have addressed the questions you put to me in your letter and will be pleased to answer any questions you may have. 

Supervisory Tools Available to FHFA 

Following enactment of the Housing and Economic Recovery Act of 2008 (HERA), 

the new Federal Housing Finance Agency came into existence with an enhanced 

array of supervisory tools. These include explicit authority to impose and enforce 

prudential standards, including capital standards; obtain reports from parties on a 

regular and on an as-requested basis; conduct targeted and full scope examinations; 

oversee executive compensation, including incentive compensation and golden parachutes; require remedial actions; and authorities to undertake a full range of enforcement actions. 

FHFA’s predecessor as supervisor of Fannie Mae and Freddie Mac was the Office 

of Federal Housing Enterprise Oversight (OFHEO). In general, OFHEO did not 

have a full range of authorities, including authority to set capital requirements or 

to undertake supervisory actions that were comparable to those of other financial 

regulators; HERA corrected that. At OFHEO, congressional appropriations were required, subjecting the regulator to potential disruptions if a budget were not in 

place; HERA corrected that. At OFHEO, no receivership authority existed which 

symbolized a regulator without a full range of capacities; HERA corrected that. At 

OFHEO much had to be done with implied authorities; HERA corrected that, providing explicit authorities and language regarding ‘‘incidental authority.’’ In addition, by merging OFHEO and the Federal Housing Finance Board, FHFA’s predecessor as supervisor of the Federal Home Loan Bank System, HERA increased 

synergies over the regulation of the Government-sponsored sector of the housing finance market. Overall, HERA made important changes to the regulatory authority 

over Fannie Mae and Freddie Mac, but by the time the law was passed it was too 

late to implement those authorities prior to the need for conservatorships. 

More specifically, let me cover a few of the basic regulatory tools that FHFA has 

today: 

Supervision and Examination. FHFA has a full array of supervisory tools, many 

of which were unavailable to OFHEO, but provided under HERA to FHFA. Since 

its creation in 2008, FHFA has implemented these tools through a comprehensive 

supervisory program described here. 

FHFA supervision is carried out by two divisions—the Division of Enterprise Regulation with responsibility for Fannie Mae and Freddie Mac and the Division of 

Bank Regulation with responsibility for the 12 Federal Home Loan Banks and the 

Office of Finance. Both Divisions employ on-site examination and off-site analysis 

and carry forward prudential standards set forth in regulation to meet FHFA’s responsibilities relating to safety and soundness and compliance with laws and regulations. 

With respect to Fannie Mae and Freddie Mac, even in conservatorships, FHFA 

maintains a permanent on-site presence of examiners who conduct examinations 

and monitor business activities, key risks and compliance. With respect to the Federal Home Loan Banks, FHFA typically carries out three on-site examinations per 

quarter so that all 12 FHLBanks are examined on-site once per year. As with 

Fannie Mae and Freddie Mac, FHFA has an ongoing program of off-site monitoring 

of the FHLBanks. 

FHFA has established comprehensive examination manuals that serve as guides 

for examination efforts and are available to the regulated entities and to the general 

public. FHFA continues to issue Advisory Bulletins on a timely basis regarding key 

matters such as credit risk management and model risk governance. Typically, 

these are based on best practices that have emerged in bank regulation, though appropriately adapted to the unique characteristics of our regulated entities, starting 

with the fact that they are not commercial banks. FHFA remains the only financial 

regulator tasked with providing an annual report to Congress on its examination 

results. 

27 

FHFA’s two supervisory Divisions work closely with the Division of Housing Mission and Goals that has expertise in mortgage-related products and markets, to ensure the agency maintains a comprehensive view of risks and housing finance activities. Together these three divisions also conduct the mission oversight of the regulated entities. 

With Fannie Mae and Freddie Mac each in conservatorship, FHFA’s oversight of 

these companies goes beyond traditional supervisory activities. As the 

conservatorships have lasted far longer than originally anticipated, FHFA has responded by developing an Office of Conservatorship Operations and an Office of 

Strategic Initiatives that carry out FHFA’s responsibilities regarding the current operations of the conservatorships. These Offices coordinate and collaborate with the 

other divisions to enable FHFA to meet its responsibilities and its mission of ensuring our regulated entities operate in a safe and sound manner so they may serve 

as a reliable source of liquidity and funding for housing finance and community investment. 

Enforcement. FHFA may take a broad range of enforcement actions by statute 

and, by regulation and policy guidance, has elaborated on the conduct of such powers. Cease and desist orders, civil money penalties, debarment of officials, the ability 

to act against institution-affiliated parties all exist within the ambit of our statute; 

additionally, the Agency has created a process for suspending individual or corporate counterparties found guilty of criminal law violations. Overall, FHFA has 

broad administrative enforcement powers regarding the regulated entities and the 

ability to access judicial remedies if necessary to address third parties through its 

independent litigation authority. 

Emergency Tools. HERA provided FHFA a broad range of regulatory tools for addressing emergency situations. The Agency does not possess a fund such as the Deposit Insurance Fund to cover specified losses, but it does maintain a working capital fund and has the ability to impose special assessments on the regulated entities 

to address any shortfalls in its resources in order to respond to emergency situations. Temporary emergency funding was provided in the form of a support agreement with the U.S. Treasury Department in 2008 and this remains the main source 

of funding to provide capital support to the conservatorships. Finally, FHFA has employed its authorities and they have been affirmed in a number of important court 

rulings. 

As to those court decisions, several have aided in rounding out FHFA authorities. 

Significantly in a case in the Southern District of New York, the Court found not 

only that FHFA had examination privilege, but also shared similar authorities to 

banking regulators. This solidified the examination privilege that facilitates effective 

supervision, but as well made clear that FHFA supervisory actions find support in 

long-standing bank regulatory powers. For a new agency, these judicial decisions are 

important. 

In sum, the agency is equipped to meet the mission Congress has set for it. What 

I will now address is the regulatory structure set forth in S.1217, and, based on 

some of the lessons learned during this crisis, where areas exist for improvement 

in terms of regulatory structure and powers. 

S.1217, Housing Finance Reform and Taxpayer Protection Act of 2013 

FHFA has endorsed the need for legislative action on housing finance reform. 

S.1217 is an important effort in moving that process forward. 

Proposed Regulatory Structure. S.1217 would establish a new model for the secondary mortgage market and a new supervisory agency, the Federal Mortgage Insurance Corporation (FMIC). The range of FMIC’s duties and responsibilities represents a movement away from traditional examination- and enforcement-based supervision to a multifaceted construct that covers availability and transparency of information, standard-setting to enter and participate in the market, supervision of 

participants, access to credit and the secondary mortgage market, insurance of securities and establishment and operation of databases including a mortgage data repository. Implementation of the bill’s varied elements will require careful thought 

and planning over the 5-year transitional period and the undertaking of appropriate 

transitional steps. It must be noted, however, that beyond the regulatory structure 

and authorities, a key lesson learned during the financial crisis is that, even with 

adequate powers, regulators will not always get it right; therefore, if taxpayers are 

going to be exposed to risk of losses, sufficient private capital must be available in 

front of taxpayers, as contemplated in S.1217. 

Regulatory Tools That Should Be Added. The bill provides FMIC with limited explicit regulatory authority, though additional tools may be implied and, importantly, 

an ‘‘incidental powers’’ provision is set forth. Making regulatory authority clear and 

explicit, including where appropriate the ability to establish prudential standards, 

28 

set capital requirements and take enforcement actions, would enhance market stability and provide a higher degree of confidence to all market participants. Further, 

the ability to address both the primary parties to be regulated and to have certain 

authorities in relation to their contractual counterparties would be in line with existing legal practice. Where the bill implies authority, but does not expressly confer 

it, action FMIC would determine to take could lead to litigation and result in different outcomes in different jurisdictions, undermining the operation of a national 

housing finance market. 

Reliance on implied authority also makes it difficult to say what is missing. What 

is clear is that FMIC needs a full array of supervisory and enforcement authorities 

with regard to the market participants for which it must set standards and approve 

entry, including the authority to set capital standards, request reports from and examine these participants, establish enforceable prudential standards, require participants to undertake remedial actions where appropriate and impose penalties for 

bad behavior and bad actors. In the structure proposed in S.1217, providing FMIC 

with these tools is not only important for market integrity, but also to protect taxpayers in light of the risks associated with FMIC insurance. These powers are familiar to current participants in the housing finance market—many of which are already subject to supervision by FHFA or by a State or Federal regulatory authority—and to the extent they have not been provided to FMIC or are only implied in 

S.1217, they should be made explicit. 

FHFA has provided language to demonstrate how these powers, which could be 

implied and are incidental to other authorities already expressed in S.1217, could 

be made clearer in the bill. For example, FMIC has authority to approve or suspend 

approval for participants and ‘‘suspending’’ implies requiring remedial action; this 

should be made explicit. Also, FMIC’s authority to revoke approvals implies the ability to revoke participation and thus prohibit participation; such prohibition should 

be made explicit. 

Finally, as reaffirmed by the crisis, greater sharing of supervisory information 

among regulators, greater cooperation among regulators, such as FHFA–CFPB efforts on a national mortgage data base, and greater transparency for markets, such 

as FHFA directing the publication by the Enterprises of historical loan data, are 

critical. These are core areas on which FHFA is working and will continue to build. 

Improvements to S.1217 Regulatory Structure. Because S.1217 sets a new direction for the housing finance market, two questions are critical—as the Committee 

has asked, does the legislation get the right structural pieces in place for the new 

market to function smoothly and efficiently and does it provide for an effective transition from the current system to the new market? FHFA has identified some areas 

where the bill could more fully answer these questions. 

For example, S.1217 acknowledges that many likely participants in the new market are already subject to prudential supervision by other safety and soundness 

State or Federal regulators by authorizing consultation or directing FMIC to coordinate with another agency, but more could be done to ensure that other regulators 

share information with FMIC and that exams are coordinated, reducing burdens on 

participants and improving supervisory approaches and outcomes. FMIC and FHFA 

roles in the Financial Stability Oversight Council should be clarified to ensure that 

during market transition appropriate representation remains in place. FMIC should 

have an appropriate and explicit role in the Federal Financial Institutions Examination Council. 

There may also be gaps to be filled. For instance, today all mortgage servicers are 

subject to certain compliance oversight with regard to consumer protections, but 

nonbank servicers may not be subject to prudential oversight. The bill does not address enhanced supervision of nonbank servicers, even though their safety and 

soundness and their conformance with required practices are critical to FMIC’s 

mandate to protect taxpayers. Assigning regulatory oversight to FMIC with the ability to set and enforce prudential requirements could help fill this gap. Additionally, 

FHFA has seen certain State and local laws that may impair the efficient operation 

of a national secondary mortgage market. 

The bill also provides for FMIC to be funded exclusively by insurance fees, which 

would be collected on mortgage-backed securities that FMIC insures. Relying exclusively on fees as a funding base, particularly as the new market is developing, may 

present certain challenges. Clearly, at its inception, FMIC should have sufficient resources to be fully operational and sound. Further, funding FMIC and growing the 

insurance reserve could require rather large insurance fees in FMIC’s early years. 

In times of market distress, FMIC revenues could drop substantially. These challenges may be addressed by expanding FMIC’s sources of funding to include other 

fees and assessments; for example, creating application fees, which are not explicit, 

and restoring assessments on the Home Loan Banks for their supervision. 

29 

Transition. Transition to the new agency involves a simultaneous wind down of 

the Enterprises and the transfer of functions and employees from FHFA to FMIC 

and the hiring of additional employees as needed to fulfill the new agency’s responsibilities. FHFA was created 5 years ago by merging the functions and employees 

of three agencies—OFHEO, the Finance Board and elements of the Department of 

Housing and Urban Development—into a single agency with all of the functions of 

its three parts. Here, the transition involves employees from one agency, but into 

a framework with multiple responsibilities. S.1217 establishes a two-step transition 

that would have FHFA and FMIC coexist for 5 years, which could be confusing and 

inefficient for both market participants and agency employees. 

FHFA’s experience in standing up a new agency would argue in favor of immediately transferring all FHFA personnel and responsibilities to FMIC, thus permitting a smooth integration, a focus on meeting the bill’s 5-year goal of full implementation and maintaining the congressional direction to wind down Fannie Mae and 

Freddie Mac. In particular, moving all employees to the new agency—or, possibly, 

renaming and empowering FHFA as FMIC—avoids issues of dispersion of resources 

and expertise that may prove beneficial to the various tasks assigned in the legislation. Guidance would be helpful on the legal authority of FMIC’s Director to act before the Board is fully constituted. Funding in transition may be critical to assure 

that a smooth start for FMIC occurs with a solid capitalized reserve fund, systems 

and technology in place and providing resources to address challenges not anticipated at this time. 

New Utilities. FHFA continues work on the Common Securitization Platform. As 

FHFA and, later, FMIC move to develop more fully the National Mortgage Database 

and an approach for a national mortgage market repository for notes and other documents, it may be beneficial to address these two items with additional legislative 

language. A national note repository can bring benefits to homeowners, lenders, the 

State foreclosure process and efforts of groups such as the Uniform Law Commission 

to make more uniform State foreclosure laws. 

Conclusion 

FHFA continues to support early congressional action to make clear for FHFA, 

for its regulated entities, for borrowers and for financial markets the directions you 

believe most appropriate to protect taxpayers, maintain access to housing finance 

products and services and the strongest regulatory structure that is credible, empowered, clearly defined and transparent to carry forward your directions. While all 

of this has complexities, that should not deter prudent actions. 

In closing, FHFA appreciates the opportunity to work with you and your staffs 

and those of the cosponsors, as well as those of other Committee Members, to assist 

in any way we can as you move forward on this critical task of addressing a new 

housing finance structure. The certainty that can come from such efforts will benefit 

homeowners, investors, and taxpayers. 

PREPARED STATEMENT OF DIANE ELLIS 

DIRECTOR, DIVISION OF INSURANCE AND RESEARCH, FEDERAL DEPOSIT INSURANCE

CORPORATION

NOVEMBER 21, 2013 

Chairman Johnson, Senator Crapo, and Members of the Committee, I appreciate 

the opportunity to testify before you today on ‘‘Powers and Structure of a Strong 

Regulator’’. As the Committee considers reforms to the Nation’s housing finance system, including insurance and supervisory models similar to the Federal Deposit Insurance Corporation (FDIC), you have requested that we provide you with a description of the elements of the deposit insurance system that are the most important 

in achieving our mission. 

Many lessons have been learned over the deposit insurance system’s 80 years of 

operation. Drawing from these lessons, both Congress and the FDIC have made a 

number of improvements to the deposit insurance system. During our history, which 

includes two serious banking crises in the last few decades, certain authorities and 

regulatory tools stand out as particularly important. These include clear and explicit 

statutory authority, monitoring to assess risk exposure and to take action in response when necessary, appropriate pricing of insurance, and adequate funding arrangements. In addition, the FDIC has experienced the challenges of managing a 

transition between agencies, which occurred when the Resolution Trust Corporation, 

created to resolve failed savings and loan institutions during the early 1990s, was 

folded into the FDIC at the conclusion of that crisis. 

30 

My testimony today elaborates on and describes these important authorities and 

tools through the lens of the FDIC’s experience. In some cases, the elements of our 

regulatory and insurance regime may be relevant primarily to the FDIC’s unique 

role and mission. In other cases, the Committee may determine that the lessons we 

have learned over the years provide insights that may be useful to the Committee 

in this important work. The FDIC stands ready to provide assistance to the Committee in this effort. 

Explicit Authority 

Since its founding in 1933, Congress has given the FDIC a clear mandate: to protect depositors and maintain financial stability. The FDIC has been successful in its 

mission in large part because Congress has clearly defined by statute the amount 

of deposits covered under the FDIC’s deposit guarantee and the condition—bank 

failure—that triggers the exercise of that guarantee. At the same time, Congress 

has allowed the FDIC flexibility to craft specific regulations to cover the myriad details of its operations. The clarity of Congress’ mandate provides credibility in the 

eyes of depositors, virtually eliminating the risk of bank runs and panics, thus providing a foundation of stability to our banking system during times of financial distress. While the banking industry pays the costs of deposit insurance, the full faith 

and credit of the U.S. Government ultimately backs the FDIC’s deposit guarantee. 

The existence of clear statutory authority over the years also has served as the 

foundation of our supervisory approaches. Statutes clearly state congressional expectations and goals, enabling us to monitor and control for the risk posed to the Deposit Insurance Fund (DIF). For example, certain laws, such as prompt corrective 

action, provide statutory tripwires for supervisory action. At the same time, the 

statutes outlining our supervisory authorities provide flexibility to create a robust 

examination process within the statutory grant of authority. 

Clear statutory authority also has been critical to the FDIC’s resolution activities, 

which enable us to mitigate losses to the DIF and help maintain financial stability 

through timely resolution of failed banks and payment of depositor claims. Our authorizing statutes delineate the priorities of claims and provide direction to all parties in the claims process. This clarity enables the FDIC to resolve failed financial 

institutions efficiently and effectively, usually over the span of a single weekend. 

Monitoring and Controlling Risk 

An effective insurance program must include a variety of tools to identify and 

manage risk exposure, not only at the time when insurance is granted but also 

while that insurance stays in force. As deposit insurer, the FDIC assesses the risk 

of an institution at the time that it applies for insurance. After admittance into the 

system, the FDIC monitors the condition of that institution through on-site examinations and remote monitoring, and through our back-up examination authority in 

the case of an institution primarily regulated by another Federal banking agency. 

Risk mitigation should include setting explicit capital standards and must be an ongoing process that allows for intervention before losses occur and insurance must 

be paid out. While the FDIC is not the primary Federal regulator of all FDIC-insured institutions, all FDIC-insured institutions are subject to the same, or very 

similar, framework of regulations, policies, guidance, examination protocols, ratings, 

capital standards, reporting requirements, and enforcement authority. 

In determining membership participation in the deposit insurance system, the 

FDIC carefully considers factors prescribed in section 6 of the Federal Deposit Insurance Act (FDI Act) and implements policies and guidance that supplement the 

factors when conducting reviews of deposit insurance applications. These factors include the financial history and condition of the institution, adequacy of the capital 

structure, future earnings prospects, general character and fitness of management, 

risk presented to the DIF, convenience and needs of the community to be served, 

and the consistency of the institution’s corporate powers with the purposes of the 

FDI Act. Under one housing finance model the Committee is considering, the Government insurance fund would have authority to approve participation by four types 

of companies: private mortgage insurers, servicers, issuers, and bond guarantors. 

The factors for approving each of these companies differs slightly, and are similar 

to, but not the same as, the statutory factors found in section 6 of the FDI Act 

which the FDIC uses to determine eligibility for Federal deposit insurance. 

Capital Requirements 

Strong capital requirements are one of the most effective means for controlling 

risk-taking by participants in the system and the FDIC has found explicit capital 

standards to be an important tool to protect the DIF. As mentioned above, the 

prompt corrective action framework in section 38 of the FDI Act defines minimum 

capital ratios and imposes progressively tighter restrictions on an institution’s acVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00034 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
31 

tivities once these minimums are breached. The ratios defined in section 38 are intended to trigger regulatory sanctions when banks become less than well capitalized, but individual institutions may be required to hold capital levels that are higher than statutory minimums based on their risk profile and activities. As the Committee considers various legislative approaches, it may want to consider inclusion 

of explicit capital standards for all significant participants in the new system and 

the consequences of breaching those standards. 

Ongoing Monitoring and Reporting Requirements 

Requirements for ongoing monitoring, reporting requirements, and access to 

records are essential to an effective regulatory regime. In the FDIC’s case, these 

tools enable banking regulators to supervise FDIC-insured institutions on an ongoing basis and to identify and respond to increasing risk in the system. Providing 

the proposed mortgage insurer with similar authorities would enable that insurer 

to determine independently a participant’s financial condition and compliance with 

laws and standards. For example, the FDI Act provides for the authority to conduct 

examinations and investigations, the minimum frequency of examinations, the authority to examine affiliates and other related entities, coordination and information 

sharing with other agencies, and penalties for obstruction of examination authority, 

among other things. 

