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S. HRG. 113–95

ESSENTIAL ELEMENTS OF HOUSING FINANCE

REFORM

HEARING

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED THIRTEENTH CONGRESS

FIRST SESSION

ON

DISCUSSING THE ESSENTIAL ELEMENTS THAT MUST BE A PART OF 

HOUSING FINANCE REFORM LEGISLATION AND ENSURING THAT REFORM OF THE HOUSING FINANCE SYSTEM IMPROVES THE CURRENT 

SYSTEM WITHOUT CREATING MARKET DISRUPTIONS THAT THREATEN 

OUR HOUSING RECOVERY OR INCREASE COSTS FOR BORROWERS

SEPTEMBER 12, 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 

GLEN SEARS, Deputy Policy Director 

ERIN BARRY FUHER, Professional Staff Member 

KARI JOHNSON, Legislative Assistant

GREG DEAN, Republican Chief Counsel 

CHAD DAVIS, Republican Professional Staff Member

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor

(II)

CONTENTS

THURSDAY, SEPTEMBER 12, 2013

Page

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

Opening statements, comments, or prepared statements of: 

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

Senator Tester .................................................................................................. 3

WITNESSES 

Julia Gordon, Director of Housing Finance and Policy, Center for American 

Progress ................................................................................................................ 4

Prepared statement .......................................................................................... 35

Response to written question of: 

Senator Corker .......................................................................................... 85

Jerome T. Lienhard, II, President and Chief Executive Officer, SunTrust 

Mortgage, Inc. ....................................................................................................... 5

Prepared statement .......................................................................................... 54

Response to written question of: 

Senator Corker .......................................................................................... 86

Richard Johns, Executive Director, Structured Finance Industry Group ........... 7

Prepared statement .......................................................................................... 55

Response to written question of: 

Senator Corker .......................................................................................... 88

Mark Zandi, Ph.D., Chief Economist, Moody’s Analytics ..................................... 9

Prepared statement .......................................................................................... 62

(III)

(1)

ESSENTIAL ELEMENTS OF HOUSING FINANCE 

REFORM 

THURSDAY, SEPTEMBER 12, 2013

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

The Committee met at 10:17 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. 

I would like to thank the witnesses for joining us today as the 

Committee sets out on a path that I hope will lead to comprehensive housing finance reform. Our witnesses are here to help educate us regarding what essential elements must be a part of housing finance reform legislation in order for it to be credible and successful. We must ensure that reform of the housing finance system 

improves our current system and does not create market disruptions that threaten our housing recovery or unnecessarily increase 

costs for borrowers. 

During our first housing finance reform hearing this Congress, 

Ranking Member Crapo and I explored whether a bipartisan solution to reform the housing market was possible. At that time, there 

was no agreement regarding the role of the Federal Government let 

alone what a new structure could look like. I would like to thank 

Senators Corker and Warner and the cosponsors of the bill for 

showing that there is bipartisan support for a Government guarantee in a new housing system and willingness to move legislation 

forward. 

Recognizing that there are many details that need to be explored 

and discussed by the full Committee and that many Committee 

Members have input of their own that they would like to include, 

we plan to hold hearings this fall to explore the finer points of proposed changes. This will give the entire Committee the opportunity 

to explore the various modifications and wholesale changes that we 

will consider. Ranking Member Crapo and I are undertaking this 

in-depth process with the goal of reaching agreement by the end of 

the year. 

To give a sense of what a massive undertaking this process is, 

our housing finance market is the second largest and most liquid 

financial market in the world. So the consequence of getting any 

major reform wrong cannot be overstated. To that end, it is essential that we fully understand the mechanics of how a new system 

2

would function, and how we should smoothly transition from the 

current system to a new one. Any new housing finance system and 

the transition to it could dramatically change the way that families 

qualify and affect who can afford to buy a home. 

I have asked the experts testifying today to help us analyze proposed changes to the system and to help us understand which essential pieces of the current system should be preserved. Better understanding the interaction between the pieces that we would like 

to preserve—like widely available, 30-year, fixed-rate mortgages—

and the changes we would like to make is critical in order to 

achieve meaningful improvements to the current system. 

With that, I will turn to Ranking Member Crapo. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you, Mr. Chairman. There seems to be 

more traction toward moving forward with housing reform than 

there has been at any point during the 5-year conservatorships of 

Fannie Mae and Freddie Mac. Mr. Chairman, thank you for making this a top priority of the Committee during this Congress. 

In March of this year, this subject became one of our first hearings, and now I look forward to working toward a solution with you 

and all of the Senators of this Committee. 

Many other people deserve credit for getting the ball moving and 

getting it going forward well on this important topic. Senators 

Corker and Warner and all of the cosponsors of their bill have 

worked collaboratively in developing a proposal that will help 

shape our debate as we move forward, and I thank them and their 

staffs for their hard work. 

Senator Reed also has put a tremendous amount of work into 

helping us get toward the right answers and the right legislative 

language, and there are many other Senators on this Committee 

who may not have introduced legislation but who have put a tremendous amount of thought and effort into the issue behind the 

scenes advocating for a resolution. 

Chairman Hensarling likewise deserves a lot of credit and our 

thanks for his work in moving a proposal out of the House Financial Services Committee. In fact, given the President’s recent comments, it appears we now are experiencing the first moment since 

the crisis that the White House, the Senate, and the House are all 

moving forward or advocating for reform. 

Given this circumstance, we must use this opportunity to concentrate on building consensus around ending the conservatorships 

while building a stable secondary market that brings back private 

capital and avoids repeating the mistakes of the past. 

As I noted, a tremendous amount of work on this topic has already been done by many of the Committee’s Senators, and we 

must not lose this momentum. 

As such, the Banking Committee intends to hold a series of hearings to gain insight from experts, regulators, and stakeholders to 

ensure that the Committee moves forward in an educated fashion. 

These hearings will provide a more in-depth analysis of some of the 

necessary components of reform with a goal of marking up a bipartisan bill by the end of the year. 

3

There will be costs and tradeoffs associated with every decision 

that we make. As we evaluate those tradeoffs, I am pleased to have 

before us a panel that represents decades of real experience and 

study of our mortgage markets. I look forward to hearing from the 

witnesses, gaining their input and analysis about what are the essential elements of any reform. It will also be helpful to hear what 

questions we need to be asking to arrive at the best solutions. 

Despite the tough decisions that lie ahead, our task is vital. For 

more than 5 years, our housing finance system has remained in 

limbo, unable to innovate or even function outside of a massive 

Government intervention. In those 5 years, we have seen other financial markets recover while watching the housing market remain stagnant. During those same 5 years, we watched the bill to 

the American taxpayers rise to nearly $200 billion while simultaneously creating numerous legal questions that our courts may be 

sorting out for years to come. This cannot be allowed to continue. 

Chairman Johnson and I were able to work together with the 

other Senators on the Banking Committee to pass the Federal 

Housing Administration Solvency Act of 2013 out of Committee 

with a large, bipartisan vote. As a Committee, we must re-create 

that consensus while turning our full attention to reforming the 

Government-sponsored entities and our broader housing finance 

market. 

Hopefully our past work and the further collaborating of our Senators has engendered a level of trust and good will that can lead 

this Committee to a strong product with an equally strong level of 

support. 

Mr. Chairman, again I thank you, and I look forward to working 

with you and all Members of the Committee as we move forward. 

Chairman JOHNSON. Thank you, Senator Crapo. 

Are there any other Members who would like to give a brief 

opening statement? Senator Tester. 

STATEMENT OF SENATOR JON TESTER 

Senator TESTER. I would, and I apologize to Senator Corker right 

now because I know he hates these things, but I am not going to 

be here for the questions, so I have got to say this. 

First of all, I want to thank the Chairman and Ranking Member 

for their opening statements. We have got an opportunity here to 

do something good. I was sent to Washington, D.C., to try to fix 

what is wrong with Washington, D.C. We can make excuses up. We 

can talk about how we are too busy to do this. We can talk about 

Syria. We can talk about the debt limit. We can talk about all that 

stuff. But the bottom line is we can multi-task, we must multi-task. 

And if we let this opportunity escape us by not working together 

and pushing it forward—the same way we did with the FHA Solvency Act, I might add—then we are not doing our constituencies 

the services that they expect of us. 

So I look forward to working with everybody on this Committee 

to get the Warner-Corker bill across the finish line. Thank you. 

Chairman JOHNSON. Is there anyone else? 

[No response.] 

4

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. 

Before we begin, I would like to introduce our witnesses who are 

here with us today. 

Our first witness is Ms. Julia Gordon, who is the director of 

housing finance and policy at the Center for American Progress. 

Mr. Jerome Lienhard is the CEO of SunTrust Mortgage. 

Mr. Richard Johns is the executive director of the Structured Finance Industry Group. 

And, finally, we have Dr. Mark Zandi, chief economist at Moody’s 

Analytics. 

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

Ms. Gordon, you may proceed. 

STATEMENT OF JULIA GORDON, DIRECTOR OF HOUSING 

FINANCE AND POLICY, CENTER FOR AMERICAN PROGRESS 

Ms. GORDON. Good morning, Chairman Johnson, Ranking Member Crapo, and Members of the Committee. Thank you so much for 

inviting me to testify today. I am Julia Gordon, director of housing 

finance and policy at the Center for American Progress and convener of the Mortgage Finance Working Group, which released a 

comprehensive reform plan back in January of 2011 and has been 

meeting weekly since then to study the future of housing finance. 

We stand at a critical inflection point for our Nation’s housing finance system. While housing prices have begun to recover in many 

parts of the country, the fundamentals are not yet strong. The 

mortgage market today is significantly smaller than it was in the 

early 2000s. Two-thirds of originations are refinancings rather than 

home purchases. And much recent price appreciation can be attributed to cash investors. 

In the meantime, the demographics that represent the future of 

home ownership, such as first-time home buyers, millennials, and 

people of color, have largely been shut out of the conventional 

mortgage market. 

Production of apartment units is falling behind demand, and 

rents have risen significantly, with more than a quarter of all renters spending more than half of their income on housing. In our 

view, the status quo no longer serves the American public’s best interests, and it is time to reform the system. 

We are pleased to see a broad consensus emerging on the general 

outlines of housing finance reform that we must have a Government backstop behind private capital, that the long-term fixed-rate 

mortgage is a crucial product for families interested in home ownership, that the system must include not just single-family but also 

multi-family finance, and that the system provide access to all 

creditworthy borrowers and lenders of all sizes. 

I commend Senators Corker and Warner for pushing this debate 

forward. By recognizing this consensus and developing a strong bipartisan framework for reform, they have done a true public service. 

However, we still have a great deal of work ahead of us to adjust 

and fill in this framework so that it will work well for all borVerDate 0ct 09 2002 12:08 Feb 06, 2014 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 S:\DOCS\85236.TXT SHERYL
5

rowers, all lenders, and all investors throughout all economic cycles. 

First and foremost, a new housing finance system must place the 

Nation’s housing needs at the center of the system. The structures 

and processes of the secondary market are not ends in and of themselves. Providing broad access to affordable, sustainable credit will 

provide the greatest benefit in the long run not only to families but 

also to lenders and investors while protecting taxpayers from future bailouts. 

The system must provide a level playing field for all creditworthy 

borrowers in all geographic areas for all housing types and for 

lenders of all sizes. Additionally, it needs the capacity to help more 

families obtain mortgages in the conventional market through credit supports and safe innovation rather than relegating large swaths 

of borrowers to FHA unnecessarily, where mortgages are more expensive and where the Government will continue to provide a 100-

percent guarantee. And to serve those families not yet ready for or 

interested in home ownership, the system should provide financing 

to preserve existing privately owned affordable housing stock and 

support the construction of new affordable units. 

To create a deep liquid market and support widespread availability of a long-term fixed-rate mortgage product, we need both a 

Government guarantee and a healthy TBA market. We agree that 

there is no reason for the Government to guarantee 100 percent of 

the risk, and in our 2011 proposal we suggested that chartered 

bond guarantors stand in the first loss position, which is one of the 

options presented in the Corker-Warner bill. 

However, we have significant concerns about the other option 

presented in that bill, which is having issuers lay off the risk directly through the private capital markets. We are concerned that 

structured transactions alone cannot effectively maintain the TBA 

market, provide broad access to sustainable credit, protect the taxpayer, and maintain access to credit throughout economic cycles. 

We expect, though, that bond guarantors will access the capital 

markets to lay off risk, perhaps along the lines of the Freddie 

STACR deal. 

It perhaps goes without saying, but any new system also must 

support effective and fair mortgage servicing practices as well as 

appropriate systems to provide clarity regarding property title. 

Finally, we need strong regulatory tools to ensure safety and 

soundness throughout the system, including examination, supervision, and enforcement authority for entities accessing the Government guarantee. 

Thank you again for inviting me to testify today, and I look forward to continued discussion on these important matters as the 

Senate moves forward on housing finance reform legislation. 

Chairman JOHNSON. Thank you. 

Mr. Lienhard, you may proceed. 

STATEMENT OF JEROME T. LIENHARD, II, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, SUNTRUST MORTGAGE, INC. 

Mr. LIENHARD. Good morning, Chairman Johnson, Ranking 

Member Crapo, and Members of the Banking Committee. I am Jerome Lienhard, president and CEO of SunTrust Mortgage, which 

6

is a subsidiary of SunTrust Banks. Thank you for allowing me to 

participate in the consideration of this important subject. 

I am appearing today in my capacity at SunTrust Mortgage, and 

this testimony was prepared after consultation with the Regional 

Bank Group, an informal coalition of mid-sized lending institutions 

located throughout the United States. All views expressed today, 

however, are my own. 

SunTrust is headquartered in Atlanta and operates mainly in the 

southeastern United States. SunTrust Mortgage is based in Richmond, Virginia, and employs about 4,300 teammates. Last year, we 

originated over $32 billion in mortgage loans which helped more 

than 120,000 of our clients purchase a home or lower their monthly 

payment through refinancing. 

Today I would like to make two important points from the perspective of a regional bank: 

First, while there is a need to reform the housing finance system, 

it is critical to retain the basic ‘‘plumbing’’ of the system that draws 

in enormous sums of investment capital and provides borrowers 

with interest rate certainty. These features can be retained in a 

mortgage market that serves both the interests of borrowers and 

taxpayers alike. 

Second, reform must bring more private capital into the mortgage market in a principal loss position without reducing the global 

demand for mortgage-backed securities and while protecting competitive access for small and medium-sized institutions that serve 

millions of homeowners. 

I will spend a few minutes elaborating on each of these points. 

Out of thousands of mortgage loans that we make each year, on 

average we hold only one in six on our balance sheet. So while we 

own approximately $30 billion worth of mortgage loans, we actually 

originated and service more than $140 billion in mortgages involving more than 800,000 households. This is possible for us only due 

to the existence of the secondary mortgage market. 

To provide our clients with basic information regarding how 

much they can afford to pay for a house, we must be able to tell 

them the interest rate and the monthly cost of the loan. You cannot 

really buy a house if you do not know what your mortgage payment 

will be. 

We do this by referencing a daily pricing sheet that provides the 

interest rate and loan terms that we can offer on a guaranteed 

basis. These prices are set from the price of mortgage-backed securities trading in the ‘‘To Be Announced’’ or TBA market. The TBA 

security price assumes delivery of conforming mortgages into a 

Freddie Mac or Fannie Mae mortgage-backed security on a forward 

basis. This forward-pricing mechanism of the secondary market allows us to lock in the interest rates for our clients for up to 90 

days. 

But without that certainty, primary market lenders would be unwilling and, frankly, unable to provide forward price certainty to 

their customers. 

Through the combination of mortgage standardization and the 

function of the MBS market, the existing system provides a tangible benefit to borrowers. And these benefits are available for anyone who transact with originators of any size: local banks, Main 

7

Street banks such as SunTrust, as well as the largest mortgage 

originators. 

While there is a need to address taxpayer risk by making structural changes to the housing finance system, these are key features, elements, and processes essential to maintaining a secondary 

market. 

Regarding the critical issue of the structure of the credit guarantee, our markets perform so well in large part because credit risk 

associated with mortgage default is assumed by the GSEs. Investors from around the world allocate trillions of dollars of capital to 

our markets because it only involves interest rate risk to them. 

