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86–598 PDF 2014

S. HRG. 113–167 

HOUSING FINANCE REFORM: ESSENTIAL ELEMENTS 

OF A GOVERNMENT GUARANTEE FOR MORTGAGE-BACKED SECURITIES 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING HOUSING FINANCE REFORM, CONCENTRATING ON THE 

STRUCTURE OF A GOVERNMENT GUARANTEE FOR MORTGAGEBACKED SECURITIES 

OCTOBER 31, 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 

COLIN MCGINNIS, Policy Director 

GLEN SEARS, Deputy Policy Director 

BRIAN FILIPOWICH, Professional Staff Member 

ERIN BARRY FUHER, Professional Staff Member 

GREG DEAN, Republican Chief Counsel 

HOPE JARKOWSKI, Republican SEC Detailee 

MIKE LEE, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

KELLY WISMER, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

THURSDAY, OCTOBER 31, 2013 

Page 

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

Opening statements, comments, or prepared statements of: 

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

WITNESSES 

Joseph Tracy, Executive Vice President and Senior Advisor to the President, 

Federal Reserve Bank of New York ................................................................... 4 

Prepared statement .......................................................................................... 30 

Phillip L. Swagel, Professor of International Economic Policy, University of 

Maryland School of Public Policy ........................................................................ 5 

Prepared statement .......................................................................................... 88 

Michael S. Canter, Senior Vice President and Director of Securitized Assets, 

AllianceBernstein, on behalf of the Securities Industry and Financial Markets Association .................................................................................................... 7 

Prepared statement .......................................................................................... 94 

David H. Stevens, President and Chief Executive Officer, Mortgage Bankers 

Association ............................................................................................................ 9 

Prepared statement .......................................................................................... 103 

(III)

(1) 

HOUSING FINANCE REFORM: ESSENTIAL ELEMENTS OF A GOVERNMENT GUARANTEE 

FOR MORTGAGE-BACKED SECURITIES 

THURSDAY, OCTOBER 31, 2013 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:05 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 our witnesses for joining us to explore one 

of the fundamental questions of housing finance reform, the structure of the Government guarantee for mortgage-backed securities. 

I would like to commend Senators Corker and Warner and the 

cosponsors of S.1217 for recognizing in their bill that the housing 

market as we know it cannot function without a Federal backstop 

for mortgage lending. As we have heard in other hearings this fall, 

the guarantee must be explicit, appropriately priced, and stand behind private capital that is not guaranteed. 

However, the details of how a new guarantee should be structured is paramount to a well-functioning national market. The Government guarantee in the current system ensures that qualifying 

mortgages are TBA eligible, which allows borrowers to lock in their 

interest rates and connects loans and MBS with investors from 

across the country and around the globe. If the structure of the 

new guarantee is not compatible with TBA execution, a wide range 

of stakeholders have expressed concerns that access to credit will 

tighten for borrowers, making mortgages more expensive, especially in rural and historically underserved areas. This outcome is 

unacceptable. 

Determining who is willing to step in to take the first-loss position with private capital is also an important factor when considering the interaction with the TBA market and the stability of the 

future housing market. During the recent crisis, private capital 

pulled back and was unwilling to take credit risk except at an extremely high cost to borrowers. If a new system allows a variety 

of private capital participants, we must make certain that the new 

system is safeguarded against future boom and bust cycles, like 

that which recently occurred in the PLS market. It will be essential 

to create a system that protects taxpayers, but also does not create 

2 

so many inefficient layers that the mortgage market becomes too 

expensive for qualified borrowers. 

In previous hearings, we explored how the PLS and multifamily 

markets function, and earlier this week, we examined solutions to 

improve the consumer’s interaction with the mortgage market. The 

witnesses at each of these hearings recommended changes that 

would provide market efficiencies and better protect taxpayers. I 

look forward to hearing from today’s witnesses about their visions 

for the future structure of the Government guarantee for MBS and 

how different structures would impact pricing and availability of 

credit. 

This is a complex issue that has broad implications for both the 

guaranteed mortgage market and the PLS market. As I hope our 

aggressive hearing schedule demonstrates, Ranking Member Crapo 

and I are taking this seriously and moving with urgency. However, 

the housing market represents almost 20 percent of our economy. 

For the sake of families just getting back on their feet after the 

housing and economic crisis, we cannot afford to get the details 

wrong. 

Senator Crapo, would you like to make an opening statement. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Yes, and thank you, Mr. Chairman. Today’s 

hearing is another opportunity, an important one, to discuss the 

role of private capital in the context of housing finance reform. 

Today, Fannie Mae, Freddie Mac, and Ginnie Mae back nearly 

100 percent of newly issued mortgage-backed securities. Additionally, the Federal Reserve is supporting the housing market by purchasing $40 billion a month of mortgage-backed securities. Clearly, 

we need to move toward a more limited role for the Federal Government and bring private capital back into the housing market. 

Several Members of this Committee have supported an approach 

that provides for a limited, well defined Government housing backstop. Senator Corker and Senator Warner are to be commended for 

the extensive work that they have done. 

During Tuesday’s hearing, I noted that if we are to consider 

housing reform options that include a Government guarantee, we 

must ensure that the taxpayer is standing only behind mortgages 

that meet strong underwriting standards. Also, we must ensure 

that there is adequate private capital taking the first loss at the 

security level if we are to avoid the future taxpayer losses similar 

to the bailouts of Fannie Mae and Freddie Mac, which required 

nearly $190 billion from the taxpayers. 

S.1217 allows for the development of various private sector risk 

sharing mechanisms, including regulated bond guarantors, senior 

subordinated deal structures, and credit-linked note structures. 

Bond guarantors would maintain 10 percent of the capital against 

their insured bonds and would become insolvent before the proposed Federal Mortgage Insurance Corporation insurance would 

step in to cover losses. This would mean that the full resources of 

the guarantor would be available before reaching the Mortgage Insurance Fund. 

Capital markets transactions also would be an option to facilitate 

private sources of capital to absorb first losses on covered securiVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
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ties. In those transactions, the bill states that the first-loss position 

must be at least 10 percent of the principal or face value of what 

is defined as a covered security for mortgage-backed securities 

transactions. 

I am interested in the thoughts of today’s witnesses on how these 

structures would interact with the ‘‘to be announced,’’ or TBA, market. The TBA market allows investors the ability to limit their 

mortgage lending exposure by relying on the certainty of forward 

pricing on interest rates for home mortgages. And the liquidity provided by those investors helps to drive down the cost to homeowners. While not all available financing products must be TBA 

compatible, we should keep an eye on their interaction with the 

current TBA marketplace to ensure that enough options will be 

available to allow for this market to thrive. 

The Federal Housing Finance Agency, FHFA, has already begun 

work on developing options for transferring credit risk to the private sector. The FHFA’s 2013 Scorecard required that the Government-Sponsored Enterprises demonstrate the viability of multiple 

types of risk transfer transactions. The work of the FHFA in this 

regard has been encouraging and shows the market’s appetite for 

owning the first-loss piece. The Freddie Mac STACR Deal and 

Fannie Mae’s NMI and C Deals are important examples of how private capital can participate at a higher level in this market. 

In addition to the private capital that would be held to take 

losses on covered securities, S.1217 would also create a privately 

funded Mortgage Insurance Fund modeled after the Federal Deposit Insurance Corporation’s Deposit Insurance Fund. 

I look forward to the witnesses’ testimony on whether these 

forms of private capital adequately protect the taxpayer. Are we 

doing enough to protect taxpayers from losses? Are there lessons 

we can learn from the FHFA on how to bring private capital back 

into the market? What are the mileposts for building capital during 

the transaction? And I look forward to working with the Chairman, 

as he has indicated, and with the other Members of this Committee 

as we address these critical issues. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Crapo. 

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

opening statement? 

[No response.] 

Chairman JOHNSON. I would like to remind my colleagues that 

the record will be open for the next 7 days for additional statements and other materials. 

Our first witness is Mr. Joseph Tracy, Executive Vice President 

of the Federal Reserve Bank of New York and Senior Advisor to 

the President of the Federal Reserve Bank of New York. 

The Honorable Phillip L. Swagel is Professor of International 

Economic Policy for the University of Maryland School of Public 

Policy. 

Mr. Michael S. Canter is Director of Securitized Assets at 

AllianceBernstein, testifying on behalf of the Securities Industry 

and Financial Markets Association. 

The Honorable David H. Stevens is President and CEO of the 

Mortgage Bankers Association. 

4 

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

Mr. Tracy, you may proceed. 

STATEMENT OF JOSEPH TRACY, EXECUTIVE VICE PRESIDENT 

AND SENIOR ADVISOR TO THE PRESIDENT, FEDERAL RESERVE BANK OF NEW YORK 

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

Members of the Committee, thank you for the opportunity to appear before you today. 

My name is Joe Tracy. I work at the Federal Reserve Bank in 

New York. It is important for me to emphasize that my remarks 

today and the conclusions of the research that I will share with you 

represent my own views and are not official views of the New York 

Fed or any other element of the Federal Reserve System. 

I commend the Committee for focusing on the elements necessary 

to constitute a robust housing finance system in the United States. 

By robust, I mean that such a system must provide for the uninterrupted flow of credit to housing markets, even in periods of market 

stress. In the wake of the financial crisis, significant progress is 

underway to improve the resiliency of financial markets. Nevertheless, we must plan ahead for the risk of future market stresses. 

My coauthors and I have started with the observation that in the 

face of truly systemic housing shocks, Governments always intervene. It is not hard to imagine why. Given the importance of housing to Americans and to our economy, at some level of housing 

market stress, the Government faces intense pressures to take action. We cannot eliminate the risk that the Government may have 

to intervene, so we need to acknowledge that risk and establish a 

system to reduce and manage it or we will reinstate an implicit 

guarantee that puts the taxpayer at unacceptable risk. In my view, 

the private sector and the borrower must absorb all losses up to an 

agreed point, with the Government absorbing all further losses. 

The level at which the Government steps in must be well known 

in advance and credible to the market, meaning that there should 

be no speculation as to when and how the Government would intervene. 

In addition, the Government must determine its exposure net of 

the loss absorption capacity provided by the private sector. The required private capital should be of high quality and should be determined relative to the total risk associated with a given set of 

mortgage underwriting standards. Now, this may sound complicated, but it is really not brain surgery. The Government should 

bear only the cost of extraordinary systemic risks and the private 

sector must bear losses associated with the normal business cycle. 

If this can be arranged, then the largest portion of the guarantee 

fee will be priced by the market and not by the Government. 

Our research has explored the notion that the Government support would be triggered by the total losses across an entire group 

or vintage of mortgage-backed securities. Vintage-based support 

would likely only be triggered by a truly systemic shock. A vintage 

approach would also provide a transparent and finite maximum 

loss for the private sector to absorb, supporting robustness at the 

onset, during, and through the aftermath of a crisis. I believe that 

the costs of the recent devastating economic downturn would have 

5 

been far less to the taxpayer, and the housing market would have 

rebounded far quicker, had a vintage-based program containing 

adequate high-quality private capital been in effect. 

Attracting private capital to finance residential real estate is another important consideration. Securitization backed by a predictable level of Government support has a useful function in facilitating the allocation of the different risks associated with mortgage 

lending to different sets of investors through the TBA market. I 

think the TBA market will be a key to ensuring Americans’ continued widespread access to the 30-year fixed-rate mortgage. 

The TBA market is also important to the role of small banks and 

lending institutions in a competitive housing finance system. Ensuring an easy, predictable path to securitization of standardized 

mortgage products is essential to making mortgage credit available 

throughout our country in traditionally underserved and rural 

areas and urban areas, and to all sets of current and potential 

homeowners, provided by financial institutions of different sizes 

and in different locations. A strong regulator whose primary focus 

is the housing finance system can also help ensure fair access to 

smaller institutions. 

In summary, it is my personal belief that housing finance reform 

must incorporate an explicit Government backstop accompanied by 

significant sources of high-quality first-loss private capital. 

Thank you for the opportunity to appear before you today and I 

look forward to the questions. 

Chairman JOHNSON. Thank you. 

Mr. Swagel, you may proceed. 

STATEMENT OF PHILLIP L. SWAGEL, PROFESSOR OF INTERNATIONAL ECONOMIC POLICY, UNIVERSITY OF MARYLAND 

SCHOOL OF PUBLIC POLICY 

Mr. SWAGEL. Thank you, Chairman Johnson, Ranking Member 

Crapo, and Members of the Committee. Thank you for the opportunity to testify. 

I also see Government intervention as inevitable in housing, 

making an explicit guarantee preferable so that taxpayers are compensated for taking on this risk. Still, it is extraordinary for any 

private financial activity to have taxpayers come to the rescue of 

those who make bad investment decisions. The terms of the Government backstop should reflect this, that a guarantee, any guarantee, is simply extraordinary. My written testimony has a full discussion. I will briefly note some of the key issues in designing the 

guarantee. 