This statutory examination authority underpins our program of regular examinations and is supplemented by regulations, policies (including the standard CAMELS 

ratings system used for all FDIC-insured institutions), guidance, and procedural 

manuals. Importantly, this authority also allows the FDIC to review examination 

findings for banks we do not supervise directly and to conduct backup examinations 

and reviews of those institutions as necessary. Similarly, a statutory basis for regular examinations and investigative authority would enhance the mortgage insurer’s 

on-site monitoring ability. Where participants are subject to oversight by other Federal or State agencies, the proposed law could clarify requirements for coordination 

of examination activities and information sharing agreements. 

Additionally, supervisory monitoring efforts are enhanced through review of quarterly Call Reports that are required by section 7 of the FDI Act, provisions of which 

also impose penalties for failure to file accurate reports. Imposing reporting requirements on approved participants could enable the mortgage insurer to conduct offsite monitoring. 

The FDIC has also found it essential that its monitoring authority include the 

ability to create standards to determine whether there has been a change in ownership, which can alter a bank’s risk profile. 

Authority To Take Enforcement Action 

Ongoing monitoring allows the FDIC to identify risks in the banking sector, but 

we also have explicit statutory authorities that allow us to take action when an institution is engaging in potentially unsafe and unsound practices. Supervisors of 

FDIC-insured institutions have a wide array of formal and informal enforcement actions to ensure compliance with rules and standards and to correct problematic 

practices or conditions before a bank becomes insolvent and causes a loss to the 

DIF. Informal enforcement actions can take the form of memoranda of understanding or Board resolutions. Section 8 of the FDI Act gives the FDIC the authority to pursue formal enforcement actions and civil fines against institutions, their 

affiliates and certain individual actors, after notice and an opportunity for a hearing. These actions include cease and desist orders, civil money penalties (CMPs), 

Prompt Corrective Action (PCA) Directives, written agreements, and, ultimately, 

termination of deposit insurance. The FDI Act also grants the authority to take actions against bank-affiliated individuals including removal and prohibition orders to 

prevent their participation in the financial services industry for certain misconduct 

and violations. Providing similar authorities to the Federal mortgage insurer might 

enable it to correct problem situations before they result in a loss to its insurance 

fund. 

While they are valuable supervisory tools in certain circumstances, provisions for 

suspension or revocation of the approved status of participants or the ability to impose CMPs are not sufficient alone as tools for effective risk management. Providing 

monitoring authority and authorizing a broader array of informal and formal corrective actions would enhance the mortgage insurer’s ability to take corrective actions 

prior to losses being incurred. 

Insurance Pricing 

The FDIC has had experience over its history with both flat rate and risk-based 

pricing for insurance. Initially, Congress directed the FDIC to charge all banks the 

same assessment rate. This flat-rate system lasted for 60 years, but it had problems 

32 

1Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 

103 Stat. 183 (1989). 

which became evident in the late 1980s when banks started to fail in large numbers. 

The flat-rate system resulted in less risky banks excessively subsidizing riskier 

banks and did nothing to reduce the incentives for banks to take excessive risk. 

In response to the banking crisis of the late 1980s, Congress ended the flat-rate 

system in 1991 and directed the FDIC to adopt a risk-based assessment. Since 1993, 

the FDIC has had a risk-based pricing system where banks that take on more risk 

pay more in deposit insurance assessments. An important feature of the risk-based 

pricing system is that it is forward looking. Since the system relies on measuring 

the likelihood that a bank could fail and cause a loss to the insurance fund, it is 

inherently more complex than a flat-rate system. To more accurately price for risk, 

the FDIC must collect a wide range of financial and supervisory information, which 

it does through quarterly financial reports prepared by banks as well as monitoring 

and supervising insured institutions. 

The FDIC supports a risk-based pricing structure for deposit insurance. However, 

deposit insurance may not be perfectly analogous to Federal mortgage insurance. A 

Federal mortgage insurer is likely to have a greater ability to mitigate risk at the 

outset, for example, by setting robust underwriting standards for the underlying 

mortgages. 

Funding 

Funding arrangements also play a critical role in the success of an insurance system, including the FDIC’s deposit insurance system. A well-designed system ensures 

that adequate funds are readily available to respond to problems as they arise and 

to avoid delays in closing failed banks or paying insured depositors. These arrangements also determine the amount and the timing of the industry’s contribution toward the costs of insurance and the degree of taxpayer exposure. 

The Importance of Prefunding 

The FDIC has always had an explicit, ex ante fund paid for by the banking industry to satisfy claims as they arise. Alternative arrangements, such as pay-as-yougo or ex post assessments, increase the risk that bank closings will be delayed. 

Delays in closing failing institutions (as the FDIC observed through the experience 

of the failed Federal Savings and Loan Insurance Corporation) increase the ultimate 

cost of failure and undermine confidence in the banking system more generally. 

Prefunding for future losses is also more equitable. With a pay-as-you-go or ex post 

system, surviving banks pay the costs generated by those that fail, which penalizes 

those banks that are less risky. 

Prefunding also allows an insurer to smooth the cost of insurance over time. The 

FDIC works to charge steady premiums and avoid procyclical pricing, where rates 

increase in difficult times—when banks can least afford to pay them and when those 

funds are most needed to lend and promote economic growth. Most bankers indicate 

that they prefer steady, predictable premiums rather than procyclical rates. Finally, 

as with any insurance arrangement, an ex ante fund is reassuring to depositors and 

taxpayers, thereby promoting confidence and enhancing financial stability. 

The Challenge of Determining the Size of the Fund 

The question of whether to have an ex ante fund is easier to answer than the 

question of fund size, which involves balancing significant trade-offs. The FDIC balances the need for a fund that is sufficient at all times to pay depositor claims 

against the possibility of holding funds that could be better used by banks for lending. 

Over its history, the FDIC has experienced mixed success with various approaches 

to determining an optimal fund size. For more than 50 years, Congress set premium 

rates and there was no official target fund size, so the reserve ratio (the ratio of 

the amount in the DIF to estimated insured deposits) fluctuated considerably. This 

period coincided with great economic stability and few bank failures, so deposit insurance fund adequacy was not a pressing concern. 

That situation changed during the late 1980s as the U.S. experienced a large 

number of bank and thrift failures and large losses to both the banking industry 

and taxpayer. To address concerns about the viability of the deposit insurance fund 

in the aftermath of these losses, Congress made a series of changes to the FDIC’s 

authorities for managing the size of the fund. In 1989, Congress instituted for the 

first time a target for the size of the fund, called a Designated Reserve Ratio (or 

DRR), which was initially equal to at least 1.25 percent of estimated insured deposits. 1

33 

2Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. No. 102-242, 105 

Stat. 2236 (1991). 3Deposit Insurance Funds Act of 1996, Pub. L. No. 104-208, 60 Stat. 446 (1996). 

4Federal Deposit Insurance Reform Act of 2005, Pub. L. No. 109–171, 120 Stat. 9 (2006). 

5Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 

Stat. 1376 (2010). 6The FDIC developed a Loss Distribution Model, which views the deposit insurance fund as 

a portfolio of credit risks, representing exposure to different banks. For each bank, a probability 

of failure, loss given failure, and exposure upon failure were estimated to arrive at an expected 

loss for that bank. An economic model determined the statistical relationships among these elements of expected loss and economic variables such as interest rates, stock price indices, and 

housing prices. Finally, a simulation model was incorporated to determine a wide range of economic events and produce a distribution of possible future failures and losses to the deposit insurance fund. 

In 1991, Congress required that, when the fund was below 1.25 percent, the FDIC 

would be required to raise assessment rates to reach the target within 1 year or 

charge very high rates, even in periods of economic distress. 2 In 1996, shortly after 

the reserve ratio reached its target, Congress prohibited the FDIC from charging 

well-capitalized and well-managed banks anything whenever the fund was at or 

above that target. 3 The resulting hard target left the FDIC with almost no ability 

to let the size of the fund materially increase or decrease. 

This framework created a number of problems including: 

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

• a free-rider problem where new entrants and fast growers diluted the fund but 

paid nothing, and 

• potentially volatile and procyclical premiums. 

In 2006, Congress removed the hard target and allowed the FDIC to manage the 

fund within a range of 1.15 and 1.50 percent of estimated insured deposits. 4 Unfortunately, the recent crisis came soon after these changes were enacted and bank 

failures again caused the fund to become negative. To prevent a repeat of these 

problems, the Dodd-Frank Act increased the minimum reserve ratio to 1.35 percent 

and removed the hard cap, which had required that the FDIC return to the industry 

all amounts that would cause the reserve ratio to exceed 1.50 percent. This new authority effectively allows the FDIC to determine the optimal target, so long as it is 

at least 1.35 percent of estimated insured deposits. 5 Some flexibility in determining 

a target fund size may be beneficial for the Federal mortgage insurer, preventing 

it from facing challenges similar to the fund management problems the FDIC faced 

in its past. 

Striving for Countercyclical Funding 

Given its expanded authority, the FDIC has a number of options to choose from 

in determining an optimal size for its fund. The FDIC has explored sophisticated 

approaches that draw upon the portfolio management techniques and best practices 

used by other financial institutions that have to manage capital and financial 

risks. 6 The appeal of these model-based approaches is the promise of greater rigor 

and precision in determining potential losses and an optimal fund size. However, 

model-based approaches pose a host of practical challenges. It is difficult, for example, to accurately determine relationships between economic variables and the variables affecting a bank’s failure or to project economic events. 

Therefore, in the end, the FDIC took a different approach to determine the most 

appropriate fund size, one grounded in the agency’s actual financial experience. 

Having experienced two banking crises in the past three decades, it looked at the 

costs associated with these crises to address two related questions. First, how high 

did the fund need to grow to prevent it from ever going negative? And, second, what 

steady premium rates would have been required to achieve the desired balance? The 

analysis revealed that if the DIF had been allowed to grow to at least 2 percent 

of insured deposits prior to each of the two preceding banking crises, a steady average premium rate of a little over 8 cents per $100 of domestic deposits would have 

been required to meet these goals. This approach would have avoided the 

procyclicality that resulted in volatile premium rates, which necessarily increased 

during periods of bank failures. 

This straightforward approach remains the underpinning of FDIC’s current fund 

management strategy. It was used to set a long-term reserve ratio goal (DRR) of 

2 percent in 2011 which continues today. This 2 percent target is viewed as a soft, 

rather than hard, target. While the FDIC has set rates to achieve the statutorily 

required 1.35 percent minimum reserve ratio, there is an explicit plan to reduce 

34 

rates gradually, but not to zero, if the fund exceeds the long-term 2 percent target. 

In determining an optimal size for a fund for mortgage insurance, similar trade-offs 

and historical experiences may be considered. 

Successful Transition of Assets From One Entity to Another 

The FDIC has unique experience with transitioning the assets and responsibilities 

of one entity to another. In response to the savings and loan crisis of the late 1980s, 

Congress dissolved the insolvent Federal Savings and Loan Insurance Corporation 

(FSLIC), and divided the duties of resolving the crisis between the FDIC and a temporary agency, the Resolution Trust Corporation (RTC). As the RTC was intended 

to be a temporary agency to address that specific crisis, Congress set a statutory 

termination date of December 31, 1995, and provided for the transfer of RTC’s responsibilities to the FDIC. 

A number of factors contributed to the successful transition from the RTC to the 

FDIC. The resolution authorities and activities of the RTC and FDIC were very 

similar. The assets from failed savings and loan institutions resolved by the RTC 

were very similar to the assets of failed banks and savings and loan institutions 

being handled by the FDIC. In addition, both agencies shared similar policies, procedures, and organizational structures. The employees handling many of the RTC assets ultimately transitioned to the FDIC along with the assets. 

Even with these similarities, the FDIC and RTC managements engaged in extensive and cooperative planning for the transition to ensure the continuity of operations. The remaining RTC assets were managed and accounted for in a separate 

fund as they were wound down. The FDIC/RTC experience may provide some analogies to the housing finance reform, but other aspects of the reform are more complex. Transition in this context involves two large organizations in conservatorship 

with various assets and liabilities transferring partly into Federal hands, with other 

assets potentially being sold into the private sector. 

Conclusion 

Again, thank you for the opportunity to share with the Committee the FDIC’s experience and insights regarding the elements essential for a Federal insurance program. As noted at the outset, our history may provide relevant lessons as the Committee contemplates the creation of a Federal mortgage insurance entity. The FDIC 

has benefited from explicit statutory authority, risk monitoring and control tools, 

appropriate pricing of insurance, and adequate funding arrangements. We are 

happy to provide any assistance that the Committee would find valuable as it continues its important work to address housing finance reform. 

PREPARED STATEMENT OF KURT REGNER 

ASSISTANT DIRECTOR, ARIZONA DEPARTMENT OF INSURANCE, ON BEHALF OF THE

NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS

NOVEMBER 21, 2013 

Introduction 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, 

thank you for the opportunity to testify today. My name is Kurt Regner, and I serve 

as the Assistant Director, Financial Affairs Division of the Arizona Department of 

Insurance. Arizona sits on the Mortgage Guaranty Insurance Working Group of the 

National Association of Insurance Commissioners (NAIC), and it is on behalf of the 

NAIC that I present this testimony today. 

The NAIC is the United States’ standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 States, the 

District of Columbia, and five U.S. territories. Through the NAIC, we establish 

standards and best practices, conduct peer review, and coordinate our regulatory 

oversight. NAIC members, together with the central resources of the NAIC, form the 

national system of State-based insurance regulation in the United States. 

State insurance regulators appreciate the opportunity to offer our expertise and 

perspective on Federal efforts that impact our system of supervision. As the prudential regulators of insurance, we are in the business of protecting insurance policyholders and ensuring competitive insurance markets. As insurance markets evolve, 

State insurance regulators remain extensively engaged with all relevant stakeholders to promote an optimal regulatory framework and mortgage insurance is no 

exception. In that arena, we are very mindful of the need to carefully balance solvency standards with ensuring the availability of coverage in the market. We also 

appreciate the strong desire in Congress to address a number of issues arising from 

the mortgage transaction, but want to ensure that any legislation appropriately conVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00038 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
35 

siders the existing regulatory regime that is designed to meet these important objectives. 

Today, I will provide the Committee with an overview of the private mortgage insurance (PMI) market, how participants are regulated by State insurance departments, and highlight actions underway at the NAIC and in the States. I will touch 

on related issues with respect to financial guaranty insurers, although this is not 

an area of my expertise. I will also offer impressions on how our regulation can fit 

in with the objectives of recent legislative proposals. 

History of Private Mortgage Insurance 

Any discussion of PMI should begin with an understanding of how the industry 

has evolved over time. The PMI industry dates back to the 1880s, when mortgage 

banks were first formed to finance loans to people securing land in the Midwest and 

West. Then as now, PMI promotes home ownership by facilitating the flow of credit 

from lenders and investors who might not otherwise have the capacity or desire to 

assume incremental credit risk. PMI enables those lenders to mitigate default risk 

when a borrower makes a smaller downpayment, which inherently increases the 

risk of loss. 

The PMI industry went bankrupt and disappeared for some time following the 

Great Depression and the housing collapse of the early 1930s, but reemerged in the 

late 1950s as alternatives to the Federal Government’s Federal Housing Administration (FHA) and Veterans’ Affairs (VA) mortgage insurance programs. State insurance regulators, understanding the lessons of the 1930s collapse, saw the need for 

stronger laws and regulations to ensure PMIs were equipped to handle economic 

shocks for all the tail risk (i.e., the least likely yet most severe risk) they carry. 

Since then, the PMIs have faced and largely managed episodes of severe stress in 

the 1980s, early 1990s, and most recently with the housing crisis a few years ago. 

Through the most recent financial crisis, the financial sector’s collective assumptions about the housing market were proven wrong. As regulators, we recognized 

that regulatory requirements for mortgage insurers need to be enhanced to address 

the risks uncovered by the crisis. Today, the downturn’s effects are clearly still 

being felt by PMI providers, although market and economic trends have generally 

stabilized in the last couple of years. The PMIs continue to suffer losses from the 

2005–2007 books of business as some consumers continue to struggle with their 

mortgages. However, new defaults should keep trending downward assuming a continued housing and economic recovery; and newer, better priced, and higher credit 

quality business will continue to strengthen the PMIs. While the main players in 

the PMI space survived the crisis, they are recovering slowly as they try to improve 

their financial situations. We have been in the process of adjusting regulatory requirements to address the risks uncovered by the crisis. We have also been keenly 

focused on improving the competitive landscape for the mortgage insurance market 

by ensuring that opportunities exist for new market entrants and that our supervisory framework does not undermine the availability of coverage for new homeowners and the lenders that service them. 

How Private Mortgage Insurance Works 

At its most basic level, mortgage insurance underwrites the risk of borrowers defaulting on their loans. The borrower pays the premiums, and the lender is the beneficiary of the policy. PMI premiums are paid either in monthly installments or a 

single premium payment at loan origination. Unlike FHA or VA loans, the amount 

of loss coverage is usually capped as a proportion of lost loan principal, usually between 20 to 30 percent of the loan balance. 

Generally, mortgage insurers provide coverage in four basic forms: flow insurance, 

bulk insurance, pool insurance, and reinsurance. 

• Flow insurance provides coverage on an individual loan basis and is purchased 

at the time a loan is originated. The lender selects the carrier, but the cost is 

paid by the borrower. 

• Bulk insurance provides coverage on each loan in a larger group of loans that 

have already been originated. These loans may have flow insurance already, in 

which case the bulk provides a second layer of protection against losses. 

• Pool insurance provides coverage of multiple mortgages, generally in connection 

with mortgage securitizations. Insurers provide coverage for losses up to an aggregate limit. 

• Private mortgage reinsurance, in which the primary insurer passes a portion of 

the risk to a third party insurer, has generally been written by ‘‘captive’’ reinsurers affiliated with lenders. 

36 

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

Supervision of Mortgage Insurers 

PMIs are regulated by the States in which they do business, with the State of 

domicile providing primary regulatory oversight. Each domestic State conducts financial oversight of the companies operating in its jurisdiction. State laws and regulations that are specifically tailored for mortgage insurance control the risk PMIs 

can assume through a variety of limitations, including reserve requirements, capital 

requirements, investment and risk concentration restrictions, and restrictions on 

nonmortgage insurance related activities. 

PMIs are required to file all policy forms and premium rates with State insurance 

departments, and must also file audited financial statements, prepared in accordance with statutory accounting principles (SAP) developed by insurance regulators. 

The NAIC has a Mortgage Guaranty Model Act that has been adopted in substantial form by all the States primarily responsible for the regulation of mortgage guaranty insurers. 1 As I alluded to previously, the NAIC is in the process of making 

adjustments to this model and it is anticipated that these States will adopt the new 

version of the model. 

Capital Requirements 

PMIs are generally required to maintain risk-to-capital ratios not exceeding 25 to 

1. Most State regulators are authorized to exercise discretion in administering this 

requirement. 

State regulators are currently considering modifying the NAIC model to replace 

the 25 to 1 risk-to-capital ratio with a more refined capital requirement. This includes most notably, conformance with a risk-based capital formula to be developed 

for mortgage guaranty insurers. Regulators are also considering a separate loan 

level cash flow projection capital model requirement if the risk-based capital formula falls below the required threshold. 

In addition to the capital ratio requirements, there are minimum capital requirements. Currently, PMIs cannot transact the business of mortgage guaranty insurance unless, if a stock insurance company, it has paid-in capital of at least $1 million and paid in surplus of at least $1 million, or if a mutual insurance company, 

a minimum initial surplus of $2 million. A stock company or a mutual company 

must maintain a minimum policyholders’ surplus of at least $1.5 million. State regulators are currently considering modifying the NAIC model to increase the required 

paid in capital and paid in surplus to $10 million and $15 million, and at all times 

thereafter a minimum policyholders’ surplus of at least $20 million. 

As a practical matter, the minimum capital and surplus requirements are chiefly 

of importance in the technical details of organizing or reorganizing a PMI. Under 

the business plans of PMIs that are in business or in the process of being organized, 

a PMI writing business on a direct basis requires hundreds of millions or billions 

of dollars in capital and surplus. 