Now, the problem, of course, is that providing credit protection 

puts taxpayers at risk. Using private sources of capital to cover 

credit exposure can help alleviate taxpayer risk. 

We must also consider that if a variety of credit risk devices 

emerge in place of the relatively simple credit guarantee we have 

today, it could make mortgage-backed securities difficult for investors to value, fracturing the investor base, reducing liquidity, and 

increasing costs. If that market shrinks dramatically, so does lending to homeowners. 

To the extent that private capital is intended to stand before any 

taxpayer-backed guarantees, the entities and instruments must be 

subject to regulatory oversight. If regulators cannot understand nor 

keep track of the various risk-sharing mechanisms, there is a danger that they will not perform as needed under crisis conditions. 

And, finally, any new source of private sector credit protection 

should be available for all primary market lenders, including large, 

small, and Main Street institutions. Measures that create advantages for the very largest issuers of mortgage-backed securities or 

make the cost of market access more expensive for some and not 

others will reduce competition and must be avoided. 

Let me conclude by thanking the Committee again for the time, 

attention, and consideration. I look forward to answering any of 

your questions. 

Chairman JOHNSON. Thank you. 

Mr. Johns, you may proceed. 

STATEMENT OF RICHARD JOHNS, EXECUTIVE DIRECTOR, 

STRUCTURED FINANCE INDUSTRY GROUP 

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

Members of the Committee on Banking, my name is Richard Johns. 

I am the executive director of the Structured Finance Industry 

Group, or SFIG, a trade industry group that includes over 160 corporate members from all sectors of the securitization industry. On 

behalf of myself and SFIG’s members, I thank you for this opportunity to address the Committee regarding proposed housing finance reforms, including the role to be played by the Government 

in the housing finance system and the importance of returning private capital to the residential mortgage market. 

SFIG is generally supportive of the framework contained Senate 

bill 1217 and believes the reform process, particularly in relation 

to the securitization markets, must proceed in a measured and deliberate way. We appreciate the Committee’s methodical approach 

in considering such reforms. 

8

A central focus of any reform effort must be the preservation of 

the To Be Announced or TBA market, which is the third most liquid securities market in the world and handles over 90 percent of 

the Government-guaranteed MBS trading volume. The reason behind this deep liquidity of the TBA market is in its homogenous 

nature driven by standardization of loan pools and underwriting 

criteria, market standards and history, and the elimination of credit risk via the Government guarantee. 

This deep liquidity not only drives down costs allowing a cheaper 

interest rate to be charged to the consumer, but it also enables the 

mortgage originator to hedge its risk, which in turn can be passed 

through to the consumer in the form of a rate lock to give them 

certainty of interest rate. Any reform process needs to be considerate of the credit risk to the homogeneity of the TBA market. For 

this reason, we suggest that there are three sequential stages that 

any reform effort should follow in order to preserve the TBA market. 

First, the conversion into a common TBA should be adopted, 

making Freddie and Fannie MBS fungible and, therefore, deliverable into a single TBA market. 

Second, any legislation should provide for the creation of a single 

agency security. This would facilitate the conversion and continued 

liquidity of legacy securities and promote a deep and liquid newissue MBS market. 

And then, third, a common securitization platform should be established to oversee and maintain the standardization of the market for Government-guaranteed MBS. 

SFIG believes that retaining a Government guarantee against 

catastrophic loss for MBS is crucial to preserving the health of the 

TBA market. 

Historically, rates investors have been attracted to the Government-guaranteed MBS in which the Government bears the bulk of 

the credit risk, and they have contributed trillions of dollars to the 

agency market because of those guarantees. Limiting the Government’s involvement in the market by changing or ending the current infrastructure must account for the crucial contribution that 

rates investors make to the agency market and their historical 

aversion to credit risk. 

We also believe that private investors have a role to play in ensuring against the credit risks posed by residential mortgages. To 

that end, SFIG generally supports having private capital take on 

credit risk in the first loss position with the explicit Government 

guarantee covering catastrophic risk. 

SFIG continues to analyze the amount of risk that a private investor should assume, and we will provide the Committee with our 

ideas at a later date. However, whatever the final private enhancement is, it should be based on underwriting-related factors such as 

historical loss data, the likely loan times, and general housing and 

economic indicators. 

Turning next to the mechanics of transitioning to a new structure, this process must be transparent, appropriate to market conditions, and handled with great care to minimize the disruptions to 

the flow of credit to consumers and, in particular, to ensure the 

continued health of the TBA market. 

9

We believe steps must be taken to preserve the market for legacy 

securities while allowing sufficient time for eligible loans under the 

reformed system to be generated and take hold in the TBA market. 

SFIG believes that the best way to facilitate this transition is to 

create a single agency security to which the legacy securities would 

be converted. We also believe that the current and new infrastructure should operate in tandem for some period of time until the 

new framework has demonstrated that it will facilitate the continued functioning of the TBA market. 

Finally, there are a number of initiatives underway around the 

country in which governments plan to exercise their eminent domain power to seize underperforming mortgage loans. Such use of 

eminent domain will undermine congressional efforts to encourage 

private capital in the market, and we encourage the Committee to 

include a provision limiting it in any reform legislation. 

In conclusion, while we recognize the need to correct the errors 

of the past, we urge the Committee not to lose sight of the ways 

in which the agency market, and particularly the TBA market, has 

and continues to work well, enabling many Americans to enjoy the 

benefits of home ownership. We look forward to working with the 

Committee as it considers these vitally important issues. Thank 

you again for the opportunity to share SFIG’s views. 

Chairman JOHNSON. Thank you. 

Dr. Zandi, you may proceed. 

STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST, 

MOODY’S ANALYTICS 

Mr. ZANDI. Thank you, Mr. Chairman, Mr. Vice Chairman, and 

the rest of the Committee, for the opportunity to be here today. 

For the purposes of the meeting, the Committee hearing, you 

should know that I am on the board of MGIC. That is the largest 

mortgage insurer in the country. That is important for you to 

know. I am also on the board of the Reinvestment Fund. That is 

one of the Nation’s largest CDFIs. And I am also, obviously, an employee of the Moody’s Corporation. So those are very important 

things. These are my opinions, not those of Moody’s or anyone else. 

There are many essential elements to a good, well-functioning 

housing finance system. I go through many of them in my written 

testimony. I want to focus in my current remarks on one essential 

element, and that is the capital requirements of the new system. 

So I am going to talk a little bit about the amount of capital that 

is appropriate, the sources of that capital, and the cost of that capital. 

I should say up front that I am taking as given that we are in 

a world of a hybrid system; that is, private first loss capital with 

a catastrophic Government guarantee. So in almost all circumstances, private investors will shoulder the burden of the 

losses. In very rare circumstances, catastrophes, the Government 

would step in and backstop the system. The guarantee would be explicit. It would be paid for by lenders and borrowers and not taxpayers. And the hybrid system is in the spirit of Corker-Warner. 

It is also what the President has recently come out in support of. 

In terms of the amount of capital, in my view the appropriate 

amount of capital—a good benchmark for the appropriate amount 

10

of capital is the Great Recession. In the recession, Fannie, Freddie, 

the private MIs lost or will lose ultimately about 4 percent. That 

is the loss rate, all in. To be conservative, I think it would be appropriate to capitalize the system at 5 percent. I think that would 

cover all significant circumstances. 

That would be particularly conservative in the sense that the 

mortgages that get the Government guarantee in the future system 

under all proposals would be QM and, therefore, the loans that got 

Fannie and Freddie into real trouble, the Alt-A loans, would not be 

guaranteed in the future system. So I think 5 percent would be appropriate. 

In terms of the sources of capital, they should be varied. We need 

capital—we need lots of capital. This is going to take a lot of capital, and it should come from everywhere. So we need capital coming from mortgage bond guarantors, MI companies, and the capital 

markets. Very important. When you have varied sources of capital, 

that creates stability in the system. That would be particularly, I 

think, the key feature of capital coming from mortgage bond guarantors. And it will be cheaper if you have it from varied sources 

of capital, and the capital markets are very, very important to that. 

And I think in the Corker-Warner legislation, one of the key features of that legislation that I find attractive is that it promotes 

varied sources of capital. We need that. It is very important to the 

future of the housing finance system. 

In terms of the cost of the capital, you know, it is not free. If we 

are going to have a higher capitalization rate, mortgage rates are 

going to be higher. The question is how much higher. Well, it depends on lots of moving parts, and it may have to make a lot of 

assumptions. But my sense is under reasons assumptions that to 

go from the current system to a system that is capitalized at 5 percent probably would add another 40 basis points to mortgage rates, 

roughly speaking—excuse me, 40 basis points in G-fees, and that 

would be passed through largely in higher mortgage rates. Just for context, every 10 basis points is about $15 on a monthly 

mortgage payment, so you do the arithmetic, going to the new system under my assumptions would add about $60 to the average 

monthly mortgage payment. 

One other thing to note is that the cost will vary considerably depending on how the system is designed, and it will vary depending 

on the credit risk of the borrower, and it will vary according to 

where you are in the business cycle. The numbers I just articulated 

are for the typical borrower through the business cycle. 

Let me end by saying—this is very important—the current system is dysfunctional. We have to change it. It is not good for taxpayers. It is not good for home buyers. I think it is laudable that 

you are taking this up in a very serious way. 

Thank you. 

Chairman JOHNSON. Thank you very much for your testimony. 

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

the clock for each Member. 

Ms. Gordon, I am very concerned about the mortgage access in 

rural areas. What is needed in a new system to ensure that borrowers with similar qualifications have equal access to mortgages 

no matter where they live? How would you design requirements to 

11

ensure that borrowers and lenders in States like mine are not left 

out? 

Ms. GORDON. Thank you for that question. It is a very important 

question, both for rural borrowers in States like yours and for any 

borrower who lives in either a rural area or who may be in an 

urban area or some area that is not as well and easily served by 

primary lenders. 

So what is important to remember is that while the interface for 

most borrowers with the system is through their primary lender, 

lenders will make those loans that the secondary market encourages them to make through policies. And we have had—in the system that, you know, we are hoping to reform, there have been 

mechanisms through Fannie and Freddie that do require lenders to 

be mindful that they are equally serving all creditworthy borrowers, you know, regardless of where they live or whether, you 

know, their file is a little bit harder to go through all the papers 

for than somebody else’s. 

And we are very concerned that if we do not build in mechanisms 

to address that, lenders will be able to, you know, what you might 

think of as cream the market, just basically do the low-hanging 

fruit, do the easy mortgages, do the mortgages with higher balances within whatever the loan limits are of the system, and that 

people will be disadvantaged, particularly in States like yours. 

And so we think it is critical to establish in this bill some kind 

of responsibility for the secondary market to oversee making sure 

that all of these parts of the market are being adequately served, 

which means, you know, doing some kind of examination of the 

market, some kind of examination of where the demand and need 

is, and then looking at whatever entities ultimately are accessing 

the Government guarantee and providing the wrap, making sure 

that they are covering all of these different populations equally. 

Chairman JOHNSON. Mr. Lienhard, will qualified borrowers and 

lenders of all sizes have fair access to the secondary market if private capital is require to play a larger role in front of a Government guarantee? Will this work with the TBA market? And how 

does the TBA market impact borrowers and lenders? 

Mr. LIENHARD. Thank you for the question, Senator. I think that 

the beauty of the TBA market or actually the beauty of the construct that we have now and what I think needs to be preserved, 

as I mentioned in my testimony, is this separation of credit risk 

from interest rate risk. And so presumably the interest rate risk 

investors do not differentiate between the creditworthiness of the 

borrower. That is disintermediated ahead of the TBA market by 

the credit guarantee function. So as I understand your question—

and I would be happy to have you help make me more clear in that 

understanding—I think the answer to your question is properly 

structured, yes. But I think that the critical nature of that structure does not necessarily reside in the TBA market but, rather, in 

the guarantee aspect of whatever reform we do. I do not know if 

that is a comprehensive answer. 

Chairman JOHNSON. Mr. Johns, do you believe private investors 

are willing to stand in the first loss position before our Government 

guarantee both in good times and bad? What will investors need 

12

to accept credit risk of a first loss position? And does that work 

with the TBA market? 

Mr. JOHNS. I think the short answer is that investors are prepared to step into that role, as we have seen on the Freddie transaction. There was a sizable demand for the credit-linked note product, and I think there were 50 investors or over 50 investors, and 

the investors were scaled back fairly significantly, and I think all 

reads from the market are that there will be support for, you know, 

being able to facilitate those transactions again. 

In addition, obviously, you have to look at the sort of broad 

swath of options out there such as the mortgage insurers and the 

bond insurers, you know, together with the capital markets, looking for the way to raise the private capital. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. 

I hope this question I want to get into here will evoke responses 

from all of you on the panel. I am going to start out with Dr. Zandi 

and Mr. Johns and then move to Mr. Lienhard and Ms. Gordon. 

The issue is the forms and sources of private capital that we 

need to bring into the market. I think there is pretty clearly an 

emerging consensus that whatever the shape of the future housing 

finance system we create is, it must be designed to attract more 

private capital and decrease the Government role from what we 

currently have. 

That being said, I think that I see in the testimony of the witnesses a little variation in terms of how we should approach that. 

Mr. Johns and Dr. Zandi, in your testimonies you both have advocated for the allowance of various forms of private capital to come 

into the system to meet market needs. So to start with you, what 

are the benefits that you see to sourcing private capital from many 

sources? And maybe you could also kind of define what you see 

those sources being broadly? 

Mr. ZANDI. Well, there are two broad sources. The first is what 

I would call an insurance source—bond guarantors, private mortgage insurers, insurance entities. And the second I would label as 

capital market sources. Both are critical to a well-functioning system. 

The insurance capital is more stable through thick and thin because of the way it is structured and set up, and one of the goals 

of any future housing finance system is that it obviously has to be 

stable. We need the flow of mortgage credit through good times and 

bad times. 

The strength of the capital markets source of capital is that it 

can bring down the costs, and most of you get price discovery. You 

get a clearer sense of what the cost of risk is, because capital markets are pretty good at doing that. And so by bringing in capital 

market sources, you will lower the cost to mortgage borrowers 

through lower mortgage rates. So both are very important. 

Now, how you structure that and how you align those two 

sources of capital up is a very difficult but critical question, and 

that is very, very important, but both sources are needed. 

Senator CRAPO. Well, thank you, and we probably need to get 

into that in some depth, but I do need to move along. So, Mr. 

Johns, do you want to add anything to that perspective? 

13

Mr. JOHNS. I think that I would go along with what Dr. Zandi 

said, that we would support their—I think, you know, maybe a couple of points. It is all—well, it is not all about—a lot of our focus 

needs to be on making sure that the TBA market continues to function when you look at the private capital alternatives. And, you 

know, insurance is not something that necessarily can directly impact the pool of loans within the MBS, and, therefore, I think that 

is something that has some potential. 

The credit-linked note structure that Freddie did was a synthetic 

transaction, and, therefore, the actual loans that it referenced, you 

know, were not specifically sort of cash-flow impacted in the structure of the transaction, leaving the TBA market largely unaffected 

as a consequence. 

There are other structures, senior subordination, you know, 

structures where you might say—you know, have a sort of deep 

subordination piece of the transaction and then have a AAA or a 

senior rated piece that is delivered into the TBA market. That is 

a different structure that we would have to look at and evaluate 

exactly how we would get that to work with the TBA market that 

is currently based on a pass-through mechanism. 

Senator CRAPO. All right. Thank you. 

And, Mr. Lienhard, I may have to get to you next time, the next 

round, because I am running out of time and I wanted to get to 

Ms. Gordon, because if I understand it correctly, you believe we 

should rely solely on bond guarantors. Is that correct? 

Ms. GORDON. That is what I believe, and it is really for two reasons. One is, as everybody has been discussing, the importance of 

the TBA market and the belief that even—you know, we have already heard that a senior substructure would pose some problems 

for TBA. But even if you have some other kind of reference pool 

type structure, the fact is that these sort of one-off deals do not 

lend themselves as well to the kind of homogeneity that you need 

for an effective TBA market. They do not do as good a job at allocating risks across years, regions, lenders, and the like, but especially across years that you have an insurance format. 