The most important decision, by far, is the amount of private 

capital required to take losses before the guarantee kicks in. The 

first-loss private capital will both protect taxpayers and provide incentives for prudent behavior by industry participants with their 

own capital at risk. The capital should be at both the level of the 

individual loan, with downpayments and private mortgage insurance, and at the mortgage-backed security. 

We learned in the crisis the importance of downpayments and 

the importance of individual homeowners having equity, so having 

considerable downpayments, I would say, is very important to protect taxpayers. 

6 

The 10-percent capital requirement in S.1217 is appropriate and 

essential. The existence of an explicit guarantee is a huge step for 

people concerned about bailouts, but a 10-percent requirement 

should provide considerable comfort regarding taxpayer protection. 

By way of comparison, the losses of Fannie and Freddie together 

were shy of 5 percent, though they would have been larger had the 

Fed not intervened in its various ways. So a 10-percent capital requirement, again, should give a lot of comfort regarding taxpayer 

protection. 

Now, requiring private capital will translate into higher mortgage interest rates. The analyses I have seen say that this will be 

around 40 or 50 basis points for the average borrower. As we all 

know, the Fed can shift around interest rates by that much with 

a single statement, or, as we saw this summer, a single 

misstatement. And, of course, the Fed would use monetary policy 

to help lessen any negative macroeconomic impact of housing finance reform. 

A simple way of thinking about the 10-percent capital requirement is that if a 5-percent capital requirement is a safe amount to 

protect taxpayers, then the incremental cost of going from 5-percent capital to 10-percent capital will be modest. After all, the capital position from the fifth percentage point to the sixth, to the seventh, on up to the tenth, is quite safe. So, if someone tells you that 

it is expensive to go from 5- to 10-percent capital, then they are 

really telling you that 5 percent is not enough private capital to 

protect taxpayers. It is not possible to have it both ways. It is not 

consistent to say that 5 percent is safe, but 10 percent is costly. 

A suitably large capital requirement will also foster a diversity 

of sources of funding for mortgages, including more balance sheet 

lending and a revival of private label securitization, in addition to 

mortgages that continue to be packaged into guaranteed securities. 

I would say this change is desirable when today most new mortgages are backed by the Government, and yet too many potential 

homeowners find it difficult to obtain financing. With reform, private investors will take on the risks and rewards involved in housing finance. Now, the nonguaranteed mortgage-backed securities 

played an important role in the run-up to the financial crisis, but 

the regulatory regime has changed, notably with the advent of the 

Consumer Financial Protection Bureau, which has authority to address bad behavior by nonbank originators. 

So with this in mind, I would say a revival of private label 

securitization is a desirable policy outcome, and ultimately, it 

should be seen as a policy success to have some mortgages that 

could receive a guarantee voluntarily choose not to obtain one. 

I would also have the secondary guarantee kick in only after the 

entire private capital of the entities taking the first-loss position at 

the level of the mortgage-backed security. The Government would 

then cover the full principal and interest of guaranteed MBS. Such 

an arrangement would ensure that an event in which the Government pays out on the guarantee is both rare and consequential, 

where the shareholders of the failing firm will be zeroed out, investors and risk transfer will take losses, and management will be 

fired. This is the appropriate consequence of having the Government make good on the guarantee. Anything less, having the guarVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
7 

antee apply a vintage at a time or a mortgage-backed security at 

a time, will mean that the full consequences of failure do not operate. 

A new housing finance system will both ensure that funding is 

available and protect taxpayers and the overall economy. An appropriately designed guarantee is an important element of such a new 

system. 

Thank you again for having me participate. 

Chairman JOHNSON. Thank you. 

Mr. Canter, you may proceed. 

STATEMENT OF MICHAEL S. CANTER, SENIOR VICE PRESIDENT AND DIRECTOR OF SECURITIZED ASSETS, 

ALLIANCEBERNSTEIN, ON BEHALF OF THE SECURITIES INDUSTRY AND FINANCIAL MARKETS ASSOCIATION 

Mr. CANTER. Thank you. Chairman Johnson, Ranking Member 

Crapo, and Members of the Committee, thank you for the opportunity to testify before you today. My name is Michael Canter and 

I am a Senior Vice President, Portfolio Manager, and Director of 

Securitized Assets at AllianceBernstein, an asset management firm 

with $450 billion of assets under management. I am appearing 

here today on behalf of the Securities Industry and Financial Markets Association, a trade association representing hundreds of securities firms, banks, and asset managers. 

SIFMA and its members’ primary focus in considering reform of 

the GSEs is the preservation of the ability of secondary markets to 

support the 30-year fixed-rate mortgage. The 30-year fixed-rate 

mortgage is a stable and predictable way by which most Americans 

have historically financed their home purchases. Such 30-year 

mortgages, however, present significant risks to lenders. To manage this risk, lenders need access to a liquid forward market for 

mortgage loans. 

Today, the to be announced, or TBA markets, serve this function, 

allowing mortgage originators to sell conforming loans before they 

are originated and enabling the originator to provide interest rate 

locks to borrowers well in advance of closing. Furthermore, the 

TBA market provides the necessary liquidity that enables a national market, whereby regional differences do not impact credit 

availability for borrowers in particular locations. In addition to the 

loan origination aspect, the TBA market provides an important 

benefit to investors, such as pension funds, 401(k) plans, mutual 

funds, State and local Governments, and global investors. 

Today’s hearing asks this panel to consider the essential elements of a guarantee. Homogeneity is what makes the TBA market 

succeed. This homogeneity is driven by two main factors, standardization of terms and the absence of credit risk. Terms are currently 

standardized through the GSEs’ lending, servicing, documentation, 

and other guidelines. Credit risk is addressed through the implied 

but near explicit Government guarantee on the principal and interest payments of the mortgage-backed securities. 

Thus, to truly preserve the advantages of the TBA market, it is 

essential that a Government guarantee provides timely payment of 

all principal and interest associated with the securities. Otherwise, 

the mortgage-backed securities would no longer be an interest rate 

8 

investment, but a credit investment, as well. A credit investment 

requires an entirely different investor base than the one that currently holds the $5 trillion of mortgage-backed securities guaranteed by Fannie and Freddie, and certainly, any change to this full 

guarantee would raise mortgage borrowing costs. 

We believe that taxpayers should only be exposed to catastrophic 

or tail event losses in the newly envisioned mortgage finance system. Thus, private capital will need to take the first layer of risk 

of mortgage borrowers defaulting. We support an approach where 

the size of this first-loss layer fluctuates with the demand for mortgage credit risk. If constructed otherwise, the regime will tend to 

be procyclical and exacerbate booms and busts. But the most important factor in considering how to structure this risk to be taken 

by private capital is whether or not a particular approach will disrupt the critically important liquidity of the TBA market. 

We view the recent risk sharing transactions executed by Freddie 

Mac and Fannie Mae, called STACR and CAS, as prime examples 

of how the capital markets can provide first-loss capital without 

disrupting the TBA structure. In essence, through these transactions, Freddie and Fannie have bought reinsurance, if you will, 

from the bond market and hedged their credit risk to borrowers defaulting. While these two transactions are just the start of the 

GSEs’ risk sharing program, we believe they are an important part 

of the solution to the complex problem of how to bring private capital back into the mortgage market. 

There are some market participants who have concern that there 

is not enough capital in the bond market to absorb the credit risk 

necessary to buffer taxpayers from loss. At AllianceBernstein, we 

are more sanguine about this possibility. The way we look at it is 

that the private label residential mortgage-backed securities market is approximately $850 billion in size, the overwhelming majority of which is rated noninvestment grade. Ten to 15 percent of this 

amount gets paid back to investors each year, and investors are 

looking for a way to reinvest. Thus, a whole market has now 

formed that holds noninvestment grade mortgage credit risk that 

simply did not exist pre-crisis. 

Just as important, the marketplace has built up an enormous 

amount of intellectual capital, systems, and models to analyze 

mortgage credit risk. We believe that fixed-income investors across 

the globe will want to participate in this market, thereby spreading 

the risk across many market participants. 

The benefit of this is not just the avoidance of concentrating risk 

in a small number of financial institutions, but also that fixed-income investors will price mortgage credit risk relative to other 

risks in the marketplace. Financial companies that can only take 

one type of risk do not have this flexibility. The price transparency 

that these risk sharing transactions will bring will help all market 

participants. 

In conclusion, I want to thank you all for proceeding with this 

critically important reform effort. SIFMA and its member firms 

stand ready to assist you and your colleagues as you develop a 

more sustainable housing finance system. Thank you. 

Chairman JOHNSON. Thank you. 

Mr. Stevens, you may proceed. 

9 

STATEMENT OF DAVID H. STEVENS, PRESIDENT AND CHIEF 

EXECUTIVE OFFICER, MORTGAGE BANKERS ASSOCIATION 

Mr. STEVENS. Thank you, Chairman Johnson, Ranking Member 

Crapo, and Members of the Committee. Thank you for the opportunity to testify today. 

My name is David H. Stevens. I am the President and CEO of 

the Mortgage Bankers Association. I appreciate the opportunity to 

share MBA’s views on how to ensure that the multiple objectives 

of secondary market reform can best be balanced, ensuring liquidity in the secondary market, providing mortgage products that borrowers want at a price that is competitive and protecting taxpayers 

from risk. 

We are encouraged by recent legislative activity that has revived 

this policy debate on the future of Fannie Mae and Freddie Mac, 

including S.1217 offered by Senators Warner and Corker, and commend the efforts of the Chairman and the Ranking Member on 

thoughtfully working to create a comprehensive framework for the 

future of housing finance. 

MBA believes a successful secondary market needs to produce a 

more stable and competitive system that benefits lenders and borrowers. The transition to an improved system must retain and redeploy key aspects of the GSEs’ existing infrastructures, including 

certain operational functions, systems, people, and business processes. In order to prevent disruptions to day-to-day business activities of lenders and to ensure fair, competitive, and efficient mortgage markets for borrowers, any new proposal must be carefully 

phased in to protect the housing finance system from unnecessary 

disruptions. 

With regard to the future structure of the secondary mortgage 

market, MBA believes a stable and successful system must include 

three key elements. First, an explicit Government guarantee for 

mortgage securities backed by a well-defined class of high-quality 

mortgages. 

Second, protection for taxpayers through deep credit enhancements that puts private capital in a first-loss position with no institution too big to fail. 

And, three, a fair and transparent guarantee fee structure to create an FDIC-like Federal insurance fund in the event of catastrophic losses. 

The Government should provide quality regulation of guarantors 

and systems along with clearly defined but limited catastrophic 

credit backstops to the system. Without this Government backstop, 

the mortgage market would be smaller and mortgage credit would 

be much more expensive. This means that qualified low- to moderate-income households would have less access to affordable mortgage credit and be less able to achieve sustainable home ownership. The multifamily rental market, which predominately serves 

those with modest incomes, would also be adversely affected. 

How, then, do we define where private risk taking ends and 

where Government support begins? In most proposals, private entities or capital structures are assumed to take losses up until the 

point that the entities fail or the structures are tapped out. The 

key question then becomes how much capital the entities need to 

10 

set aside to absorb losses, or, alternatively, how thick subordinate 

tranches within capital market structures need to be. 

The answer to the question of how much capital should be set 

aside is not simple. First, there will always be uncertainty regarding precisely how much risk resides within a pool, vintage, or population of mortgages. Lenders, investors, rating agencies, and regulators have developed considerable information and analytics which 

can accurately gauge the relative risk of default and loss from 

mortgages within different characteristics. However, despite these 

accurate and precise estimates of relative default risk, it is more 

difficult to get a handle on the level of absolute risk, which must 

be estimated across a range of home price, interest rate, and economic scenarios. 

So, what level of protection is enough? Private credit enhancers 

should have sufficient capital so that it is extremely rare that the 

insurance fund is called upon, and the insurance fund and associated premiums should be large enough that Government outlays 

would almost never be required. However, there is a cost to being 

too conservative. Requiring capital beyond the reasonable economic 

risk drives up cost, which would limit access to credit for borrowers 

and will distort market behaviors. 

Congress should set broad parameters for the regulators to establish capital requirements and credit enhancement levels that are in 

line with regulatory capital standards for mortgages held by other 

institutions. For example, legislation should reference the most recent version of the Basel standards when instructing the regulator 

on proper levels of capital. In effect, Congress should establish a 

system where there is no opportunity for regulatory capital arbitrage. Regardless of who holds mortgage credit risk, regardless of 

capital type, the capital requirements should be relatively the 

same. 

In addition to regulations around capital requirements, the regulation should also have rigorous criteria for approving lenders, 

servicers, credit enhancers, and other participants in the market. 

The regulator should also be an active supervisor with access to 

timely information that allows them to be able to make judgments 

about potential required actions to limit risk to either the insurance fund or the taxpayer. 