Reserve Requirements 

As I mentioned earlier, PMIs have significant reserve requirements to protect 

against economic shocks, given the large amount of tail risk they carry. PMIs maintain up to four separate reserve components: 

1. Unearned premium reserves: This reserve requirement reflects the amount of 

premium for the portion of the insurance coverage that has not yet expired. 

2. Contingency reserves: This is a long-term, countercyclical regulatory capital requirement. PMIs contend with cyclical volumes of claims that generally stay 

within certain parameters but occasionally spike, with potentially significant 

consequences. This risk is kept in check by requiring PMIs to keep in reserve 

50 percent of net earned premiums for 10 years in anticipation of larger defaults. These reserves are built over time and drawn down only when losses 

exceed statutory thresholds (typically 35 percent of premiums or more) or State 

regulators authorize special releases. 

This requirement is also in place to prevent excessive dividends or otherwise 

dissipating reserves that might be needed to pay claims in a highly adverse 

loss scenario. 

3. Loss reserves: This is a short-term regulatory reserve requirement. Sometimes 

called ‘‘case basis loss reserves,’’ these must equal expected losses on delinquent loans of which the insurer is aware. 

4. Premium deficiency reserves: This reserve is established when anticipated 

losses plus related expenses exceed expected future revenue. It is intended to 

37 

2 Center for Insurance Policy Research. ‘‘Financing Home Ownership: Origins and Evolution 

of Mortgage Securitization—Public Policy, Financial Innovations, and Crises’’. August, 2012. 

http://www.naic.org/cipr 3Mortgage Insurance Companies of America (MICA). ‘‘2012–2013 Fact Book and Member Directory’’. 4Mortgage Insurance Companies of America (MICA). ‘‘2012–2013 Fact Book and Member Directory’’. 

cover potential losses from all business in force, since mortgage insurers can 

be responsible for future losses. 

Contingency reserves are intended to be built up over good times in stable markets, so that when the housing market slumps and PMI is most needed, the providers will be well-positioned to pay out claims. 

State regulators are currently considering modifying the NAIC model to increase 

the risk sensitivity of the contingency reserves previously mentioned. 

Coverage, Investment, and Geographic Restrictions 

Coverage provided by mortgage guaranty insurers ceded is limited to 25 percent 

of the entire indebtedness to the insured. 

Insurance regulators also place limits on the ability of a PMI to invest in any particular security, and while they can invest in stocks, bonds, notes, and other instruments, they may generally not invest in real estate. 

PMIs are not allowed to insure loans that are individually in excess of 10 percent 

of the company’s aggregate policyholders’ surplus and contingency reserves. Also, 

PMIs are prohibited from having more than 20 percent of total insurance in force 

in any one ‘‘Standard Metropolitan Statistical Area’’, as defined by the United 

States Department of Commerce. 

These concentration limitations are intended to protect against sector and regional housing slumps—it enables PMIs to use premiums collected in more stable 

regions to offset losses incurred in distressed markets. It is worth noting here that 

the broad geographic scope of the housing crisis illustrates the unique challenge for 

PMIs. Geographic spreading of the risk is an effective tool, for example, for property 

insurance where natural disasters and economic events are not necessarily correlated. However, the 2008 crisis illustrated that lending risk can be correlated at 

the extremes, so there are unique challenge that PMIs and regulators must manage 

to address the unique characteristics of this product. 

Nonmortgage Activities 

PMIs are ‘‘monolines’’ and generally may not engage in activities other than mortgage related insurance because of the unique type of insurance risks involved. Unlike insurance designed to protect against loss of life or property, the risks faced by 

PMIs are directly correlated with the housing market and economic conditions. Although monolines are subject to unique risks, they are not exposed to the multitude 

of risks that a multiline writer is exposed to protecting the monoline writer from 

risks that they do not underwrite. However, PMIs may be affiliated with a variety 

of other types of businesses that do write other types of insurance or engage in other 

types of financial services. 

Recent Trends in the PMI Market 

Next, let me to turn to discussing the state of the PMI market. The financial crisis 

found PMIs exposed on the front lines—after all, they were the ones directly underwriting the risk of borrowers defaulting on their loans. Since PMIs provided coverage on high loan-to-value mortgages with very thin equity slices, they were vulnerable to potential losses in the event of rising delinquencies and defaults. 2

The PMI industry recorded its best year in terms of new insurance volume in 

2007, with total new insurance written exceeding $300 billion for the first time. 3

A short 2 years later, new insurance written had declined to $81 billion as the market for mortgage insurance shrunk, following the collapse of the housing market and 

the subprime crisis. As home prices plummeted, the wave of mortgage defaults and 

home foreclosures weakened mortgage insurers’ capital position as a result of substantial losses. Having to set aside substantial capital to cover future claims severely constrained mortgage insurers’ ability to write new business. The very challenging market conditions that the mortgage insurance industry experienced since 

the eruption of the crises are reflected in the sharp rise of the industry’s loss and 

combined ratios. The industry’s loss ratio (losses over net premiums earned) jumped 

from 41 percent in 2006 to a record high 218 percent in 2008. 4

38 

5GAO Report: ‘‘FHA Mortgage Insurance: Applicability of Industry Requirements Is Limited, 

But Certain Features Could Enhance Oversight’’. September, 2013. 6Promontory Financial Group, LLC, ‘‘The Role of Private Mortgage Insurance in the U.S. 

Housing Finance System’’. January, 2011. 

As of year-end 2012 there were a total 34 active monoline writers of mortgage 

guaranty products within 9 insurance groups. Of these 9 insurance groups, 7 groups 

accounted for 95.7 percent of gross mortgage guaranty premiums. 

Gross premiums written for monoline mortgage guarantors have fluctuated over 

the past 5 years from low of $4.9 billion in 2012 to a high of $7.4 billion in 2008. 

Gross paid losses peaked in 2010 at $12.9 billion (77.4 percent of which was reported within the six largest guarantors) compared to $2.8 billion for 2007. Contingency reserves were nearly exhausted over the past 5 years, totaling $221.4 million 

at year-end 2012 compared to $13.4 billion in 2007. 

It is also worth noting that today, most residential mortgages insured by PMIs 

are sold to Fannie Mae and Freddie Mac, the Government-Sponsored Enterprises 

(GSEs). They have a statutory requirement to obtain credit enhancement on singlefamily residential mortgages purchased with loan-to-value ratios of over 80 percent. 

PMI is the major credit enhancement they use. 5 A recent study on the role of PMI 

explained that in addition to the regulatory structure, PMIs are preferable to other 

credit enhancements because of lender diversification, delayed losses, and acquaintance with the risks. 6 However, in the event the GSEs are wound down, it is unclear 

how PMI providers will be affected. 

Although market and economic trends appear to have generally stabilized in the 

last couple of years, this trend has not yet helped mortgage insurers to materially 

improve their financial situation. Many mortgage insurers have been able to obtain 

additional capital, but the losses were material enough that it’s expected to take additional time to fully recover. 

State Regulators’ Ongoing Efforts To Make Adjustments to MI Regulations 

State insurance regulators are actively studying what changes are deemed necessary to the solvency regulation of mortgage guaranty insurers. The NAIC’s Mortgage Guaranty Insurance (E) Working Group was formed by the Financial Condition 

(E) Committee in late 2012. This Working Group is assessing what changes should 

be made to the Model Act, and each of the previously mentioned potential changes 

have been developed by this NAIC group. 

In February 2013, the Working Group released a list of potential regulatory 

changes in which it identified the issues with mortgage guaranty insurance as it exists now. The primary problems are threefold: 

1. The overconcentration of mortgage originations in only a few banks has increased the pressure on mortgage insurers to accept everything given to them 

by any single bank or risk losing all the business from that bank. 

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

3. The lack of incentives to continue adhering to strict underwriting standards 

during booming periods when there is no threat of discontinued business. 

In addition to the previously mentioned potential changes to the NAIC model and 

a new Risk Based Capital formula specific to Mortgage Insurance, the following additional potential changes are being considered: 


11211301.eps
39 

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

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

• The need to refer potential accounting issues to the NAIC’s Statutory Accounting Principles (E) Working Group for further consideration as a longer-term 

project than what the Working Group is focused on currently. 

The Working Group’s next steps are to expose a concept draft of a new model for 

public comment and debate. 

Financial Guaranty Insurance 

I understand that you are also interested in bond insurers (also known as ‘‘Financial Guarantors’’). Since Arizona is not a domestic regulator for a financial guarantor, I have limited expertise in the area and encourage the Committee to discuss 

the regulation of these insurers with a State that regulates one of the remaining 

financial guarantors. Nevertheless, as an experienced insurance regulator, I do have 

some thoughts on the state of the industry. Bond insurers are distinct from other 

property casualty insurers. Their business is based almost exclusively on selling 

their credit rating to other parties. This niche industry developed in the early 1970s 

and initially focused on wrapping AAA ratings around lower-rated municipal obligations for a small fee. Bond insurance benefited municipalities by both increasing the 

market for their bonds and lowering their net costs. In the 1990s, bond insurers expanded their business into structured products like Asset Backed Securities, Credit 

Default Swaps, and Collateralized Debt Obligations. These more complicated investment vehicles, some of which were tied to subprime-backed mortgages, exposed 

bond-insurers to greater risk, which became painfully evident during the financial 

crisis. 

Since the crisis, the structured bond insurance market has basically dried up. The 

bond industry struggled to remain relevant following the 2008 economic crisis and 

ensuing housing crash. The industry declined to only two affiliated active writers, 

who are only writing coverage on traditional municipal business, and are rated 

AA—by Standard and Poor’s. 

Gross written premiums for monoline financial guarantors have steadily fallen 

over the past 5-year period, from $4.4 billion in 2007 to $1.2 billion at year-end 

2011. Gross paid losses peaked in 2009 at $10.8 billion (mostly due to the four large 

insurers), compared to $110.6 million for 2007, with reported losses of $3.4 billion 

at year-end 2011. Contingency reserves totaled $6.1 billion at year-end 2011 compared to $8.7 billion for 2007, before the financial crisis started. 

On a positive note, this has opened the door for new participants, as newly established insurers and surviving players compete to meet the continued demand for 

bond insurance for municipal obligations. There have been two recent entrants who 

have written $8 million in traditional municipal business as of mid-year 2013—one 

is rated AA—and the other is rated AA by Standard and Poor’s. The 2008 crisis dramatically illustrated the risk inherent to many of the structured products linked to 

the mortgage market that financial guarantors were seeking to insure. 

Current Legislative Proposals 

State regulators working through the NAIC recognize the important role that PMI 

continues to play in the housing market and the role that recent legislative proposals contemplate the PMIs and the financial guarantors playing in that market. 

While, at this time, the NAIC has not taken a position on any of these legislative 

proposals including S.1217, the bipartisan Housing Reform bill introduced by Senators Corker and Warner, we certainly appreciate the need for and the efforts by 

Congress to address the issues that arose during the financial crisis with the housing finance system and the GSEs. We recognize that there are many who would like 

a more prominent role for the private market in housing finance markets and less 

reliance on the GSEs, and insurance regulators remain committed to helping Congress shape such proposals. 

However, any effective proposal needs to take into account the existing regulatory 

regime and the lessons State insurance regulators learned during the crisis. In this 

regard, we caution against solutions that solely or substantially rely on the use of 

private mortgage insurers and financial guarantors as the lubricant for the housing 

market engine. Private mortgage insurers appropriately insure individual loans and, 

to date, there has been little experience with their insuring securities. Indeed, there 

may be regulatory concerns with expansion into this business as they could in some 

cases take on risks in the same loan or type of loan as both a guarantor of the secuVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00043 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
40 

7GAO Report 13-583: ‘‘Insurance Markets: Impacts of and Regulatory Response to the 2007– 

2009 Financial Crisis’’. June 2013. 

rities and the insurer of the individual loan. Conversely, financial guarantors have 

substantial experience in the area but failed to live up to expectations during financial crisis and, given our experience to date, insurance regulators remain skeptical 

of their capability of insuring anything other than municipal debt—particularly if 

the underlying financial instrument they seek to insure is not appropriately capitalized and secure. Reliance on these entities should not be considered the ‘‘magic bullet’’ that will fix the housing finance market. Moreover, throughout this process, neither PMI nor financial guaranty insurance should be seen as a substitute for due 

diligence or sound underwriting by mortgage servicers or bond issuers. 

The NAIC is concerned with proposals for a new Federal regulator with the authority to develop, adopt, and publish standards for the approval of insurers that 

provide first loss coverage for individual loans (such as the PMIs) or provide coverage for eligible bonds. While insurance regulators recognize that any new Federal 

entity charged with establishing and maintaining the requirements surrounding a 

Government guarantee has a strong interest in ensuring that taxpayers are not left 

with the bill, appropriate deference should be given to existing State insurance regulatory requirements such as capital and reserving requirements that are designed 

with the dual purpose of protecting policyholders and ensuring competitive insurance markets. The incentive is simply too great for a regulator charged with maintaining the viability of a Government guarantee to overshoot this regulatory objective and put in place standards, particularly solvency standards such as capital requirements, that are more stringent than necessary. This would ultimately threaten 

the availability of coverage and undermine the objective of a private market solution 

to support a vibrant housing market for the future. 

We would propose that any new Federal entity defer to the State regulators’ supervision of the companies within their purview, which are designed to protect policyholders and ensure availability of coverage. Instead, the focus should be on establishing standards for any unregulated entities that may participate in the housing 

finance framework and create standards relating to the establishment and administration of any new Government guarantee. If there are issues of common concern 

that arise, Federal regulators should work hand in hand with the insurance regulators to address them, as is done today with the Federal Housing Finance Administration, the Federal Reserve, and the other Federal financial regulatory agencies. 

Conclusion 

As the GAO recently affirmed, U.S. insurance regulators have a strong track 

record of effective supervision of insurers, even in the face of the worst financial crisis since the Great Depression. 7 The NAIC and State regulators are committed to 

working alongside Congress and Federal banking regulators to help ensure open, 

competitive, and stable housing and mortgage insurance markets that promote investment in home ownership while protecting both lenders and borrowers. 

The NAIC looks forward to contributing meaningful input as insurers, lenders, 

borrowers, policyholders, and the Federal Government work together to develop a 

new framework for housing regulatory structure in the U.S. Together, we will meet 

any new challenges posed by a dynamic housing market. We remain committed to 

effective regulation of the PMI and financial guaranty industries, and to making 

changes to our regulatory structure where necessary. We continue to believe that 

well-regulated markets make for competitive markets and well-protected policyholders. 

Thank you again for the opportunity to be here on behalf of the NAIC, and I look 

forward to your questions. 

41 

APPENDIX 


11211302.eps
42 


11211303.eps
43 


11211304.eps
44 


11211305.eps
45 


11211306.eps
46 


11211307.eps
47 


11211308.eps
48 


11211309.eps
49 

1 Indeed, in 1982 the rate differential between the State with the highest mortgage rate and 

the lowest mortgage rate spiked up to 600 basis points. ‘‘The Future of Housing Finance: Who 

Will Qualify?’’, Rosen Consulting Group and Ranieri Partners, October 25, 2013, p.5. Available 

at http://www.ranieripartners.com/latest-news. 

PREPARED STATEMENT OF BART DZIVI 

CHIEF EXECUTIVE OFFICER, THE DZIVI LAW FIRM, P.C. 

NOVEMBER 21, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, 

thank you for inviting me to testify on the proposed powers of the regulator and 

the regulatory structure for the secondary market for housing loans. I have represented many clients in the private sector and the public sector in the nearly 30 

years that I have worked on housing finance issues, but my comments today are 

my own views and are not intended to reflect the views of any of my current or 

former clients. My views expressed today draw upon my experience with financial 

institution regulatory agencies, both as a lawyer exposed to the savings and loan 

crisis two decades ago (where I was involved by first representing the regulators as 

they pursued various wrongdoing in the western United States and then as counsel 

to this Committee) and then my recent experience as counsel to the Financial Crisis 

Inquiry Commission and its review of the housing finance problems at our largest 

financial institutions. 

I commend the Committee for undertaking this hearing, and the other hearings 

related to the permanent replacement of Fannie Mae (Fannie) and Freddie Mac 

(Freddie) with a new structure to support housing finance through a vibrant secondary market that relies more on private capital, and presents less risk to the 

American taxpayer. The prior model of Fannie and Freddie, investor owned companies where the senior managers were given financial incentives to take outsized 

risks, was deeply flawed public policy. The fact that Fannie and Freddie operated 

for almost their entire existences without a regulator with the strong supervisory 

powers like the Federal Housing Finance Agency (FHFA) only exacerbated those 

flaws. However, uniform standardization in home loans and a national platform for 

issuing securities provided an efficient means for millions of American homeowners 

to access affordable credit. Before the advent of what effectively became a national 

market for mortgage loans, there was a lasting and sustained rate differential on 

mortgage loans in various regions across the country. 1 The development of a national mortgage market was a significant improvement for rural States that were 

located far from the centers of capital in the United States. 

The Committee should analyze both what was good about Fannie and Freddie for 

American homeowners, and what was bad about Fannie and Freddie for American 

taxpayers. I urge the Committee to continue its thoughtful and deliberate approach 

to this problem because the issues involved are complicated, and the outcomes could 

have a profound impact on the U.S. economy for generations to come. In the fall 

of 2008, Congress was faced with a crisis and immediate action was needed to stabilize the financial system. As a result of the efforts of the FHFA to stabilize the 

operations of the conservatorships of Fannie and Freddie, currently we are not in 

a crisis, and Congress has the luxury of time. Finding the right solution is more 

important than getting a quick solution. 

In framing my remarks today, I will use S.1217 as a point of departure. The introduction of S.1217 by Senator Corker and Senator Warner and their bipartisan cosponsors represents an important first step in raising the issue of creating a permanent replacement for Fannie and Freddie. I do, however, believe there are ways in 

which the structure proposed in that legislation, especially the regulatory structure, 

could be improved. 

Today, I will present my views with respect to the legislation’s impact on safety 

and soundness supervision of the newly proposed Federal Mortgage Insurance Corporations (FMIC), and the various private entities and businesses in the housing finance sector that could be involved in the securitization process. In looking at 

S.1217, I see two primary structural issues for the Committee to consider regarding 

the regulatory agency: 

First, and most importantly, what is the appropriate level of safety and 

soundness supervision of the various private entities, such as the mortgage 

originators, mortgage servicers, and private mortgage insurers, that will be 

in business with the FMIC? 

Second, is it sufficient that the FMIC be run by a board of Government appointees, or should the FMIC’s business of granting a Government guarVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00053 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
50 

2Pub. L. No. 97-320 (Oct. 15, 1982). 

3Pub. L. No. 101-73 (Aug. 9, 1989). 

4 ‘‘Fuzzy Numbers Lead to Prickly Politics’’, Steve Sloan, Congressional Quarterly Weekly, 

(Oct. 30, 2010). 5 In my view, the abolition of the FHFA is unnecessary and would add further complications 

to the transition to a system where Fannie and Freddie are replaced permanently with a new 

organization. My references to a Federal agency in this section could mean the FHFA if the 

Committee determined its abolition was unnecessary and made it the safety and soundness supervisor for both the FMIC and the Federal Home Loan Banks. If the Committee determines 

not to abolish the FHFA, it also could consider whether the single director should be replaced 

with a three person board. 6 I believe the Committee should consider an alternative structure where the FMIC itself is 

the sole issuer of mortgage backed securities. The primary goal in issuing these securities with 

a Federal guarantee is to have a low cost of funds that is passed onto individuals with home 

mortgages at a low markup. The structure of the system proposed in the bill would have multiple issuers, and because of the liquidity premium for smaller outstanding issues, such bonds 

would undoubtedly have a higher interest rates, and a larger bid ask spread, than bonds issued 

by one large issuer. The FMIC could act as the sole conduit for entities that desire to issue securities, much as the Office of Finance acts as the sole issuer for all the Federal Home Loan 

Banks. 12 CFR 1273. 

antee on mortgage securities be subject to safety and soundness oversight 

by a separate Federal agency? 