And also, just to Dr. Zandi’s point regarding price discovery, we 

do have to—the private capital market’s track record on pricing 

mortgage risk is checkered, as is everybody’s, and so that is an 

area where you do introduce some uncertainty. And, again, even if 

in any individual structured transaction that actual transaction is 

funded, if you do not know how the investor institutions are carrying that on their books and evaluating it, you do not know if you 

are just exporting risk out of that particular mortgage-backed security into the larger financial system. 

Senator CRAPO. Well, thank you. My time has run out, but we 

will get back to this. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman. I want 

to commend Senator Corker and Senator Warner for moving so 

thoughtfully on this issue. I think, again, I thank the witnesses, 

but also the Chairman and the Ranking Member because, as we 

move here, I think we appreciate with each step how complex, 

interrelated, and how thoughtful we have to be about these judgments. We are transforming a huge, huge part of our economy, and 

14

I am glad we started, and I think Senator Corker and Senator 

Warner deserve a great deal of credit. Thank you, gentlemen, very 

much, and I thank the Chairman and the Ranking Member. 

Mr. Zandi, just this very simple-minded question in a very complex field, but you talk about capital, but one of the—sort of looking 

back, there was a lot of mysterious capital in the banking field several years ago, i.e., people created entities, borrowed, leveraged 

themselves up to their—you know, wherever they could, and then 

it used that capital to go in and to invest in different products. 

I know there is an ongoing FHFA pilot program, $30 billion in 

credit risk, et cetera. In general, and in terms of the pilot, is that 

an issue we have to deal with? And how might we deal with it in 

terms of avoiding being overleveraged? 

Mr. ZANDI. Well, that is a good question. One of the concerns 

about capital markets as a source of capital is, in fact, leverage in 

the entire system. This is what Ms. Gordon was referring to. And 

it needs to be considered in the context of the broader financial system and any future housing finance system that we establish. So 

that is a potential risk created by drawing capital from the capital 

markets. 

I do not think we are anywhere close to that yet. We are in early 

stages here, and what Freddie and Fannie are doing is quite small 

in the context of all the things that are going on, and quite appropriate, in my view, because we need to experiment. We need to see 

what works, what does not work, what the risks really are, and 

how to manage those risks. 

So what they are doing is entirely appropriate, but you are right 

when we are thinking about the future of the housing finance system and the capital structure and where the capital is coming 

from, this is one of the risks that we need to really think about because there is a potential systemic problem. 

Senator REED. And that just touches on what I think everyone 

has reflected, that there has to be a regulatory authority here that 

is looking at where the capital is coming from, that is looking at: 

Are these products accessible, available to everyone? Do they include multi-family housing as well as single-family housing? And 

that is something I think we would all recognize. 

Mr. ZANDI. Yes, I think I am taking as given that we are going 

to have a catastrophic Government guarantee. I cannot see any 

system that does not work without that, and that requires regulation. 

Senator REED. And that guarantor would be effectively a regulator as well as a guarantor. 

Mr. ZANDI. Exactly, yes. 

Senator REED. Mr. Johns, you talked about the TBA market is 

very critical, and there are multiple proposals, but one proposal 

seems to separate it into sort of two categories: first, a guaranteed 

piece up front, and then an unguaranteed piece, which would be 

sort of—or senior/junior, however you want to describe it. The issue 

might be, How do you price the second piece? It is pretty easy with 

a guaranteed—or easier to price a guaranteed issuance. I think 

that is a fair assumption. Is that a problem with this, having this 

set of bifurcated approach to TBA markets? 

15

Mr. JOHNS. I do not know whether it is a problem necessarily. 

It is certainly something I am happy to take away to our members 

and talk about. 

What I might highlight there is that with that proposal you are 

creating a bifurcation of the old market versus the new market, 

and consequently, you will have a very shallow new market when 

you move forward with that structure, which creates its own liquidity issues in and of itself. 

Senator REED. So the question then—one of the first questions 

not only in terms of pricing is liquidity. Would actually anyone 

come into that market given the narrow—the ability—the lack of 

liquidity. Is that a fair——

Mr. JOHNS. I think so. I mean, look at liquidity as almost synonymous with cost. If you have shallow liquidity, the cost goes up. 

If you have deep liquidity, the cost goes down. 

Senator REED. Again, I think this is extremely helpful, and as we 

go forward, I think we will learn more and I think very productively raise more questions than initially we will have answers, and 

that will allow us to come to a better answer at the end of the day. 

But thank you all for your excellent testimony. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Mr. Chairman and Ranking Member, thanks 

for having the hearing, and I do think we are at a point in time, 

after really 5 years—I remember how controversial the whole 

Freddie/Fannie issue was during the time we tried to do financial 

regulation. I think we are at a point where we are ready to take 

that on, and I thank you for having these outstanding witnesses. 

To the witnesses, you know, 10 Members of this Committee, 5 on 

each side, have gotten behind the bill called S. 1217, and numbers 

of other folks on the Committee I know are working on this issue 

and have really spent a lot of time on it. And I commend everybody 

for the time they spent on this issue. 

But starting with you, Dr. Zandi, is Senate bill 1217, with 10 

Members of this Committee on it and probably others being added, 

a good starting point? 

Mr. ZANDI. Absolutely. I think it is an excellent starting point. 

I think it shows a lot of hard work and a lot of good ideas and 

thoughts. And I do not know why you would want to start from 

scratch. I would start with that legislation. It is an excellent place 

to get going. 

Senator CORKER. Mr. Johns? 

Mr. JOHNS. I would agree. I think, you know, as I testified, we 

do believe that there is a phased implementation that we can work 

with on this, but the framework in and of itself and the end game 

is something that in general the industry is supportive of. 

Senator CORKER. Mr. Lienhard? 

Mr. LIENHARD. I believe a multi-trillion-dollar industry being run 

in conservatorship is long term an untenable situation. I think this 

bill definitely highlights all of the issues in moving forward, so, yes, 

I think it is a very good start. 

Senator CORKER. Ms. Gordon? 

16

Ms. GORDON. Absolutely I agree. I am just so glad that someone 

has started because I agree with Mr. Lienhard that we cannot continue in the conservatorship mode. 

There does remain, as I mentioned, work to be done. I think we 

have done a lot of work on the sort of asset class side of things. 

We still need to do a lot of work on the access for borrowers side 

to get the bill to a place where we will, you know, feel like it can 

pick up and do better than the last system. 

Senator CORKER. I appreciate that, and I would hope everybody 

would continue to make what has been worked on for a year even 

better, and I thank you for that comment. 

One of the things I think that the 10 Senators who all made 

major contributions to this piece of legislation, all of which are on 

this Committee, tried to do was to create something that is more 

dynamic. I think all of us know we have this duopoly right now. 

I know that even though it has some strengths, there are a lot of 

weaknesses in that regard. And just again to go in the same order, 

have we done something with the construct? Again, we all know 

that, you know, there are tweaks that people would like to make, 

but have the 10 Senators on this Committee that have worked on 

this created something that is more dynamic in structure than the 

system we now have? 

Mr. ZANDI. Yes, and I think that goes to the fact that in the legislation, you worked very hard to promote varied sources of capital. 

It is not just coming from one place. Let a thousand flowers bloom. 

Let us see what works here, what does not work. At some points 

in time, some sources of capital are going to work better than other 

sources of capital. And I think that makes the system dynamic, as 

you say, certainly more innovative because there is going to be 

more competition in the system as a result of that; lower costs because you are going to have capital coming in from different places; 

and, ultimately more resilient, as well. 

So, I think that is the strength of the legislation, that you are 

allowing the system to be, as you call it, more dynamic, yes. 

Senator CORKER. Thank you. 

Mr. JOHNS. I would agree again with what Dr. Zandi says. I 

think as well the developments of a common securitization platform that allows you to have more dynamicism, and the various 

forms of capital that could be—you know, private capital that can 

be considered for the proposed enhancement I think as well leaves 

you with a dynamic element. Of course, that could, you know, settle hopefully as we feel our way as to what the most viable structure is. 

Senator CORKER. OK. 

Mr. LIENHARD. I am assuming we have the same definition of dynamic, yes, but one of the things I am concerned about—and it is 

not entirely clear to me that the bill yet addresses this—is the relative potential—the potential to disadvantage a regional originator 

versus a national originator, an unintended consequence of that 

simply because of the regional concentration or various exposures 

that exist in certain States, and so that would be something I 

would really be concerned about. So dynamic, yes, but I am not 

sure that is clear. 

17

Senator CORKER. Well, and I am glad you made that comment. 

You know, I have spent a lot of time with your CEO and your 

former CEO, and, you know, regionals are kind of no-man’s-land. 

You know, some people like that, some people do not. I think you 

all like it. But I do think that we have done a lot here to focus on, 

you know, where the—making sure the larger institutions do not 

have an advantage and making sure that the smaller institutions, 

as I think the Chairman alluded to when he began, had a lot of 

access. But I agree that we need to do some work to ensure that 

the regionals that in some ways are no-man’s-land end up in a good 

place, and I appreciate you bringing that up. And I am not going 

to go to you, Ms. Gordon, because I am—I know I am out of time. 

I do want to say just if I could make one point, thank you, though 

for being here and thanks for your organization’s contributions to 

helping us all with this bill. 

There has been some discussion about capital and the increased 

cost—of the 10 percent capital, I might add, Dr. Zandi. But I am 

just, of course, getting with you. 

The fact is, you know, there are numbers of things that actually 

lower the cost, and when you look at the increased competition, the 

fact that you have issuers who are going to be competing with technology, you have got a single security platform instead of a dual 

platform like we have now, you have the full faith and credit, you 

have got uniform PSA, you have got a clear definition of reps and 

warrants, and, candidly, you move beyond the legal limbo that we 

are in. 

So I know that there are some costs of capital, but when you create the kind of dynamic and clear clarity that we would be doing 

with this bill, you also have some things that would lower costs. 

Would that be a fair statement to make? 

Mr. ZANDI. Absolutely. And I did not comment on the 10 percent 

capital. In my view, 5 percent is appropriate. But getting to 10 percent, I think it can be organized in a way that it is not too costly. 

And you are absolutely right, there are things in the legislation—

which should be, by the way, in every legislation—that will lower 

costs relative to where we are today, absolutely. 

Senator CORKER. I thank all of your for your testimony and your 

contribution and Mr. Chairman and Ranking Member for having 

this hearing. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. Thank you all for 

your testimony. 

As the Committee considers its priority for housing finance reform, I think there are several objectives, but one that I would like 

to hear from you on that I think is very important and that I consider the bedrock of our current system is the 30-year, fixed-rate 

mortgage, which has made home ownership more accessible and affordable for generations of Americans, and most assessments of the 

market have concluded that, without some form of public sector 

guarantee or backstop, the vast majority of home buyers would lose 

access to that type of product. 

So, number one, for the panel, do you all agree with this assessment? And, second, can you discuss what would be the impact to 

home buyers and even homeowners who, as they try to sell, would 

18

find themselves with a marketplace quite different in terms of who 

the buyer would be of losing a 30-year, fixed-rate mortgage? 

Ms. GORDON. I am happy to take a start. Yes, we absolutely 

agree with you that the 30-year, fixed-rate mortgage has been a 

tremendous product for families. It is sustainable. It helps make 

home ownership affordable. And we think protecting it should be 

one of the key goals of the work we are doing here now. 

We believe you really need two things to protect that product: 

one is the Government backstop guarantee, and the other is the 

TBA market, which needs to be sufficiently liquid that institutional 

investors can move in and out as they are required to do so that 

they continue to have interest in participating in this system. And 

so that is—you know, as we go forward—assuming that we have 

now somewhat crossed the Rubicon of having the guarantee and 

these discussions, really digging down and making sure that we are 

really protecting that TBA market and that we fully understand 

the impact of these different structures on that is really important. 

You know, as Mr. Johns said, if we start to fragment that or make 

TBA shallower, it will not work as well. 

Mr. JOHNS. I would just follow on from Ms. Gordon there. I think 

Ms. Gordon highlighted the need for the TBA and the Government 

guarantee. I think the two are effectively the same. If you are 

going to have the TBA remain liquid, you know, then the guarantee is required. And if the guarantee is there, the TBA market 

should be there providing we are cautious not to fragment that 

market, which will enable the maintaining of the 30-year fixed. 

Senator MENENDEZ. Well, I hope we have crossed the Rubicon. 

I am never sure we have crossed the Rubicon until we cross it. But 

I hope that that is there. I think this is one of the essential elements, and I think those who have been working on this issue—

I have shared my thoughts on it—I think they believe so, too. 

Another thing that I am concerned about is a multitude of housing finance reform plans that many of you have either authored 

and/or helped contribute to. I think most of those plans acknowledge the need to keep in place some form of that Government guarantee or backstop, and in doing so, the attention naturally turns 

to policies as it relates to protecting taxpayers from losses, which 

is an important interest. 

One example that is given in that regard is setting minimum underwriting standards for a mortgage to qualify for a guarantee. 

And as part of those standards, some proposals have suggested requiring a high minimum downpayment for a borrower to qualify. 

Now, certainly no- and low-downpayment mortgages were a 

major problem during the financial crisis, and a downpayment certainly can affect the size of the riskiness of a loan. But my concern 

is that if we go too far in the other direction and set the bar too 

high, we will end up shutting out the market of creditworthy individuals and families who will have other compensating factors and 

are in a high-risk default at all. I know that in my own case, the 

first home that I bought, if some of the standards that are being 

suggested were the case, I would never have achieved that. And I 

was a responsible borrower and have been a responsible borrower 

ever since. 

19

So my concern is a requirement that is too high can seriously undermine the goal of helping Americans afford home ownership. 

There is one prominent analysis that estimates that it would take 

an average family 14 years to save for a 5-percent downpayment 

and 22 years to save for a 10-percent downpayment. 

So my question—maybe, Ms. Gordon, I think you have done a lot 

of work in this regard, but I am happy to hear from others—can 

you elaborate on the importance of getting the calibration right on 

the policies like downpayment requirements in order to properly 

balance the goals of protecting taxpayers but also meeting the goals 

that we have of making sure that we can give responsible borrowers the opportunity to have the ability to own their home? 

Ms. GORDON. Thank you so much for asking that question. This 

is a matter of utmost concern to us when we think about accessibility of the system to the average homeowner. 

First, let me just say that while we saw a problem during the 

crisis with loans that had low downpayments, it was not the low 

downpayment characteristic that caused these loans to be risky. 

These loans tended to be heavily risk layered; you know, maybe it 

was a negative amortization loan that had a low downpayment and 

had little or no underwriting that was taking place. And that 

caused loans that were low downpayment to be risky or to fail. 

There is quite a great deal of evidence that well-underwritten and 

safe fixed-rate mortgages that were made with low downpayments 

performed quite well throughout the crisis. And so, you know, I 

think we cannot just isolate that one factor and say this factor in 

and of itself is a big problem. 

That said, you know, different lenders will have different views 

as to downpayment, which I think is appropriate. What I do not 

think we should do is enshrine a particular number in legislation. 

I think that would be a mistake regardless of which number we 

pick. 

Senator MENENDEZ. Thank you. 

Chairman JOHNSON. Senator Johanns. 

Senator JOHANNS. Let me also add my voice to those who are 

saying thanks to Senator Warner and Senator Corker. And to the 

Ranking Member and to the Chair, thank you so much for taking 

this issue on. 

Ms. Gordon, I could not agree with you more. Thank goodness 

somebody after 5 years has grabbed hold of this, because the one 

thing that seems clear from everybody’s testimony is the current 

system is not where we want to be. We need to head in a different 

direction. 

Dr. Zandi, you are probably feeling picked on because I am going 

to start with you also at the start here. 

Mr. ZANDI. Well, you know, all my life I have been at the end 

of the list. 

[Laughter.] 

Senator JOHANNS. That is right. 

Mr. ZANDI. Bring it on. It feels good. 

Senator JOHANNS. It feels good to be in the A category, I guess. 

Mr. ZANDI. In the A category, yes. 