A successful secondary market needs to be more stable and more 

competitive for all lenders, with greater protections for borrowers 

and taxpayers. The system should utilize familiar and operationally reliable business systems, processes, and personnel from the 

existing GSE model. And it is essential that any new system be accessible by lenders of all size and business models as a robust and 

competitive marketplace benefits everyone, including borrowers, 

taxpayers, and our industry. 

I look forward to your questions. Thank you. 

Chairman JOHNSON. Thank you all for your testimony. 

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

the clock for each member. 

Mr. Stevens, what is the impact on homebuyers if the first-loss 

private-capital requirement for the guarantee is set too high, and 

should the requirement be set by legislation or by regulator? 

11 

Mr. STEVENS. Thank you for that question, Mr. Chairman. The 

impact that we are concerned about here is twofold, one, that it be 

very clear that the guarantee be 100 percent on the mortgagebacked security but that first-loss credit enhancement be provided 

by a deep level of private capital. 

Setting a flat line standard in a legislative initiative concerns us 

only to the effect that it could create systemic distortions, the likes 

of which we have seen actually in the current model. With the 

GSEs holding only 45 basis points of capital compared to what private capital standards are, we have seen an unusual distortion 

where lenders sold off literally all of their risk to a Government 

guaranteed structure. So we all recognize that capital level has to 

go up. 

The challenge to a flat line is that it does not take into account 

the risk-based measures within that structure of mortgages in a 

pool. Some mortgages, for example, at very high loan-to-values, at 

lower FICO scores, might actually require higher capital than 

would be proposed, say, in a 10-percent level, while other mortgages at lower LTVs, lower loan-to-values, with bigger 

downpayments and higher credit scores, might require less than 10 

percent. 

And so from that standpoint, we strongly recommend that the 

regulator be required in a very transparent way to set capital levels using econometric measures that take into account historical recessions and depressions and other variables when they account for 

the capital standards required ultimately in the mortgage 

securitization market and that it not necessarily be set as an explicit number in a legislative format. 

Chairman JOHNSON. Mr. Tracy, your research recommends providing the Government guarantee to an entire group or vintage of 

MBS instead of to an institution or a single MBS, as proposed in 

legislation. What are the risks with the institution or single MBS 

approaches? 

Mr. TRACY. Thank you, Chairman. I think the key question that 

we need to ask ourselves with any of these design approaches is 

how is that approach going to function in those rare events where 

the Government is acting upon that Government guarantee, so the 

market has basically been subject to a systemic shock? It is our 

view that the vintage-based approach is going to be more robust 

under those conditions of severe market stress and will be better 

capable of continuing to provide access to mortgage financing. 

Our concern with some of the other approaches is that, again, by 

definition of a systemic shock, all insurers in other models are 

going to be facing the same types of pressure, and our concern is 

that you might run the risk of a collapse in the provision of mortgage credit under those circumstances. If that were to materialize, 

then it puts the Government back in a situation of do we need to 

somehow intervene to remediate that problem and, again, provide 

some alternative form of that mortgage credit. 

So, we think the vintage approach is a little more robust in that 

very specific rare instance where the Government has to step in on 

its guarantee. 

Chairman JOHNSON. Mr. Canter, you suggest that the design of 

the STACR and CAS deals is compatible with the TBA market. 

12 

How can S.1217 be improved to accommodate this from a risk 

taken? 

Mr. CANTER. So, the advantage that STACR and CAS have is 

that Fannie and Freddie are sitting in front of the transaction. So 

they are sitting in front and they are simply ceding out the risk, 

passing the risk off to the capital markets. Within S.1217, it would 

be the financial guarantor that would have the risk and then they 

would pass it off. 

And so what is important is that all the standards be the same 

across the financial guarantors, which they would as per the FMIC, 

but, you know, and that the regulations’ infrastructure all is the 

same and so that when it is passed off to the marketplace, it is, 

in essence, perceived the same way as if Fannie or Freddie is being 

accepted into the marketplace now. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. 

Dr. Swagel, in your testimony, you address the issue of adverse 

selection. You state that there is a concern that originators would 

seek to obtain the Government guarantee only on their riskiest 

loans, which, of course, then would result in the Government winding up insuring only lower-quality securities. How should we address that problem? 

Mr. SWAGEL. Thank you. Adverse selection is a problem anytime 

there is a Government guarantee. Whether the capital requirement 

is 10 percent or 5 percent, you have the same problem with adverse 

selection. And the industry, of course, will want to have its riskiest 

loans covered by a guarantee. So it is critical to have a strong regulator, an independent regulator who maintains high underwriting 

standards. Ultimately, that is the basis for protecting taxpayers. 

Senator CRAPO. Are there ways to make sure that any proposed 

Government backstop adequately takes that into consideration? 

How would a regulator do that? 

Mr. SWAGEL. You know, in my mind, it is important to have 

these standards hard coded into the legislation. I think we all understand the pressures on the regulator will be in the direction of 

less capital and lower standards. And that is why I would have the 

capital requirement specified directly in the legislation, to avoid 

those sorts of pressures. 

Senator CRAPO. All right. And, Mr. Canter, one of the ways that 

we can encourage private capital in the future housing finance system is to provide markets with certainty about how any proposed 

risk sharing will work in practice. The FHFA recently carried out 

a number of transactions designed to give a better sense of how the 

market might price risk in the future. What can we learn from the 

private market’s response to these transfer transactions? 

Mr. CANTER. I think we can learn that the market is very capable of measuring and taking mortgage credit risk. We estimated at 

AllianceBernstein that the expected loss on the STACR and CAS 

transactions ranged between 10- to 15-basis points cumulatively 

over a 10-year period. So, when you are thinking about a first-loss 

buffer of 10 percent, that is many, many multiples of that expected 

loss. 

And so what is important is how that 10 percent is structured, 

because, in essence, what we learned is that everything above an 

13 

attachment point of, say, 1.5 or 2 percent, everything above that 

point is going to be considered investment grade. That is a big deal 

in the fixed-income markets, even still. Even after the crisis and 

everything that the rating agencies went through, it is still a big 

deal for the way we manage money. And so if everything above 2 

percent is investment grade, it just opens up many, many more investors able to invest in the transactions. 

And so you want to take advantage of that, and in order to do 

that, you have to make it so that bond investors around the world 

can invest, and that is the huge advantage of doing that as opposed 

to an insurance company model where the return on capital might 

be excessive because they want an equity return on capital as opposed to a bond return on capital. 

Senator CRAPO. All right. And I think you already answered this, 

but moving forward, what are the mileposts we should be looking 

for to assure that markets are comfortable with the system? 

Mr. CANTER. Well, certainly, the acceptance of the deals and how 

they are trading in the marketplace, you know, as we look to transition to a new system and how that system is actually constructed 

and what that transition looks like is going to be key. But, the continuation of these deals is important, how they are priced. Are 

Fannie and Freddie able to open up new markets? So, for instance, 

are they going to be able to actually transfer risk away from the 

bond market even and actually into the property and casualty insurance market, right, or reinsurance market as another outlet for 

this risk. So, the more places you are able to place this risk, the 

better and more resilient the private market capital system will be. 

Senator CRAPO. All right. And, just quickly, the S.1217 framework has approved bond guarantors as well as capital market executions, such as senior subordinate structures and credit notes. 

Why is it important that we encourage these various sources of private capital? 

Mr. CANTER. I think it is important because we do not actually 

know what the most efficient structure is going to be, and like Mr. 

Stevens mentioned, there are different FICO scores, different LTVs 

that are out there and we want to leave lots of room for those types 

of borrowers, as well. So, the more options as we go into a new system, the more options we have, the more chances we have of success and flexibility. I think the most important thing that is really 

in S.1217 is the flexibility that it offers for all of these different 

avenues. 

Senator CRAPO. Thank you. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman, and thank you for 

this hearing. 

I appreciate particularly the final comments of Mr. Canter about 

the flexibility in S.1217. I guess I want to make one comment before I get to questions. Mr. Stevens and I have had, we have had 

lots of conversations about S.1217. We understand your concerns 

on the capital number. 

I guess I would point out, for those of us who want to make sure 

we maintain access for borrowers across the spectrum, that your 

notion that if you had a series of lower FICO scores with less quality loans, that you might require even more capital than 10 percent 

14 

for those kind of pools. I actually think that would mean that that 

would decrease the availability of those loans to get funded. You 

would, in effect, be segregating them into some kind of worse pool 

and could dramatically cut back access. 

So, I do think Mr. Swagel’s comments that if the 10 percent 

mark has been a bit overshot, that this kind of top-line standardization, that the sophistication of your industry, Mr. Canter, and 

others would be able to price that and tranche that appropriately, 

so if the number should be at four, five, six, or whatever, that that 

remaining capital would be priced at a lower level and we could 

then avoid the notion of kind of all the bad loans being lumped off 

and, consequently, not have access to the market that they have, 

I think, under our proposal or under the current system. 

I guess I want to ask first—again, there are two questions I want 

to get at. One is, S.1217, we acknowledge that there are ways of 

trying to make sure we guarantee particularly smaller lenders, we 

try to get geographic diversity, we try to make sure that the Federal backstop is only in a catastrophic event, and again, I might 

mention that with the G fees, there is also a reinsurance fund that 

backs up even before we hit the taxpayer. But I guess—and I 

would hope you would all be able to say just yes or no on this— 

does the panel believe that the bond guarantors who, whatever 

amount of capital they put up, should all go out of business or be 

fully liquidated before you would ever tap into the insurance? 

Mr. STEVENS. Absolutely. 

Mr. SWAGEL. Yes. 

Senator WARNER. Mr. Tracy. 

Mr. TRACY. In that model, yes, but we prefer a different model. 

Yes. 

Senator WARNER. Mr. Swagel. 

Mr. SWAGEL. Yes. 

Senator WARNER. Mr. Canter. 

Mr. CANTER. My personal view is yes. There are disagreements 

among members of SIFMA on that. 

Senator WARNER. Right, because they might be some of the institutions that might go out of business. 

Mr. Stevens. 

Mr. STEVENS. Absolutely. That is why competition in the model 

is extremely important. You would have multiple entities. 

Senator WARNER. We tried to build that in. 

I guess one of the things, going back to Mr. Tracy’s comment, 

and we tried to stay—leave some flexibility on this, is we have got 

Mr. Tracy’s notion of a vintage model, I think, that Senator 

Crapo—which kind of helps on the TBA market, which perhaps 

gets us more in terms of geographic diversity. Mr. Swagel, I think, 

wants to make sure we keep it at the guarantor level so there is 

more responsibility. Could you each, in my remaining minute and 

a half, pros and cons of vintage versus security level in terms of 

where the guarantee is. 

Mr. SWAGEL. Sure. I will just say, the problem with the vintage 

approach is that failure is not consequential, right, or with a cooperative with vintages, there is a failure in a year, the executives 

stay there, the shareholders are fine. I mean, there is not the sort 

of—there should be fire and brimstone when there is failure. When 

15 

the Government has to write a check, really severe consequences 

should follow, and you cannot have that with a co-op that is a single co-op that is too big to fail. I think there are other ways to address this sort of a systemic risk. There has to be securitization, 

and in some senses, Dodd-Frank does that. 

Senator WARNER. I am not sure, though, that—and I do not want 

to put words in Mr. Tracy’s mouth—that it has to be a single coop, but one of you speak to it. Mr. Tracy. 

Mr. TRACY. No. We have never stipulated that it has to be one, 

although we would imagine that you would not have many. And, 

yes, while it is important to impose market discipline, our concern 

is in periods of a systemic shock and the sort of market stresses, 

whether or not all of these bond guarantors are going to be facing 

similar pressures. And the market discipline effect collectively 

might manifest itself as a restriction in the ability to supply mortgage credit. So, what we like about the vintage approach is that it 

is designed to help restart the system and make sure that these 

entities can continue to lend even after a systemic shock. 

Senator WARNER. I have run out of time, but I would love to 

get—perhaps later, Mr. Canter or Mr. Stevens could give me their 

views on that. 

Chairman JOHNSON. Senator Johanns. 

Senator JOHANNS. Thank you, Mr. Chairman, and thank you to 

the panel for being here. 

Let me, if I might, take a bit of a step back here. As you know, 

the House is working on a piece of legislation. The Senate has 

S.1217. I think the House concept envisions no backstop. Let me 

just go down the panel and ask, first of all, do you envision any 

possibility that you would have a workable system here if there 

were no backstop whatsoever? And I will just start with Mr. Tracy, 

and if you could keep your answers fairly quick, or fairly short. Mr. 

Tracy. 

Mr. TRACY. I think the problem I alluded to in my statement was 

the credibility of that no backstop, and my suspicion is it would not 

be credible, so we would be back to an implicit guarantee. Also, it 

creates, then, credit risks that the investors have to manage, and 

I think that is an advantage of a backstop guarantee, is that you 

can basically sell securities to people who are only interested in 

managing the interest rate risk, not the credit risk. 