Safety and Soundness Supervision of Private Business Partners of the 

FMIC 

Under S.1217, the FMIC would be created with multiple responsibilities, including the power to establish a Mortgage Insurance Fund to charge fees to be deposited 

in a fund, and to issue a full faith and credit Federal guarantee to cover losses on 

securities insured by private parties, after application of a first loss position by either investors or a guarantor. The FMIC would be governed by a five member board 

of presidential appointees, subject to Senate confirmation. The FHFA, which has enforcement powers similar to the Federal banking agencies, would be abolished. 

Given that a Federal credit guarantee is involved, it is critical that any supervision of the private entities participating in the securitization be in the hands of 

a strong, independent Federal regulator. During the savings and loan crisis of the 

1980s, the country learned the hard way that when providing access to Federal 

guarantees, it may not be prudent to rely on State legislatures and State regulatory 

officials, with weak Federal oversight. In the 1980s, Congress allowed States wide 

authority to set the investment rules for State chartered savings and loans, but allowed them to have access to Federal guarantees for deposit insurance. 2 Before 

Congress slammed that door shut in 1989, 3 weak State supervisors in just a few 

States loosened the rules and let a torrent of new operators acquire charters, or buy 

up existing companies, and then the American taxpayer eventually picked up the 

tab for $124 billion of losses. 4 State regulators may be appropriate for certain entities, such as companies involved in the life insurance business that are supported 

by State guarantee funds, but when the fund backing any losses is a Federal fund, 

and the American taxpayer has exposure, prudence demands that a strong Federal 

regulator be in charge. 

The legislation establishes a process for the FMIC to establish standards for approving private parties doing business with the FMIC. The private parties participating in the securitization process and subject to Government oversight are limited 

in the legislation to private mortgage insurers, mortgage servicers, bond issuers, 

and bond guarantors that do business facilitated by the FMIC. The FMIC is given 

the power to suspend or revoke the authority of those entities to do business with 

the FMIC, and the power to adopt a civil money penalty process. 

I believe this portion of the legislation can be improved substantially by allowing 

a Federal agency with safety and soundness duties more like the Federal banking 

agencies to supervise the activities of the private parties participating in the 

securitization process. 5 I recommend that three specific changes be considered by 

the Committee. 

First, I would broaden the definition of the private parties in the securitization 

process that are subject to Government oversight, and increase the flexibility of the 

Federal agency to define by regulation the key mortgage securitization participants 

that are subject to its authority. The specified entities in the legislation—private 

mortgage insurers, mortgage servicers, issuers 6 and bond guarantors—should be expanded in the statutory language, and the statute should expressly grant that Federal agency the authority to adopt regulations in the future further expanding the 

list. For example, it is my view that mortgage originators, due diligence firms, and 

trustees of the securitization trusts holding the mortgages that are underlying the 

51 

7 12 U.S.C. 481. The relevant criminal code provisions in Title 18 of the United States Code 

should also be amended. 8The broad context of this term was set forth in testimony during legislative hearings that 

has been accepted by courts as a guiding principle. ‘‘Generally speaking, an ‘unsafe or unsound 

practice’ embraces any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal 

risk of loss or damage to an institution, its shareholders, or the agencies administering the insurance fund.’’ Financial Institutions Supervisory Act of 1966, Hearings on S.3158 before the 

House Committee on Banking and Currency, 89th Cong., 2d Sess. At 49-50 (1966) (statement 

of Federal Home Loan Bank Board Chairman Horne). 9 12 U.S.C. 1818(b). 

10 12 U.S.C. 1818(c). 11 12 U.S.C. 1818(e), (f), and (g). 12 12 U.S.C. 1818(i)(2). 

guaranteed securities should be subject to oversight by the Federal agency. 

Securitization trustees occupy a key position from which they could protect investors, but often have little accountability for their actions, and in the past have not 

shown great vigor in exercising their potential powers. The Federal agency should 

have the power to take actions that can influence all the key participants in the 

mortgage securitization market place. 

If this new secondary market structure is meant to last, then the Federal agency 

must be given the power to adapt to changing times and changing financial markets. Otherwise, over time, the agency will be left writing rules applicable to horse 

drawn buggies as Google-powered self-driving cars cruise the freeways. 

Second, I would grant the Federal agency the express power to examine and inspect the books and records of all the entities that participate in the mortgage 

securitization, and afford the agency examiners who do that inspection the same 

powers and protections that are afforded to national bank examiners. 7 Federal bank 

examiners today essentially have unfettered access to all the materials and documents available to the senior managers of the banks they inspect, even materials 

that are subject to litigation privileges. The Federal examiners need access to this 

information, which is often in the form of confidential reviews and reports, to fully 

inform their views, and the private parties need to know that divulging such information does not impair existing litigation privileges. 

Third, the proposed legislation grants the FMIC the power to set standards for 

private parties and suspend them from doing business with the FMIC if they violate 

those standards. That is a blunt weapon. Instead of relying upon a concept of program suspension for private parties that violate the agency’s standards, supplemented with a general grant of power to create a civil money penalty system, I 

would create an express enforcement system modeled after the Federal banking 

laws, with the power to take action for violations of law and regulation, and also 

for engaging in unsafe and unsound practices. That final phrase, ‘‘unsafe and unsound practices’’, is a key weapon in the arsenal of the bank regulatory agencies. 

It was added to the Federal banking laws in 1966 at the request of the Federal 

banking regulators and allows them to address developing practices and conditions. 8 The remedies available to the Federal agency in enforcing its authority 

should include cease and desist powers, 9 temporary cease and desist powers, 10 the 

power to take action against individuals (referred to as institution affiliated parties) 

to prohibit such individuals from engaging in further business related to the Mortgage Insurance Fund, 11 and a civil money penalty system with express amounts 

and tiers similar to those of the Federal banking agencies. 12

Cease and desist authority allows a Federal regulator to take more precise action 

than relying upon the blunt action of causing the private business to be barred from 

doing any further work on mortgage securitizations that have the benefit of a Federal guarantee. Certainly there would be instances in which the offenses do not warrant causing the private entity to be barred from all further work, but nonetheless 

call for remediation. And, as is the common practice with the Federal banking regulators, instead of actually using the statutory power to issue a cease and desist 

order, in most instances a consent agreement would be negotiated between the private business and the Federal agency setting forth the scope of the appropriate remedial action. This is a much more effective tool than relying upon the 

brinksmanship of threatening to bar the private party from engaging in business 

with the entity providing the Federal guarantee. 

Separation of the Business of Guaranteeing the Securities and Supervising 

the Entity That Makes Guarantees 

S.1217 grants the FMIC the power to issue the guarantee of mortgage securities 

and does not subject the FMIC to supervision by a separate safety and soundness 

52 

13 ‘‘Regulating Housing GSEs: Thoughts on Institutional Structures and Authorities’’, Lawrence J. White and Scott W. Frame, Federal Reserve Bank of Atlanta Economic Review, April 

2004, fn. 6. 14 ‘‘Government-Sponsored Enterprises: The Government’s Exposure to Risks’’, General Accounting Office, GGD90-97 (Aug. 1990), p.9. Freddie Mac, which in the early 1980s was a subsidiary of the Federal Home Loan Banks and was not investor owned like Fannie Mae was at 

that time, and Freddie ‘‘was consistently profitable throughout the 1980s . . . [avoiding] most 

interest rate risk . . . and . . . [with] credit losses . . . lower than industry average.’’ Id. at 

8. However, Freddie Mac was not subject to stringent safety and soundness standards, and operated with razor thin capital (0.62 percent of its assets and outstanding MBS at the end of 1989). 

Id. 15Federal Housing Enterprises Financial Safety and Soundness Act of 1992, Pub. L. No. 102- 

550 (Oct. 28, 1992) Title XIII. Even then, this new agency was hobbled with statutory restrictions giving it far less authority (compared to the Federal banking regulators) to supervise the 

safety and soundness of Fannie Mae and Freddie Mac. 16 ‘‘Government-Sponsored Enterprises: The Government’s Exposure to Risks’’, General Accounting Office, GGD90-97 (Aug. 1990), p.11. 17 ‘‘Government-Sponsored Enterprises: The Government’s Exposure to Risks’’, General Accounting Office, GGD90-97 (Aug. 1990), p.152. 18 ‘‘Federal Home Loan Bank System: Reforms Needed To Promote Its Safety, Soundness, and 

Effectiveness’’, General Accounting Office, GGD-94-38 (Dec. 1993). 19 Id. at 4-5. Although my testimony today focuses on the FMIC and the supervision of the 

various private parties with which it will do business, I also would suggest that having the 

FMIC be responsible for running the Mortgage Insurance Fund, and being the safety and soundness supervisor of the Federal Home Loan Banks raises some conflicts that are parallel to the 

conflict that were in place when the Federal Home Loan Bank Board was responsible for running the FSLIC insurance fund (that insured savings and loans deposits), and supervising the 

Federal Home Loan Banks. When the FSLIC was running low on funds to close troubled savings 

and loans, it lowered collateral standards applicable to FHLBank loans to savings and loans, 

and pressured them to make loans that they would not otherwise make. I believe the Committee 

should consider allowing the FHFA to continue to exist, and act as the safety and soundness 

supervisor for the FMIC, the private parties involved in FMIC securitization, the Federal Home 

regulator. Instead, the legislation creates a board of directors composed of Presidential appointees, and relies upon them to be self policing when extending a Government guarantee on mortgage securities. I am troubled by this framework. 

A review of the history of the housing finance system shows why this proposed 

approach might be troublesome. The recent crisis is not the first time that the housing GSEs have faced significant financial troubles. By 1981, Fannie Mae, which had 

a Chief Executive Officer that was a presidential appointee, and presidentially appointed members serving on its board of directors, was insolvent on a market value 

basis. 13 Fannie Mae continued to generate cumulative net losses in 1981, 1982, 

1984, and 1985. 14 At that time, Fannie Mae had no independent safety and soundness supervisor with strong enforcement tools; its operations were subject to ‘‘light 

touch’’ supervision by HUD until Congress created the Office of Federal Housing 

Enterprise Oversight in 1992. 15 While the specific manner in which Fannie Mae 

blew a hole in its balance sheet back in the 1980s (holding long term assets in portfolio that it financed with short term debt) would not be available to the proposed 

FMIC, the similar structural incentives are in place for excessive risk taking. History has shown that merely having a presidentially appointed executive and some 

presidentially appointed directors did not restrain that organization’s push to zealously expand its business. 

In the 1980s, there was no strong independent Federal regulator to restrain the 

Freddie or Fannie business managers’ zealous push to expand their book of business. As the GAO said in the early 1990s, the multiple roles given to HUD created 

an inherent conflict of interest. 16 HUD was a promoter of housing, yet it had a role 

as safety and soundness regulator of Fannie and Freddie. Multiple conflicts arise 

in this scenario. HUD’s conflict at that time is evidenced by its response to the 1990 

GAO report, in which it argued that Fannie’s and Freddie’s minuscule then existing 

capital (each had less than 1 percent of capital to back its assets and outstanding 

mortgage backed securities) was more than enough to meet any stringent capital 

standards. 17

In another context, the GAO has previously noted that making operational business decisions and being an arms’ length safety and soundness supervisor are incompatible. In 1993, GAO issued a report noting that the Federal Housing Finance 

Board still had several governance functions with respect to the operations of the 

Federal Home Loan Banks (such as approving budgets and dividends), and was also 

charged with being the safety and soundness supervisor of the Federal Home Loan 

Banks. 18 GAO recommended that safety and soundness supervision should be done 

by a single independent regulator, and that the governance decisions should be 

given to the Federal Home Loan Banks and their shareholders. 19 Congress wisely 

53 

Loan Banks, and its Office of Finance. The Office of Finance issues bonds on behalf of all the 

Federal Home Loan Banks, and is subject to FHFA enforcement actions because Congress defined it as an entity affiliated party. 12 U.S.C. 4502(11). A graphic depiction of the current regulatory system, the system proposed by S.1217, and an alternative structure are set forth in Exhibits A, B, and C to this testimony. 

If the Committee were to adopt the alternative approach, it could consider whether the best 

way to structure the FMIC’s guarantee operations would be as a Government corporation (the 

GNMA model), or as a member owned cooperative (the FHLBank model). The primary benefit 

of the industry cooperative model is that it requires the industry to have ‘‘skin in the game’’ 

in the form of stock purchased in the cooperative in order to do business with the cooperative. 

It is not clear to me that there would be enough critical mass of business for the mutual 

securitization company for small companies envisioned by section 215 of the proposed bill to 

ever begin operation. 20Pub. L. No. 106-102 (Nov. 12, 1999). 21 ‘‘Mass. Thrifts To Seek U.S. Insurance’’, Laurie Cohen, Chicago Tribune (May 24, 1985), 

p.C1 (Ohio, Maryland, North Carolina, and Massachusetts deposit insurance systems were 

closed in 1985, and only the Pennsylvania Savings Association Insurance Corp. remained open). 

The Nebraska Depository Insurance Guaranty Corporation had declared bankruptcy in 1983. 

‘‘After the Ohio bank run, extend Federal insurance to all banks’’, R. Richardson Pettit, N.Y. 

Times (March 24, 1985), p.2. 22The fund established by Ohio had all its directors elected by State thrifts. ‘‘The Ohio Deposit Guarantee Fund—The Ohio Alternative to FSLIC’’, Ronald Alexander, 15 Akron L. Rev. 

431, 436 (1982). 23The ineffectual Maryland Savings-Share Insurance Corp., for example, had three of its 

board members appointed by the Governor of Maryland. ‘‘Toothless Watchdog Shares Blame’’, 

R.H. Melton and John Mintz, Washington Post, (Dec. 26, 1985) p.A1. 24 ‘‘FDIC insurance premiums not likely to change soon, Gruenberg says’’, Ken McCarthy, 

SNL Bank and Thrift Daily (Oct. 9, 2013). 

followed the advice of GAO, and later eliminated the governance powers that the 

FHFB had previously held. 20

In the current context, an organization charged with ensuring the availability of 

mortgage credit to the maximum extent possible will want looser underwriting 

standards so more families can have access to housing; a safety and soundness regulator will want tighter underwriting standards to prevent losses during economic 

downturns. This proposed structure puts the FMIC in an inherent conflict of interest. In running the business of guaranteeing securities and setting the standards 

for the private parties involved in the securitization, they would naturally want the 

business to expand as much as possible to provide as many benefits to as many 

American households as possible; a safety and soundness regulator, on the other 

hand, should want the standards to provide protection to prevent losses when an 

economic downturn occurs. This fundamental tension is why I believe the roles 

should be separated into separate organizations. 

Some have suggested that the deposit insurance model, with a special purpose 

Government backed corporation providing a guarantee of insured deposits should 

provide comfort to those considering the proposed model of the FMIC operating 

without independent oversight from a separate safety and soundness supervisor. To 

this I say please examine the results of such specialized deposit insurance systems 

that have been run by special purpose corporations in the housing finance system: 

there are some rather spectacular failures. The most famous of these, of course, is 

the Federal Savings and Loan Insurance Corporation, which collapsed for good in 

1989, and caused an enormous loss for the taxpayers. 

But the FSLIC failure was not an isolated incident. Into the mid-1980s there were 

several States that had State laws creating deposit insurance programs funded by 

assessments on State chartered housing lenders. By 1985, all but one of these programs had failed, or were closed before they failed. 21 Some of these were operated 

exclusively with State chartered thrift members on the board of directors, 22 and 

some had directors appointed by the State government. 23 But because none of them 

charged their members enough for their deposit insurance, they all failed. 

Even the fiscal history of the FDIC should not give great comfort to those saying 

putting Government appointed directors on the board of a governmental entity giving credit guarantees is sufficient protection in all contexts. At the end of 2009, the 

Deposit Insurance Fund managed by the FDIC had a negative balance of $20.9 billion. 24 One must question whether that negative balance would have been substantially larger but for the extraordinary steps taken in 2008 by Congress, the Federal 

Reserve, and the FDIC to pump hundreds of billions of dollars into the financial system. Although the FDIC system of deposit insurance has been a dramatic success 

in protecting small savers and stabilizing the American banking system, there are 

issues that should cause the Committee to be careful in exporting that model into 

other areas. In the years leading up to the recent crisis, from 1996 to 2006, the overwhelming majority of banks paid nothing for their deposit insurance from the 

54 

25 In 2006, the FDIC adopted a premium for 2007 in which banks had to pay at least 5 basis 

points. ‘‘FDIC Fees: A 5-BP Floor and Most To Pay More’’, Joe Adler, American Banker (Nov. 

3, 2006), p.1. 26Prepared Testimony of FDIC Chairperson Tanoue, United States Senate Committee on 

Banking, Housing, and Urban Affairs, June 20, 2001. The FDIC Chairperson also noted that 

the FDIC’s system was procyclical, exacerbating downturns, because ‘‘premiums are volatile and 

are likely to rise substantially during an economic downturn when financial institutions can 

least afford to pay higher premiums.’’ Subsequent legislation and actions by the FDIC have reduced, but not eliminated, those distortions. 27 Recent calculations indicate that net TARP outflows have been approximately $40 billion. 

See, http://www.projects.propublica.org/bailout/. In constant dollars, in 2009 the cost of the 

savings and loan crisis was estimated at $293 billion. http://www.propublica.org/special/government-bailouts 28The 30-year fixed-rate mortgage was first introduced by the FHA. ‘‘Private Risk, Public 

Risk: Public Policy, Market Development, and the Mortgage Crisis’’, Daniel Immergluck, 36 

Fordham Urb. L. J. 447, 456 (April 2009). By 1970, FHA still accounted for 30 percent of single 

family loans. Id. at 457. 

FDIC. 25 A former FDIC Chairperson noted in testimony before this Committee over 

a decade ago that the statutory model then in effect did not allow the FDIC to ‘‘price 

risk appropriately,’’ and that underpriced deposit insurance premiums had a number of negative effects. 26

The proposed legislation partially addresses this problem by setting reserve ratios 

for the new Mortgage Insurance Fund that appear to be floors, not caps, but I would 

go further and direct the Federal agency to establish a meaningful minimum 

nonzero charge for the fees charged to purely private parties for the Federal guarantee that applies even after the targeted reserve ratios have been met. 

Conclusion 

Because of the stability of the marketplace resulting from the conservatorships of 

Fannie and Freddie being overseen by the FHFA, Congress has the luxury of taking 

its time to get these issues right. In 1982, Congress first attempted to fix the problems of a broken housing finance system, and the struggling FSLIC, by expanding 

the powers of savings and loans. While accepted portfolio theory recognizes that diversification of investment classes can lower risk, the realities of the marketplace 

often steam roll theory. If those expanded powers had been limited by requiring 

them to be exercised only through acquisitions by existing commercial banks with 

experience in making those types of investments it might have worked. Instead, the 

law expanding savings and loan powers was exploited by a group of real estate developers who seized control of traditional savings and loans, operated under light 

touch supervision, and used them to fund their risky ventures. Congress back then 

certainly did not intend to invite rogue agents into the system, but flawed reliance 

on weak supervision created a perfect storm. The ‘‘cure’’ created by Congress in 1982 

exacerbated the problem several fold, and the final cost to the Federal Government 

to make good on the insured deposits of failed savings and loans far exceeded the 

final cost to the Federal Government of the extraordinary measures taken under 

TARP. 27

I am very concerned about the potential for a similar exacerbation of current 

problems. Certainly the existing problems that created insolvencies at Fannie and 

Freddie are significant and demand a permanent solution, but let the cure not be 

worse than the disease. Some type of Federal backing of the mortgage market appears to be a necessity if Congress desires American homeowners to have continued 

access to 30-year fixed-rate mortgages at an affordable cost. 28 But great care must 

be taken in designing a system where as yet unknown private parties will have access to a Federal guarantee. Whatever you design will be a huge magnet for those 

trying to exploit the system to make a quick profit and leave the taxpayers holding 

the bag. 

55 


11211310.eps
56 


11211311.eps
57 


11211312.eps
58 

PREPARED STATEMENT OF ROBERT M. COUCH 

COUNSEL, BRADLEY ARANT BOULT CUMMINGS, LLP, ON BEHALF OF THE BIPARTISAN

POLICY CENTER HOUSING COMMISSION

NOVEMBER 21, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, 

thank you for the opportunity to be here today to discuss housing finance reform. 