Senator JOHANNS. I was following your testimony about capitalization, and I think there are a lot of central pieces to this legislaVerDate 0ct 09 2002 12:08 Feb 06, 2014 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 S:\DOCS\85236.TXT SHERYL
20

tion, S. 1217, but I think that has got—we have got to get that 

right, or this thing just does not work. 

You expressed an opinion that 5 percent is a good benchmark. I 

do not disagree with that. I think there is some safety built into 

that. You talked about varied sources of capital, and you have expanded on that. 

You then talked about G-fees and the impact on the monthly 

payment. I want you for the record, just so we are clear on this, 

to please explain how G-fees and other sources of capital are going 

to get us to this varied capital system, if you will. Do you follow 

my question? 

Mr. ZANDI. I am not sure I do. 

Senator JOHANNS. Yes. What I am trying to figure out is: How 

would you describe G-fees relating to what we are trying to accomplish here? That is really what I am getting to. 

Mr. ZANDI. G-fee is a guarantee fee. It is the cost to mortgage 

borrowers through the mortgage interest rate for paying for the potential losses that will occur from the lending. So, you know, you 

make loans. Some loans are going to go bad. That is going to create 

losses. And you need to charge a fee to compensate for those losses, 

and that is what the guarantee fee is. 

Now, if you want to be prepared for a little bit of loss, then you 

would only need a lower G-fee. If you want to be prepared for bigger losses, which I think we are talking about here—and we need 

to be prepared for bigger losses given what we went through—it is 

going to result in a higher G-fee or a higher mortgage rate. 

Senator JOHANNS. And to get to——

Mr. ZANDI. Does that make sense? 

Senator JOHANNS. It does. 

Mr. ZANDI. OK. 

Senator JOHANNS. To get to the 5 percent that you think we 

should be focused on, you are saying that the net effect of this to 

the borrower is going to be roughly $60 a month. 

Mr. ZANDI. Yes. That is obviously a lot of moving parts, a lot of 

assumptions. I am making assumptions about the future finance 

system, how we are going to organize ourselves. But my sense of 

it is that is a good ballpark figure. To get from where we are today, 

literally today, to that 5 percent world that we all feel really comfortable about and everything looks proper, I think it is going to 

be $60 a month, roughly. 

Senator JOHANNS. OK. Now let me shift focus a little, and others 

can jump into this. In my State, like so many other States, I am 

worried about the small lender, the community bank out there that 

is not looking to be regional, but they want to serve their clientele. 

They want to create a relationship and continue that relationship. 

We have tried with S. 1217 to make sure that their interests are 

protected. I would like your opinion as to whether you think S. 

1217 gets us there. 

Mr. ZANDI. Would you like my opinion? 

Senator JOHANNS. Yes. Start, and we can go right on down. 

Mr. ZANDI. I do. I think it is clear that the legislation is very sensitive to this issue. There are two key elements of the legislation 

that address this. One is in the common securitization platform 

there will be multi-lender securities. So what that means is that 

21

small lenders—community banks—can sell into a security, and that 

security will get the Government guarantee. So they have access to 

the Government guarantee. So that is very important and I think 

critical to any system, because that is important for rural areas 

and more niche markets. 

The second aspect of this is in the legislation itself there is a 

carveout for a bond guarantor that would service, explicitly service 

small lenders. So it is in the legislation. It is there to help protect 

against some of the concerns that you might have. 

So I think there are things we can think about and we can tweak 

this and make this probably work a little bit better. But I think 

those two things go a long way to addressing that concern. 

Senator JOHANNS. I am just going to have to ask the rest of the 

panel if they see something different, because I am out of time. Mr. 

Johns? 

Mr. JOHNS. I would not say I see anything different. I would 

maybe sort of add to that that when you are looking at some of the 

constructs of, for instance, the credit-linked note product, you also 

want to be amenable—or we should as an industry be looking at 

potential structures that allow multi-issuers to that extent, which 

also, I think, ties in with one of the points that Mr. Lienhard made 

earlier. 

Senator JOHANNS. Go ahead. 

Mr. LIENHARD. As I look at the legislation, I do think that it has 

addressed the needs of small lenders well, and I think about the 

regionals as being the ones sort of disadvantaged. 

Senator JOHANNS. OK. 

Mr. LIENHARD. I will answer in the negative. 

Senator JOHANNS. Ms. Gordon, any thoughts on that? 

Ms. GORDON. I am glad the legislation does have some specific 

structures that will help in this regard. You know, I think some 

other things that—there are some ways to prevent market concentration that are not in here, such as preventing an originator 

from also being a bond guarantor, that I think we should think 

about for this legislation. 

Senator JOHANNS. OK. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. 

I want to again actually start with Mr. Zandi. I think you appropriately pointed out that any reform may add some costs. But 

wouldn’t you agree that at this point in conservatorship that we 

have an artificially low, nonsustainable pricing system in that we 

have no private capital, we have a direct Government guarantee, 

Fannie and Freddie have—so that regardless of what reform would 

look like, there is going to be some bump-up in mortgage rates just 

because the system now has, in effect, no capital at risk? 

Mr. ZANDI. Yes, I think that is clear. I mean, I think the question 

is ultimately who pays. Is it the taxpayer who is going to pay for 

the mortgage, or is it going to be the lender and the borrower who 

pays for the mortgage, the full, all-in cost going through thick and 

thin economies? And right now it is on the taxpayer. 

Senator WARNER. Right now it is 100 percent on the taxpayers, 

no private capital at risk. 

Mr. ZANDI. And I think that is not appropriate. 

22

Senator WARNER. We, in effect, have while potentially artificially 

low mortgage rates at this point, we clearly have all taxpayer exposure. 

Mr. ZANDI. It is all taxpayer exposure, and it is inappropriate. 

And, actually, given the rise in G-fees since the GSEs have been 

in conservatorship, this has become less of an issue, but it is certainly still an issue. 

Senator WARNER. And would there be any disagreement on the 

panel in terms of the current status? 

Mr. Lienhard, let me acknowledge—one, thank you for coming up 

from Richmond. And, two, I agree with some of my colleagues that 

while we have, I believe, tried to make a very good-faith effort to 

make sure that the community-based banks, the credit unions and 

others, get access through a mutual or other entity so that they get 

that kind of fair pricing and nondisadvantage, that the regionals 

are kind of in between here. How will we get you into a market 

where there is—you get the same kind of pricing protection, but 

you get the kind of geographic diversity and others that you need? 

You know, at least as one of the group of 10 who have been involved in this, I am open for business on how we sort that through 

in a better way. I am not sure if you want to make any direct comment right now, but I look forward to——

Mr. LIENHARD. I mean, the only comment I would make is thank 

you for acknowledging that, Senator, and I think it is important to 

point out the fact that I believe our customers or our clients are 

advantaged by our ability to compete not only with small lenders 

but also the large lenders. And to the extent that the regionals are 

just by construct disadvantaged, that reduces the competition. So 

I appreciate both your and Senator Corker’s acknowledgment of 

this and would really look forward to working with your staff on 

ways to resolve——

Senator WARNER. And let me also acknowledge, I think servicing 

improvements need to be made and there are multi-family improvements. 

Ms. Gordon, I want to thank you again publicly for all the ideas 

and input you have had. I also want to make a bit of an editorial 

comment here in that, you know, kind of looking back at the old 

system, where we had a profit—you know, this profit-making enterprise that, as times were good, would make profits but when times 

were bad, the public bore the risk. It seemed like we had almost 

too many functions in Fannie and Freddie. We had a profit-making 

venture. We had this Government backstop entity. And we also 

had, you know, very important, again, goals that you have articulated quite well, you know, market access goals. 

I would argue that the way S. 1217 has tried to separate out 

those goals—and I know you have got ideas on tweaks, but actually 

make sense. And would you acknowledge at least—as a matter of 

fact, in the old system, unfortunately, these entities got criticism 

from both ends of the political spectrum. They got from those who 

were perhaps on the progressive end saying you are not doing 

enough, and you got interests from more the market-based section 

saying you are disrupting your market function by doing too much. 

Would you acknowledge that many of the very appropriate public 

housing goals that we would sometimes legislate with housing 

23

trust funds and others, worthy goals, but were oftentimes never 

funded? 

Ms. GORDON. Well, we have certainly had a problem in the past 

with not achieving, you know, exactly what we wanted to achieve. 

The National Housing Trust Fund and the Capital Magnet Fund 

are not being funded now even though the enterprises are awash 

in proceeds. And so I am not even sure why they are not being 

funded at this point. 

I think that in looking at the bill, which, you know, we are very 

glad to see, though we do, of course, want some tweaks, that there 

is the provision to collect a fund that will be used to support those 

borrowers or communities that need something of a leg up to participate in the conventional market. 

I do think, just to refer back to my answer to Chairman Johnson 

earlier, that the bill probably needs to do more to ensure that existing creditworthy borrowers are served, regardless of where they are 

or whether they are self-employed or whether they live in a rural 

area. I think we need to advance more on that. 

But I think we should be aware, you know, in a policy sense that 

Fannie and Freddie did have a very clear public purpose. It did 

have affordable housing goals. And while there are those who 

think, I think incorrectly, that the goals caused the crisis, whereas 

there are others, as you noted, on the progressive side who feel like 

the goals never did enough, the fact is if we are dismantling that 

system, it is absolutely critical to have a strong sense of public purpose at the center of this new system in a way that is sustainable 

and appropriate. 

Senator WARNER. And my time is up. I would simply say—and 

I know there are others who disagree with part of this, but at least 

if we are going to have these goals and part of the nontax pricing 

function of this Government backstop would give this auditable, 

identifiable funding entity that you could—we could measure in a 

way that we were never able to measure when it was commingled 

in the old system. And, again, we may agree whether this is appropriate or not, but I actually think there is a lot more transparency 

and a lot better ability to audit than we had in the past. And I 

thank again the Chair and the Ranking Member for the hearing 

and their willingness to work on this. 

Chairman JOHNSON. Senator Toomey. 

Senator TOOMEY. Thank you very much, Mr. Chairman. I want 

to follow up in the direction that Senator Warner was going. But 

first a quick question. I hope there is unanimity about this. That 

is, with respect to this idea that some municipalities have floated 

that they will, under the justification that they give citing eminent 

domain, they are threatening to confiscate certain private-label 

mortgages from investors. 

So putting aside what strikes me as an egregious affront to the 

Constitution, the rule of law, and private contracts, does everybody 

agree that, to the extent that this were actually to take place, it 

would certainly discourage private capital from going into the residential mortgage market? Does everybody agree with that? And 

that that has, of course, the consequence of making mortgages either less available or more expensive or both? 

24

Mr. JOHNS. I would actually go a little further and say not just 

it will discourage, it is discouraging, the mere threat——

Senator TOOMEY. The mere threat is already having that effect. 

Mr. JOHNS. Absolutely. 

Senator TOOMEY. Does anybody dissent from that? 

Ms. GORDON. I mean, I am not sure I will dissent that the threat 

is having an effect, but I will say that, first of all, I think this is 

a local matter; and, second, there have been numerous efforts for 

municipalities to be able to address the problem that they face. 

And until they have a way to address that problem, it is not surprising that a number of different avenues are being pursued. 

Senator TOOMEY. OK. Thanks. 

Let me go on to the heart of this, another matter, which is I am 

little concerned that it sounds as though it is almost given as a certainty that there must be a Government guarantee in this market. 

And I would remind everybody, for what it is worth, the House 

Banking Committee has passed out of Committee a GSE reform 

bill that has no Government guarantee. So this is not terribly unusual. I would also point out we have huge segments of our capital 

markets that have never had a Government guarantee. Nobody 

contemplates a Government guarantee, I trust, for commercial 

paper markets and corporate bond markets and other sorts of markets where the private sector provides massive liquidity on a routine basis. 

I also want to stress there are very substantial risks, I think, 

that attend to a Government guarantee. The obvious is it puts taxpayers at risk. And I think we should not overlook that risk that 

taxpayers bear. 

I think it tends to divert capital that would otherwise go to other 

places, but if the Government is weighing in with a guarantee, it 

creates incentives to send money in certain places. It probably encourages excessive risk taking. 

And the last and the biggest risk, I think we have heard allusions to it around this table today, which is the inevitable 

politicization of the process. If you have a Government guarantee, 

it is necessarily a political process to define the terms under which 

one has access to that guarantee. And in the process of setting 

those rules, what we hear—and, in fact, the Senator from New Jersey brought it up as his very next question—the concern that 

maybe not enough people will have that access. All the politics always drives toward ever expanding the universe of people who will 

have access to this, and I do believe that this political mandate to 

expand mortgage lending to people, including some who were not 

able to pay back those mortgages, was absolutely at the heart of 

the financial crisis that we just went through. And it seems to me 

maintaining a Government guarantee preserves—continues that 

risk. And it can be lessened somewhat. I am sure there are ways 

to do that. But I do not see how it ever goes away. 

Now, it seems to me the arguments I hear and justification for 

the Government guarantee usually seem to be variations on three 

arguments: one, we need it to maintain the 30-year, fixed-rate 

mortgage; number two, it helps keep mortgage rates lower than 

they would otherwise be; and, number three, it is the assurance 

25

that we will always have a liquid market, even in the worst of circumstances that might otherwise dry up the private capital. 

I think we should spend some time really evaluating these presumed advantages. I do not think we have challenged them as 

thoroughly as we might. 

A quick question. Mr. Zandi, I think you were asked the question 

in a House hearing, a Banking hearing, I assume, about whether 

or not you thought there would be a 30-year, fixed-rate mortgage 

product in the absence of a Government guarantee. And if my information is correct, the answer was that we probably would have 

such, and we do, after all, have private-label securities, including 

30-year, fixed-rate private-label mortgages that have no Government guarantee. So the product does exist in the absence of a Government guarantee. Isn’t that true? 

Mr. ZANDI. It does. It would be a marginal product compared to 

where it is today. Europe, the rest of the world, would be a good 

case study for what the 30-year, fixed-rate would look like without 

a Government guarantee. And if you look at those markets, the 

share of the market that has a 30-year, fixed-rate, fully prepayable 

mortgage is small, 10, 15 percent of the market. 

Senator TOOMEY. But there could be other differences that might 

explain part of that as well. 

Mr. ZANDI. Could, yes, absolutely. 

Senator TOOMEY. And so it is not clear that that is the whole 

thing. And we have had private-label mortgages and jumbo mortgages that are 30-year and fixed and they have no Government 

guarantee. 

Mr. ZANDI. Yes, but I think it is reasonable—a prudent planner 

would expect, without any Government guarantee—take the House 

financial services bill, the PATH bill. If that were law, taken as is, 

the share of the mortgage market that would be a 30-year, fixedrate, fully prepayable mortgage would be much, much smaller than 

it is today. 

Senator TOOMEY. Or it might be maintained but at a higher rate. 

Mr. ZANDI. Well, it would be at a higher rate, so then it would 

be unaffordable and therefore the share would be——

Senator TOOMEY. Well, it is an open question as to how much of 

the difference in rate gets capitalized in land values and——

Mr. ZANDI. Absolutely. And, by the way, all your concerns I sympathize with. Those are very legitimate concerns and need to be explored. I totally agree with that, that you are absolutely right, 

those are things we need to worry about. That is why a high rate 

of capitalization in a hybrid system is critical because it addresses 

some of those concerns. It does not mitigate them, but it addresses 

them. 

Senator TOOMEY. I see I have run out of time, but I do hope we 

will drill down a little bit more on some of these issues. And, Mr. 

Chairman, I appreciate the indulgence. 

Chairman JOHNSON. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. I am very pleased 

that the Committee is going to focus on housing finance reform this 

fall. I think it is very important. But as always, the devil is in the 

details, so I just wanted to ask a couple of questions. 

26

I want to go back to the question about underwriting criteria. As 

you know, there are lots of factors that go into that: income level, 

total assets, credit history, savings, outstanding debt obligations, 

downpayment amount, just to name some of them. And a borrower 

can do poorly on some of those but still do well on others and be 

a good candidate for a mortgage. 

Community bankers tell me that this very flexible, holistic approach is very important to them in placing mortgages and making 

their lending decisions based on individual circumstances and market conditions. 