Senator JOHANNS. Theoretically, at least, and I think practically, 

if you have a system where you have got the appropriate backstop, 

the whole idea is that you do not use it, but it is there and it is 

reassuring to the marketplace. 

Mr. TRACY. That is correct. 

Senator JOHANNS. Yes. 

Mr. SWAGEL. So, I would agree with everything that Joe said, 

and I would just say, in the House bill, they still have the FHA 

as a guarantor, so they do have a Government backstop. It is more 

limited than in the Senate version. 

Senator JOHANNS. Right. 

Mr. CANTER. We do not think it would be workable without a 

Government guarantee. Under the presumption that it is important 

for the housing market to have 30-year mortgages and that mortVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
16 

gage availability is vital to the housing market, we do not think it 

is workable without a Government guarantee. 

Senator JOHANNS. Yes. Great. 

Mr. STEVENS. I would agree. And, Senator, to your point, if you 

keep the first-loss protection deep enough with private capital up 

front, to your point, it would be, obviously, the desired outcome 

would be a rare or never instance that the Government ever gets 

tapped to back that up. But the international global markets have 

confidence to buy those mortgage-backed securities because they 

know at least in a worst-case scenario, they have a counterparty 

they can depend on. 

Senator JOHANNS. OK. Let me take that and jump right to some 

of your testimony, Mr. Stevens. You were talking about the whole 

idea of flexibility, and you are looking at a former mayor and Governor. I always said to Congress, give me flexibility. I do not like 

one-size-fits-all. So, I understand where you are coming from. 

But having said that, here is what I worry about, and try to convince me why my worry is not justified. You could literally have a 

system that I think Senator Warner was alluding to, where you 

have a group of mortgages and poor credit scores and maybe in the 

part of the country that is not performing very well and a whole 

host of factors entering into that, and what worries me is that that 

category would almost be junk bond status. 

Mr. STEVENS. Mm-hmm. 

Senator JOHANNS. You could go to another area and you would 

have, you know, a good economy or wealthy people, big houses, 

great credit scores, everything is going right for them, and they get 

the triple-A treatment, if you will. 

Mr. STEVENS. Right. 

Senator JOHANNS. Am I missing something here? 

Mr. STEVENS. No. This is, obviously, a complex problem that is 

difficult to answer in a hearing, but just to lay out some basic 

groundwork. So, FHA today is a flat-price model. The risk is priced 

the same whether you are the best credits or the worst credits, and 

we have seen what happened in that portfolio. 

The other thing we are seeing today, Senator, is in the risk-based 

model, which is the way the GSEs are currently operating, they are 

actually doing very little high-risk mortgages. Seventy-five percent 

of all African American purchase borrowers got their mortgages 

through a Ginnie Mae mortgage in the last 2012 year, not through 

Freddie Mac or Fannie Mae. First-time homebuyers are getting 

their mortgages through a Ginnie Mae program. So, we are already 

seeing the impact in the current purchase market with a very 

deeply steeped curve of risk-based cost in the GSE model where the 

best credits and the lowest risk are easily being insured or guaranteed by Freddie and Fannie and everything else is being traded 

away. 

The adverse selection occurs on the other side, as well, however. 

If you look at the private label market, those are the best credits—— 

Senator JOHANNS. Right. 

Mr. STEVENS. ——the high credit score, lowest LTVs, highest net 

worth borrowers are also trading away. So, getting this balance 

right so that you do not create market distortions, I think that is 

17 

the difficult work that needs to be discussed as you move forward 

in your legislative process. 

Senator JOHANNS. I have run out of time. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you, all of 

you. 

I think the question I was pondering in my mind is a follow-up 

to, really, what Senator Johanns was raising, but maybe presenting a little bit different piece of it. If you have this variable 

capital standard based on downpayments and credit scores, I assume also under that formulation would be the amount of private 

market insurance you have incorporated, and I see a nodding head 

on that. 

In that context, we have—Mr. Swagel has noted that he would 

like to see things hard-wired up front because of concern about 

pressures on regulators undermining the system. Is it possible to 

have the flexibility you are talking about and the hard wiring that 

Mr. Swagel is talking about? Are those two things really driving in 

different directions? 

Mr. STEVENS. I will take a stab at this, Senator. The way we 

dealt with this in the past with the GSEs is to ensure that they 

had a duty to serve the system through affordable housing goals, 

and that was one way to encourage that activity. However, obviously, that is going to be a discussion that will ensue in this debate. 

I do believe that if I look at the worst adverse selection that took 

place through interventions, it was at the FHA, where seller-funded downpayment assistance programs, for example, was a form of 

intervention that caused extraordinary harm to that portfolio, and 

had it not been there, the portfolio would have never gone negative. 

So I think we have reflection points in terms of the impact of too 

much interventions, as it were, into this form or structure, and so 

framing in the roles. 

One of the advantages of the existing GSE structure, for example, and there are advantages and disadvantages, but one of the 

advantages is they are private companies. And so there was no, 

other than the goals, it was much more difficult to legislatively direct them. 

So, getting this balance right, both in the flexible pricing model 

so that the Government and taxpayer does not get adversely selected with the worst credits, but also making sure that there is 

a structure that interventions are protected to a point where you 

do not create systemic risk in the market, these are the nuances 

that really have to be teased out, in my view, in this legislative 

process, because this is where getting it right or wrong is going to 

shift the markets, and we have seen it today in terms of what is 

happening. Again, when the GSEs’ capital is only 45 basis points, 

it created a harmful outcome, and that is the part that I would love 

to follow up on and we would love to follow up on with the Members of this Committee. 

Senator MERKLEY. Thank you very much. 

Mr. Swagel. 

18 

Mr. SWAGEL. I have two quick thoughts. One is on the flexibility, 

and I think you got it exactly right, that the flexibility can be 

there, and one natural way to do it is to have an escape hatch in 

a crisis. During a crisis, private capital will be scarcer, or less willing to fund housing, so that is a macro policy decision, have the 

Fed Chair and the Treasury Secretary together say that the FMIC 

can adjust the amount of private capital and have the Government 

insurance, in some sense, expand, as it did in this last crisis. 

The second point, on the flexibility, is about this adverse selection, and I think it is important to keep in mind that the loans inside the Government guarantee will still be under the QM standard, so that is pretty safe. Or, at least the industry has said that 

is safe. So it is kind of strange to have the industry say, well, 5- 

percent capital will give us no adverse selection, but 10 percent 

will, when there will still be QM loans. So I just—I think the adverse selection issue can be overstated with regards to the 10-percent capital limit. 

Senator MERKLEY. Well, I think that point is pretty interesting 

in that, essentially, a piece we often do not talk about is a form 

of insurance, is that we have eliminated the liar loans, if you will— 

undocumented loans, a more formal term for it—and proceeded to 

really eliminate the teaser rate strategy and the steering payments 

that incentivize folks to steer people into high-risk loans. And all 

of that certainly provides a significant factor in the broader discussion here. 

I was—your point made sense to me, Mr. Swagel, about the fact 

that if 5 percent is safe, then the cost of going to 10 percent should 

be very low. That certainly sounds like a very logical argument, but 

I had not heard it presented in that way. Does anyone disagree 

with that point or want to throw something else in there? 

Mr. STEVENS. Yes. I would just reiterate that in the transactions 

we have seen from Fannie or Freddie, which are very much down 

the middle credit transactions, very good FICO, 60 to 80 loan-tovalues, that it has been shown that, really, everything above a 2- 

percent type of level is investment grade. So that means maybe excess of 5 percent would be rated triple-A, and again, that opens up 

a lot of potential buyers. 

Senator MERKLEY. Mm-hmm. Well, is that point, though, possibly consistent with the point Mr. Swagel made that, mathematically, the cost of that additional amount should be low, even if it 

is not necessary? 

Mr. STEVENS. Could I just—— 

Senator MERKLEY. Yes, yes, please. 

Mr. STEVENS. —quickly add that, keep in mind that the FMIC’s 

guarantor program will not be the only outlet. Lenders, with their 

consumers, will choose best execution. And so under a Basel standard, Senator, just as an example, using an 8-percent capital requirement to hold whole loans at a 50-percent risk weighting, that 

is 4-percent capital for those mortgages. They will remain all of 

their best credit mortgages. My concern is not the 10 percent or the 

5 percent per se. It is the relative adverse selection that will 

occur—— 

Senator MERKLEY. Yes. 

19 

Mr. STEVENS. ——as a result of having one out, two out of context with the other and having the FMIC ultimately inherit only 

the higher-risk mortgages because people have—— 

Senator MERKLEY. Yes. 

Mr. STEVENS. ——the institutions have options. 

Senator MERKLEY. Yes. The difference between different institutions. 

Mr. STEVENS. Right. 

Mr. CANTER. Could I just note that—— 

Senator MERKLEY. Yes, I will accept—let me just note, it is up 

to the Chair, because I am now over my time, so I will leave it up 

to the Chair as to whether we need to—— 

Chairman JOHNSON. One more response. 

Mr. CANTER. Thank you. I just wanted to say, however, if the 

extra 5 percent, from 5 to 10 percent, if that capital was going to 

try to be raised from the debt market for corporations, meaning 

you have an insurance company that is looking to raise capital by 

issuing debt, that is a very, very different story. That would be inordinately expensive. It would not get nearly the same treatment 

as a risk sharing transaction. 

Senator MERKLEY. Thank you. 

Chairman JOHNSON. Senator Vitter. 

Senator VITTER. Thank you, Mr. Chairman, and thanks to all our 

witnesses. 

This discussion is certainly very important, so I thank the Chairman and Ranking Member for promoting it. I, quite frankly, think 

it should have happened a while ago. We are 5 years out from the 

crisis and all this was absolutely at the center of the crisis. So I 

think we should have attacked this head-on a while ago, but better 

late than never and I am eager to move from this discussion to a 

markup as soon as possible. 

And in conjunction with that, I want to thank and applaud the 

work of many Committee Members, including Senators Corker and 

Warner and folks who have been working on their bill. I think that 

is a very, very strong and positive starting point. If we were at a 

markup today, I would support that starting point. But I really 

hope it is not eroded in any way, particularly with regard to key 

provisions like shielding the taxpayer from first losses between now 

and a markup. So, let me go to some of those issues in my questions. 

Professor Swagel, in that bill, Section 204(e) prohibits entities 

taking the first-loss position from receiving Government assistance. 

Is that prohibition too broad or not, and if flexibility is added, is 

it not difficult to impossible to still be assured that you are really 

preventing the taxpayer from being in a first-loss position? 

Mr. SWAGEL. Right. The consequence of failure should be severe, 

and that means no bailout, no assistance. The investors who make 

bad decisions should suffer losses, and only then should the Government write checks. So I would avoid that sort of flexibility, 

again recognizing that the Dodd-Frank bill has the kind of protections against systemic risk in Title II. 

Senator VITTER. Right. So, again, you would support the language in 204(e) as it is, not put in that flexibility that some are 

pushing for? 

20 

Mr. SWAGEL. That is correct. 

Senator VITTER. OK. Well, as you could tell from my earlier comments, I agree with you, and that is exactly the sort of retrenchment that I certainly hope does not happen between now and the 

markup. 

We have touched on this, but again, some are suggesting that 

capital requirements in S.1217 are too high, and I have heard the 

arguments about adverse selection. Is anybody saying it is too high 

just in terms of being able to raise that capital, because I just point 

out that when the FDIC released a new leverage ratio that was due 

in a short amount of time, $100 billion, bank stocks went up the 

following few days. So I do not think the market was shaking in 

its boots over that. This is over a 10-year period. 

Mr. STEVENS. I agree. I think the capital could be raised. I do 

not think that is the issue. 

Mr. CANTER. I think it really depends on how the capital is 

raised. I think that if you were just going to strip out the financial 

guarantors and they were just financial guarantors and they kept 

all the risk, I think that the return on capital that the equity investors would want to make on that investment in those companies 

would be very high. You are talking double-digit types of returns 

on 10 percent. That is way too much capital to raise, OK. 

But when you start using the securitization market and risk 

sharing transactions, that is when it becomes doable. You know, we 

are very bullish on the risk sharing transactions and their ability 

to fill that gap, but it is an unknown at this point. 

Senator VITTER. OK. Anyone else on that point? 

[No response.] 

Senator VITTER. All right. If we open up the system to being capitalized by a greater variety of sources, in general, can we not bring 

in capital more quickly if we do that right—or more cheaply, rather, if we do that right? 

Mr. STEVENS. Absolutely, Senator. I think that is exactly right. 

In exploring more forms of risk share options, whether it is structured front end, back end, pool, all of those will bring in opportunities for competition. 

Senator VITTER. Anybody else on that point? 