Before I get into the substance of my remarks, I want to commend the Committee 

for the deliberate, bipartisan approach it has taken in examining this very complicated subject, one of immense importance to the American people and our Nation’s economy. The series of hearings that the Committee has convened have done 

an excellent job in illuminating the key decision points in designing a new, more 

sustainable housing finance system. These hearings, in turn, have performed a vital 

service by helping educate the public. 

This past March, the Committee heard from my good friend and colleague Senator 

Mel Martinez, who outlined the housing finance reform recommendations of the Bipartisan Policy Center Housing Commission. 

Founded in 2007 by former Senate Majority Leaders Howard Baker, Tom Daschle, 

Bob Dole, and George Mitchell, the Bipartisan Policy Center is a Washington-based 

think tank that actively seeks bipartisan solutions to some of the most complex policy issues facing our country. The Housing Commission was launched in October 

2011 with the financial support of the John D. and Catherine T. MacArthur Foundation. The commission has 21 members from both political parties who bring to the 

table a wide variety of professional experiences. Former Senators George Mitchell, 

Kit Bond, and Mel Martinez, and former HUD Secretary Henry Cisneros, serve as 

commission cochairs. 

Suffice it to say that the commission strongly supports the objectives of S.1217, 

the Housing Finance Reform and Taxpayer Protection Act, and I am pleased that 

many of the bill’s provisions reflect our own recommendations. Like S.1217, the 

commission proposes the wind down of Fannie Mae and Freddie Mac over a 

multiyear transition period; a greater role for private capital in assuming mortgage 

credit risk; and a continued Government presence through a limited ‘‘catastrophic’’ 

guarantee of mortgage-backed securities that is funded through the collection of actuarially sound fees charged to borrowers. The commission believes that a limited 

Government guarantee in the secondary market is essential to ensure widespread 

access to long-term and fixed-rate mortgage financing, in particular the 30-year 

fixed-rate amortizing single-family mortgage. 

The Powers of the New Regulator 

The new housing finance system envisioned by the commission and outlined in 

S.1217 will only work with a strong regulator at the system’s center. This regulator 

will function as ‘‘Mission Control’’ for the new system and will be charged with fulfilling two responsibilities that are admittedly in tension: promoting a widely accessible mortgage market, while protecting the wallets of the American taxpayers. 

The commission calls its proposed regulator the Public Guarantor, while S.1217 

establishes the Federal Mortgage Insurance Corporation (FMIC) to assume the regulatory and guarantee functions currently performed by the Federal Housing Finance Agency (FHFA), Fannie Mae, and Freddie Mac. 

Under the system envisioned by the commission and outlined in S.1217, the new 

regulator would have significant powers and responsibilities, including (a) guaranteeing investors the timely payment of principal and interest on covered mortgagebacked securities (MBS); (b) collecting fees in exchange for providing this insurance 

as well as to cover operational costs; (c) establishing and maintaining a catastrophic 

risk fund; (d) developing credit risk-sharing mechanisms for private entities to assume the first-loss position; (e) qualifying private institutions to serve as issuers of 

securities, servicers, private mortgage insurers, bond guarantors, and other types of 

credit enhancers; and (f) overseeing and supervising the common securitization platform developed by the FHFA. 

S.1217 also commendably seeks to promote transparency and standardization in 

the market by directing the FMIC to maintain a database of uniform loan level information on eligible mortgages, establish an electronic registry for eligible mortgages that collateralize covered securities, and develop standardized securitization 

agreements. Greater transparency and standardization should encourage more riskbearing private capital to enter the mortgage system. 

As the former president of a savings bank in Alabama, I particularly appreciate 

the provisions of S.1217 that require the FMIC to facilitate access to the secondary 

market by small, midsize, and community banks, many of whom may lack 

securitization capabilities. Ensuring access to the Government-guaranteed secVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00062 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
59 

1Ginnie Mae in its current form might not have sufficient capacity to become the Public 

Guarantor, but might be a suitable vehicle if given greater authorities and flexibilities. 2Section 205. 

ondary market on full and equal terms to lenders of all sizes and types was a major 

objective of the commission. 

Looking at S.1217, let me highlight five areas where the Committee can strengthen the FMIC’s role in the new housing finance system while promoting mortgage 

liquidity: 

1. The Ginnie Mae Model. The commission examined a variety of models around 

which to design a new housing finance system. We concluded that the Ginnie Mae 

model offers a number of distinct advantages that can be successfully reproduced 

in the segment of the mortgage market now dominated by Fannie Mae and Freddie 

Mac. This model has a proven track record of promoting broad access to affordable 

mortgage credit while posing minimal risk to the taxpayers. 

An important advantage of a Ginnie Mae-like approach is that it allows for a 

greater number of financial institutions to be issuers of MBS. As applied to the 

FMIC, the Ginnie Mae model would carefully align the interests of all the parties 

in the mortgage chain and allocate risk among them: (1) the borrowers (who have 

downpayment and home equity risk and, in some States, face the risk of a deficiency 

judgment); (2) the MBS issuers (who maintain the risk associated with ‘‘representations and warranties’’) and the mortgage servicers (who have risk for the timely 

payment of principal and interest); and (3) a credit-enhancement facility that assumes ‘‘first-loss’’ credit risk. Like Ginnie Mae, the Public Guarantor would stand 

in the fourth-loss position (behind borrowers, MBS issuers and mortgage servicers, 

and private credit enhancers) with a significant buffer of protection for the taxpayers. 1

As you revisit S.1217, we urge you to consider legislative language that would 

allow the FMIC to replicate the Ginnie Mae model as a part of its ongoing operations. 

2. Common Securitization Shelf. The commission felt strongly that the portion of 

any new housing finance system guaranteed by the Public Guarantor must have a 

single security or ‘‘common shelf’’ for single-family mortgages in order to ensure the 

system’s liquidity, interact effectively with the To-Be-Announced (TBA) market, and 

establish an equal playing field for lenders of all sizes. A common shelf also allows 

mortgages with different terms, interest rates, and other attributes to be pooled into 

a single security. 

In our proposal, the Public Guarantor is specifically directed to provide a common 

shelf. Based on our reading, it is unclear whether S.1217 contemplates the FMIC 

guaranteeing a single, common security or multiple securities. We recommend that 

the FMIC be explicitly directed to provide a common shelf for the segment of the 

market it backstops and to focus its efforts on promoting the liquidity of the new 

mortgage-backed securities. 

3. Resolution Authority. Under the commission’s proposal, the Public Guarantor 

would have the authority to temporarily take over the business of issuers, servicers, 

and/or private credit enhancers that happen to fail and to transfer that business to 

other private participants in the mortgage system. S.1217 does not appear to give 

the FMIC the same type of resolution authority. With resolution authority, the 

FMIC can help preserve liquidity and ensure a fully functioning market, particularly during periods of economic stress. 

4. Emergency Authority. The commission also proposed that the Public Guarantor 

be given the authority to price and absorb first-loss credit risk for limited periods 

during times of severe economic stress in order to ensure the continued flow of mortgage credit. Under these circumstances, the Public Guarantor would be required to 

notify the Treasury Department, the Federal Reserve, and the chairs of the appropriate congressional committees before taking any such action. 

S.1217 provides the FMIC with similar emergency authority, but this authority 

is subject to a number of more stringent conditions. First, the authority may only 

be exercised upon the written agreement of the Chairman of the Federal Reserve 

Board and the Treasury Secretary, in consultation with the HUD Secretary. Second, 

it may only be exercised for a period of 6 months. Third, the authority may not be 

exercised more than once in any given 3-year period. 2 While these safeguards are 

understandable, the Committee may wish to consider empowering the FMIC with 

the flexibility to respond more quickly to emergency conditions in the mortgage market. 

5. Wind Down of Fannie Mae and Freddie Mac. The hard and fast 5-year deadline 

that S.1217 proposes for transitioning from the current Government-dominated 

housing finance system to one in which private capital plays a larger role in bearing 

60 

3Section 101(c). 

4 Examples of wholly-owned Government corporations include Ginnie Mae, the Export-Import 

Bank of the United States, the Overseas Private Investment Corporation, and the Pension Benefit Guaranty Corporation. 5While there is no general incorporation statute at the Federal level, the Government Corporation Control Act of 1945, as amended (GCCA), does provide for standardized budget, auditing, debt management, and depository practices for most Government corporations. Under the 

GCCA, ‘‘wholly-owned’’ Government corporations are required to submit annual ‘‘business type’’ 

budgets to the President. See, Kevin R. Kosar, ‘‘Federal Government Corporations: An Overview’’, Congressional Research Service (June 8, 2011). Among a number of items, these budgets 

must (a) contain estimates of the financial condition and operations of the corporation for the 

current and following fiscal year, (b) contain estimates of operations by major activities, administrative expenses, borrowings, and any appropriations that may be needed to restore capital 

impairments, and (c) provide for emergencies and contingencies. Budgets submitted to the President by the Government corporation become part of the budgets submitted by the President to 

Congress. 6See, Section 203. 7The President of Ginnie Mae is responsible to the Secretary of HUD and, ultimately, to the 

President of the United States. 

credit risk may not allow for sufficient flexibility and adjustments during this critical period. The commission adopts a more flexible approach by suggesting that a 

transition period of 5 to 10 years be built into the legislation. 

Structure and Governance of the New Regulator 

The FMIC and the Public Guarantor are similar in that both would be self-supporting institutions that do not rely on Federal appropriations but rather finance 

their catastrophic risk funds and operational expenses through the collection of 

guarantee fees. The primary purpose here is to protect the taxpayers from unnecessary risk, but operating largely outside the appropriations process also gives the institutions some insulation from political interference. 

S.1217 describes the FMIC as an ‘‘independent agency of the Federal Government,’’ 3 whereas the commission proposes that the Public Guarantor be established 

as an independent, ‘‘wholly-owned’’ Government corporation under the Government 

Corporation Control Act of 1945. 4 The commission concluded that establishing the 

Public Guarantor as a wholly-owned Government corporation would provide it with 

an additional layer of protection from political influence while subjecting it to wellestablished budgetary and fiscal controls. 5 We encourage you to examine whether 

this type of organizational structure is appropriate for the FMIC. 

S.1217 appropriately specifies that the multifamily businesses of Fannie Mae and 

Freddie Mac must be transferred to the FMIC, and it appears that the Mortgage 

Insurance Fund would cover both single-family and multifamily mortgage-backed 

securities. 6 The commission, on the other hand, concluded it was best to establish 

separate single-family and multifamily catastrophic risk funds since single-family 

and multifamily lending are fundamentally different businesses with different underwriting approaches. I encourage the Committee to take a second look at this 

issue. 

Governance 

With respect to the governance of the new regulator, the commission ultimately 

recommended vesting authority in a single individual appointed by the President of 

the United States and subject to Senate confirmation. In reaching this judgment, 

we recognized that the regulator of the new system would have an enormous set 

of responsibilities, particularly in the early stages of the new system’s build out. Our 

view was that putting a single person in charge would promote accountability and 

ease of decision making. 

Ginnie Mae does not operate under a Board of Directors with management oversight responsibilities. 7 In my view, and speaking as a former President of the organization, Ginnie Mae has consistently been one of the best-run organizations within 

the Federal Government. But I certainly understand that its governance model is 

somewhat unique among Federal agencies and there are logical reasons for establishing a Board of Directors for the FMIC. 

The most compelling reason is that rebooting our Nation’s housing finance system 

and running the FMIC is a huge undertaking requiring a deep bench of experience. 

An engaged, experienced Board of Directors can be an enormously valuable asset 

to the Director of the FMIC. While the Director should have demonstrated experience in financial management and a broad understanding of the capital markets, 

he or she must also be someone who can draw upon and utilize the skills of others, 

including the members of the FMIC Board, and inspire the members of the FMIC 

61 

8Section 103(a)(1)(B)(i) through (iv). 

9Section 102(c). 

10Section 104. 11Section 104(a)(2)(A)(i). 12Section 104 (a)(3)(A) and (B). S.1217 also requires the Comptroller General of the United 

States to conduct an annual audit of the financial transactions of the FMIC. These audits, too, 

should assist Congress in performing its oversight responsibilities. Section 106(c). 

staff to work at a high level of proficiency. Having these personal qualities is essential for the FMIC Director to be effective. 

If, as contemplated by S.1217, the FMIC is to be managed by a Board of Directors, 

I encourage the Committee to amend the legislation to ensure that members of both 

political parties are represented on the Board. Bipartisan representation on the 

FMIC Board will provide some assurance to the public and Congress that the Board 

is making decisions for sound operational and risk-management reasons, and not 

because of political considerations. Building public confidence in the new housing finance system will be particularly critical in the early stages of its development. 

There is plenty of precedent for this bipartisan approach: Critical financial regulatory agencies like the Securities Exchange Commission and the Commodities Futures Trading Commission are required to have political balance. Likewise, no more 

than three members of the five-member Board of Directors of the Federal Deposit 

Insurance Corporation may have the same political affiliation. While there have 

been occasions when these and other similarly governed Boards and commissions 

have descended into partisan bickering, the totality of the evidence over the years 

suggests they have worked reasonably well. 

I strongly support S.1217’s requirement that members of the FMIC Board have 

significant experience in at least one of the following fields: asset management, 

mortgage insurance, community banking, and multifamily housing. 8 This requirement will help ensure that relevant experience is represented on the Board. There 

is also precedent for this approach. For example, one of the members of the FDIC 

Board is required by statute to possess a background in State bank supervision. 

During my career in the mortgage banking industry, I have seen first-hand how 

duplicative and overlapping examination and reporting requirements can increase 

expenses and raise mortgage costs. To improve coordination among our Nation’s financial regulators, as well as to facilitate information sharing about market developments and potential risks to the stability of the financial system, I support 

S.1217’s decision to make the Chairperson of the FMIC a member of the Financial 

Stability Oversight Board (FSOC). 9 As we build a new housing finance system, 

FSOC should promote regulatory streamlining and harmonization and, when appropriate, encourage regulators to rely on the work and conclusions of their counterparts to avoid unnecessary duplication. 

Finally, I support the establishment of an Office of Inspector General (IG) within 

the FMIC to promote the efficient operations of its programs and detect and deter 

fraud and other forms of corruption. 10 I also support the additional requirement established in S.1217 that the FMIC IG conduct periodic audits of the adequacy of 

the private capital assuming the first-loss position in the new housing finance system and make recommendations for addressing any deficiencies. 11 By requiring the 

IG, as well as an independent actuary, to issue annual reports to Congress on the 

adequacy of the guarantee fees charged by the FMIC and the Mortgage Insurance 

Fund itself, S.1217 provides an important mechanism to assist Congress in performing its oversight responsibilities. 12

Thank you for your attention. I look forward to your questions. 

PREPARED STATEMENT OF PAUL LEONARD 

SENIOR VICE PRESIDENT OF GOVERNMENT AFFAIRS, THE HOUSING POLICY COUNCIL

OF THE FINANCIAL SERVICES ROUNDTABLE

NOVEMBER 21, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, 

thank you for the opportunity to appear before you today. 

My name is Paul Leonard and I am the Senior Vice President of Government Affairs of the Housing Policy Council of the Financial Services Roundtable. The 31 

members of the Housing Policy Council originate, service, securitize, trade, invest 

in, and insure mortgages. We estimate that our member companies originate three 

quarters of all residential mortgages in the U.S. and service about two-thirds of 

those mortgages. 

62 

The Housing Policy Council strongly supports reform of our Nation’s housing finance system. Our members appreciate the time and attention Chairman Johnson, 

Ranking Member Crapo, and the Committee are devoting to housing finance reform. 

We also want to thank Senators Corker and Warner and their cosponsors for their 

thoughtful and significant contribution to advancing housing finance reform. 

For many years, consumers, lenders, the housing industry, and the broader economy benefited from the secondary mortgage market that was facilitated by Fannie 

Mae and Freddie Mac, the housing GSEs. At the height of the financial crisis, however, fundamental flaws in the design and operation of the GSEs were exposed. 

Those flaws included insufficient capital requirements and an inherent tension between the interests of private shareholders and the public mission of the GSEs. The 

GSEs also were subject to a certain amount of ‘‘moral hazard’’ since they operated 

under a special congressional charter that shielded them from traditional market 

forces. 

A new model is needed for the secondary market in conventional mortgage loans 

that preserves the availability of stable mortgage credit for qualified homebuyers, 

retains key operations, systems, and people critical to the current system, and corrects the flaws in the existing GSE model by requiring more private capital and better protection for taxpayers. 

The structure and duties of the Federal agency charged with overseeing the successors to the GSEs is equally important. Just as the structure of the GSEs contributed to the crisis, so too, did the structure and the limits on some of the powers 

of the Office of Federal Housing Enterprise Oversight (OFHEO). 

Congress corrected many of those problems with the passage of the Housing and 

Economic Recovery Act of 2008 (HERA). Unfortunately, those reforms came just as 

the financial crisis was cresting and could not prevent the collapse of the GSEs. 

Given that history, the members of the Housing Policy Council support a strong and 

effective regulatory structure for the entities that will replace the GSEs. 

In the balance of my statement, I will highlight what we believe are the more important features of that structure, how those features compare to some of the provisions in the Corker-Warner bill, and how they mesh with our vision of housing finance reform. 

The Structure of the Federal Regulator 

First, as Senators Corker and Warner have proposed, we support the creation of 

an independent Federal agency to oversee the transition from the current GSE system to a new structure for housing finance. We also agree that the independence 

of this agency is enhanced by a funding structure that is based upon assessments 

and fees as opposed to Congressional appropriations. While we appreciate the 

checks and balance that are provided by the appropriations process, insufficient 

funding of OFHEO inhibited that agency’s ability to properly supervise the GSEs. 

Like the Corker-Warner bill, we support the creation of a board to govern the 

agency, the members of which would be appointed for staggered multiyear terms. 

Multiyear terms remove the members of the board from the shifting winds of politics. And a board, rather than a single director, ensures a greater continuity of policies and sufficient consideration of alternative perspectives. Care needs to be taken, 

however, not to micromanage the qualifications for membership on the board. The 

goal should be to ensure that board members have sufficient experience and judgment to oversee the agency. 

The Corker-Warner bill proposes different divisions to handle key duties of the 

agency. It calls for a division on underwriting, a securitization division, and a division to oversee the Federal Home Loan Banks. Creating separate divisions to focus 

on the unique issues within each of these areas is appropriate. 

The Corker-Warner bill also proposes the establishment of advisory committees. 

We support the creation of advisory committees to help ensure regular contact with 

stakeholders to enhance the knowledge base of the agency and the quality of its activities. Indeed, we would recommend that the creation of advisory committees be 

mandated, since discretionary authorities can be ignored. FSOC provides an example of such a neglected authority. 

We agree with the requirement in the Corker-Warner bill that the new regulatory 

agency have its own Inspector General. It is appropriate to provide for this oversight 

and prevent fraud and abuse. At the same time, care needs to be taken not to have 

the Inspector General become a ‘‘shadow’’ regulator by giving the Inspector General 

authority to review and second guess policy decisions of the board. The additional 

powers the Corker-Warner bill gives the Inspector General may tilt in that direction. 

63 

The Duties of the Federal Regulator 

Let me now turn to the duties of this agency. We believe that the fundamental 

duty of the agency should be to ensure that the secondary mortgage market operates in a safe and sound manner. In other words, the new agency should be, at its 

core, a prudential regulator that ensures the integrity of the market and the solvency of the reserve fund that stands before a Federal guarantee. If the agency performs this basic duty properly consumers, and the economy as whole, should enjoy 

a steady flow of reasonably priced conventional mortgage credit in all economic cycles. 

As a prudential regulator, the agency should have the authority to set standards 

for the segment of the secondary market that is linked to a Federal guarantee. That 

should include setting the boundaries of the acceptable credit terms associated with 

federally guaranteed mortgage securities. These boundaries, alone, should prevent 

the types of problems experienced by the GSEs. Also, to enhance the liquidity of federally guaranteed mortgage securities, the agency should establish the terms and 

conditions governing pooling and servicing agreements and should establish common 

terms and conditions for guaranteed mortgage securities. In other words, the agency 

should provide for the creation of a single form of guaranteed security that promotes 

a simple, liquid and transparent market. On the other hand, the agency should not 

have authority to set standards for the private label market. That market will not 

be supported by any form of Federal guarantee and should be able to evolve independently. Indeed, effective operations in that market can serve as a signal on the 

health of the overall market to the new agency. 