So I understand why the Government would want to make its 

guarantee—make sure that its guarantee is available for mortgages 

that are likely to be repaid. But the question is how to make sure 

that the Government is insuring decent mortgages. So I want to 

ask a structural question as we are thinking about this statute. 

Should the statute set a specific condition that must be met, like 

a certain downpayment amount or a certain credit score or a certain income level, and then hold hard and fast to that no matter 

what as a matter of statutory law? Or is it better to let the mortgage market adapt based on market conditions and based on new 

information about what combination of underwriting criteria best 

predict repayment? Ms. Gordon, maybe I could start with you on 

that. 

Ms. GORDON. Sure. Thanks so much for this question, because I 

believe the answer is we absolutely should not set underwriting criteria in legislation in the context of the housing finance system. 

What we do have now that we did not have before is through the 

Dodd-Frank Act there are quite specific rules now governing the 

underwriting of mortgages, and those rules have been the subject 

of much discussion, much work by the Consumer Financial Protection Bureau, and, you know, quite a lot of interested parties have 

been involved in that process. And while not all of us agree with 

every part of the way the rules came out, those rules are there 

now, and they are underpinning that aspect of consumer protection. And so I think it would be difficult if we, as I said, enshrined 

things in legislation. 

Senator WARREN. OK. And let me just ask that same question of 

Mr. Lienhard. You do this for a living. 

Mr. LIENHARD. Yes, I think that one of the pitfalls I see with 

hard-coding underwriting standards into legislation is that underwriting expertise and criteria can change over time, and so presumably we get better and better at understanding the characteristics 

of borrowers and the collateral in terms of sort of what a downpayment or what debt-to-income ratios or any other criteria that might 

emerge years from now. So I think that is sort of problematic, because when it is in legislation, then it is hard to sort of innovate 

and advance. 

I also think that the capital standards for the private capital 

should be able to create very legitimate risk to the guarantees, and 

that will force, in my view, to borrow Senator Corker’s word, a dynamic underwriting enforcement or mechanism that I think you 

are looking for through the guarantee, the private guarantee function. So I would be very opposed to hard-coding underwriting 

standards. 

27

Senator WARREN. Good. Thank you. 

I am going to assume that I am going to get a similar answer, 

because I want to try to hit a second question. So if I am not, you 

should flag me. OK? 

Mr. ZANDI. Well, I think the loans that are guaranteed by the 

Government in the system should be QM. 

Senator WARREN. All right. Got it. 

Mr. ZANDI. And that should be hard-coded. 

Senator WARREN. Got it. But it is QM. 

Mr. ZANDI. QM. 

Senator WARREN. Rather than coding in a specific quality. 

Mr. ZANDI. Right. Should be QM, though, because that gets rid 

of a lot of the egregious loan products that are at the heart of problems we had. 

Senator WARREN. Right. So I want to ask a different question 

then as well, and that is, there are—because there are limitations 

on the scope of the Government guarantee, there will be mortgagebacked securities that are not guaranteed. That is our private-label 

market. We might make an estimate, just to get us started, that 

that might be something like half the market, $5 trillion. We do 

not know. I realize it will depend on other factors and likely go up 

and down. 

But here is my concern. My worry is that we will have a guaranteed market and we will have a private-label market, but that the 

private-label market will create the same kind of problem that we 

ended up in in 2008. There is no explicit guarantee of the privatelabel market, but if it is so big and so important that the players 

in the market begin to believe that there is an implicit Government 

guarantee, that that in turn will create the problems of moral hazard, of excessive risk taking, the problems with Fannie and Freddie 

that got us here in the first place, and all the problems of they 

scoop up the profits in good times and then leave the taxpayer with 

the bill in bad times. 

So I am worried about the question of whether or not we need 

some Government regulation of the nonguaranteed market to ensure that this kind of aggregation of risk does not occur. Dr. Zandi? 

Mr. ZANDI. I think it is appropriate for you to be concerned about 

this, and let me make a broad statement and then a more specific 

one. 

Broadly, it is very important to consider housing finance reform 

in the context of the entire mortgage finance system. You know, 

right now we have just been focused on the part that would get the 

Government guarantee, but we have to think about it in the context of bank lending in terms of the private-label securities market 

and what may come from other sources. So we have to think about 

this—and the FHA, by the way. So we have to think about this holistically, and that is one very good thing about the PATH Act. It 

did try to think about it holistically. So that is key. So that is a 

broad statement, and so you are exactly right that we should be 

focused on this. 

More specifically, I do think that there should be some levers to 

address this risk. I do think we have QRM. QRM feels like it is 

going to be set to QM. But I would argue that QRM and QM are 

not coming down from the Mount, right? These are things that we 

28

can adjust and set in the future if things seem to be going awry, 

because now regulators are looking at the system in a—looking at 

it in terms of systemic risk, that this is now a lever we have, the 

regulators have a lever to change it if we need to. 

The other thing I would say is that the regulator that we are 

talking about here in the context of housing finance reform should 

have broader authority as well to look at the entire system and 

make some changes, if need be. I am just making this as an example. You know, I think it might be appropriate that we have a rep 

and warranty system that is consistent across all lending so that, 

you know, we do not get that bifurcation in the mortgage finance 

system. And if you do that, then you can control for this risk right 

at the root, you know, in the origination process. 

Now, we have to think this through, and I am thinking out loud 

for you, but—and there may be things I am not thinking about, but 

I think that is the kind of way I would approach this, yes. 

Senator WARREN. Good. Thank you very much, and thank you for 

your indulgence, Mr. Chairman. I hope we can pursue this later. 

Thank you. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you. Good to see you, Mark. 

I started wrestling with the GSE reform, as you know, and others probably, about 10 years ago. I had an economist that was advising the Banking Committee at the time I was Chairman of the 

Committee, and she came to me and told me then could she have 

30 minutes of my time. I said, ‘‘Absolutely.’’ And she explained to 

me then how thinly capitalized Freddie and Fannie were and how 

concerned she was and we should be with the implicit guarantee. 

And also some of the underwriting standards had eroded, so to 

speak. 

We tried then to reform Freddie and Fannie. We were not trying 

to put them out of business. We were trying to build their capital 

up and so forth and change some things, to no avail. Of course, we 

are where we are today, and that is why we are having this hearing. 

I am concerned about the housing market. Right now Fannie and 

Freddie are about the only game in town. But we still—they are 

sitting in our lap. They are doing a lot better, I think, under the 

leadership of Mr. DeMarco. They are buying better mortgages. Is 

that fair, Dr. Zandi? 

Mr. ZANDI. Yes, that is fair. 

Senator SHELBY. All of that? 

Mr. ZANDI. Yes. 

Senator SHELBY. But still if we are going to reform the GSEs, 

how do we, if we do, limit or can you limit the implicit guarantee? 

See, a lot of us would like to create the private sector period, if we 

could. Is that possible? I do not know it is probable. And a lot of 

people do not want to have capital. Fannie and Freddie, as I just 

said, had some of the thinnest capital of any financial institution 

in the world left standing. 

Mr. ZANDI. Right. 

Senator SHELBY. Capital itself will not solve everything, but it is 

a cushion, a big one. Some people argue—and I have not analyzed 

everything in this proposal by Senators Warner and Corker, but we 

29

are doing it. Will this legislation—I will start with you, Dr. Zandi. 

Would this legislation change dynamically how the GSEs operate? 

Or will it be akin to what we had before? 

Mr. ZANDI. It will change it wholesale, Senator. You know, I 

think just to give you context, Fannie and Freddie before the crisis 

had 50 basis points of capital, 0.5 percentage points, and that is 

being charitable. 

Senator SHELBY. You could see through it, couldn’t you? 

Mr. ZANDI. The quality of the capital was highly questionable. 

Senator SHELBY. Sure. 

Mr. ZANDI. We are talking about in the Corker-Warner bill as 

written now 10 percent capital, and I am arguing, you know——

Senator SHELBY. I know. 

Mr. ZANDI. Yes. So and then there are many, many other 

changes in the legislation. So we are talking—and it is an explicit 

guarantee. It is not implicit. You know, it is right there in our face, 

and we are saying it is explicit, and we are charging for it, and we 

have all the appropriate mechanisms for ensuring that taxpayers 

get their money back. 

Senator SHELBY. But won’t you have to tie capital, which is a 

cushion—is 5 percent maybe not enough? You can argue that. Or 

10 percent or 8 percent. But adequate capital, good capital, with 

underwriting standards and so forth. You know, we have—we all 

have preached and pushed for people to have a chance to own a 

home here. But, gosh, we found out that everybody cannot or would 

not want to own a home or would ever make the payments and so 

forth, which is sad in a way. But some people do not want to buy. 

Our home ownership has gone down some. But isn’t the key to any 

mortgage underwriting the underwriting itself, the credit, the 

downpayment, what they got in the game, and the capital of the 

institution, all this tied together? 

Mr. ZANDI. Sure, absolutely. You can have all the capital in the 

world, but if you are making——

Senator SHELBY. Bad loans. 

Mr. ZANDI. It is not going to matter, right? It is going to wipe 

out the capital. So we have to make sure it is not garbage in. We 

have to make sure that it is high-quality mortgages that are getting the explicit Government backstop, yes. 

Senator SHELBY. What is your—and I will give, with the help of 

the Chairman maybe, others a chance to answer. You said you believe this is a step in the right direction, you know, this proposed 

legislation. You have got to have some concerns there. How can we 

improve this legislation? 

Mr. ZANDI. I do have concerns. 

Senator SHELBY. OK. 

Mr. ZANDI. Some of it just resolves around the specific numbers. 

But in terms of structure, I would just mention one thing, and that 

is, I think it is very important that the institutions that are providing the capital cannot also be making the loans, that we need 

a clear break between these functions. Because if you allow them 

to combine, then you can get a vertically integrate market. What 

I mean is big institutions that feel like Fannie Mae and Freddie 

Mac that are too big to fail. So we need to separate those two 

30

things, those two functions, and that has to be clear in the future 

housing finance system. 

Senator SHELBY. Heretofore they have been buying the loans, 

haven’t they? 

Mr. ZANDI. Yes. Now, in the current structure, Fannie and 

Freddie do not originate loans. We need to preserve that aspect of 

the current system. 

Senator SHELBY. OK. Mr. Johns, do you have some observations 

on this? 

Mr. JOHNS. Yes, I think the capital does have to be tied to the 

underwriting standards. I think we would encourage, you know, if 

there is going to be a hard-coded number in the legislation, you 

know, in addition to that you want to have some regulatory flexibility that would allow you to take account of those differences in, 

you know, not just underwriting standards but any other criteria 

that should drive the loss number higher. 

Senator SHELBY. Mr. Lienhard? 

Mr. LIENHARD. I think my concern hinges around the execution. 

So while we need to move forward in terms of reform and the current system is untenable, it is very simple for an originator and the 

nature of the guarantee is very straightforward. There is no way 

we will replace that, but we will have multiple options, and those 

options involve in my mind, as I think about implementation, execution risk on the part of issuers. 

Senator SHELBY. Give us a couple of examples. 

Mr. LIENHARD. If you choose the wrong structure, if you choose 

the wrong guarantee and how that attaches to the TBA market and 

how—you know, we simply cannot——

Senator SHELBY. Should that be done by the regulator, the structure, or should we tie it to legislation and put it in a straitjacket? 

Mr. LIENHARD. I think that the regulator is intimately involved 

in regulating those structures. That is actually really important. 

But the legislation should set the tone, and I think it is important 

for the Committee to recognize that, you know, it is not that easy 

for originators to just simply switch to a new structure or a new 

provider if, in fact, it is turning out that that mechanism is not 

working well. So I think the choice, the multiple choice and this 

idea of competition is a really good one, but the execution associated with sort of switching choices is challenging from an implementation perspective. 

Senator SHELBY. Let me—well, you answer first, Ms. Gordon, 

and then I have got one follow-up. 

Ms. GORDON. Just a couple of comments on things that have 

come up throughout your remarks. I do think it is important to 

note that the erosion of underwriting standards was, in fact, initiated and led by what was happening in the private securitization 

market. It was not until toward the end of that period that Fannie 

and Freddie, because of their conflicted responsibility—well, because they were chasing profit and market share, they at that 

point abandoned what had been very sound underwriting standards that had kept the market safe for many years, and that was 

their big mistake, along with the gross undercapitalization that you 

have talked about. 

31

I do think now that we have instituted underwriting standards 

through QM and risk retention standards through QRM that it is 

easier to link up this new system to those standards, which will 

help on the underwriting side, and we have already talked about 

the capitalization side. 

Senator SHELBY. Let me ask my last question here. We have had 

testimony before this Committee before on a number of occasions 

that in the multi-family area, conventional FHA, but conventional, 

too, that there are very few foreclosures. Very few. And I know that 

is—we are not talking about apples and oranges. We are talking 

about big apples and smaller apples here, I think. And I know that 

their underwriting is very important in multi-family for the most 

part, especially conventional. You have got to have some skin in 

the game. But is the lack of skin in the game—in other words, lack 

of downpayment underwriting—that causes some of our problem? 

Dr. Zandi? As opposed to multi-family. 

Mr. ZANDI. Yes, I mean, I think in the single-family system, precrisis, currently, there is not enough skin in the game. We do not 

have enough capital, private capital. We do not require the folks 

that are receiving the mortgages and benefiting from issuing the 

mortgages to fully participate in the risk. So that is what we need 

to fix, and if we get that right, I think we will have a much sounder system with lower default rates and, you know, address some of 

the concerns that Senator Toomey has with regard to moral hazard. 

Senator SHELBY. Mr. Johns, do you have anything? 

Mr. JOHNS. Are you talking about skin in the game from the——

Senator SHELBY. Downpayment. 

Mr. JOHNS. From the consumer perspective. 

Senator SHELBY. Equity. In other words, if I—I remember 

anecdotally, I remember when I was very young—and that was a 

long time ago, but my wife and I bought our first house, built our 

first house, which we still live in. We want to pay as much down 

as we could to make the payments lower and also to pay it off as 

soon as we could, because we came from parents who came out of 

the Depression. They did not want debt. You understand that well. 

Now a lot of people do not want to pay anything down, even if they 

could. So I am speaking of skin the game. 

Mr. JOHNS. OK. So I think on that side I would support what Dr. 

Zandi is saying. It is an interesting sort of dichotomy because obviously you will have—we have many members within the Structured Finance Industry Group. You range from the issuers to 

servicers and the originators, and you have investors at one side. 

Clearly there is a balance of play there from a market perspective 

as to, you know, the more skin in the game that a homeowner has, 

then, you know, clearly there is less likelihood of default. At the 

same time, if you add that requirement to can you access the market, then it may reduce the amount of originations that you have 

that you can clear away and get low-cost funding for. 

So, you know, as an organization, it is something that we are 

very aware of. You know, if we look at the risk retention rules that 

have sort of recently come out, clearly it is an issue that will be 

debated over the next couple of months until, I think—at least 

until the common letters are submitted on October 30, and I would 

32

be happy to come back and give you a full read on where the industry as a whole sits on that. 

Chairman JOHNSON. Could the Senator think about wrapping 

up? 

Senator SHELBY. I will conclude. You have been very generous 

with my time and yours, too. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Heitkamp? 

Senator HEITKAMP. We all know how you feel, waiting to be last. 

We are in a spot where we have choices, and if we get bogged down 

on political ideology, we will make the choice to do nothing. Because I have been around here long enough now in my short time 

period to know that when we get into philosophical debates, we do 

not do reform. We do not do the things that we need to do to give 

certainty to the market, to give certainty to the American people, 

and to respond to their concerns. 

So I am going to ask one very broad question, which is three 

choices: Do nothing, which seems to be the kind of choice of default 

in Washington, D.C., as we bog down in philosophical debates. We 

have got the PATH Act, which shows that this is going to be market driven. Very little information—and maybe I am just not looking in the right places, but very little information about the consequences on the American middle class and home ownership and 

new families as a result of the lack of expression of explicit Federal 

guarantee and the availability of the 30-year, fixed-rate mortgage 

into the future. And we have got a hybrid. We have got an opportunity to do real reform, and I know that there are so many of you 

on this panel who have participated in that discussion. Great work. 