Mr. SWAGEL. I would just say that the initial risk sharing transactions are very small and they are costly, but as Fannie and 

Freddie scale up, there will be greater liquidity and the costs will 

go down. 

Senator VITTER. OK. Thank you very much. 

Chairman JOHNSON. I apologize for interrupting this hearing, but 

we have just reached a quorum and have two nominees that we 

need to quickly address. So, this hearing is in recess and I move 

the Committee into Executive Session. 

[Whereupon, the Committee proceeded to other business and reconvened at 11:10 a.m.] 

Chairman JOHNSON. Senator Warren. 

Senator WARREN. Is it all right if I stay here, Mr. Chairman? 

Chairman JOHNSON. Yes. 

Senator WARREN. Thank you. Well, it is good to be here. As the 

Senator from Massachusetts, home of the World Champion Red 

Sox—— 

21 

[Laughter.] 

Senator WARREN. ——I have a few questions. I hope I worked 

that in subtly. 

[Laughter.] 

Senator WARREN. But, we have been talking about the 10 percent up-front first-loss money ahead of the guarantee and whether 

or not that part is right. But, the question I want to focus on is 

the back end, that is, when is the guarantee triggered, because I 

think that is also very important. 

And we have two financing models that we have talked about in 

S.1217. One is the bond approach or mutual approach that you 

were talking about, Mr. Tracy, but the other is the structured 

transaction. And so what I want to focus on is the difference in 

trigger between those. 

So, as I understand it, one would think in a structured transaction what we may be doing is every time any particular transaction runs beyond the 10-percent first-loss money, then the Government is in the position of writing a check, which would mean, 

if that is so, that the Government is in the position of writing 

checks long before there is any systemic risk, but really just backing up a bad deal. 

The flip side of that is in a big bond approach or mutual approach, it is a long time before you see 10 percent of the first-loss 

money disappear, and that may mean that the Government is coming in only long after the market has begun to crater and we have 

serious systemic problems. So, I think of this kind of like a 

Goldilocks problem, too hot or too cold in terms of the Government 

intervention. 

So, the first question I want to ask is about how we get the dial 

between those two, is there a way to do it, and then go to the implications of that. 

Mr. Stevens, you were nodding. Would you like to comment on 

that? 

Mr. STEVENS. Well, I think you are raising an important point, 

and at the highest level, we agree with your premise, and that is 

why having various types of options in place for the credit enhancement component, you know, to keep in mind before the Government, the taxpayer, gets affected by this, you have the borrower’s 

equity, you have the first-loss credit enhancement, and then you 

have the guarantor who is there, and then, finally, you have the 

Federal fund at the regulator level. So, all of those have to be 

pushed through in order to ultimately get to a loss to the taxpayer. 

Senator WARREN. Right, which is just a way of saying, we hope 

we are never going to be there. 

Mr. STEVENS. That is right. 

Senator WARREN. But when you sit on this side, you have got to 

write the law in the fear that we are going to be there someday. 

Mr. STEVENS. That is right. 

Senator WARREN. That is the point here. So, the question is, 

what is the right trigger? Should we be backing up every deal? 

Mr. STEVENS. I think, ultimately, the backstop on—we have to 

separate the backstop on the MBS itself versus how we structure 

the credit enhancement within the transactions themselves, and I 

think keeping that dialog separate is important, right. So the 100- 

22 

percent guarantee on the mortgage-backed security for whatever 

framework of loans are allowed for within this new guarantor 

model, that will frame in the size and scope that the Government’s 

role plays in this new entity. 

But once you get past that, we think there needs to be a variety 

of competitive structures on the credit enhancement model itself. 

So, it cannot do just solely senior substructures, for example, in 

this new model. We think there needs to be multiple entities, as 

well, because a single entity can create this too big to fail approach 

in the cooperative model. 

Senator WARREN. So—and I am still trying to work through that, 

because I certainly understand—that is why I said it is a too hot, 

too cold problem. I understand that part of the problem. But here 

is my concern. I do not know how these things can exist in the 

same universe in the sense that if I were an investor and I knew 

that investing in structured transactions would get a quicker trigger in terms of when the Government has to pay, then those will 

be priced differentially, right? 

Mr. STEVENS. I do not think so—— 

Mr. CANTER. There is no—— 

Senator WARREN. Everyone will bleed in one—you do not think 

they will go that way? 

Mr. CANTER. There is no reason for the Government to pay anything on a structured transaction until the capital of the financial 

guarantor is wiped out. 

Senator WARREN. Well, I get that, but that is the question we are 

asking. 

Mr. CANTER. So, on a deal-by-deal basis, let us say on one deal, 

a financial guarantee company sells off 10 percent of the risk, the 

bottom 10 percent, OK. 

Senator WARREN. Right. 

Mr. CANTER. Well, investors take that risk. 

Senator WARREN. I get that. 

Mr. CANTER. Well, let us say the risks get to be 20 percent. Well, 

the financial guarantee company is going to have to pay the 10 percent in excess of the first 10 percent, not the Government, OK. The 

Government would only kick in if all of the capital for the financial 

guarantee company were wiped out. 

Senator WARREN. No, I understand that, but the question is, you 

have got differential points at which the Government kicks in if the 

trigger is by transaction or by structured deal versus if it is a mutual pool, and this is what Mr. Tracy was going to—— 

Mr. TRACY. Yes. 

Senator WARREN. ——when he was talking about the vintage 

question. But the point is, they trigger differently, which means— 

I will put it this way. If they are priced the same, then the market 

will show us which one is giving a better deal for investors. 

Mr. Tracy, did you want to comment, and I am now out of time, 

so I—— 

Mr. TRACY. So, the key to the investor is they know that they are 

facing no credit risk. 

Senator WARREN. Yes. 

Mr. TRACY. And so that is important. The virtue of the vintage 

effect is that there is no uncertainty as to the amount of losses that 

23 

the utility is going to take before the insurance kicks in, and then, 

importantly, those losses cannot spill into prior vintages, and so 

the capital that is being freed up from those vintages as they pay 

down is available for new lending, nor can those losses spill forward so that the guarantee fees on the new loans also will not need 

to be used to pay back any of those losses. So, this helps to support, 

I think, lending going on even after a vintage may trigger. 

Now, what the threshold is depends on, again, how frequently do 

we think, or what circumstances do we want to call a systemic 

event? But I do believe that the optics are important. It is really 

helpful if the Government is only paying out in a systemic event, 

not if a particular security went bad, not if a particular issuer went 

bad. 

Senator WARREN. So, I understand the point, and I will just stop 

by saying I get this. The question is whether or not these can all 

exist simultaneously or the market will drive away from, in effect, 

the mutual pool. All of this, it seems to me, affects the pricing of 

the insurance and, ultimately, the regulatory oversight, which 

would be very different in a pool than it would be, for example, in 

structured transactions. 

So, thank you, Mr. Chairman. Thank you for your indulgence. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Mr. Chairman, thank you, and thanks for having this series of hearings. This is a complex topic and I think, obviously, it gives everybody an opportunity to ask complex questions. If mine are redundant, I apologize. I have been in another 

hearing. 

But I would like to ask Mr. Swagel and Mr. Stevens to talk a 

little bit about the fact that one of the ways we are looking at reforming GSEs is through a bill, S.1217, that a lot of members up 

here have been a part of, and I think each of you have opined 

about. But one of the things that has been such a problem is that 

Fannie and Freddie not only add credit to the deals, but they also 

compose all of the plumbing that takes place, which really makes 

them, if you will, essential to the marketplace and, no doubt—I 

hate using this word, I am so tired of it—but certainly too big to 

fail, because without them, you do not have the plumbing. 

One of the things that S.1217 seeks to do, and many others have 

looked at in different ways, is to separate that credit enhancement 

from the plumbing itself, creating a much more dynamic situation, 

and I wonder if the two of you might comment on that. 

Mr. SWAGEL. Maybe I will start. I think it is really important in 

terms of this. This is one of the most desirable features of S.1217, 

is the entry and competition. We see today the negative effects of 

insufficient competition in mortgages, right. Too many people do 

not have access and interest rates are too high for many people. 

And this sort of entry and competition, let others come in, will both 

help homeowners and address this too big to fail problem. 

You know, one key element to that is having the common 

securitization platform so that a new entrant can compete on equal 

grounds with, whether it is Fannie or Freddie or large institutions. 

So that is a key element in having the competition. 

Mr. STEVENS. And, Senator, I completely agree with your point 

and what Phil said, is we believe a common utility for 

24 

securitization clearly eliminates the dependency on any single 

guarantor institution for that process, and I think another variable 

benefit for regulators and for policymakers is you get far greater 

transparency, both to the regulatory community and to the markets. We already see the challenges today between data from 

Freddie Mac and Fannie Mae and how it is released and the lack 

of cohesiveness between the two ways they release data. Having a 

single utility that could be accessible by all institutions, large and 

small, bank and nonbank, eliminates that dependency and it creates greater transparency in the marketplace. 

Senator CORKER. Thank you both. 

Mr. Swagel, there has been some debate about when, under 

S.1217—and again, I just keep referring to that because I know 

there have been a lot of discussions about it—but the way S.1217 

is now constructed, a bond guarantor would have to go insolvent 

prior to any kind of FMIC guarantee kicking in. I know there have 

been some folks who have said that is not workable. I just wonder 

what your comment might be in that regard. 

Mr. SWAGEL. I would say it is both workable and appropriate 

that the Government should not be writing checks, that the guarantee should activate only in an extreme situation, and in between, 

as markets deteriorate, well, of course, the Fed will be taking action. Congress can take action, as well. But the guarantee should 

be there only for the extreme situation. 

Senator CORKER. And, I guess, just to sort of tease that out, 

there have been people who have said, what we really ought to do 

is each grouping, if you will, of securities, if one of those fails, it 

should kick in. But— and I do not know if anybody else wants to 

comment on this— to me, to have it only kick in when an entity 

that is guaranteed becomes insolvent means that the strength of 

these guarantees has to be really there, whereas with the other, 

certainly, you could have much weaker bond guarantors participating in it. Would that be true or false? 

Mr. SWAGEL. No, I agree with that, and I think the capital is 

there. I mean, there is a search for yield and this is good origination and people should be willing to take on this housing credit 

risk. 

Mr. CANTER. I would just add that the financial guarantees, by 

their very nature, are going to be extremely highly correlated, and 

so when one is failing, it is going to be highly likely that the others 

are going to be under the stress, as well, and that complicates the 

problem of what is the housing market going to look like then. 

Senator CORKER. Any other comments on that? 

Mr. STEVENS. I agree with the premise, Senator, and, as a matter 

of fact, there should be early warning signs so that you know when 

an institution is close to failure so you can be prepared to transition any risk to one of the other entities in order to keep the markets functioning. 

Senator CORKER. Thank you very much. 

I am going to ask Mr. Swagel this question and not Mr. Stevens, 

based on what I heard he might have said earlier today in testimony. But, you know, some people are trying to correlate the 10- 

percent capital issue that we are talking about right now relative 

to S.1217 and FMIC, or the bond guarantors, or, candidly, creditVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
25 

linked notes or AMBPs or whatever it is, with bank capital, and 

I would like for you to, if you would—people are saying, well, bank 

capital is different and, therefore, loans are going to flow in a particular direction. Would you like to editorialize on that, if you did 

not in your opening comments? 

Mr. SWAGEL. Sure, and I did not say this in my opening comments. Banks have a 4-percent capital standard, but they also have 

a much more burdensome regulatory regime. There are capital surcharges for large banks, liquidity requirements, FDIC deposit premiums, and so on. So, 4 percent in securitization would not be the 

same as the bank standard. 

The other thing I would editorialize on is to say I think it is good 

to have an incentive for lending not to be done through the guarantee. We want a diversity. We want more balance sheet lending. 

So a high capital requirement for securitized guaranteed lending 

would lead more lending back onto balance sheets. I think that is 

a fine thing. 

Senator CORKER. Right. Mr. Chairman, I know my time is up. I 

do want to thank these witnesses, and, Mr. Chairman, I had a 

pretty energized discussion with one of the witnesses earlier this 

morning. Look, the housing industry is a big part of our Nation and 

I know that we need to get this right. At the same time, people 

make a lot of money off this and make a lot of money off the fact 

that the Government, candidly, takes a lot of risk for them. I do 

look forward to working with you and all of the witnesses that are 

here today to try to come up with the right balance. I hope we can 

do that soon. But, again, thank you for having this hearing and I 

thank each of you for testifying. 

Chairman JOHNSON. Senator Manchin. 

Senator MANCHIN. Thank you all for being here, and thank you, 

Mr. Chairman, for holding this. 

I have a problem with the guarantees. I always have had a problem with the guarantees. When I was Governor, I used to sit there 

and watch the taxpayers of West Virginia take all the risk and 

someone else get the uptick. It never made any sense to me. We 

do not do that in the real world, and the business world does not 

work that way, but yet when the Government steps up to the plate 

and underwrites everything, you see a lot of things floating back 

and forth that normally would not float in a normal market. 