In exercising its standard setting authority, the agency should be required to seek 

public comment. While we give FHFA high marks for the manner in which the conservatorship has been conducted, many of the policy actions taken under the conservatorship have fallen outside the scope of the normal notice and comment process. Going forward, the basic standards and policy actions taken by the new agency 

should be subject to public notice and comment. This process will give all market 

participants and the public the opportunity to comment on proposals and decisions 

by the regulator and will increase confidence in the process and the decisions made 

by the regulator. 

This Federal regulatory agency also should have the power to federally charter, 

or otherwise certify, the key participants in the market for guarantee securities. In 

other words, the Congressional charters granted to the GSEs should be repealed and 

the entities that take their place should be subject to a chartering process similar 

to the chartering of a national bank or a Federal thrift. This new regulatory chartering process will also eliminate the perception of the special status that the GSEs 

experienced through their unique charters. 

The agency should have examination and enforcement powers, including resolution powers. Congress did give such authorities to FHFA in HERA, and those authorities should be extended to the new agency. Congress should also require the 

agency to have a concrete resolution plan for the successors to the GSEs so that 

all market participants can understand how they would be resolved, if necessary. 

The agency should have rulemaking powers, including the power to set appropriate capital standards and the power to adjust conforming loan limits. Congress 

should resist hardcoding some standards, including capital standards, in law. Setting appropriate capital standards requires a complex analysis and detailed consideration of market conditions, as well as consumer impact. Moreover, setting specific 

standards into the statute could have unintended consequences in different economic cycles. Congress has long deferred to the expertise of the Federal banking 

agencies to set the specific capital standards for banking firms. We believe that a 

similar approach should be applied to the firms that replace the GSEs. This discretionary authority also would permit the agency to adjust capital in periods of severe 

economic downturns to ensure that the market continues to function. 

Likewise, Congress should give the new agency some flexibility to determine the 

point at which the Federal guarantee on qualifying mortgage securities is triggered. 

This trigger point may differ for different structures. In other words, the trigger 

point for securities backed by a federally chartered guarantor may not be the same 

as the trigger point for a securities structure in which investors assume some first 

loss risk on those securities. However, whatever the triggering point is should be 

clearly disclosed to investors, and it should be clearly understood that the Government guarantee stands behind private capital and a reserve fund that is funded by 

industry. 

In those cases in which the agency is given some flexibility to set prudential 

standards, the agency should be required to explain its rationale for the standards 

and justify them. This could be achieved through regular reports to Congress. 

64 

The agency should have responsibility for the reserve fund that stands in front 

of the Federal guarantee. This should include setting the price for the guarantee 

and the premiums to be paid into the reserve fund to ensure that private capital 

stands before the taxpayers. We strongly disagree with the assertion by some that 

such a fee structure cannot be priced to protect taxpayers. The FDIC’s bank insurance fund serves as an example of a Federal guarantee program that has never imposed a cost on taxpayers. 

The agency should be authorized to oversee the establishment of a securitization 

platform for federally guaranteed securities. This platform should be used as the 

basis to securitize and manage a single agency security created by multiple participants. Such a platform would likely influence the private label market, but the 

issuers of private label securities should not be required to use the platform. While 

some issuers may choose to do so, it would be preferable to have separate and distinct platforms to maintain a clear distinction between guaranteed and nonguaranteed securities. 

Finally, the agency should not be burdened with too many responsibilities that 

would detract from its basic prudential mandate. For example, we do not see the 

need for the agency to oversee a Mutual Securitization Corporation for smaller firms 

as long as a cash window is available for such firms The cash windows operated 

by the GSEs have provided smaller firms with full access to the secondary market, 

and the GSEs should continue to provide this function during the transition period. 

We would not, however, oppose the creation of a Mutual Securitization Corporation 

or similar facility it is deemed necessary. 

More importantly, the agency should not have antitrust and market pricing powers, as implied by section 216 of the Corker-Warner bill. Other agencies already 

have sufficient antitrust powers, and pricing controls would only have a market distorting impact. Nor do we believe that the agency should be responsible for overseeing an electronic mortgage registry, as proposed in the Corker-Warner bill. This 

may be needed, but this authority would detract from what should be the prudential 

mandate of the new agency. 

Our Vision of Reform 

The model for the secondary market that we favor is a guarantor structure built 

around several privately capitalized companies that would be chartered and regulated by the new agency. Under this model, lenders of all sizes and business models 

would originate mortgage loans that meet certain minimum standards and sell 

those loans to the guarantors in exchange for mortgage securities or cash. The federally chartered guarantor then would assume the credit risk on the securities. 

The Corker-Warner bill also envisions a capital markets structure, in which any 

entity could issue Government guaranteed mortgage securities provided the entity 

met appropriate standards, including the assumption of a first loss position. We 

have no objection to the inclusion of such an option in the legislation. However, we 

believe that there are significant impediments to its effective implementation, not 

the least of which is the ability for investors to assess the credit risk of the securities. 

The Corker-Warner bill also provides that guarantors and issuers could be separate entities. Again, we have no objection to this option, but would note that separate entities would require separate capital structures and there are limits on the 

amount of private capital to support housing finance. Moreover, there are market 

efficiencies associated with the combination of the guarantor and issuance functions. 

Such a structure provides a single point of contact for lenders in the securitization 

process. Additionally, to the extent that the separation of these functions is based 

upon concerns related to market concentration, we would note that current accounting and capital rules would prevent an originator from controlling a guarantor since 

it is unlikely that the originator could gain ‘‘true sale’’ treatment for the mortgages 

it acquirers. 

The securities issued under this model should carry an explicit ‘‘backstop’’ Federal 

guarantee that ensures payments to investors in the event a guarantor could not 

perform on its guarantee. Guarantors would pay a fee for the Federal guarantee and 

part of that fee would be placed into a reserve fund, administered by the Federal 

agency. Guarantors also should be able to transfer the credit risk that they assume 

to other parties through reinsurance and capital markets structures. Additionally, 

as I previously noted, guarantors should maintain a ‘‘cash window’’ to purchase and 

to aggregate whole loans for smaller lenders. On the other hand, guarantors should 

not be permitted to engage in loan origination, mortgage servicing or speculate in 

mortgages or mortgage backed securities. 

The securities created by guarantors would be run through a shared securitization 

platform. This shared platform would provide common administrative and systems 

65 

support for the guarantors and would ensure that the securities have a single form 

with common terms and conditions. 

While this model has some similarities to the existing GSE model, it differs in 

several key respects: 

• Market Distortions Created by ‘‘Implicit’’ Federal Support for the GSEs Eliminated—Guarantors would not be granted any of the special privileges currently 

given to the GSEs under their Congressional charters (e.g., exemption from 

State taxation, line of credit with Treasury). The guarantors would be chartered 

by the Federal agency, and the ‘‘explicit’’ Federal guarantee provided under this 

model would apply only to the securities, not to any other debt or equity of the 

guarantors; 

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

the guarantors reduces systemic risks and reduces barriers to entry. 

• Systemic Risks Reduced Through Limitations on Activities—Unlike the GSEs, 

guarantors could not establish portfolios to speculate in mortgages or mortgage 

securities; 

• Tensions Between Competing Missions Eliminated—Guarantors would not be 

subject to specific housing goals, thereby avoiding the conflict that existed between the shareholders of the GSEs and the public mission of the GSEs; 

• Competition Enhanced Through Multiple Guarantors—This model envisions 

more than just two guarantors. The mandatory use of a common securitization 

platform would reduce barriers to entry for entities seeking to act as guarantors 

since it would reduce the costs associated with designing and implementing key 

administrative functions associated with securitization. The new Federal agency 

also should be encouraged to promote the development of multiple guarantors. 

• Prudential Regulation and Supervision Enhanced—Guarantors would be subject 

to more stringent regulation and supervision than the GSEs, including heightened capital standards set by the new agency. 

Some Transitional Steps 

The transition to any new model for the secondary market will take some time. 

We commend FHFA for the key steps that it has taken in that process, including 

new risk sharing arrangements, adjustments to guarantee fees and proposed adjustments to conforming loan limits. We commend FHFA for the steps it has taken, and 

suggest the following additional actions during the transition to a new system: 

• Single Security—FHFA could increase the liquidity in the current agency market and reduce taxpayer costs by creating a unified agency security that can be 

substituted for Fannie Mae MBS and Freddie Mac PCs (the terms and conditions applicable to this new security would then serve as a foundation for the 

standard securitization agreements applicable to guaranteed securities issued 

under our proposed new system); 

• Reps and Warranties—FHFA has made some progress toward reforming representations and warranties applicable to mortgages sold to the GSEs. However, 

the rep and warranty framework continues to inhibit new loan generation, and 

requires additional reforms; 

• Risk-Sharing Structures—FHFA should continue to develop risk-sharing arrangements with GSE securities to increase the level of private sector capital 

in front of the Federal Government. These structures could then be adopted by 

guarantors following the transition from the GSEs to the new model; 

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

• Guarantee Fees—FHFA’s efforts to induce or ‘‘crowd’’ private capital back to the 

market by increasing guarantee fees are not the only steps needed to entice additional private capital into the market. The obstacle to a more vibrant private 

market is not only price, but a more efficient securitization process. Additional 

increases in guarantee fees may only increase costs for consumers and profits 

for the GSEs; and 

• Conforming Loan Limits—Gradually reducing the existing conforming loan limits and aligning the limits applicable to the GSEs and FHA. The reduction in 

the loan limits should be done with careful consideration of current market conditions. 

66 

Conclusion 

The Housing Policy Council supports reform of the secondary mortgage market 

system. These reforms should create a system that can provide consistent availability of stable products like the 30-year fixed-rate mortgage to American consumers by requiring more private capital and stronger protections for the taxpayer. 

A reformed system should include a Government backstop behind layers of private 

capital and a strong prudential regulator to set standards and oversee the participants in a new secondary mortgage market system. 

We look forward to working with the Committee in its efforts to produce bipartisan housing finance reform legislation. Thank you. 

67 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED 

FROM ALFRED M. POLLARD 

Q.1. On what date will the entire Common Securitization Platform 

be ready to perform all of its functions? 

A.1. The Enterprises are currently developing the Common 

Securitization Platform (CSP), and have built the core functionality 

and the related infrastructure components. Preliminary testing is 

underway. The CSP’s design and its development have necessarily 

evolved over time, and a significant amount of work remains with 

regard to both the CSP itself and the business entity that will own 

it. The Enterprises are engaged in developing and implementing 

operational and business processes for the CSP and the joint venture entity, and they are developing their integration plans critical 

to the success of the CSP. Fannie Mae and Freddie Mac are conducting this work under FHFA’s guidance and with industry input. 

Consequently, plans for this project will continue to evolve as the 

Enterprises take into account the many factors that will drive 

project success. The project plans will not be finalized until the Enterprises, under FHFA’s oversight, are in a position to do so. As a 

result, we do not yet have a date by which the Common 

Securitization Platform will be operational. 

Q.2. When the Common Securitization Platform is finally ready to 

perform all of its functions, how much money, all in, will have been 

spent in total by FHFA, each GSE, and Common Securitization Solutions, LLC, including contracting costs? Does this cost include the 

cost of any adjustments and upgrades that may be necessary so 

that Fannie and Freddie can take advantage of the Common 

Securitization Platform? If not, what is this additional cost expected to be? 

A.2. As discussed above, the Common Securitization Platform 

project plans, inclusive of the design, build and testing of the technology and the Enterprises’ system and process changes, are being 

finalized. As a result, we have neither final plans nor specific budgets assigned to these still-in-development projects. To date, the following funds have been spent: 

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

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

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

Q.3. FHFA staff has stated that FHFA ‘‘has not prepared a formal 

valuation analysis regarding the platform,’’ which I find disturbing, 

especially since taxpayer funds are essentially at stake here and 

are in the process of being spent. Should we be worried by the fact 

that FHFA is making financial decisions with taxpayer funds without any ‘‘formal valuation analysis regarding the platform?’’ 

A.3. FHFA understands your concern but believes that the approach to the project has been prudent and well considered. The 

project is consistent and aligned with many other projects undertaken by the Enterprises, at the direction of the agency, to achieve 

uniformity in areas essential to achieving an effective mortgage 

securitization system. The Servicer Alignment Initiative, Common 

Appraisal Data Portal, and Uniform Mortgage Data Program are 

some of the projects that have established common and uniform 

68 

standards and practices in the Nation’s housing finance system, 

providing benefits not just to the Enterprises, but also to other 

market participants. 

The decision to engage the Enterprises in this project is neither 

solely nor even principally a financial decision, although the financial costs associated with it are very important and being monitored. Rather, the decision is rooted in FHFA’s legal obligations, 

both as conservator and regulator. The decision is based on achieving market efficiencies and providing policy makers with options as 

they determine the future of the U.S. housing finance system. The 

agency has determined that the building and operation of the CSP 

would also achieve many supervisory goals and realize other significant benefits. 

Q.4. Fannie and Freddie are still two distinct legal entities, and 

FHFA acts as conservator for each GSE. Given how valuable the 

Common Securitization Platform would be to each GSE on its own, 

how did FHFA, as conservator for each GSE, determine that a 50/ 

50 joint venture was the right decision for each GSE? In preserving 

and conserving the assets of Fannie with a view towards putting 

it in a sound and solvent condition, why would FHFA, as conservator for Fannie, give Freddie a 50-percent stake in such a valuable asset? 

A.4. As Conservator, FHFA decided that it was most beneficial to 

establish common securitization technology, which would be available to Fannie Mae and Freddie Mac and ultimately to all market 

participants, rather than have each Enterprise separately undertake extensive and proprietary infrastructure projects. FHFA believes that building the CSP functionality once, through the joint 

and collaborative efforts of, and its use by, both Enterprises, will 

be more cost-effective than having each Enterprise independently 

rebuild its core securitization and servicing systems. Neither of the 

Enterprises’ existing systems would allow for relatively quick, effective and efficient access by the industry either in the near or 

medium term. Furthermore, independent and proprietary Enterprise systems would not allow for uniformity across the mortgage 

finance industry, thereby exacerbating the current disarray within 

the industry and complicating the already difficult task before policy makers. FHFA believes that two different systems rather than 

common technology could seriously delay or complicate attempts to 

reform the Nation’s housing finance system. Independent technology provides policymakers with greater options for reforming 

the system than would a rebuilding of the Enterprises’ individual 

systems. FHFA and the Enterprises have established a process to 

ensure that each Enterprise’s contribution to the joint venture is 

equitable and fair retroactively and prospectively. 

Q.5. Please provide all formation documents prepared in conjunction with the formation of Common Securitization Solutions, LLC 

(CSS), including but not limited to the operating agreement, all 

legal opinions, all resolutions from the Board of Directors for each 

of Fannie Mae and Freddie Mac duly authorizing the formation of 

CSS, and documentation of all costs incurred thus far and expected 

costs associated with CSS. 

69 

A.5. We would be happy to provide you and your staff an opportunity to review the documents noted above at the FHFA offices. 

Please contact Peter Brereton, Associate Director for Congressional 

Affairs, if you would like to schedule such a review, and if you require additional information or have additional questions. 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM DIANE ELLIS 

Q.1. S.1217 proposes the regulator have, with the consent of other 

officials, emergency powers in a crisis that only lasts 6 months. 

Should we consider expanding that authority, or providing other 

countercyclical tools that a regulator may need in a future crisis? 

A.1. Since the length, depth, and frequency of financial crises are 

hard to predict, any emergency systemic risk authority should 

allow some flexibility in the frequency or duration of the use of that 

authority. 

The FDIC has found it important to have sufficient authority and 

flexibility to respond to crises promptly in a way that maintains 

public confidence and financial stability. The FDIC has always 

been funded by the banking industry. Under section 7 of the Federal Deposit Insurance Act (FDI Act), 12 U.S.C. §1817, the FDIC 

has the specific authority to raise assessment rates and charge special assessments and broad authority to require prepayment of assessments. The FDIC has used this authority to cover losses and 

maintain liquidity during periods marked by a high volume of bank 

failures. The FDIC also has lines of credit with the U.S. Treasury 

and the Treasury’s Federal Financing Bank, and can borrow from 

the banking industry and from the Federal Home Loan Banks. 

The FDIC’s ability to access these lines of credit coupled with the 

U.S. Government’s full faith and credit backing of the FDIC’s deposit insurance system reassures the public that the FDIC can pay 

its depositors promptly in the event of a bank failure, eliminating 

the risk of bank runs and panic. The lines of credit also reduce the 

likelihood of having to charge highly procyclical assessments. Ultimately, though, the banking industry would bear the costs of deposit insurance by repaying any emergency lines of credit were 

they to be drawn upon. 

Q.2. What is needed in legislation to ensure that Federal and State 

regulators coordinate on supervision and resolution? 

A.2. The FDIC has found its supervisory and resolution authorities 

essential to fulfilling its mission of protecting depositors and maintaining financial stability. The FDIC coordinates with Federal and 

State regulators under authorities provided by the FDI Act. These 

authorities include coordination and information sharing with 

other agencies, the ability to review examination findings for banks 

we do not supervise directly, and the ability to conduct backup examinations and reviews of those institutions as necessary. 

The FDIC’s most important tools in regulating entities primarily 

supervised by another agency are: (1) ongoing communications with 

the primary Federal regulators and State supervisors, (2) maintaining clear standards for sharing information and examination 

reports, (3) coordinating examination schedules, and (4) working toVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00073 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
70 

gether on interagency issues through the Federal Financial Institutions Examination Council. The FDIC has maintained a Memorandum of Understanding (MOU) with the other primary Federal 

regulators (Office of the Comptroller of the Currency [OCC], Board 

of Governors of the Federal Reserve System [FRB], and the former 

Office of Thrift Supervision [OTS]) on Special Examinations for 

many years, the most recent version updated in 2010. In addition, 

the FDIC, FRB, OCC, and National Credit Union Administration 

entered into a MOU with the Consumer Financial Protection Bureau in May 2012 to implement supervisory coordination and information-sharing requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). 

With respect to the proposed legislation, it is possible that many 

guarantors would already be subject to a regime of Federal or State 

regulation and supervision, which also may include a process to 

handle insolvency. This underscores the need for clearly defined 

roles and rules for cooperation and coordination between the FMIC 

and the various Federal and State regulators with authority over 

the guarantors. Where entities subject to the legislation are subject 

to oversight by other Federal or State agencies, the legislation 

could clarify requirements for coordination of examination activities 

and information sharing agreements. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN 

FROM DIANE ELLIS 

Q.1. Fannie Mae and Freddie Mac’s duty to serve the entire primary market is an important aspect of our current housing finance 

policy. The duty to serve ensures that creditworthy people in all 

parts of the country can get access to mortgages with reasonable 

rates and terms. Without a duty to serve, people in rural areas, 

lower-income neighborhoods, and primarily immigrant or minority 

neighborhoods might find that mortgages are no longer readily 

available. 

S.1217 envisions a secondary market with many issuers of Government-guaranteed securities. Unlike Fannie and Freddie, which 

serve the entire Nation, certain issuers in the S.1217 model may 

purchase loans only from certain parts of the country or may specialize in targeted loan profiles. Assuming there is a secondary 

market with several issuers, do you have views on how we could 

structure and enforce a duty to serve? 

A.1. While a ‘‘duty to serve’’ for individual issuers could be created 

by establishing and enforcing obligations similar to those in the 

Community Reinvestment Act, bringing affordable rate mortgages 

to some communities that would otherwise not be served by the 

marketplace, eliminating the nationwide scope of the territory 

Fannie and Freddie occupy with respect to their issuance of securities almost certainly means that many hundreds of communities in 

this country would see a drastic increase in mortgage rates, and a 

significant decrease in the availability of mortgage credit. I do not 

believe that there is any other mechanism for addressing this issue 

other than having an issuer with a nationwide scope. 