I have read a lot of the work that has come out of your organization and I really appreciate it. For somebody who brings maybe a 

new perspective to this issue, it has been extraordinarily helpful. 

And so those are our three choices. Obviously the bill that we are 

considering today is the hybrid. It is that choice. 

I want to ask you, Doctor, where can we better inform the American public about the actual consequences to our middle class and 

to our citizens on the consequences of those three choices? Where 

do we go for that information? Because I know you have been 

asked here kind of pick a choice or do a critique, and that was 

going to be my question, which is do a critique between the PATH 

Act and what we have in front of us in terms of affordability and 

availability of home ownership. But I want to know who is going 

to do that work so that we can better inform the public. 

Mr. ZANDI. Well, I think the thing that would resonate with people is, you know, how much is this going to cost me? You know, 

what does it mean for my monthly mortgage payment? And——

Senator HEITKAMP. If I can just interrupt, it may also be, Can 

I get a mortgage? 

Mr. ZANDI. That as well, sure, absolutely. But I think if we can 

come up with that number under different pieces of legislation, 

that would be quite informative. You know, I have taken a crack 

at that. I have done that for the PATH Act. I have done that for 

Corker-Warner, under different capitalization assumptions. And, of 

course, there are a lot of moving parts. But we have done that 

work. We can make it better and refine it as the legislation improves, but——

33

Senator HEITKAMP. And can you give some insight on your conclusions as a result of that work? 

Mr. ZANDI. Yes. So if we go from the current system to where I 

think the system should be, 5 percent capitalization, that would 

add roughly $60 to the monthly mortgage payment. 

If we go to a 10 percent capitalization—so this is what is in 

Corker-Warner right now—that would probably add another $60 to 

the monthly mortgage payment. So it would be $120 from where 

we are today. And, again, a lot of moving parts and a lot of assumptions. 

If we go to the PATH Act, then—and I am going to do this calculation for you precisely, but I am just going to give you a sense 

of the ballpark estimate. I do not want to be on the record saying 

a specific number and be wrong, but it is probably double that. You 

know, it is probably $240 a month from where we are today. So it 

is a significant increase in the cost. 

And, obviously, those are big numbers, right? I mean, just add 

it up. And that means that for the average typical home buyer, it 

is going to be a lot harder to get a mortgage. And then for the people—and those numbers I just gave you, that is for the typical borrower. That is for the person that is right down in the middle of 

the distribution of borrowers in a normal economic environment. If 

you go to the person—take QM and go to the end of the box, you 

know, the guy that is just marginal, still qualifies but is marginal, 

in a bad economy, in a recession, let us say, then the cost is going 

to be higher than that, measurably higher than that. 

So these decisions you are making really mean a lot for Americans. I mean, 65 percent of Americans own a home. You are going 

to affect them. 

Senator HEITKAMP. And I see I am out of time, but I just want 

to reiterate the point that for so many Americans, their home has 

not just been a house. It has also been their investment, banking 

on the availability. And as we look at a reduction in the number 

of companies, in fact, an elimination in the number of people—entities in the private sector who are willing to do a defined benefit 

plan anymore, we are all now saving for our future. I worry greatly 

how all of this will affect retirements into the future, how all of 

this will affect our ability to supplement our older income. And so 

this is enormously important, not just to the American economy, 

but it is enormously important to Americans that we get this right. 

And I think, you know, we have this Committee, at least the 10 

of us who have sponsored this legislation, take a look at this and 

say if we do nothing, this place will not result in reform. And that 

may be the worst outcome for the people who most disagree with 

this provision. 

And so I just want to—you all have had an enormous opportunity, I think, here to provide input. I hope that you will continue 

that, and I thank you for the work that you have done on behalf 

of the American people and on behalf of the American economy. It 

has been extraordinary, and I have really enjoyed listening. 

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

being here today. Your testimony will help guide our hearings 

going forward. I look forward to continuing this discussion and 

34

working with Senator Crapo and all of my colleagues on the Committee to achieve an agreement on housing finance reform. 

This hearing is adjourned. 

[Whereupon, at 12:07 p.m., the hearing was adjourned.] 

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

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PREPARED STATEMENT OF JEROME T. LIENHARD, II

PRESIDENT AND CHIEF EXECUTIVE OFFICER, SUNTRUST MORTGAGE, INC.

SEPTEMBER 12, 2013

Good morning Chairman Johnson, Ranking Member Crapo and Members of the 

Banking Committee. I’m Jerome Lienhard, president and CEO of SunTrust Mortgage, a subsidiary of SunTrust Banks. Housing finance reform is a critical matter 

with wide-ranging implications. Thank you for allowing me to participate in the consideration of this important subject. 

I am appearing today in my capacity at SunTrust Mortgage and this testimony 

was prepared after consultation with the Regional Bank Group, an informal coalition of mid-sized lending institutions located throughout the United States. All 

views expressed today, however, are my own. 

SunTrust is headquartered in Atlanta and operates mainly in the Southeastern 

United States. We are committed to Lighting the Way to Financial Well-Being by 

listening to client needs and offering a broad range of banking, borrowing, and investment services for individuals and small to-mid-sized businesses. 

SunTrust Mortgage, the organization that I lead, is based in Richmond, Virginia 

and employs about 4,300 teammates. Last year, we originated over $32 billion in 

mortgage loans which helped more than 120,000 clients purchase a home or lower 

their monthly payment through refinancing. 

The Regional Bank Group consists of 18 financial institutions that share a business model and a set of values dedicated to providing banking products and services 

to America’s families and businesses. We take in deposits and redeploy them by 

making loans in our communities. Our clients are people and businesses with real 

needs such as checking accounts, loans and payment services. 

Today I’d like to make two important points from the perspective of a regional 

bank:

• First, while there is a need to reform the housing finance system, it is critical 

to retain the basic ‘‘plumbing’’ of the system that draws in enormous sums of 

investment capital and provides borrowers with rate certainty. These features 

can be retained in a mortgage market that serves the interests of borrowers and 

taxpayers alike.

• Second, reform must bring more private capital into the mortgage market in a 

principal loss position without reducing the global demand for mortgage-backed 

securities and while providing competitive access for small and medium-sized 

institutions that serve millions of homeowners.

I will spend a few minutes elaborating on each of these points. 

Out of thousands of mortgage loans that we make every year, on average, we hold 

only one in six on our balance sheet. So while we own $30 billion worth of mortgage 

loans, we actually originated and service more than $140 billion in mortgages involving more than 800,000 households. This is possible for us, and other regional 

banks, due to the existence of the secondary mortgage market. 

This vast majority of the mortgages we originate for sale in the secondary market 

are either ‘‘conforming’’ loans, meaning they comply with the guidelines set by 

Fannie Mae and Freddie Mac; FHA loans, which comply with the insurance terms 

established by the Federal Housing Administration in HUD; or VA loans eligible for 

the Veterans Administration’s guaranty program. 

The process by which we price and close the loan and package it for the secondary 

market are important to a well-informed discussion relating to housing finance reform. 

Our clients come to SunTrust Mortgage through our branches, on-line or through 

our network of loan officers and institutional mortgage partners. We listen closely, 

assess needs, and thoroughly explain the full range of products that we have available to our clients. 

To provide the client with basic information regarding how much they can afford 

to pay for a house, we must be able to tell them the interest rate and the monthly 

cost of the loan. You can’t buy a house if you don’t know what your mortgage payment will be. 

We do this by referencing a daily pricing sheet that provides the interest rate and 

loan terms that can be offered on a guaranteed basis. These prices are set from the 

price of MBS trading in the ‘‘To Be Announced’’ (TBA) market. TBA security prices 

assume delivery of conforming mortgages into a Freddie Mac or Fannie Mae mortgage-backed security on a forward basis. The forward-pricing mechanism of the secondary market allows us to lock in the interest rate for clients for up to 90 days. 

55

Once we lock an interest rate, we proceed through the mortgage lending process. 

Acting as an agent for Fannie Mae and Freddie Mac, we make sure the client’s 

mortgage is properly qualified, underwritten, documented, settled and delivered 

using GSE guidelines and requirements. This requires expertise and very detailed 

execution. 

But it all starts with the certainty we have regarding how we are funding the 

mortgage. Without that certainty, primary market lenders would be unwilling and 

unable to provide forward price certainty to borrowers. The MBS market solves the 

‘‘chicken or egg’’ problem of funding risk by allowing lenders to set mortgage loan 

delivery terms up front, while allowing execution and delivery to follow. 

Through the combination of mortgage standardization and the function of the 

MBS market, the existing system provides a tangible benefit to borrowers. And 

these benefits are available for borrowers who transact with originators of any size: 

local banks, Main Street banks such as SunTrust, as well as the largest mortgage 

originators. 

While there is a need to address taxpayer risk by making structural changes to 

the housing finance system, the securitization platform, the standard-setting on 

lending and documentation and the servicing requirements are absolutely essential 

to maintaining a secondary market. This infrastructure is so foundational that we 

must emerge from housing finance reform with these key functions intact. 

Let me conclude with a few remarks on the critical issue of the structure of the 

credit guarantee. Our markets perform so well in large part because credit risk associated with mortgage default is assumed by the GSEs. Investors from around the 

world allocate trillions of dollars of capital to our market because it only involves 

interest rate risk. 

The problem, of course, is that providing credit protection puts taxpayers at risk. 

Using private sources of capital to cover credit exposure can help alleviate taxpayer 

risk. 

However, if changes are made to the credit guarantee function, it must work well 

for investors. It must also operate transparently and with scale. The U.S. mortgage 

market involves trillions of dollars. This quantity of private capital required to backstop the market is very significant. If that market shrinks dramatically, so does 

lending to borrowers. 

We must also consider that if a variety of credit risk devices emerge in place of 

the relatively simple credit guarantee we have today, it could make mortgagebacked securities difficult for investors to value, fracturing the investor base, reducing liquidity and increasing costs. 

To the extent that private capital is intended to stand before any taxpayer-backed 

guarantees, the entities and instruments must be subject to regulatory oversight. 

If regulators cannot understand nor keep track of the various risk sharing mechanisms, there is a danger that they will not perform as needed under crises conditions. 

Finally, any new source of private sector credit protection should be available for 

all primary market lenders—including large, small and Main Street institutions. If 

certain entities cannot obtain competitive access to credit protection in the secondary market, they will have a great difficulty competing in the primary market. 

Measures that create advantages for the very largest issuers of MBS, or make the 

cost of market access more expensive for some and not others, will reduce competition and must be avoided. Additionally, any new framework should maximize the 

secondary market liquidity in the new MBS to ensure that regulated financial institutions are able to participate as investors, use the securities as liquid assets, and 

pledge them as collateral. 

Let me conclude by thanking the Committee again for its time, attention and consideration. We stand ready to provide you with any assistance or advice you may 

need as your important work continues. I look forward to answering any of your 

questions. 

PREPARED STATEMENT OF RICHARD JOHNS

EXECUTIVE DIRECTOR, STRUCTURED FINANCE INDUSTRY GROUP (‘‘SFIG’’)

SEPTEMBER 12, 2013

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

Banking, Housing and Urban Affairs:

My name is Richard Johns. I am the Executive Director of the Structured Finance 

Industry Group, Inc. (‘‘SFIG’’), a trade industry education and advocacy group established in March 2013 that presently is comprised of over 160 corporate members 

56

1 In order for a common TBA to be implemented successfully, a number of issues need to be 

considered and addressed, and SFIG believes originators, financial intermediaries and investors 

must play a major role in that process.

from all sectors of the structured finance and securitization market, including investors, issuers, financial intermediaries, law firms, accounting firms, technology firms, 

rating agencies, servicers, and trustees. A key element of SFIG’s mission is to educate and advocate on behalf of the structured finance and securitization industry 

with respect to policy, legal, regulatory and other matters affecting or potentially 

affecting the structured finance, securitization and related capital markets. It is 

with that mission in mind that I thank you for this opportunity to address the Committee regarding proposed housing finance reforms, including the role to be played 

by the Government in the housing finance system and the importance of returning 

private capital to the mortgage market. 

As this Committee continues its examination of potential reforms to our system 

of housing finance, SFIG welcomes the opportunity to provide commentary and 

analysis, particularly as it relates to the impact of various reform options on the 

securitization markets. Before I proceed, I want to acknowledge the effort of all 

those who are working to make reasonable but necessary reforms to the housing finance system. SFIG believes that the reform process must proceed in a measured 

and deliberate way, and we appreciate the Committee’s methodical approach in considering reforms that are so inherently critical to the U.S. housing market and the 

economy as a whole. As an organizing principle for this process, we suggest that 

there are three sequential stages that any reform effort should follow in order to 

preserve the TBA (‘‘To Be Announced’’) Market. First, a conversion into a common 

TBA should be adopted, making Fannie and Freddie MBS fungible and therefore deliverable into a single TBA Market, eliminating current pricing and liquidity inefficiencies in the Agency Market.1 Second, any reform legislation should provide for 

the creation of a single agency security that not only would facilitate the conversion 

and continued liquidity of legacy securities but also would promote a deep and liquid new-issue MBS market. Third, a common securitization platform should be established for the purpose of overseeing and maintaining the standardization of the 

market for Government-guaranteed MBS. With that organizing principle in mind, 

SFIG believes that there are a number of issues that must be addressed in any reform process, specifically: 

• An integral part of any reform will be to ensure the continued liquidity of the 

TBA Market, which is the most efficient and cheapest mechanism to enable a 

mortgage consumer to ‘‘lock in’’ the interest rate at the time when a mortgage 

loan is approved and thereby minimize the cost of borrowing. The TBA Market 

also creates efficiencies and cost savings for lenders that are passed on to borrowers in the form of lower rates. Currently, the TBA Market is reliant in part 

on the existence of Government-guaranteed MBS, making it imperative that 

any reform legislation include provisions that preserve some form of a Government guarantee.

• The best approach to risk sharing in a reformed housing finance system would 

be for private capital to assume the first risk of loss, the proper amount of 

which should be flexibly assessed in light of market factors, while retaining an 

explicit Government backstop against catastrophic loss. The retention of the 

catastrophic Government guarantee is critical to ensuring the continued participation of institutional ‘‘rate investors,’’ which provide a majority of the capital 

currently invested in the Agency Market.

• The transition from the status quo to a new housing finance structure must be 

transparent, appropriate to market conditions, and handled with great care to 

minimize any disruptions to the flow of credit to consumers, and in particular 

to ensure the continued functioning of a healthy TBA Market. Of utmost concern is that steps must be taken to allow the fulfillment of existing commitments (including contracts for future delivery) and preserve the market for legacy securities (i.e., outstanding Government-guaranteed MBS), while allowing 

sufficient time for eligible loans under the reformed system to be generated and 

take hold in the TBA Market. SFIG believes that the best way to facilitate this 

transition would be to create a single agency security to which legacy securities 

would be converted and which Fannie and Freddie could begin issuing even before a single securitization platform is fully functional. This would allow for cost 

savings as well as greater liquidity in the TBA Market. Failure to take such 

steps not only would discourage investors from participating in both the leftover 

57

2Sources: Securities Industry and Financial Markets Association; UK Debt Management Office; FRG Finance Agency; Japan Securities Dealers Association; AsianBondsOnline.com; Agence 

France Tresor Monthly Bulletin.

and post-reform TBA Market, but it also would create substantial mortgage 

funding issues.

• Any new infrastructure for the housing finance system must provide for or facilitate the standardization of MBS instruments that receive an ultimate Government guarantee in order to ensure the continued functioning of the TBA 

Market. Standardization is critical to maintaining the fungibility and liquidity 

of the Government-guaranteed MBS that drive the TBA Market.

• Any reform legislation should leave to regulators, working with market participants, the determination of the specific types of representations, warranties, enforcement provisions and recourse to be used in the new housing finance system.

• With respect to affordable housing, Congress should explicitly promote that goal 

through a stand-alone program not linked in any way to the operation of the 

secondary mortgage market, and should fund that program through separate 

legislative mechanisms.

• Conversely, Congress should reduce the upper loan limits for Government-guaranteed loans to ensure that the benefits of low-cost mortgage loans are directed 

at the segment of the population most in need of those loans. 