I guess what I would ask any of you, and, Mr. Swagel, maybe 

we will start with you again because you have been pretty outspoken about this, and I appreciate it, but the bottom line is, you 

think it will disrupt the markets. Do you think, are we going to 

harm or hinder the markets? Everything I am hearing you say is 

you think it is going to be more diversified. There will be more people that are going to benefit than will be harmed. 

And for the naysayers that say, oh, wait a minute, we cannot operate without Fannie and Freddie, well, if you have been raking in 

the unbelievable profits that have been out there for some people 

with the Federal Government and the taxpayers of this country underwriting all the risk, I understand why you would be upset. We 

have disrupted your model, if you will. Give me if I am missing 

something here. 

Mr. SWAGEL. I agree. The old model was broken and had the—— 

26 

Senator MANCHIN. Well, we are still in conservatorship, right? 

Mr. SWAGEL. And we are still in it. We are still—— 

Senator MANCHIN. So, no matter how well they might tell you 

they are doing—— 

Mr. SWAGEL. Yes. There still is—— 

Senator MANCHIN. —we are still in trouble. 

Mr. SWAGEL. —capital. 

Senator MANCHIN. OK. 

Mr. SWAGEL. I think that the new system will work and will benefit people. There has to be a transition. We do not want to go from 

zero capital to 10-percent capital instantly, but we will do that over 

time and we will buildup to it. There will be an impact on interest 

rates, but it will be very modest, in my view, and the new system 

will open up capital to many people who are outside of it now. 

Senator MANCHIN. Right. I mean, if I was taking the risk, I 

would go right to Fannie and Freddie. 

Mr. SWAGEL. Yes. 

Senator MANCHIN. And that is where they have been going. So 

that makes it very logical. But now, I might have a chance for 

someone to say, you have got a pretty good model there. I might 

go with you. 

Mr. SWAGEL. I would want private investors to take a risk on—— 

Senator MANCHIN. Well, let me ask you about S.1217. Any of you 

all can answer this, if you will. But I know that most of the Committee has signed onto the bill and everyone is looking at some way 

to make it a little bit better. What can you do to give us some direction of what we could do to modify it? If you see something in 

S.1217 that would help it, to enhance it, and we will start, Mr. Stevens, with you. 

Mr. STEVENS. Thank you, Senator. And I want to be very clear. 

I and the MBA strongly advocates the winding down of Fannie Mae 

and Freddie Mac. There are absolutely unacceptable distortions in 

the current business model. They are undercapitalized at 45 basis 

points. That should clearly be higher. We have advocated something ten times that amount, or greater, depending on how the discussion goes. 

And I applaud—we applaud the work done on S.1217, without 

question. We have provided a lot of feedback to the authors as well 

as staff on an ongoing basis and we think there is—it is clearly, 

whether it is acknowledged or not, it has become the baseline text, 

as is acknowledged by the discussion here today. Very much looking forward to what the leadership introduces in the final bill. 

I think, at this point, we are talking about complexities such as 

issuer guarantor models versus securitization models, construct of 

the form of the credit enhancements, and these are things that we 

would provide ongoing feedback on. I am not sure it would be as 

helpful to go through those here today, but there is a lot of good 

in that structure that can be clearly used in a—and it is hopefully 

something that gets implemented in the Committee, or introduced 

in the Committee. 

Mr. TRACY. So, Senator, I might just mention, I think it is important, given the complexities that we have been talking about, to 

keep a degree of humility in terms of our ability to design, in some 

sense, an ideal system. And this really suggests that we take an 

27 

incremental approach, an approach that is conservative at the outset, and then as we gain experience, you can try to sort of expand 

the approach itself. And so in particular on things like the underwriting standards and the credit box, I would start, again, with a 

more conservative approach and then expand it as we get more information. But I do think we need to be humble about our ability 

to anticipate every aspect that we may—any of these designs may 

be faced with. So we want to be able to build in some learning as 

this process is rolled out. 

Mr. CANTER. I think it is important to leave a lot of flexibility 

for the regulator to react to how that transition is taking place. 

Senator MANCHIN. Sure. 

Mr. CANTER. The other thing I would mention is that the bill in 

the House has an aspect that we like, which is that it has a prohibition on eminent domain. Eminent domain is where a municipality could use that power to take a mortgage, and I think that 

that would be extremely harmful to any type of outlet of private 

label securities. And so a mention of that, I think, would be—— 

Senator MANCHIN. Just very quick, if I may, Mr. Chairman, do 

any of you—and you can give a very quick yes or no—believe that 

the 10-percent deductible should be modified? Too high? Too low? 

Just real quick, and just start right down. 

Mr. STEVENS. We think there is room for discussion on that subject. 

Senator MANCHIN. OK. 

Mr. CANTER. I think it depends a lot on how that 10 percent is 

funded. 

Senator MANCHIN. I have got you. 

Mr. SWAGEL. I think it is appropriate, but I agree with Michael 

that it has to be done right. But it is appropriate. 

Mr. TRACY. And, as I have stated, it depends on the credit box 

and all the other dimensions. 

Senator MANCHIN. I have got you. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

gentlemen, thank you for your testimony, and not only your testimony but the work you have done over many years to help us understand the issues and come up with some concrete proposals. 

Senator Warner and Senator Corker have done, I think, a superb 

job in trying to get this process moving forward. Now the Chairman and Ranking Member are taking it and I commend them for 

their activities. 

But, Mr. Stevens, we have been going back and forth, the 10 percent, 5 percent, 10 percent. I think everyone can see that raising 

the capital is—it is certainly feasible. But you have suggested there 

are some unintended consequences of operating at the 10-percent 

level. Could you—and I know you mentioned them before, but could 

you sort of list them as specifically as possible. 

Mr. STEVENS. Senator, I wish I could draw it on a chart, but 

I—— 

Senator REED. That would help us. 

Mr. STEVENS. Well, and I will provide that as a follow-up, some 

feedback. 

28 

I want to be very clear that we clearly acknowledge that the capital levels of the GSE structure are ridiculously low and it has created adverse outcomes to the markets. We know that. The question 

is, how do you get it right in such a way that the future system 

ultimately does not create another set of distortions. 

Credit is spread across geographies, across downpayment, FICO 

credit scores, borrower profiles, products, et cetera, and so when 

you set a flat capital standard, the true cost of capital in any loan, 

depending on where it crosses in the spectrum, to have a flat line, 

hard line capital standard when credit is nuanced across a spectrum could ultimately create some adverse selection. 

I have heard other comments to the fact here in the panel, but 

I know for a fact that institutions have options. They do what is 

called best execution. We call it Best X. We talk about it all the 

time. You have options to hold, sell, securitize, or other investors 

in the marketplace. The goal here is to create a system that is absolutely safe and sound, that puts the Government only in the absolute worst case catastrophic position and the capital standard 

has to go up. If it goes up too far, the distortion will shift the other 

way, where institutions will retain or sell away to other sources the 

absolute best product and this FMIC will then be perhaps undercapitalized because they framed in the box too narrowly as a result. 

And I think that is an opportunity, to the degree that we can be 

helpful, we would love to talk about other ways to get there that 

hopefully could satisfy the broad set of stakeholders. 

Senator REED. Let me just follow up with a question, and that 

is that at times, we have to restrain the market. We saw that in 

2006, 2007, et cetera—— 

Mr. STEVENS. Right. 

Senator REED. And we didn’t because the capital for Fannie was 

statutorily 1 percent, because we could implore them, but they 

could say, no, we do not have to do anything like this, et cetera. 

And then there are other times when, frankly, it is in our best interest economically to try to encourage the housing market. 

Can I conclude from your comments that this flat sort of level, 

if we pick a flat level, will not give us policy tools to either restrain 

or support, or am I missing the point? 

Mr. STEVENS. No, I think that is generally right. The one thing 

that S.1217 does have in it is a provision to change the capital 

standard in a recession. So I think that was a smart addition. 

But I would say this, Senator, is legislating these numbers may 

be locking in to a position where a regulator could do a better job 

if they were required to be transparent, use econometric modeling, 

use the data elements of the loans that are being distributed, and 

make certain that the catastrophic position of the Government is 

never breached. And so the question is, do you legislate the capital 

standard or do you set framework in place that the regulator must 

be obligated to follow in order to protect the U.S. taxpayer. 

Senator REED. Just my reaction is that there was a statutory 

capital limit, I believe, of 1 percent for Fannie and Freddie, as I 

recall. 

Mr. STEVENS. Right, which is too low, though. 

29 

Senator REED. Much too low, but also, it allowed the entities to 

always argue with the regulator that they were doing them a favor 

by raising more capital because the law only required 1 percent. 

So I think your point is well taken about whether this should be 

flexible with regulation, good regulation, or statutory. It is harder 

for us to change things around here. You might have noticed. 

[Laughter.] 

Senator REED. My time is rapidly expiring, and Mr. Canter, I am 

tempted to jump into the TBA market, which you talk about arcane 

issues, but I do not have to tell you. This is what you do. It is the 

futures market that allows, basically, mortgages to be sold before 

they are technically originated and it locks in prices. It is the way 

we operate today. And I think your testimony suggests that there 

might be some problems with the current proposals with respect to 

the TBA market. Could you very quickly, because my time is expiring, give us a glimpse? 

Mr. CANTER. Well, I think what is important is that if we are 

going to have financial guarantors that are also going to be, in essence, guaranteeing the security, that if they were to miss a payment but yet they are still solvent, the Government will need to 

make that payment, and it needs to be clear to the market that the 

Government will make that payment. 

So, if you are targeting the same investor base as we have today, 

that own Fannie-Freddie wrapped securities, it needs to be clear 

that we do not have to worry about the ability or the willingness 

of a financial guarantor company to make an interest or principal 

payment. 

Senator REED. And that—is that implicit in the legislation that 

we are talking about today, or is that something we would have to 

make clearer? 

Mr. CANTER. I think it should be clearer. 

Senator REED. Clearer. And that raises kind of the issue, sort of 

a big macro issue, of it looks like we are sort of making—the Government is making up for the miscues of the private sector on a 

regular basis, which is not a very popular position anywhere. 

Mr. CANTER. Well, I think, given the enormous power that FMIC 

would have over that financial guarantor, I think it is highly unlikely. But, nonetheless, it would be important to state it. 

Senator REED. Thank you. Thank you, gentlemen. Thank you, 

Mr. Chairman. 

Chairman JOHNSON. Thank you all, our witnesses, for being here 

with us today. I want to thank Senator Crapo and all of my colleagues for their continued dedication to housing finance reform. 

This hearing is adjourned. 

[Whereupon, at 11:37 a.m., the hearing was adjourned.] 

[Prepared statements supplied for the record follow:] 

30 

1http://www.newyorkfed.org/research/stafflreports/sr644.html 

PREPARED STATEMENT OF JOSEPH TRACY 

EXECUTIVE VICE PRESIDENT AND SENIOR ADVISOR TO THE PRESIDENT, FEDERAL

RESERVE BANK

OCTOBER 31, 2013 

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

thank you for the opportunity to appear before you today. My name is Joe Tracy. 

I work at the Federal Reserve Bank of New York. Today I will be discussing research 1 in the area of Government support for housing finance that colleagues and 

I at the New York Fed have conducted. It is important for me to emphasize that 

my remarks today, and the conclusions of the research that I will share with you, 

represent my own views and are not official views of the New York Fed or any other 

element of the Federal Reserve System. 

I commend the Committee for focusing on the elements necessary to constitute a 

robust housing finance system in the United States. By ‘‘robust’’ I mean that such 

a system must provide for the uninterrupted flow of credit to housing markets even 

in periods of market stress. In the wake of the financial crisis, significant progress 

is underway to improve the resiliency of financial markets. Nevertheless, we must 

plan ahead for the risk of future market stresses. 

My coauthors and I have started with the observation that in the face of truly 

systemic housing shocks, Governments always intervene. It is not hard to imagine 

why: given the importance of housing to Americans and our economy, at some level 

of housing market stress, the Government faces intense pressure to take action. We 

cannot eliminate the risk that the Government may have to intervene. So we need 

to acknowledge that risk and establish a system to reduce and manage it, or we will 

re-create an implicit guarantee that puts the taxpayer at unacceptable risk. 

In my view, the private sector (and the borrower) must absorb all losses up to 

an agreed point, with the Government absorbing all further losses. The level at 

which the Government steps in must be well known in advance and credible to the 

market, meaning that there should be no speculation as to when and how the Government would intervene. 