Q.2. It’s critically important that regulators of the housing finance 

market have the authority to take countercyclical action—to slow 

71 

things down when the market is heating up too rapidly, and to 

open the flow of credit when the market slumps too low. As we’ve 

seen, the housing market is naturally procyclical, and regulators 

must be able to temper those boom-bust cycles to ensure availability of credit and to protect taxpayers. 

One way to exert countercyclical pressure is to raise Government 

guarantee fees during boom periods and lower the fees during declines in the market. But that won’t work unless regulators have 

the authority to exert countercyclical pressure on the private-label 

market as well—otherwise, when guarantee fees go up during a 

boom period, it will just drive securitization from the guaranteed 

market to the private label market. 

Do you have any ideas on how regulators can exert countercyclical pressure on the private-label market? 

A.2. Neither a regulatory agency nor a Government credit facility 

has particularly powerful tools to dampen a boom that occurs during bouts of irrational exuberance. 

A Government credit facility, such as a Federal Home Loan 

Bank, can expand its balance sheet and provide needed credit during a bust; but during a boom, private sources of funding will displace it. 

If you grant a regulatory agency the power to set safety and 

soundness standards in the private-label market that must be met 

before any issuer can sell securities to the public, the regulatory 

agency could exert some countercyclical pressure on the market 

through enforcing those standards. The most important thing a 

regulatory agency could do during a boom period is to avoid relaxing its standards, and continue rigorous enforcement of existing 

standards in the private-label market. For example, when the OTS 

relaxed its standards on what constituted a safe lending program, 

and allowed savings and loans to offer riskier loan products with 

teaser rates and negative amortization during the boom period in 

the last decade it added further fuel to the bonfire. Theoretically, 

a regulatory agency could increase the safety and soundness standards applicable to private market participants during a boom period. If the threshold for a safe mortgage loan is a twenty (20) percent downpayment during ordinary times, a regulatory agency 

could increase the standard to twenty-five (25) percent during a 

boom time to protect against the potential for a larger fall in prices. 

That is somewhat similar to what certain exchanges do to margin 

requirements for particular securities or commodities that have a 

sudden and significant increase in price. However, in the nearly 30 

years in which I have practiced law in the housing finance sector, 

I have not witnessed any regulator of housing lenders make a 

meaningful increase in safety and soundness standards during the 

boom times; it is only after the losses accrue that regulators take 

note and increase safety standards. 

In addition to maintaining rigorous enforcement of safety and 

soundness standards, imposing requirements for transparency and 

accountability is also important. Having meaningful claw back provisions on compensation of senior management of private lenders 

ensures that managers who profit during the boom times, and then 

depart, are held accountable for their actions. If such managers 

know that claw backs with real teeth are in place, they will have 

72 

an incentive to act with more prudence during the boom times because they will be accountable during the bust. Transparency, and 

full disclosure of all material lending criteria to investors, is important so that participants can judge whether other parties are acting 

prudently, and steer their own business away from those who act 

imprudently during a boom time. Warren Buffet famously has said 

it is only when the tide goes out during the bad times that we can 

see who is wearing a bathing suit; if the water were less murky 

during the good times we could see who is wearing a bathing suit 

before the tide went out. In my view, the most important thing 

Congress can do is acknowledge that housing is a very procyclical 

industry, and build in significant safeguards that will lessen the 

damage when the inevitable bust occurs. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK 

FROM DIANE ELLIS 

Q.1. The FDIC’s mandate is made very clear as you note in your 

written testimony—‘‘to protect depositors and maintain financial 

stability.’’ The new FMIC will have both a supervisory role and a 

role to oversee the insurance fund. What do you think the mandate 

of the FMIC should be? 

A.1. Congress has given the FDIC a clear mandate: protect depositors and maintain financial stability. Congress has explicitly defined the amount of deposits covered under the FDIC deposit guarantee, and when insurance coverage is triggered (that is, when a 

bank fails). Clarity is important not just because it enables the 

FDIC to do its job, but because it establishes credibility in the eyes 

of depositors. The FDIC’s explicit statutory authority assists in accomplishing our mission, and we rely on this authority along with 

supervisory tools to identify risk and take action to mitigate such 

risk. 

The bill the Committee is considering clearly states two purposes 

of the FMIC: (1) to provide liquidity, transparency, and access to 

mortgage credit by supporting a robust secondary mortgage market 

and the production of residential mortgage-backed securities, and 

(2) to protect the taxpayer from having to absorb losses incurred 

in the secondary mortgage market during periods of economic 

stress. How to best balance these policy priorities is a question 

properly reserved for Congress. 

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

A.2. Congress has consistently provided the FDIC with clear and 

explicit statutory responsibility and authority for creating a riskbased assessment system, maintaining a viable deposit insurance 

fund, supervising State nonmember banks, acting as backup supervisor for all insured banks, and resolving failed institutions. Congress has not mandated that the FDIC establish separate divisions 

for its insurance and supervision functions and, in general, Congress has left the FDIC’s internal organization to the FDIC, although there are exceptions. For example, the FDIC is required to 

have a separate asset disposition division. While FMIC’s internal 

structure is important, consideration also should be given to ensurVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00076 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
73 

ing that FMIC has clear statutory responsibilities and authorities 

and sufficient discretion to respond to varying circumstances. 

Q.3. The FDIC currently manages exposure risk to the deposit insurance fund (DIF) at the time when insurance is granted to an institution but also while the insurance stays in force. In determining 

membership eligibility, the FDIC considers factors including financial history and condition of an institution, adequacy of the institution’s capital structure, and a number of other factors. If there is 

one thing that Community Banks do not need it is one more Federal agency requesting information, doing examinations, and 

layering additional standards and requirements onto them, which 

is time consuming and costly to the institution. To this end, do you 

think that institutions that are approved for FDIC insurance 

should be approved with far less rigor to have access to the FMIC 

insurance fund? Do you think that there could be coordination between the FDIC and the FMIC on the FDIC’s ongoing monitoring 

and reporting requirements? 

A.3. As the primary Federal regulator of most community banks, 

the FDIC understands the crucial role that community banks play 

in the American financial system. The FDIC has an ongoing responsibility to better understand the challenges facing community 

banks, and in early 2012 we launched a series of initiatives focusing on confronting those challenges. These initiatives remain an ongoing priority and include outreach programs, research, and improvements to make the supervisory process for community banks 

more efficient, consistent, and transparent. 

Under the bill the Committee is considering, the FMIC would 

have to consider various factors before approving participation by 

four types of companies: private mortgage insurers, servicers, 

issuers, and bond guarantors. The factors for approving each of 

these companies are similar to, but not the same as, the statutory 

factors found in section 6 of the FDI Act, 12 U.S.C. §1816, which 

the FDIC uses to determine eligibility for Federal deposit insurance. The FDI Act factors include the financial history and condition of the institution, adequacy of the capital structure, future 

earnings prospects, general character and fitness of management, 

risk presented to the DIF, convenience and needs of the community 

to be served, and the consistency of the institution’s corporate powers with the purposes of the FDI Act. 

However, a bank’s condition can change over time. For example, 

a change in ownership or business model can alter a bank’s risk 

profile. Some banks are mismanaged or take on excessive risk, 

which can cause problems for the bank. If problems are severe 

enough, they can result in the bank’s failure. Because a bank’s condition can change over time, the FDIC and the other Federal banking regulators are statutorily required to continue to monitor the 

condition of every bank after the bank receives deposit insurance. 

For example, every bank must file a quarterly report of condition 

and income. The FDIC and other banking regulators conduct periodic on-site examinations and require banks to take remedial action when deficiencies are noted. 

The FMIC would be tasked with assessing potential risks of market participants in the secondary mortgage market, which is a difVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00077 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
74 

ferent assessment than the FDIC makes for members of the deposit 

insurance system. Congress may wish to give the FMIC the authority to make the final determination on whether an institution has 

access to the FMIC insurance fund. Of course, to the extent there 

is overlap in the supervisory authority or requirements for granting 

admission to the deposit insurance system and for participation in 

the FMIC mortgage insurance system, it will be important for the 

FDIC, other banking regulators, and the FMIC to coordinate their 

efforts to avoid undue burden on participants of both systems. 

Under the FDI Act, the FDIC coordinates with other Federal and 

State regulators, and the FDIC works on interagency issues 

through the Federal Financial Institutions Examination Council. 

Additionally, the FDIC has a longstanding Memorandum of Understanding with the other banking regulators (OCC, FRB, and the 

former OTS) to facilitate a coordinated approach to supervision. 

Where entities subject to the legislation are subject to oversight by 

other Federal or State agencies, the legislation could clarify requirements for coordination of examination activities and information sharing agreements. 

Q.4. The new FMIC will oversee a deposit-like insurance fund. 

Since it will have to be at least partially funded from day-1 of the 

new operation, how do you suggest that we consider getting initial 

capital for the fund? Do you recommend a gradual increase in premiums over time? 

A.4. The FMIC guarantee will cover an insurance exposure that 

generally rises with the volume of mortgages securitized under the 

FMIC. In recognition of this fact, the draft legislation mandates 

certain target levels for the size of the Mortgage Insurance Fund 

(MIF) in terms of a percentage of outstanding balances. This is 

analogous to the statutory reserve targets mandated for the FDIC 

Deposit Insurance Fund (DIF), which are expressed as a percent of 

estimated insured deposits. 

While the proposed legislation suggests that FMIC would assess 

participants only at issuance (similar to the manner in which the 

Government-sponsored mortgage enterprises (GSEs) currently impose guarantee fees), as opposed to an ongoing basis like the FDIC, 

it does not state so unambiguously. 

Whichever assessment model the legislation or FMIC ultimately 

adopts, the FDIC’s experience suggests that maintaining relatively 

consistent assessment rates over time will be important in avoiding 

procyclicality in insurance assessments and in providing for a stable competitive landscape between insured and noninsured financial activities. In that regard, the FDIC has learned from its experience that the flexibility to determine the proper fund size is important and that a hard target for a fund (that is, a particular size 

that a fund must remain) poses problems. During the 1990s 

through 2006, when Congress required a hard target for the size 

of the FDIC’s insurance fund, a number of problems resulted, including a decade where at least 90 percent of the industry paid 

nothing for deposit insurance, a free-rider problem where new entrants and fast growers diluted the fund but paid nothing, and potentially volatile and procyclical premiums. 

75 

Also, as our experience during the recent crisis shows, the net 

worth of the insurance fund at any given time is less important 

than the availability of cash, or working capital, to meet anticipated near-term insurance obligations. As such, there are a wide 

range of potential options for providing initial working capital to 

the FMIC, including an entrance fee for participating institutions, 

or loans from the Federal Government or the participating institutions themselves. 

Q.5. Also, you note that while a risk-based pricing system that is 

forward looking works much better than the former flat-rate system for the FDIC, you also note that this is not analogous with the 

Federal mortgage insurance which might have alternative means of 

mitigating risk through underwriting standards, etc. Do you, however think that there should be a graduated scale for insurance 

premiums, where larger users of the system pay more for the insurance—perhaps based on asset size or loan origination? 

A.5. The FDIC supports a risk-based pricing structure for deposit 

insurance. Under this system, banks that take on more risk pay 

more in deposit insurance, reducing the moral hazard problem. A 

Federal mortgage insurer, however, is likely to have a greater ability to mitigate risk at the outset than the FDIC has, for example, 

by setting robust underwriting standards for the underlying mortgages. 

In the event that a gradual pricing scale or a system that differentiates between large and small FMIC users is adopted, it may 

not serve the same function as a risk-based pricing system. Under 

the FDI Act, the FDIC is permitted to establish separate risk-based 

assessment systems for large and small banks. The FDIC has different methods for assessing large and small banks, but these separate pricing systems do not usually produce dramatically or systematically higher or lower average rates for either of these groups 

of banks. In fact, the range of possible assessment rates is the 

same under both systems. Moreover, recent changes to the deposit 

insurance assessment system under the Dodd-Frank Act shifted 

more of the assessment burden from community banks to the largest institutions in order to better reflect each group’s share of industry assets. 

Whatever pricing system is adopted for Federal mortgage insurance, it is important that community banks have fair and equitable 

access to the secondary market for mortgages and to FMIC guarantees on terms that are not more expensive than for larger issuers. 

Without the ability for community banks to aggregate and 

securitize their loans, the scale economies in origination, servicing, 

and securitization could well impede the ability of community 

banks to compete in mortgage securitization. 

Q.6. It seems apparent that the Federal Government does not always price insurance appropriately. You note that through 

prefunding, the FDIC is able to ‘‘smooth the cost’’ of insurance over 

time. However, the Designated Reserve Ratio (DRR) is truly a ‘‘soft 

target’’ and that it can often fluctuate which has led to instances 

when premiums are required to be increased during a crisis. How 

can we avoid instances where the FMIC will need to increase premiums during times of economic stress-times when institutions 

76 

need to hold on to as much capital as possible? Doesn’t having the 

ability to change rates inherently add the perverse incentive that 

industry will lobby the agency to lower rates during good times 

only to have to rates painfully increased during times of stress? 

A.6. The FDIC faces the problem of procyclical assessments, and in 

fact has charged procyclical assessments in the past, with high assessment rates during and immediately after the last two major 

banking crises and low average assessment rates between the crises. Under new authorities granted under the Dodd-Frank Act, 

however, the FDIC has adopted a long-term target for the fund 

that should allow us to reduce procyclicality, while assuring that 

the DIP has sufficient funds to remain positive even during crises 

of the magnitude of the last two. In meetings between the FDIC 

and individual bankers and banking industry trade groups, the industry has consistently supported the idea of avoiding procyclical 

assessments. 

The FDIC has learned from its experience that the flexibility to 

determine the proper fund size is important and that a hard target 

for a fund (that is, a particular size that a fund must remain) poses 

problems. As discussed above, an inherent conflict exists between 

maintaining constant rates and a specific, hard target fund size. 

During the 1990s and through 2006, Congress required a hard target for the size of the FDIC’s insurance fund, which resulted in a 

decade where at least 90 percent of the industry paid nothing for 

deposit insurance. In contrast, allowing the fund to grow during 

good times should reduce premium procyclicality. 

There are some significant differences between how the FDIC 

and the proposed FMIC would generate income, however. The 

FDIC assesses on bank liabilities every quarter, while the FMIC 

would assess transactions. FMIC’s transaction-based assessments 

also may increase and decrease procyclically, that is, in line with 

overall economic activity. Congress may wish to consider ways to 

ameliorate this procyclical bias, for example, by charging sufficient 

fees during good times to build a fund large enough to withstand 

losses during a downturn. 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM KURT REGNER 

Q.1. What is needed in legislation to ensure that Federal and State 

regulators coordinate on supervision and resolution? 

A.1. Legislative text should include the requirement that prior to 

taking any action that directly or indirectly affects a regulated insurance legal entity, including, but not limited to the approvals to 

work with the GSE’s or guarantee covered bonds, a Federal regulator, at bare minimum must consult with the domestic State insurance regulator or similar official. Additionally, the legislation 

should defer to State regulators on any action related to insurance 

legal entities. 

Attachment B contains recommended changes to S.1217 that 

would ensure coordination and appropriate deference to State insurance regulators. 

77 

Q.2. S.1217 proposes the regulator have, with the consent of other 

officials, emergency powers in a crisis that only lasts 6 months. 

Should we consider expanding that authority, or providing other 

countercyclical tools that a regulator may need in a future crisis? 

A.2. Yes, it would be advisable to permit the exercise of emergency 

powers for up to 2 years. It would be advisable to revise Section 

205 to provide a reporting mechanism to Congress, whereby the 

Corporation would make a written report to Congress within 30 

days of exercising the authority provided by Section 205 (a) explaining the unusual and exigent circumstances and the policies 

devised or under consideration to address the situation. 

The private mortgage insurance regulations that we have in 

place are intended to deal with ups, downs, and sudden shocks, not 

an extended period of intense crisis. Assuming the rare occasion of 

systemic crisis in which regulators have exhausted their existing 

tools to encourage participation in the market, the capability of 

providing capital and liquidity in a time of crisis to jumpstart the 

market could be a useful tool and may also encourage entry in normal times. An additional power in time of crisis that could be useful would be the ability to adjust and lower the first loss percentage position. Requiring a reinsurance backstop related to legacy 

business is also a possibility. 

It would be advisable to revise Section 211 to allow the Chairman of the Board of Governors of the Federal Reserve System and 

the Secretary of the Treasury in consultation with the Director of 

the Federal Mortgage Insurance Corporation to increase or decrease the minimum downpayment requirement for an eligible 

mortgage on a temporary basis of up to 1 year as an additional 

macroeconomic management tool. Continuation of any extension of 

a change in the default downpayment requirement in excess of 1 

year should require the approval of Congress. 

Section 218 should allow for consultation and information sharing with State regulators for private mortgage insurers and bond 

guarantors. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK 

FROM KURT REGNER 

Q.1. You mention that financial guarantors have ‘‘substantial experience in the [housing] area but failed to live up to expectations 

during financial crisis and, given our experience to date, insurance 

regulators remain skeptical of their capability of insuring anything 

other than municipal debt.’’ Would you agree that the monoline financial guarantors did not even perform well during the financial 

crisis for municipal debt? 

A.1. I respectfully disagree. The most recent crisis saw losses paid 

on nonmunicipal securities increase substantially in 2008 to over 

$4 billion and stay at elevated levels since the crisis. Meanwhile, 

losses paid on municipal securities have remained below $300 million—an easily manageable amount for an industry with a notional 

exposure of $1.4 trillion—during each of these same periods, thus 

demonstrating the pressure put on financial guaranty insurers’ 

capitalization that had been caused by the housing market. 

78 

Q.2. The recent financial crisis exposed weaknesses in both mortgage insurers as well as monoline bond insurers (most notable examples being Ambac and MBIA), yet you also claim that the existing regulatory structure works well. If Congress enacts legislation 

that enables Bond Guarantors and/or mortgage insurers to have a 

more robust role in the housing finance system, do you not believe 

that the standards and regulatory oversight of that function should 

be done at the national level? 

A.2. State regulators have the necessary tools and authority to regulate private mortgage insurers and bond guarantors to the level 

necessary to maintain a stable housing finance system at the local 

level. Although they are different products, the Federal Government already relies on State regulators to oversee homeowners insurance, renters insurance, and title insurance which are every bit 

as instrumental to ensuring a functioning housing market. We 

would encourage Congress to continue to rely on and defer to the 

century and half of experience State regulators have in balancing 

solvency with product availability and affordability. I would encourage Federal efforts instead to focus on the activity by the institutions they appropriately regulate—ensuring lenders do not engage in the underwriting practices that led to the last crisis and 

exposed mortgage and bond insurers to extreme risks. 

79 


11211313.eps
80 


11211314.eps
81 


11211315.eps
82 


11211316.eps
83 


11211317.eps
84 


11211318.eps
85 


11211319.eps
86 


11211320.eps
87 


11211321.eps
88 


11211322.eps
89 


11211323.eps
90 


11211324.eps
91 


11211325.eps
92 


11211326.eps
93 


11211327.eps
94 


11211328.eps
95 


11211329.eps
96 


11211330.eps
97 


11211331.eps
98 


11211332.eps
99 


11211333.eps
100 


11211334.eps
101 


11211335.eps
102 


11211336.eps
103 


11211337.eps
104 


11211338.eps
105 


11211339.eps
106 


11211340.eps
107 


11211341.eps
108 


11211342.eps
109 


11211343.eps
110 


11211344.eps
111 


11211345.eps
112 


11211346.eps
113 


11211347.eps
114 


11211348.eps
115 


11211349.eps
116 


11211350.eps
117 


11211351.eps
118 


11211352.eps
119 


11211353.eps
120 


11211354.eps
121 


11211355.eps
122 


11211356.eps
123 


11211357.eps
124 


11211358.eps
125 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR COBURN 

FROM KURT REGNER 

Q.1. Would you agree S.1217 proposes to give the future Federal 

Mortgage Insurance Corporation approval and oversight authority 

over private mortgage insurers and bond guarantors? 

A.1. The GSE’s are currently the largest purchasers of mortgages 

on the secondary market, so it seems the provisions set out within 

S.1217 give FMIC de facto, if not explicit approval and oversight 

authority over private mortgage insurers and bond guarantors. In 

my view this is not necessary, given the extensive oversight already performed by State insurance regulators. 