REFORMS MUST PRESERVE THE SMOOTH FUNCTIONING OF THE TBA 

MARKET. 

As shown in the chart below, the TBA Market is the third most liquid securities 

market in the world.2

Moreover, more than 90 percent of Government-guaranteed MBS trading volume 

occurs in the TBA Market. Accordingly, any reforms must be complemented by steps 

to ensure the TBA Market’s continuing efficiency and liquidity. 

The TBA Market creates efficiencies and cost savings for lenders that are passed 

on to borrowers in the form of lower rates. It also is the most efficient and cheapest 

mechanism to enable a consumer to ‘‘lock in’’ the interest rate at the time when the 

loan is approved, rather than take the risk that interest rates will rise between approval of the loan and the closing of the loan, which would increase the cost of the 

mortgage loan to the consumer and possibly make it unaffordable. The TBA Market 

does this through a system of forward trades of mortgage loan pools for guaranteed 

MBS that facilitates the shifting of interest rate risk into the capital markets. Thus, 

originators can offer consumers this ability to ‘‘lock in’’ mortgage rates by hedging 

the risk that interest rates will rise between application and closing. In this way, 

the TBA Market allows for stability between the time of loan origination and loan 

closing, ensuring that the terms of a mortgage loan do not fluctuate due to macroeconomic changes and reducing costs to consumers. 

The distinguishing trait of trades in the TBA Market is their homogeneity (i.e.,

standardized underwriting criteria and loan features, the Government guarantee, 

the geographic diversification incorporated into the pooling process, the limited 

number of issuers, the simple structure of ‘‘pass-through’’ security features, and the 


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restriction of the range of interest rates on loans deliverable into a single security). 

The parties to the trades agree only on certain criteria of the securities to be delivered: issuer, maturity, coupon, price, par amount, and settlement date. The actual 

securities to be delivered at trade settlement are not specified on the date the transaction is executed. Rather, just before the settlement date, the seller notifies the 

buyer of the specific securities that will satisfy the TBA agreement. 

Because TBA buyers are indifferent as to the specific securities delivered, originators are able to easily and inexpensively cover their hedges should they originate 

less collateral than expected in any given period, significantly reducing the cost to 

hedge and rate lock. Moreover, since the TBA Market simplifies the analytical and 

risk management challenges for participants, a broader group of investors participates in the TBA Market than would otherwise participate if investment decisions 

were more complex. The additional investors-specifically foreign central banks, mutual funds and hedge funds-inject more capital into the market for financing mortgages and ultimately reduce the cost of capital to consumers. 

Homogeneity is what makes the TBA Market possible, specifically, the fungibility 

of the conforming loan product (through standardized underwriting criteria and loan 

features) and a Government guarantee, which equalizes credit risk. Additionally, 

due to the specific exemption from SEC shelf registration requirements applicable 

to Government-guaranteed securities, specific collateral need not be identified, thus 

allowing forward selling. It is not possible to replicate the TBA Market without 

these factors. Any reform which does not accommodate, or suitably replace, the existing TBA Market will undoubtedly impact mortgage originators and consumers 

both severely and negatively by reducing price transparency, liquidity, and the originators’ options to rate lock and thus satisfy consumer needs. 

In short, the TBA Market removes uncertainty from the mortgage origination 

business and keeps mortgage rates low for potential borrowers. As noted in a report 

published by the Federal Reserve Bank of New York, ‘‘the TBA market serves a valuable role in the mortgage finance system,’’ and ‘‘evaluations of proposed reforms 

to U.S. housing finance should take into account potential effects of those reforms 

on the operation of the TBA market and its liquidity.’’ TBA Trading and Liquidity 

in the Agency MBS Market, James Vickery and Joshua Wright, FRBNY Economic 

Policy Review, May 2013. 

One factor that any reform must account for is that the TBA Market is reliant 

in part on the existence of MBS that are guaranteed by the Government. For that 

reason, the TBA Market is extremely sensitive to any changes to the role that the 

Government will have in the housing finance system going forward. Indeed, the 

TBA Market could not be recreated without the features discussed above that are 

unique to Government-guaranteed MBS. Accordingly, SFIG believes that the maintenance of a partial, second-loss Government backstop against catastrophic loss for 

MBS is crucial to preserving the health of the TBA Market and continuing to promote stability and affordable interest rates for consumers in different market cycles. 

THE HOUSING FINANCE SYSTEM WORKS BEST WHEN THERE IS RISKSHARING AMONG PARTICIPANTS. 

Mortgage securitization is by nature a process by which the risks associated with 

residential mortgage lending are spread among various investors with differing appetites for risk. Attracting private capital to undertake these risks is of critical importance to the consumer and the economy as a whole. The Government has always 

guaranteed a large percentage of residential mortgage securitization, but historically 

the market also included securitizations funded solely by private capital with no explicit Government guarantee. These two markets cater to two different types of investors distinguished by the type of risk that each is willing to undertake, specifically, ‘‘rate risk’’ and ‘‘credit risk.’’ For this reason, any reforms that aim to limit 

the Government’s involvement in the Agency Market by changing or ending the current infrastructure must account for the impact that such changes will have on the 

flow of private capital that historically has favored Government-guaranteed MBS. 

As noted, there are two main risks associated with residential mortgage lending. 

The first, called market or rate risk, results from interest rate changes. After the 

interest rate on a residential mortgage loan is set (for example, the interest rate 

on a fixed-rate residential mortgage), that mortgage loan becomes less valuable over 

time if current residential mortgage rates rise, because the owner of that mortgage 

loan earns less in interest than it would if it owned a mortgage loan at the current 

(higher) market rate of interest. In addition, a consumer generally has the right to 

prepay his residential mortgage loan at any time (for example, if the consumer decides to sell the home), which may reduce the economic upside to the owner of the 

mortgage loan. Furthermore, refinancing of residential mortgages generally occurs 

59

3Source: Securities Industry and Financial Markets Association, Housing Finance, September 

2013, at 10.

when interest rates fall. The specific market risks associated with owning residential mortgage loans are dependent on the precise terms and types of mortgage loans. 

The second risk associated with mortgage lending is credit risk. Credit risk consists of two components: (1) default risk; and (2) loss severity risk. Default risk is 

the risk that the consumer fails to repay the loan. Loss severity risk is the risk that, 

after a consumer defaults, the lender will not recoup all of the principal lent and 

the expected interest on that principal. 

Private capital ‘‘rates investors’’ are willing to bear the rate risk and prepayment 

risk, but seek to avoid credit risk, because these investors operate under investment 

guidelines, capital requirements, and liquidity requirements that preclude them 

from purchasing private-label securities in any significant concentration. Examples 

of rates investors are foreign central banks, domestic banks and mutual funds. Historically, ‘‘rates investors’’ have been attracted to Government-guaranteed MBS—in 

which the Government bears the bulk of the credit risk—and they have contributed 

trillions of dollars to the Agency Market because of those guarantees. By contrast, 

‘‘credit investors’’ such as insurance companies and investment funds have fewer 

constraints on taking credit risk, and may in fact actively seek it out in exchange 

for higher potential returns. 

Limiting the Government’s involvement in the market by changing or ending the 

current infrastructure must account for the critical contribution that rates investors 

make to the Agency Market and their historic aversion to credit risk, as well as the 

limited pool of private capital available to fund credit risk. Accordingly, SFIG believes that retention of a catastrophic-loss Government backstop is essential to 

maintaining and increasing the participation of rates investors in the Agency Market. Indeed, SFIG believes that the TBA Market and the rates market for MBS cannot function without such a guarantee. 

However, we also acknowledge that private investors have a role to play in insuring against the credit risks posed by residential mortgages. To that end, SFIG generally supports the approach of having private capital take on credit risk, while also 

having a Government guarantee that is explicit and priced in a reasonable manner. 

Any risk-sharing structure should be carefully reviewed to ensure that the TBA 

Market is not disrupted. Furthermore, we believe that private capital should be 

placed in the first-loss position, with the private credit enhancement being calculated to cover reasonable risks presented by the market and the Government 

backstop covering catastrophic risk, i.e., the Government guarantee will generally 

be called upon only when the operation of the secondary mortgage market as a 

whole is at risk. 

SFIG supports a variety of mechanisms to bring private capital into the mortgage 

market, including corporate guarantees and capital markets transactions. Various 

forms of capital should be allowed to compete on a level playing field that balances 

sufficient risk retention at each step of the origination process to align incentives 

with the separation of functions and responsibility necessary to attract diverse capital sources. 

As for the amount of risk that a private investor should be required to assume, 

SFIG believes that the 10 percent first risk of loss provided for in S. 1217 is too 

high, as shown in the chart below.3


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We suggest that, if the Committee is determined to include some minimum level 

of risk assumption in the legislation, the level be considered a ‘‘target’’ that the 

Committee establishes based on underwriting-related factors, such as historical loss 

data in the TBA market. Furthermore, the regulators should have the discretion to 

deviate from the target based upon their own assessment of qualitative risk factors. 

The regulators will have to take a variety of complex factors into account to ensure that the private credit enhancement is rationally sized at a level that is commensurate with the qualitative attributes of risk-sharing structures. These factors 

include readily available historic information, the likely loan types, general housing/

economic indicators, any applicable representations and warranties, and whether 

the various forms of insurance and guarantees—e.g., the combination of homeowner’s equity and mortgage insurance, Mortgage Insurance Fund coverage, and the 

Government catastrophic guarantee—may be duplicative and overlapping due to 

counterparty risk, thereby reducing the amount of risk that private investors should 

assume. 

We believe that if the required private credit enhancement is too high and vastly 

exceeds the loss expectations of the associated assets, the redundant enhancement 

creates the potential for distortion. Originators must find a way to pay for the enhancement, and the available options may not be good for the consumer or housing 

market. For example, an originator may simply pass the cost of the redundant enhancement directly through to consumers via increased rates, thereby undermining 

one of the primary benefits that the Agency Market affords consumers, namely, 

lower cost loans. And even if such steps are taken, the possibility remains that there 

might not be sufficient private capital in the market to satisfy a private credit enhancement level that exceeds what is necessary to address the actual risk factors. 

THE TRANSITION TO A NEW HOUSING FINANCE STRUCTURE SHOULD 

BE IMPLEMENTED GRADUALLY AND WITH GREAT CARE. 

The transition from the status quo to a new housing finance structure must be 

handled with great care to minimize any disruptions to the flow of credit to consumers. The transition process should be carefully implemented, and to avoid severe 

market disruption should allow for: (1) a clear and transparent plan for transition; 

(2) a determination that market conditions are appropriate for the transition; (3) the 

fulfillment of existing commitments (including contracts for future delivery); (4) a 

determination that issues relating to legacy securities have been appropriately handled; (5) time to generate eligible loans; (6) testing or piloting the new structure in 

a real market environment; and (7) continuation of the TBA Market. 

SFIG’s primary transition-related concern centers on ensuring that whatever system is put in place, it performs and functions properly and continues to facilitate 

a robust TBA Market. It is imperative that steps be taken both to preserve the market for legacy securities (i.e., outstanding Government-guaranteed MBS), while allowing sufficient time for eligible loans under the reformed system to be generated 

and take hold in the TBA Market. Otherwise, the post-reform TBA Market will stall 

as: (1) investors in legacy securities are left with orphaned securities that continue 

to lose value as they factor down and their market becomes smaller and smaller; 

and (2) the market for new agency securities takes time to ramp up. 

SFIG believes that the surest method of facilitating a smooth transition is to 

allow for a conversion mechanism such that existing Government-guaranteed MBS 

are interchangeable with the new Government-guaranteed MBS. Fannie and 

Freddie could begin issuing a single mortgage-backed security even before the single 

securitization platform is fully functional. This would allow for cost savings as well 

as greater liquidity. Failure to take this step not only would discourage investors 

from participating in both the leftover and post-reform TBA Markets, but it also 

would create substantial mortgage funding issues as liquidity diminishes. 

SFIG also believes that all market participants would benefit to the extent that 

the current and new infrastructures operate in tandem for some period of time, or, 

in the alternative, appropriate portions of the current infrastructure are utilized by 

the new infrastructure. In addition, a final wind down of Fannie and Freddie should 

happen only after the new framework has been sufficiently tested and we can all 

be confident that it will facilitate the continued functioning of the TBA Market. 

We believe that these and other operational and delivery issues that will arise 

from the winding down of the existing framework and the ramping up of the new 

framework should be minimized by actively engaging directly with the relevant industry participants to determine the appropriate balance of regulatory discretion 

and legislative guidance regarding how the transition should proceed, as well as 

maintaining consistency (to the extent feasible) among the MBS issued across the 

platforms. 

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STANDARDIZATION IS ESSENTIAL TO THE FUNCTIONING OF THE REFORMED TBA MARKET. 

Any new infrastructure for the trading of Government-guaranteed securities will 

necessarily include requirements for areas such as disclosure, documentation, data 

collection and overall standardization of Government-guaranteed MBS transactions. 

Indeed, standardization of documents (e.g., standard Government loan forms), structuring and underwriting (e.g., conforming loan limits, document verification, etc.) is 

critical to the TBA Market because it increases fungibility and liquidity of Government-guaranteed MBS. These requirements should be very transparent, take into 

consideration the needs of all parties to the transactions, and include investor protections. Important to this standardization of the market will be establishing common infrastructure in the form of a common securitization platform that will lower 

barriers to entry for new participants into the system and enable different entities 

to issue a single security without variation. 

We would also caution that standards and practices that may or may not be appropriate for the new Government-guaranteed securities may not be appropriate for 

private-label securities given the wide variety of loan types, origination practices, 

servicing contracts, deal structures and the difference in negotiating power of transaction participants. The newly reemerging private-label RMBS market should not 

be expected to align completely with the rules and standards that are developed for 

the new Government-guaranteed securities. As noted above, the two markets cater 

to two different types of investors. 

LEGISLATION SHOULD NOT SPECIFY THE TYPES OF REPRESENTATIONS AND WARRANTIES TO BE USED IN THE NEW HOUSING FINANCE SYSTEM. 

We do not believe that language specifying the types of representations, warranties, enforcement provisions and recourse to be used in the new housing finance system should be prescribed in legislation. Rather, these are matters that should be 

left to the discretion of regulators. SFIG is actively focused on evaluating different 

representation, warranty, enforcement and recourse approaches that have arisen in 

the private-label RMBS market. We have also begun a dialog with regulators and 

agencies regarding this topic to explore how the Government might incorporate our 

analyses into its current efforts. Areas of particular interest include common 

securitization platform, secondary market viability of loans that do not meet Qualified Mortgage-Safe Harbor and Qualified Residential Mortgage standards, Regulation AB 2 proposals and due diligence, data, breach, repurchase and other disclosures. 

AFFORDABLE HOME OWNERSHIP SHOULD BE PURSUED THROUGH A 

SEPARATE, EXPLICIT PROGRAM DEDICATED TO THAT GOAL. 

SFIG agrees that all segments of American society should have the opportunity 

to become home owners and that the Government can and should play an important 

role in making that goal a reality. However, we do not agree with the current system, which has led to implicit subsidies in the form of purchases of subprime loans 

from noncreditworthy consumers. Instead, SFIG believes that Congress should explicitly promote affordable housing through a stand-alone program not linked in any 

way to the operation of the secondary mortgage market, and should fund that program through separate legislative mechanisms. 

On the flip side of the equation, we also agree that the current upper limits for 

Government-guaranteed loans should be reduced, to ensure that the market is focused on the segment of consumers for whom the Government guarantee is most 

essential in obtaining reasonably priced residential mortgages. 

CONCLUSION 

The issues confronting the Committee as it considers reforms to the housing finance system are critical not only to the health of the nation’s housing market, but 

to the growth of the nation’s economy generally. While we recognize the need to correct the errors of the past, we urge the Committee not to lose sight of the ways in 

which the Agency Market has worked well, and continues to work well (such as 

through the TBA Market), to facilitate the ability of Americans to enjoy the benefits 

of home ownership. To that end, we encourage the Committee to strive to retain the 

mechanisms, such as the Government guarantee, that have succeeded in bringing 

vast amounts of private capital into the housing market, while it takes steps to 

more equitably and effectively distribute the risks related to residential mortgages. 