When should the Government intervene? If markets believe that the Government 

will intervene sooner than it claims, then this will generate uncertainty, and financial markets will speculate on the timing and nature of the intervention. This uncertainty could have a destabilizing effect, leading to higher losses that the Government would ultimately have to absorb. A Government guarantee that is unclear or 

not credible, even if it is explicit and priced, will result in greater costs to the Government and, ultimately, the taxpayer. 

What should parties pay the Government for its willingness to intervene? In my 

view, the Government must determine its exposure net of the loss absorption capacity provided by the private sector. This includes evaluating the counterparty credit 

risks generated by any risk-sharing transactions. Risk-sharing must require a payment of cash from the private sector and oversight of the capital and overall risk 

profile of any participants in risk sharing. Of course, the required private capital 

should be of high quality and should be determined relative to the total risk associated with a given set of mortgage underwriting standards. This may sound complicated, but it is not brain surgery. The Government should bear only the cost of 

extraordinary systemic risks and the private sector must bear losses associated with 

the normal business cycle. If this can be arranged, then the largest portion of the 

overall guarantee fee will be priced by the market and not by the Government. 

An important design decision for a housing finance system is whether the Government backstop will apply directly to mortgage-backed securities, their issuers, or 

some other legal entity. An institution-based program could erode private sector discipline, while a security-based backstop would pick up the idiosyncratic and cyclical 

risks that are better left to the private sector. Seeking to balance these concerns, 

I have explored the notion that Government support would be triggered by the total 

losses across an entire group or ‘‘vintage’’ of mortgage-backed securities. 

Vintage-based support would likely only be triggered by a true systemic shock. A 

vintage approach would also provide a transparent and finite maximum loss for the 

private sector to absorb, supporting robustness at the onset, during, and through 

the aftermath of a crisis. I believe that the costs of the recent devastating economic 

downturn would have been far less to the taxpayer, and the housing market would 

have rebounded far quicker, had a vintage-based program containing adequate highquality private capital been in effect. 

31 

Attracting private capital to finance residential real estate is another important 

consideration. It is difficult for institutions that depend on short-term funding to 

take long-term interest-rate risk for example, the long-term interest-rate risk posed 

by 30-year fixed-rate mortgages. It is also difficult for investors who do not do the 

underwriting themselves to take long-term idiosyncratic credit risk. Securitization 

backed by a predictable level of Government support has a useful function in facilitating the allocation of these different risks to different sets of investors through 

the To-Be-Announced or ‘‘TBA’’ market. I think the TBA market will be key to ensuring Americans’ continued widespread access to the 30-year fixed-rate mortgage. 

The TBA market is also important to the role of small banks and lending institutions in a competitive housing finance system. Ensuring an easy, predictable path 

to securitization of standardized mortgage products is essential to making mortgage 

credit available throughout our country—in traditionally underserved rural areas 

and urban areas, and to all sorts of current and potential homeowners, provided by 

financial institutions of different sizes in different locations. A strong regulator 

whose primary focus is the housing finance system can also help ensure fair access 

to smaller institutions. 

In summary, it is my personal belief that housing finance reform must incorporate 

an explicit Government backstop accompanied by significant sources of high-quality 

first-loss private capital. Thank you for the opportunity to appear before you today. 

I look forward to your questions. 

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PREPARED STATEMENT OF PHILLIP L. SWAGEL 

PROFESSOR OF INTERNATIONAL ECONOMIC POLICY, UNIVERSITY OF MARYLAND

SCHOOL OF PUBLIC POLICY

OCTOBER 31, 2013 

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

thank you for the opportunity to testify on housing finance reform. I am a professor 

at the University of Maryland’s School of Public Policy and a faculty affiliate of the 

Center for Financial Policy at the Robert H. Smith School of Business at the University of Maryland. I am also a senior fellow with the Milken Institute’s Center for 

Financial Markets and a visiting scholar at the American Enterprise Institute. I 

was previously Assistant Secretary for Economic Policy at the Treasury Department 

from December 2006 to January 2009. 

It is extraordinary for any private financial activity, asset, or firm to have a Government guarantee. Any such guarantee should be strictly limited and with the 

terms and conditions that reflect the fact that it should be rare to have arrangements in which American taxpayers come to the rescue of those who made bad investments. 

I see housing finance as an instance in which having an explicit Government 

guarantee is a better policy than the alternative of not having one. Policy makers 

would feel obligated to intervene if mortgage loans were not available to Americans 

during a future financial crisis. This intervention would take place for social reasons 

because of the appropriately special place of housing in our society, and for economic 

reasons that reflect the importance of the housing sector for investment and consumption. Government officials would feel obligated to intervene if the market for 

mortgage securities locked up because these represent a vital part of U.S. financial 

markets and because problems in secondary markets would impair the flow of new 

mortgage origination. 

This means that intervention by the Government is latent. It would be better to 

formalize the Government guarantee and have it priced so that taxpayers are compensated for providing a backstop in housing finance rather than allowing the Government guarantee to remain implicit and unpriced. Unfortunately, it is not a simple matter to do away with the implicit guarantee in housing finance—it is not 

enough to simply say that there is no guarantee. A housing finance reform in which 

the Government ostensibly does not guarantee housing would inadvertently re-create the implicit guarantee that was one of the worst aspects of the previous failed 

system. The implicit guarantee made it possible for private shareholders and management to receive the upside when Fannie Mae and Freddie Mac did well, but left 

taxpayers with the bailout when the firms faced collapse in 2008. 

Any Government guarantee creates moral hazard. This is not a problem to solve 

but a fact of life. The proper policy focus is on how to minimize the moral hazard, 

recognizing that the attendant incentives exist. 

The question then is how to best structure the Government involvement in housing finance to meet the goals of ensuring that mortgage financing is available across 

market conditions while protecting taxpayers from another costly bailout and guarding the U.S. financial system and overall economy from the systemic risks that 

arose in the past failed system. In doing so, it is important to ensure that the new 

housing finance system is durable. A future financial crisis is inevitable despite the 

best efforts of regulators and supervisors. Housing finance reform should take this 

into account. 

In looking at the decisions involved with having the Government provide a guarantee on MBS that is secondary to considerable private capital, an overarching point 

is that it is vital to spell out what happens when the Government must make good 

on its guarantee. To be sure, the guarantee should be designed so that the taxpayer 

liability is far behind private capital. But eventually there will be another crisis severe enough to activate the guarantee; otherwise, there is no point in having one. 

With this in mind, I see the following key decisions in designing the guarantee. 

Switch the Guarantee to MBS Rather Than Entities 

The U.S. Government now effectively stands behind Fannie Mae and Freddie 

Mac’s insured mortgage-backed securities by guaranteeing those two firms as ongoing entities. It would be preferable to have the guarantee formalized—made explicit—and switched instead to attach to particular MBS rather than firms. This has 

several advantages. The first is that this change would allow for entry and competition into securitization and guaranty. In the past, the implicit Government guarantee allowed Fannie and Freddie to fund themselves at an advantage of around 

100 basis points compared to other financial firms. But the market power of the two 

firms meant that only around half of this implicit subsidy passed through to mortVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00092 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
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1David Scharfstein and Adi Sunderam, 2013. ‘‘Concentration in Mortgage Lending, Refinancing Activity, and Mortgage Rates’’, April. Available on ttp://www.people.hbs.edu/ 

dscharfstein/MortgagelMarketl04-2013.pdf. 

gage holders in the form of lower interest rates, with the balance going instead to 

shareholders and management of the two GSEs. Recent research provides further 

evidence that a lack of competition in the mortgage industry leads to higher interest 

rates for homebuyers. 1 Entry and competition will help prevent this situation, with 

competitive pressure pushing to homeowners any implicit subsidy from underpriced 

Government insurance. 

Entry and competition will further help address the problem of Too Big to Fail 

institutions. In the fall of 2008, policy makers felt obligated to avert the collapse 

of Fannie and Freddie to avoid a situation in which American families could not obtain mortgage lending and the banking system needed to be recapitalized en masse 

to offset losses on GSE securities. Allowing additional firms to participate in the activity of securitization and guaranty for mortgages that qualify for Government 

backing will ensure that these firms can fail without the need for a bailout. 

At the same time, it is possible that a future financial crisis will lead to the failure of many or even all firms that perform securitization and guaranty. In this case, 

it is likely that the Government would feel obligated to intervene to keep one or 

more in operation. This could be done using the authorities in the Title II Orderly 

Resolution Authority of Dodd-Frank. Under Title II, the Government could put 

money into a failing securitization and guaranty firm to ensure that at least one 

such entity remained operational to allow the continued flow of mortgage financing. 

A natural course of action would be for the assistance to be withdrawn as other private sector firms are constituted to enter the market. The Government eventually 

would be repaid for any losses suffered as a result of this assistance, in this case 

by a tax on the rest of the financial system. There is thus the ability to maintain 

the flow of mortgage financing even in the face of industry-wide losses that swamp 

all participants in mortgage guaranty. A system of multiple firms each of which is 

allowed to fail is fully consistent with the idea that securitization activity must continue throughout a crisis. 

The alternative to allowing competition and entry is to have a few firms—just one 

or two would be natural given the scale economies involved—that are guaranteed 

as entities. Such an arrangement would ensure the continuity of mortgage 

securitization, but give up the benefits of competition and innovation. A 

securitization cooperative in which the Government backstop applies one vintage at 

a time likewise would miss out on benefits of competition for consumers and limit 

the extent to which mortgage industry participants suffer appropriate consequences 

in the event of failure. Continuity of the industry is important, but this can be assured without giving up other benefits of housing finance reform. 

Ensure Considerable High-Quality Private Capital Ahead of the Government Guarantee 

Having substantial private capital in the first-loss position will both protect taxpayers and provide market participants with an incentive for prudent behavior in 

mortgage origination. It would be useful to have private capital in a variety of forms 

and through multiple mechanisms. In particular, private capital should be present 

at both the level of the individual loan through homeowner downpayments and private mortgage insurance, and at the level of mortgage-backed security. For individual loans, the salient role of underwater borrowers since the collapse of the housing bubble has made clear the importance of homeowner equity. The collapse of 

Fannie and Freddie likewise made clear the importance of capital at the level of the 

securitization. MBS-level capital can be put in place in through both common equity 

of the firm that performs the securitization and purchases the Government guarantee, and through various forms of risk transfer. This could include subordinated 

MBS tranches or other capital market structures such as credit-linked notes, or 

through capital provided by MBS insurers, provided that this insurance capital is 

strictly overseen to ensure that it represents risk-bearing capacity. 

The key in all cases is to ensure that the private capital can bear losses when 

they come, recognizing that this could be in the midst of a difficult financial market 

environment. In the recent financial crisis, insurance capital was problematic in 

some instances, as highly rated insurers such as AIG did not have the financial 

wherewithal to make good on their commitments when needed. This suggests a preference for equity capital and for capital market structures such as subordinated securities in which it is clear in advance that the financial resources exist to bear 

losses. It is possible for investors to use leverage in capital markets transactions— 

the purchasers of a credit-linked note, for example, could borrow the funds with 

90 

which to take on that risk. But such concerns are omnipresent—the risk will exist 

somewhere, and ultimately the regulators of other industry participants must be relied on to ensure the soundness of the banking system (if this is the provider of leverage in housing). The key for housing finance reform is for the housing credit risk 

taken on by private investors ahead of the Government to be clearly identified and 

funded. 

Ten-Percent Capital Requirement 

The Housing Finance Reform and Taxpayer Protection Act (S.1217) includes a 10- 

percent capital requirement at the MBS level, in addition to the norm of a 20-percent capital requirement at the level of the individual mortgage from homeowner 

equity and private mortgage insurance. This 10-percent MBS capital requirement 

is both appropriate and essential. By way of comparison, the total losses of Fannie 

Mae and Freddie Mac were shy of 5 percent of their assets, so a 10-percent requirement represents a considerable amount of capital. Indeed, there is a sense in which 

a 10-percent capital requirement at the MBS level is closer to 100 percent than the 

current capital requirement of zero, since 10 percent would have been enough for 

the two firms to have made it through the crisis. I recognize that the existence of 

an explicit guarantee is a huge step for people concerned about bailouts and the adverse effects of Government intervention in housing finance. A 10-percent capital requirement should provide considerable comfort that taxpayers are protected from future bailouts. 

At the same time, it should be kept in mind that the losses at Fannie and Freddie 

in all likelihood would have been considerably higher had the Government not intervened to support the housing market, not just through the injection of capital into 

the two firms but also through the actions of the Federal Reserve in purchasing over 

a trillion dollars of the two firms’ securities. Such quantitative easing by the Fed 

effectively reduced the losses at the GSEs. This suggests caution in looking at a 5- 

percent capital requirement as sufficient. A future system with 10-percent capital 

would not have to rely on such unprecedented central bank or taxpayer intervention 

to withstand a repeat of the recent crisis. 