Q.2. Would you agree States already have the necessary tools and 

authority to regulate private mortgage insurers and bond guarantors to the level necessary to maintain a stable housing-finance system? 

A.2. Yes, States already have the necessary tools and authority to 

regulate private-mortgage insurers and bond guarantors to the 

level necessary to maintain a stable housing finance system. Moreover, when area for improvement is identified, States act collectively together to development enhancements. Such is the case 

today—State regulators are in the process of considering targeted 

revisions to the NAIC’s Mortgage Guaranty Insurance Model Act 

(#630-11) through the open and transparent NAIC process. 

In 2011, the NAIC Financial Guaranty Insurance Guideline (E) 

Working Group considered the need to change the regulation of Financial Guarantors and the NAIC Financial Guaranty Model Act. 

The Working Group concluded that because Financial Guaranty Insurers were at the time, and are still today only actively writing 

municipal bond insurance and no company is writing guarantees on 

structured bonds following the losses incurred during the financial 

crisis, there was no need to amend the regulation of the Model Act 

at that time. 

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

to bolster the housing finance system. 

A.3. State insurance regulators are actively studying what changes 

are deemed necessary to the solvency regulation of mortgage guaranty insurers. The NAIC’s Mortgage Guaranty Insurance (E) Working Group was formed by the Financial Condition (E) Committee 

in late 2012. This Working Group is assessing what changes should 

be made to the Model Act. 

In February 2013, the Working Group identified three primary 

problems with mortgage guaranty insurance as it exists now: 

1. The overconcentration of mortgage originations in only a few 

banks has increased the pressure on mortgage insurers to accept everything given to them by any single bank or risk losing all the business from that bank. 

2. The 2008 crisis dramatically illustrated the cyclical nature of 

the housing market and the potential for significant losses if 

there is a breakdown in mortgage underwriting standards. 

Mortgage insurance is derivative of this market, and therefore 

126 

experiences periods of relative stability and high profitability 

potentially followed by periods of varying duration of significant loss. 

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

threat of discontinued business. 

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

• New reporting requirements that break out mortgage insurers’ 

exposures to different levels of risk and are used as partial 

input into the minimum capital requirements. 

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

• Referring potential accounting issues to the NAIC’s Statutory 

Accounting Principles (E) Working Group. 

• A Risked Based Capital formula specific to Mortgage Insurers. 

• Updating the geographical concentration levels. 

• Reevaluating underwriting loan standards. 

• Tighter dividend restrictions. 

• Reevaluating rescission practices and responsibilities. 

The Working Group exposed a concept draft of a new model (Attachment A) for public comment and debate, and the comment period closed February 17, 2014. We expect the NAIC to pass the 

amendments to the model later this year, and States to begin implementing the amendments soon thereafter. 

Where bond guarantors are concerned, at this time, there are no 

initiatives by the State insurance commissioners to change regulations, because bond guarantors are not actively involved in guaranteeing structured bonds, including residential mortgage-backed securities. 

Q.4. Please describe how new Federal oversight functions included 

in S.1217 would duplicate and potentially preempt the regulations 

from State insurance commissioners. 

A.4. S.1217 presents a number of potential duplication concerns for 

State regulators. 

First, there is the notion of an ‘‘approval’’ process by the new 

FMIC. There is already an approval process in place for private 

mortgage insurers to do business—it occurs at the State insurance 

departments, when we approve a license. It is our job as regulators 

to monitor the insurer’s solvency through capital requirements, reserve requirements, coverage, investment, and geographic concentration limits, and limitations on nonmortgage activities. There 

is no need for FMIC to duplicate the efforts of effective State regulation. Instead of duplicating, S.1217 should defer to the licensing 

and other standards that are required by State laws in order to 

write or provide mortgage guaranty or bond insurance coverage, 

just as bank regulators defer to State insurance regulators on the 

oversight of homeowners insurers who, in the event of a loss, are 

relied upon by lenders to be made whole or protected. 

Second, State insurance regulators carefully balance solvency 

concerns with availability of coverage to ensure a competitive marVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00130 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
127 

ketplace. Experience has shown us that the incentive is simply too 

great for a regulator charged with maintaining the viability of a 

Government guarantee, such as the FMIC, to overshoot its regulatory objective and put in place standards, particularly solvency 

standards such as capital requirements, that are more stringent 

than necessary. This would ultimately threaten the availability of 

coverage, increase cost to the policyholder and undermine the objective of a private market solution to support a vibrant housing 

market for the future. 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM BART DZIVI 

Q.1. S.1217 proposes the regulator have, with the consent of other 

officials, emergency powers in a crisis that only lasts 6 months. 

Should we consider expanding that authority, or providing other 

countercyclical tools that a regulator may need in a future crisis? 

A.1. Section 205 of the legislation provides that during exigent circumstances, the Corporation, for a period not to exceed 6 months, 

may continue to sell insurance for covered securities regardless of 

whether the security satisfies the first loss position for private market holders and other potential requirements developed under Section 202(a) of the legislation. 

Providing policy makers with adequate and timely statutory tools 

is critical to allow them to address issues prior to a crisis erupting. 

If policy makers have to wait for Congress to respond, the resulting 

financial shock, and the depth of the crisis, will be much more severe. As the recent financial crisis has demonstrated, when a severe financial crisis strikes the United States again, it is not likely 

to abate within six (6) months. One of the primary responses to the 

recent financial crisis by the Board of Governors of the Federal Reserve System (Federal Reserve) has been the purchase of mortgage 

backed securities (MBS) issued by Fannie Mae and Freddie Mac. 

On November 25, 2008, the Federal Reserve announced it would 

undertake the purchase of $500 billion of agency MBS. On February 27, 2014, Federal Reserve Chair Yellen testified that the 

Federal Reserve expects to end its agency MBS purchases this 

year. Thus, the Federal Reserve’s policy response has been to purchase agency MBS for over five (5) years. In that context, statutory 

authority to provide extraordinary issuance of insurance to back 

MBS for only six (6) months, and only after an emergency has been 

declared by the Federal Reserve Chair and the Secretary of Treasury, seems wholly insufficient to stabilize the economy. 

While the debt markets for private corporations seized up, and 

essentially halted, during the most extreme moments of the financial crisis, the Government Sponsored Entities (GSEs) and the Federal Home Loan Banks (FHLBs) were able to issue debt to fulfill 

their functions. They were only able to do so because the markets 

perceived that the United States Government stood behind that 

debt. This is the most important countercyclical weapon in the arsenal that Federal policy makers have to fight a financial crisis. 

Congress can best equip the country to withstand future financial 

shocks by keeping the FHLBs, and the replacements for the GSEs, 

financially strong and independent, so that they can issue unseVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00131 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
128 

cured debt that the markets will accept, and that the Government 

can stand behind without incurring losses, during future panics. 

I concur with that part of the analysis in the paper published by 

the Center for Responsible Lending, ‘‘A Framework for Housing Reform: Fixing What Went Wrong and Building on What Works’’, 

(Oct. 28, 2013) that suggests that the replacements for the GSEs 

(for MBS issuer guarantees) should be mutually owned cooperatives (not investor owned companies and not a Government corporation), and notes that we know this system can work because 

Freddie Mac was a cooperative within the Federal Home Loan 

Bank system when it was founded in 1970. Creating a strong mutual cooperative is the best countercyclical tool. See also, ‘‘The Capital Structure and Governance of a Mortgage Securitization Utility’’, Federal Reserve Bank of New York, Staff Report No. 644 (Oct. 

2013). 

Q.2. What can we put in statute to ensure that the FHLBs receive 

sufficient attention and oversight in a new system, given the differences between the FHLBs and the replacements for the GSEs? 

A.2. The Federal Housing Finance Board (FHFB) was the predecessor-in-interest to the Federal Housing Finance Agency (the 

‘‘FHFA’’ was created in 2008) with respect to the prudential supervision and regulation of the Federal Home Loan Banks; the Office 

of Federal Housing Enterprise Oversight (OFHEO) was the predecessor-in-interest to the FHFA with respect to the prudential supervision and regulation of Fannie Mae and Freddie Mac. 

The historical results are clear, the FHFB largely succeeded in 

its mission, and OFHEO largely failed in its mission. The results 

are due to several factors: 

• The Federal Home Loan Banks are operated as mutual cooperatives, with an incentive to constrain risk through conservative lending and investment policies; whereas, Fannie Mae 

and Freddie Mac were investor owned enterprises where senior 

managers had stock options and other asymmetric financial incentives that emboldened them to take outsized risk on very 

small capital bases; and 

• The FHFB had strong supervisory powers; whereas OFHEO 

had been hobbled by Congress with very limited statutory supervisory and enforcement powers. 

In 2008, Congress reversed its prior error with OFHEO when it 

created the FHFA and granted it even stronger supervision and enforcement tools than the FHFB possessed. Congress needs to keep 

a strong, independent, prudential regulator of both the FHLBs and 

the replacement for the GSEs. There is no basis in the historical 

record for eliminating the FHFA. I urge Congress to retain the 

FHFA as the safety and soundness prudential regulator of both the 

FHLBs and the replacement for the GSEs. 

In order to ensure adequate attention and supervision by the 

Federal regulatory agency for both the FHLBs and the replacement 

for the GSEs, I support the structure currently in law of having a 

dedicated deputy director for each type of entity. In addition, I encourage Congress to adopt a statutory requirement that both the 

head of the agency, and the deputy director for the relevant entity, 

129 

appear once a year and testify before Congress to report on the 

safety and soundness of the FHLBs, and once a year, at a separate 

time, to report on the safety and soundness of the replacement for 

the GSEs. 

Q.3. S.1217 gives the new regulator many responsibilities. What 

are the advantages and disadvantages of a structure where a single 

regulator oversees many type of companies, the insurance fund, the 

common securitization platform, and other functions? 

A.3. It would be a significant mistake if Congress created an entity 

that could grant insurance on privately issued mortgage backed securities, where the insurance had an explicit Federal guarantee, 

and the entity that issued the insurance was not supervised and 

regulated by a separate, independent Federal agency. 

Some proponents of S.1217 have argued that the Federal Deposit 

Insurance Corporation (FDIC) insures deposits at banks, and it is 

an example of how a Government corporation can do these many 

type of tasks at once. Setting up an entity to grant insurance on 

securities, without a separate regulator, creates a significant risk 

of loss for the Government as guarantor. The argument being made 

that the FDIC is an example of how a Government corporation can 

undertake these many tasks without serious problems is deeply 

flawed and understates the prospects for substantial future losses 

for the following reasons: 

• All FDIC insured banks are subject to separate safety and 

soundness supervision by their chartering entity (the OCC or 

State agency) that is designed to avoid insolvency of the bank; 

• The FDIC as receiver has access to all the assets of the failed 

institution to satisfy its claims; an issuer of a mortgage backed 

security is issuing a stand-alone security that is not backed by 

any assets of the issuing entity and only by the mortgage loans 

in the pool specific to that security, and perhaps private mortgage insurance; 

• The FDIC as receiver has extraordinary powers designed by 

Congress to maximize its ability to minimize its losses in a receivership proceeding that it controls; trying to collect from a 

busted mortgage-backed security, an insolvent private mortgage insurer that had provided a guarantee on the MBS, or an 

insolvent seller of loans into the pool would involve cumbersome and costly litigation by the Corporation resulting in 

small recoveries for the Government; and 

• Notwithstanding the advantages of the FDIC described above, 

the FDIC deposit insurance fund went negative during the recent crisis, the prior deposit insurance fund operated by the 

Federal Savings and Loan Insurance Corporation went insolvent during the 1990s, and various State and private deposit 

insurance funds have gone broke during other financial crisis. 

Having one entity performing many Federal functions, some of 

which conflict with each other, can be a recipe for disaster. One of 

the reasons that the Savings and Loan Crisis of the 1980s and 

early 1990s grew to such a large size was that one entity, the Federal Home Loan Bank Board (FHLBB), was responsible for chartering Federal savings and loans, insuring all savings and loans deVerDate Nov 24 2008 09:45 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00133 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-21 ZDISTILLER\112113.TXT JASON
130 

posits through the Federal Savings and Loan Insurance Corporation (FSLIC), and effectively running the Federal Home Loan 

Banks by appointing directors and setting operational rules for the 

FHLBs. The FHLBB was placed in a position of a conflict-of-interest by Congress, and it used its powers as head of the FHLBs to 

order the FHLBs to make loans to weak savings and loans to prop 

them up so the FSLIC could hide the extent of its true losses. The 

multiple functions envisioned for the Corporation under S.1217 create the same type of conflict of interest. Congress should avoid creating another inherently conflicted entity. 

Instead, the legislation should create a privately capitalized mutual company to operate a securitization platform because neither 

the insurance of securities nor the issuance of securities is a core 

competence of a Government agency. A separate Federal agency 

should be established and charged by Congress with issuing rules, 

and supervising the enforcement of those rules, to keep the entity 

issuing the guarantee solvent, and to keep the market functioning 

properly by requiring adequate transparency of the functions performed by the trustees and other participants in mortgage market. 

Q.4. As it relates to the regulatory structure of a new housing finance system, what are the most important changes that need to 

be made to S.1217 to ensure a strong, effective regulator? 

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

• Establish an independent agency as a safety and soundness 

regulator, completely separate from any other Federal entity, 

and completely separate from the entity issuing the insurance 

that provides the Federal guarantee on the mortgage backed 

security; 

• Provide the regulatory agency with strong enforcement and supervision tools equivalent to the tools available to the Federal 

banking agencies, and with the same independent litigation 

authority as the Federal banking agencies; 

• Grant the regulatory agency independent assessment authority, and the ability to set its own budget without further action 

by Congress or any other executive branch agency; 

• Provide the regulatory agency with the same flexibility to set 

the level of compensation for its employees as is provided for 

the Federal banking agencies; 

• Require fixed terms for the head of the regulatory agency (or 

the members of the board at the head of the agency), subject 

to removal by the President of the United States only for cause 

(and if there is a board, its members should have staggered 

terms); and 

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

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM ROBERT M. COUCH 

Q.1. S.1217 proposes the regulator have, with the consent of other 

officials, emergency powers in a crisis that only lasts 6 months. 

131 

Should we consider expanding that authority, or providing other 

countercyclical tools that a regulator may need in a future crisis? 

A.1. Any new housing finance system must be resilient enough to 

weather the inevitable periods when the housing market takes a 

downward turn. Even during these countercyclical periods, it is 

critical for the housing finance system to continue to serve as a reliable source of mortgage liquidity. 

For most of these periods, the limited Government guarantee for 

catastrophic risk assumed by the FMIC should help provide for the 

continued availability of mortgage credit because the Government 

wrap will assure investors in mortgage-backed securities (MBS) 

that the MBS will be repaid and the Government will stand behind 

the credit risk. If credit-risk protection is no longer available 

through bond guarantors (as envisioned by S.1217) and other private credit enhancers, or if the price of such credit-risk coverage is 

too high, the Congress could adjust the loan levels for the insurance programs of the Federal Housing Administration (FHA) and 

U.S. Department of Veterans Affairs (VA), thus allowing the two 

institutions to expand their activities as they did during the recent 

crisis. 

The BPC Housing Commission also proposed that its Government guarantor (similar to the FMIC) be given the authority to 

price and absorb first-loss credit risk for limited periods during 

times of severe economic stress in order to ensure the continued 

flow of mortgage credit. Under these circumstances, the guarantor 

would be required to notify the Treasury Department, the Federal 

Reserve, and the chairs of the appropriate congressional committees before taking any such action. S.1217 provides the FMIC with 

similar authority, but this authority is subject to a number of more 

stringent conditions. In addition to the 6-month limitation you cite, 

these conditions include first obtaining the prior written consent of 

both the Chairman of the Federal Reserve Board and the Treasury 

Secretary and a prohibition on using the authority more than once 

in any given 3-year period. 

As I stated in my testimony to the Committee, you may wish to 

consider empowering the FMIC with more flexibility to ensure it 

can respond quickly to emergency conditions in the mortgage market. The Committee may also wish to reconsider whether it is appropriate to impose specific time limitations on the FMIC’s ability 

to exercise its emergency authority. It was the Housing Commission’s view that prenotification to Congress was a critical part of 

the decision to use emergency powers. We also concluded that such 

notification and ongoing Congressional oversight were sufficient to 

protect against the abuse or excessive use of this authority. 

Under the Housing Commission’s proposal, neither the Government guarantor, FHA, VA, nor Ginnie Mae would be permitted to 

have retained portfolios. Similarly, as proposed in S.1217, the 

FMIC would not have a retained portfolio other than to assist in 

the orderly wind down of Fannie Mae and Freddie Mac. 

The absence of retained portfolios raises concerns about the 

availability and liquidity of mortgage credit during downturns 

when demand for MBS or the liquidity with which to purchase 

these securities could fall precipitously, as occurred in 2008 to 

132 

2009. Therefore, Federal policy should be clear on how mortgage liquidity would be managed in such circumstances. 

One alternative is through monetary policy and Federal Reserve 

actions in the market. Such policies should be established in advance of any crisis and should be understood by all market participants in order to forestall any issues that could unnecessarily raise 

the cost of housing and home ownership. By way of reference, during the 45-year history of Ginnie Mae in which it had no retained 

portfolio, the presence of a ‘‘full faith and credit’’ guarantee as well 

as Federal Reserve and Treasury purchasing authority have preserved ample liquidity in Ginnie Mae bonds through numerous 

credit crises, including the most recent one. 

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

A.2. The Government guarantor proposed by the Housing Commission is similar to the FMIC in that both are self-supporting institutions that do not rely on Federal appropriations but rather finance 

their catastrophic risk funds and operational expenses through the 

collection of guarantee fees. While the primary purpose here is to 

protect the taxpayers from unnecessary risk, operating largely outside the Federal appropriations process also gives the institutions 

some insulation from undue political interference in oversight decisions. The Housing Commission concluded that having this independence would allow the guarantor to respond more quickly to 

contingencies in the market and operate with greater efficiency in 

making decisions related to staffing, budgeting, procurement, and 

policy. 

Some may argue that an exclusive reliance on private sources to 

fund its operations raises the prospect that the FMIC might be 

‘‘captured’’ by those entities it regulates. S.1217’s creation of an Office of Inspector General within FMIC, charged with assessing the 

adequacy of the first-loss position held by private institutions as 

well as providing annual reports on the adequacy of the guarantee 

fees charged by the FMIC, is an important safeguard against this 

possibility. Ongoing Congressional oversight is also critical. The 

successful track record of the Federal Deposit Insurance Corporation (FDIC), an independent Federal agency that does not rely on 

Federal appropriations but instead is largely funded by the insurance premiums it charges to banks and thrift institutions, demonstrates that the FMIC can be self-supporting and still function 

effectively. 

S.1217 requires the Mortgage Insurance Fund (MIF) to reach a 

reserve level of 1.25 percent of the guaranteed MBS within 5 years 

and 2.50 percent within 10 years. By contrast, the FDIC has designated a reserve ratio of 2 percent. To help capitalize the MIF in 

the early stages of the new system as well as signal the Federal 

Government’s strong commitment to standing up this system, the 

profits of Fannie Mae and Freddie Mac could be tapped as an initial source of MIF funding. 

133 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM PAUL LEONARD 

Q.1. S.1217 proposes the regulator have, with the consent of other 

officials, emergency powers in a crisis that only lasts 6 months. 

Should we consider expanding that authority, or providing other 

countercyclical tools that a regulator may need in a future crisis? 

A.1. The Housing Policy Council agrees that the Federal regulator 

should retain some flexibility to adjust prudential standards during 

periods of severe economic downturns. That authority, if exercised, 

can reduce economic problems by helping to maintain a flow of 

housing finance. Since the need for that authority is based upon 

economic conditions, we do not favor any fixed, statutory deadline 

on the exercise of the authority. A premature reestablishment of 

normal prudential standards could set back a recovery. Instead, we 

suggest that Congress give the Federal regulator some economic 

markers or metrics that the regulator can monitor to determine 

when it is appropriate to reinstate prudential standards. Potential 

markers could be a leveling off of housing price declines and a leveling off of foreclosures.