We look forward to working with the Committee as it considers these vitally important issues. Thank you again for the opportunity to share SFIG’s views.

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RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER 

FROM JULIA GORDON 

Q.1. During the hearing the issue of capital markets execution, as 

opposed to bond guarantor ‘‘entity’’ execution, was discussed. Could 

you briefly discuss the advantages of allowing multiple sources of 

capital—from both the equity and fixed-income markets—take on 

credit risk? And to the extent you have concerns, if you have them, 

please make suggestions for how we might alleviate those concerns?

A.1. Thank you for your question and the opportunity to weigh in 

on this important issue. I do not believe any advantages theoretically provided by the opportunity for multiple executions outweighs 

the potential disadvantages of providing a Government wrap to individual structured transactions. As I highlighted in my testimony, 

I’m concerned about the capital markets execution for several reasons:

• A system based on bond guarantors or other ‘‘entities’’ is significantly easier to regulate for safety and soundness. Not only 

will there be fewer entities to monitor, but the insurance that 

bond guarantors will provide is more easily understood by a 

regulator than diverse and complex structured transactions.

• Bond guarantors are much more efficient at pooling and 

spreading risks, which is the core function of insurance. Structured transactions, to the extent that they cover a single or 

limited number of pools, cannot allocate risks and reserves 

across years, regions, lenders, and so on.

• As we have seen in recent private-label securitizations, investors in structured transactions have proven unwilling to assume risk on anything but the most pristine mortgages. If investors are assuming the first-loss risk, their high level of scrutiny will result in higher prices for nontraditional but still 

creditworthy borrowers, as the investors will demand a premium for taking risk that is not well-understood or serving 

borrowers who are perceived as more risky.

• Individual deals are much less likely to be able to support a 

robust TBA market, as they do not offer the same level of homogeneity in contract terms and the structures likely will require high levels of loan level disclosures. These higher levels 

of disclosure will reduce liquidity by fracturing the market into 

more individually priced securities that will not be suitable for 

the fungible TBA market. Even if a system can be found to 

permit the forward trading that characterizes the current TBA 

market, the lack of homogeneity over time/across different vintages of loans will reduce liquidity.

• Even if the structured transactions are ‘‘funded’’—as in, the 

money to cover losses is advanced to the instrument’s issuer—

86

it will be hard to ascertain how these assets are accounted for 

on the balance sheets of the involved parties. As a result, risk 

could simply be exported out of the four corners of the MBS 

into the larger financial sector. Recent and on-going experience 

with regulating derivatives and capital markets risk-sharing 

structures illustrates the difficulties in even understanding 

how risks are actually shared, let alone less in regulating 

them.

• Bond guarantors can provide more protection to the taxpayer 

at less cost. If credit losses exceed the level of capital allocated 

to a security—S. 1217 proposes capital of at least 10 percent—

in a structured transaction, the Government will be responsible for the additional losses. Bond guarantors, in contrast, 

would be obligated to use their corporate resources before tapping the reinsurance fund. The regulator could also require 

higher capital for bond guarantors in light of changing economic circumstances—an approach supported by the recent experience of loan level mortgage insurers—but it is unclear how 

this could be done when individual securities are credit enhanced through bond structures that, once set in place, are not 

amenable to changes.

Please note that nothing that I have proposed would prevent 

bond guarantors from laying off credit risk in capital markets. As 

a result, capital market investors could still be taking on credit 

risk, and their capital would still be available to fund our housing 

finance system. While this practice may reintroduce some of the 

problems I noted above—notably, accounting and systemic risk 

issues—a system in which bond guarantors are primarily responsible for first-loss credit risk would be more stable and better suited to meet the housing needs of America’s families. 

However, if the bill ultimately includes both executions as options, they must compete on a level playing field. As currently 

drafted, the bill encourages the pure capital markets approach, 

since that execution has little by way of regulatory requirements 

and can more easily meet the capital thresholds through leverage. 

Instead, the bill should include significantly stronger regulatory 

mechanisms for both executions. Initial ‘‘approval’’ of an issuer or 

bond guarantor does not equal oversight, and in fact, may be counterproductive in that it may give a green light to subsequent actions that are unmonitored by the regulator. Additionally, if the bill 

does hard-code first-loss capital requirements, we believe the 10 

percent number would be appropriate for structured transactions, 

while the appropriate level for bond guarantors could safely be in 

the 4–5 percent range. 

RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER 

FROM JEROME T. LIENHARD, II 

Q.1. During the hearing the issue of capital markets execution, as 

opposed to bond guarantor ‘‘entity’’ execution, was discussed. Could 

you briefly discuss the advantages of allowing multiple sources of 

capital—from both the equity and fixed-income markets—take on 

credit risk? And to the extent you have concerns, if you have them, 

87

please make suggestions for how we might alleviate those concerns?

A.1. The health and stability of the secondary market for mortgages depends upon availability of a range of sources of capital to 

invest in the first-loss credit risk, meaning risk that will be taken 

ahead of the risk exposure of the Government on its guarantee. 

Broadly available investment capital will promote competition not 

only among institutions, but also among the forms and structures 

of investment execution. This diversity in turn will create an incentive for market participants to find the most efficient forms of execution. 

That said, we believe that allowing for a broad range of forms of 

investment and retention of credit risk is best done on the backend of a guarantor model. That is, we believe that it would be better for legislators to create a system in which issuers of securities 

ultimately back-stopped by the Government would be required to 

use bond guarantors to lay off the top-loss risk on their mortgage 

pools, allowing these bond guarantors to then further off-load that 

risk into the capital markets. 

We hold this view for three reasons.

• First, creating a model that allows issuers to go directly to the 

capital markets as part of the bond structuring process runs 

the risk of fracturing the types of securities offered in the market to such a degree that it would compromise the ‘‘TBA’’ (ToBe-Announced) mortgage securities market. The TBA market 

depends on a high degree of standardization and homogeneity 

in issued securities. It would be unlikely for such standardization to hold in a market in which the credit risk of pools of 

loans were assumed and distributed through complex structured transactions. Moreover, participants in such transactions 

would likely seek to apply their own credit risk preferences, 

leading to more targeted pools of loans, with different credit 

characteristics and differentiated pricing. Such variability in 

the preferences of first-loss creditors regarding the composition 

of mortgage pools would make it more difficult to maintain 

fungibility of the pools and, therefore, of the resulting securities. This would materially inhibit forward trading through the 

TBA market. This problem does not arise if the system depends instead on issuers working with bond guarantors, which 

would issue a more standardized form of top-loss guarantee. 

These guarantors could then lay off some of the risks that they 

assume from issuers to the capital markets on the back end. 

In this way, the bond guarantor function would work with the 

capital markets in a transaction similar to reinsurance that 

would enable homogeneity and fungibility (meaning, ready 

trading markets) for the base mortgage securities.

• Second, we are concerned that, in a time of financial stress, the 

sources of capital in a pure and direct capital-markets-dominated execution structure could withdraw from the market 

quickly and categorically, causing a crisis in liquidity. If capital 

were to flee the market, the Government’s offer to provide a 

back-stop to pools of guaranteed loans would be ineffective to 

ensure ongoing liquidity, because there would not be market 

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participants willing to provide the first loss coverage on which 

the entire system would depend. Again, this would not be as 

significant a risk if there were a number of well-capitalized 

bond guarantors in place to take first loss credit risk.

• Third, we are concerned that regulatory oversight of the credit 

risk taken ahead of the Government backstop, which will be an 

essential function of regulatory supervision in any new system, 

would be prohibitively difficult if a significant share of firstloss risk were being structured, assumed and distributed 

through myriad and complex securitization structures and 

transactions. It would be far more straightforward to conduct 

regulatory oversight of the Government’s risk exposure if firstloss positions were being assumed by counterparties to the 

Government structured as bond guarantor agencies, as such 

oversight would entail traditional capital adequacy and risk 

management supervisory functions similar to those conducted 

today through Federal and State banking and insurance regulatory bodies.

One final related point: We believe a bond guarantor structure 

could and should enable issuers to work directly with the top-loss 

bond guarantors to provide their own mortgage-pool level credit enhancement as part of the issuer-bond guarantor transaction. This 

would enable issuers to participate in optimizing the pricing of the 

bond guarantee, driving incentives for low-cost and high creditquality practices. 

For these reasons, we would recommend allowing for a rich variety of sources of capital taking on credit risk in the system, but in 

a position supporting bond guarantors. The bond guarantors would 

interface directly with issuers and be directly accountable to the 

Government supervisory process where the Government is in a position of reinsuring that risk. This would preserve the critical forward trading function of today’s TBA market while allowing intermediation of a wide variety of capital sources. 

RESPONSE TO WRITTEN QUESTION OF SENATOR CORKER 

FROM RICHARD JOHNS 

Q.1. During the hearing the issue of capital markets execution, as 

opposed to bond guarantor ‘‘entity’’ execution, was discussed. Could 

you briefly discuss the advantages of allowing multiple sources of 

capital—from both the equity and fixed-income markets—take on 

credit risk? And to the extent you have concerns, if you have them, 

please make suggestions for how we might alleviate those concerns? 

The TBA Market 

A.1. For markets to assume credit risk, a structure or structures 

are needed to replace the depth and liquidity of the current TBA 

or ‘‘to be announced’’ market. The TBA market is a forward-trading 

market that trades on limited information. The securities are guaranteed by the Government-Sponsored Enterprises (‘‘GSEs’’) and investors assume interest rate risk and prepayment risk. TBA investors do not assume credit risk; rather they assume only the risk 

that depending on the interest rate environment, they may receive 

89

their principal sooner or later than anticipated (generally due to 

borrower prepayment on the loans) or that the market value of the 

securities may fluctuate. 

As discussed in the testimony of our Executive Director, the TBA 

market is a crucial underpinning to the American mortgage market. Originators can hedge and fund their forward origination pipelines because they can ‘‘lock in’’ the rates and prices on the loans 

during the period between each trade and settlement date. The 

TBA market is a large, liquid market, where buyers and sellers are 

able to trade large blocks of securities in a short period of time. 

The liquidity of the TBA market creates efficiencies and cost savings for lenders that are passed on to borrowers in the form of 

lower rates and broad availability of mortgage products, and helps 

to maintain a national mortgage market. The TBA market is the 

benchmark for all mortgage markets—it is the reference by which 

other mortgage markets and products are priced. Investors in a 

TBA security presently have general guidelines that indicate to 

them the ‘‘four corners’’ of what is contained in a particular security, however at the time a trade is entered into the exact composition of the security is not revealed. As an example, an investor may 

have knowledge that their particular pool cannot have more than 

10 percent of the balance of a pool consisting of high balance loans. 

SFIG is of the view that various structures may be able to function side by side with the TBA Market; however, because the TBA 

market requires a guaranty to function effectively, a capital markets execution should not be seen as an alternative to a guarantor 

model, but rather as a supplement. A guarantor should be able to 

raise capital to support its business through the equity and debt 

markets as well as pair off some of its risk to meet its capital requirements through risk transfers, swaps, credit-linked notes, etc.

Raising these various forms of capital and having a guarantor act 

as the channel through which this risk is moderated acts as a 

countercyclical measure because it reduces the reliance on contemporaneous capital raises to fund mortgages. 

Recent GSE Risk Transfer Transactions 

SFIG recognizes the importance of these transactions as a monumental first step in transferring credit risk to the private market. 

Several of our members were participants in these transactions and 

accordingly, we look forward to having the private market work 

(with SFIG’s support) with the GSEs to further build upon the recent credit risk transfer pilot transactions. These transactions may 

prove to provide an effective mechanism to transfer certain credit 

risk as a follow-on to TBA transactions, but they are not intended 

to be a funding source for originations. 

SFIG is of the view that while the transactions are an artful way 

to effectively de-risk the GSEs, due to certain structural features, 

they cannot be seen as a capital markets execution that can unilaterally replace traditional GSE functions. This is primarily because 

the recent transactions still rely on the GSEs as the ultimate taker 

of catastrophic and systemic risk. In regards to the greater system 

of secondary market mortgage funding, the GSEs still act as the 

initial funding entity and the initial risk taker, thereby facilitating 

90

reliable pricing to the consumer and allowing for a functioning TBA 

market. 

Alternative Structures 

A. Senior/Subordinate 

For banks and mortgage companies that fund originations via 

the private-label securitization market, (generally through a senior/

subordinate RMBS transaction), the following prerequisites are 

necessary before the proceeds on the loan and the rate to the consumer can be determined:

• the level of subordination likely required for each rating 

tranche for each particular pool of loans; and

• the likely price at which each tranche of these securities will 

sell.

Gain or loss on these senior/subordinate structures is typically 

determined through the subordination level that is required coupled with the pricing that the securities attain when sold. While 

hedging and rate-locking are possible in this type of market, it is 

more expensive and less efficient than in the current TBA market. 

Therefore, a lender is more exposed to market risk and uncertainty 

in a senior/subordinate structure than in a TBA security in the current market. 

The senior/subordinate structure also contains other inherent 

features that are irreconcilable with the TBA market. Specifically, 

in a senior/subordinate structure the purchaser of the subordinated 

securities (which bear the majority of the risk) requires much more 

information on each of the loans than is required or even possible 

for a TBA security. In fact, it is the lack of certain information that 

allows diverse borrowers, property types, and loan attributes, 

which ultimately comprise the housing finance market, to be converted into homogenous, credit-neutral assets through the TBA 

market. Further, because the TBA market is a forward market 

based on a hypothetical pool, loan-level data is simply not available 

at the time of a trade. Finally, because a TBA trade does not specify the collateral to be delivered, an investor who purchases (or even 

examines the loan-level data related to) a specific security would be 

barred from participation in the TBA market for that entire coupon. This would mean that investors in credit would not be able 

to hedge interest rate risk in the TBA market and would severely 

impact investor interest in either of these markets. 

A senior/subordinate structure may be used by the GSEs when 

loans are purchased by the GSEs in whole loan form for cash. 

These loans can be subsequently pooled into a senior/subordinate 

structure. 

SFIG generally believes that senior/subordinate structures 

should predominantly exist in the private-label securities market, 

which serves as a supplement, not a replacement, for the TBA market, and also acts as a check and balance on guarantee fee pricing. 

Senior/subordinate structures could also be incorporated into the 

new housing finance system on a limited basis e.g., as described 

above with cash loans. 

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B. Credit-Linked Notes, Swaps, Derivatives, and a risk index 

Credit-linked notes would most resemble the current GSE risk 

sharing transactions and would also be compatible with the TBA 

market as a follow-on transaction; however, they require a credit 

intermediary if they are to support a countercyclical market and a 

steady and reliable source of mortgage funding, as would all the 

aforementioned forms of risk-sharing. An index would be the most 

scalable and, if broad enough, would attract the deepest capital 

base and require the least amount of sophistication to invest; however, it would require a credit intermediary/guarantor as well. 

These risk-sharing and risk-transfer options, the GSE risk transfer 

transactions, along with the use of swaps and other derivatives, are 

all artful ways to fund a guarantor entity which could provide 

countercyclical capital and act as a risk intermediary to allow for 

steady and reliable pricing to originators and ultimately to the consumer. 

Conclusion 

It is SFIG’s view, as indicated in our testimony, that some form 

of TBA market needs to exist to allow market participants to forward trade, which in turn allows borrowers to ‘‘lock in’’ interest 

rates well in advance of closing and facilitates a national mortgage 

market and the extension of mortgage credit in all credit cycles. 

Any private capital resulting in credit risk transfer should be 

scalable, compatible with the TBA market, and sustainable in both 

bull and bear markets. In our discussion above, we highlight several structures, including the recent GSE transactions. These structures are an excellent way to introduce private capital and supplement a guarantor or centralized risk intermediary and thereby support a TBA market. These structures should not be seen as a replacement for the TBA market or as a replacement for the need of 

a risk intermediary to ensure a steady source of funding for mortgage credit in all market cycles. While we have belief that preserving the TBA market requires an institution to perform the role 

of guarantor, we do not believe that the Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac need to be preserved in their current form to fulfill that role. We hope that you 

consider these views as you evaluate options to reform the housing 

finance system. We welcome the opportunity to discuss our views 

with you in person.