Members of the Committee should look skeptically at assertions that a 10-percent 

capital requirement will have a serious adverse impact on the housing recovery— 

and even more skeptically at suggestions that this amount of capital is simply not 

available to finance housing. To be sure, a steeper capital requirement will translate 

into higher interest rates, but the impact should not be overstated. Recent analysis 

by Mark Zandi quantifies the impact of recapitalizing the housing finance system 

under a structure such as that envisioned in S.1217, and puts the interest rate impact at just above 50 basis points for the average borrower. In a normal economic 

environment, the Federal Reserve can shift interest rates by 50 basis points or more 

over the course of a 2 day FOMC meeting. And of course the Fed would be watching 

the impact of any increase in rates on the housing market and the overall economy 

and presumably would use monetary policy to help lessen the macroeconomic impact. Moreover, Mr. Zandi’s analysis so far has assumed that the 10-percent firstloss private capital has a uniform structure—that it is entirely common equity. Allowing for this private capital to be tranched, as envisioned in S.1217, would result 

in lower estimates of the impact on mortgage interest rates. 

To be sure, the mortgage interest rate impact is not zero, and will come on top 

of eventual interest rate increases when the Federal Reserve finally normalizes 

monetary policy. But affordability remains strong and the housing recovery will continue even with higher rates—indeed, moving forward with housing finance reform 

that spurs a return of private capital will lessen the barriers now faced by too many 

borrowers in obtaining access to mortgage financing. 

In evaluating the incremental impact of the 10-percent capital requirement over 

a smaller one such as 5 percent, it is important to keep in mind that the private 

capital ahead of the Government can be split into tranches. Investors will receive 

a higher return to take on the first-loss position at the bottom of the capital stack, 

reflecting the fact that the risk of the first 5 percentage points of housing credit risk 

is greater than that of supplying the fifth to tenth percentage points of private capital. 

The incremental cost of capital and the degree to which taxpayers are protected 

by the capital go together. If 5-percent capital is a safe amount to protect taxpayers, 

then this means that the incremental cost of going from 5-percent capital to 10 percent will be modest—after all, the capital position from the fifth percentage point 

to the tenth point is quite safe. Putting it more starkly, an assertion that the incremental cost of going from 5-percent to 10-percent capital is not modest should be 

taken as a signal that 5 percent is not an adequate capital requirement to protect 

91 

taxpayers. It is not possible to have it both ways—to say that 5 percent is safe but 

that 10 percent is costly. 

This is of course the usual implication of the renowned Modigliani-Miller theorem, 

but this is not an academic or theoretical statement. For sure there is a cost from 

higher capital, since the Modigliani-Miller conditions do not hold in practice—in 

particular, the tax code with its double-tax on the return from capital provides an 

incentive for the use of debt finance over equity. But members of Congress should 

look skeptically at those who deny that incremental capital will have a modest cost 

impact, especially if such claims are accompanied by noxious assertions about the 

supposed difference between ‘‘academia’’ and the ‘‘real world.’’ There are costs of additional capital, but these are too readily exaggerated. 

A related issue is the claim that there is simply not enough capital available to 

fund housing with a 10-percent capital requirement. This is equivalent to saying 

that the yield required to attract 10-percent capital is unimaginably high—that capital will not take on housing credit risk regardless of the rewards. This assertion 

is hard to take seriously in an era in which monetary policy has driven down longterm interest rates and spurred a search for yield. 

At the same time, the capital requirement should not instantly change from the 

current situation of zero up to 10 percent—there should be a transition period during which private investors become comfortable with the mechanisms by which they 

take on housing risk and the attendant markets for housing credit risk become more 

liquid. 

The amount of capital involved in a 10-percent capital requirement should be 

viewed in context. In round numbers, total U.S. financial market assets are on the 

order of $50 trillion, split roughly equally between equity and fixed-income securities. Housing finance is about $10 trillion of this (with the value of the housing 

stock roughly twice as large). If eventually housing finance reform results in a system in which half of mortgages are guaranteed and half are not, this means that 

a 10-percent capital requirement needs about $250 billion more in capital than one 

with a 5-percent capital requirement. This additional $250 billion is a one percentage point shift from fixed-income securities into equity. By further way of comparison, banks and the GSEs together raised around $400 billion in capital in 2007 and 

2008 in the face of mounting mortgage losses. We have all learned over the past 

5 years that a safer financial system requires more capital—if anything, the higher 

mortgage interest rates reflect the fact that the financial system was previously 

undercapitalized. Higher rates correspond to increased protection for taxpayers. 

Diverse Sources of Funding From a 10-Percent Capital Requirement 

A 10-percent capital requirement will both protect taxpayers and provide appropriate incentives for diverse sources of funding for mortgages (in addition to the incentive for prudent behavior by those with capital at risk). Starting from the situation of today in which 90 percent of mortgages have Government backing, it would 

be desirable to have more lending done without a Government guarantee so that 

private investors can finance those who fall outside the Government-backed programs. This would include both balance sheet lending and nonguaranteed private 

label securitization. 

While nonguaranteed MBS played an important role in the run-up to the financial 

crisis, the regulatory regime has changed, including through the advent of the Consumer Financial Protection Bureau (CFPB) to address behavior by nonbank originators. With this in mind, a revival of private label securitization is a desirable policy 

outcome, to end up with a mortgage market with many sources of capital and a 

greater share of housing market risk borne by private investors rather than taxpayers. Ultimately it should be seen as a policy success to have some mortgages that 

could receive a guarantee choose not to obtain one. I recognize the concerns that 

poor lending practices will reemerge with the private label market but see the regulatory apparatus, including the CFPB, as the right way to address this issue. The 

alternative would be to have the vast majority of mortgage loans receive a Government guarantee as is the case today, with the attendant current downside of the 

restricted access to financing for too many potential borrowers. It is better to allow 

private providers of capital rather than the Government to fund incremental borrowers, including by having private providers of capital figure out which risks to 

take on, and reap both the rewards from these investments and the consequences 

when loans go bad. 

A related concern over a revival of private label securitization is that Government 

policy makers will feel obligated to carry out an ex-post bailout in the next crisis. 

I believe the experience of the financial crisis shows that this is not correct in that 

the policy focus in the crisis was on ensuring the flow of new financing—that was 

a paramount reason why Fannie and Freddie were bailed out. Similarly, the TALF 

92 

program was set up by the Treasury and Federal Reserve to ensure the flow of new 

securitization to support lending and economy activity and did not provide an expost bailout to legacy assets. These considerations likewise argue against an expansion of Government guarantees more broadly than housing to other securitized assets such as by setting up a permanent TALF. I see an implicit guarantee as inevitable in housing and thus prefer to make it explicit and priced. But this is the not 

the case for other securitized lending. 

A Government guarantee gives rise to adverse selection, as originators seek to obtain a guarantee on risky loans. This is a concern for any plan with a guarantee, 

regardless of the capital requirement—this applies just as well to a system with a 

5-percent capital requirement as it does to one with a 10-percent requirement. If 

anything, the concern over adverse selection highlights the importance of the housing finance regulator, whether FHFA or FMIC, ensuring that origination standards 

remain high for loans to be eligible for a guarantee and that the private capital 

standing in front of the Government is able to absorb losses when needed. 

Still, it is the case that setting the capital requirement at 10 percent when banks 

have a 4-percent capital requirement for mortgages held in portfolio provides an incentive to have some loans stay on balance sheet and others go into guaranteed 

securitization. But again, this same concern applies even if the MBS capital requirement is the same 4 percent as for depository institutions under the Basel standards—once a guarantee is available, originators will have an incentive to obtain a 

guarantee on their riskiest loans. 

Moreover, while banks have a capital requirement of 4 percent for mortgage assets under the Basel framework, they face a broad suite of regulation that does not 

apply to securitization outside of insured depository institutions, including the 

threat of prompt corrective action when things go bad, deposit insurance premiums, 

and a capital surcharge and enhanced liquidity requirements for large banks. Adjusting for these factors means that equivalent capital requirement to compare balance sheet lending to securitization is probably more like 5 or 6 percent rather than 

the simple 4-percent Basel capital charge. The disparity between the 10-percent capital requirement for guaranteed MBS is thus smaller than it seems. And again, it 

should be extraordinary for any financial sector activity to receive an explicit Government guarantee. An elevated capital requirement is appropriate in this circumstance. An incentive for balance sheet lending and nonguaranteed securitization 

is welcome, not problematic. 

I further suggest that housing finance reform legislation include a mandated minimum capital requirement—again with 10 percent as an appropriate figure—rather 

than allowing regulators to determine this crucial figure. Experience and expectation suggest that political pressures will push regulators in the direction of less capital. This should be avoided. The housing finance regulator is still left with the vital 

task of ensuring that the capital is high-quality and able to absorb losses. But with 

the capital requirement representing the bedrock foundation on which protection for 

taxpayers rests, it would be desirable to have this specified in the legislation. 

Activation of the Guarantee 

As in the Housing Finance Reform and Taxpayer Protection Act (S.1217), I would 

have the secondary Government guarantee kick in only after the entire private capital of the entities taking the first-loss position at the MBS level. The Government 

would then cover the full principal and interest of the guaranteed MBS. Such an 

arrangement would ensure that an event in which the Government pays out on the 

guarantee is both rare and consequential. 

Private capital at the MBS level could include the equity of the private firm that 

undertakes the securitization as well as capital that shares the risk such as through 

credit-linked notes and other structures. The 10-percent capital requirement in this 

setup would require the securitizer to gather private capital equal to 10 percent of 

all of the guaranteed MBS it creates. The entire capital required for all guaranteed 

MBS from a firm would be on the line before the Government pays on any MBS. 

This ensures that the guarantee will rarely activate and that the Government will 

not have to write checks on individual MBS or even multiple MBS that go bad within a particular vintage of origination. 

Activation of the guarantee would then be associated with the failure of the private guarantor that has arranged the first-loss capital. This is appropriate to ensure 

that the investors and management involved with the private guarantor suffer the 

full consequences of failure: shareholders go to zero, management is replaced, and 

the full losses are imposed on other investors who have taken on housing credit risk. 

These consequences are attenuated in alternative approaches in which the Government guarantee applies to only a vintage of origination at a time. In such a setup, 

less capital is in front of any one vintage meaning that the guarantee will activate 

93 

more frequently. With a cooperative structure that persists over time, the management and shareholder/participants of the cooperative likewise do not suffer the full 

consequences of failure—the cooperative continues and shareholders and management remain. 

Adjusting the Capital Requirement 

Provisions to adjust the amount of first-loss private capital would be useful to 

adapt to temporary circumstances in which the willingness of private investors to 

supply capital for housing recedes in the face of market uncertainties. Such a mechanism should have safeguards, however, so that it is used infrequently. Policy makers should not seek to ensure that homeowners can obtain low interest rate loans 

at all times, and should not look to make frequent adjustments to the settings of 

the housing finance system for the purposes of macroeconomic stabilization. Instead, 

the Federal Reserve should have the primary responsibility for macro stabilization 

policy, with changes to housing finance used only when the Fed is not able to 

achieve its dual objectives. 

To ensure this separation between housing finance and macroeconomic stabilization, the director of the housing finance regulator should not have the authority to 

adjust the required amount of capital. This should be left instead to a joint decision 

of the Fed Chair and Treasury Secretary, along the lines of the revised Fed authorities under exigent circumstances. As in S.1217, it is appropriate to ensure that any 

reduction in the capital requirement be explicitly temporary and subject to a limited 

number of renewals by another decision of those two officials. Such a limited timeframe for renewal of a reduced capital requirement is useful to ensure that the minimum capital requirement is not subverted. A crisis lasting longer than 12 or 18 

months—one or two renewals of the initial 6-month authorization for a reduced capital standard—is appropriately addressed by legislation rather than regulatory initiatives. 

Market Structure for Guaranteed Securitization 

The approach taken in S.1217 would arrive at a housing finance system in which 

multiple firms compete in the business of securitization and guarantee, gathering 

the required private capital and purchasing the secondary Government guarantee. 

As noted above, such a system would involve competitive pressures that pass on the 

benefits of any inadvertent Government subsidy from underpricing of the secondary 

insurance to homeowners through lower interest rates. Multiple firms would likewise help address the too big to fail problem by ensuring that one or more could 

fail without impairing the flow of mortgage financing. 

A key requirement for such a system is that sufficient firms are willing to enter 

into the business of securitization, gathering the private capital and purchasing the 

secondary Government guarantee. S.1217 appropriately looks to jump-start the process of entry and competition by making all of the infrastructure of the existing 

GSE’s licensable to approved issuers of guaranteed MBS (this infrastructure is the 

property of Fannie and Freddie, which remain private firms, and thus would be obtained for compensation). Among the new entrants would be a mutually owned firm 

to ensure that smaller banks have access to the secondary Government guarantee 

without having to go through one of the large banks that today dominate mortgage 

origination (a single securitization cooperative inevitably would be dominated by 

large banks). This step of licensing infrastructure would considerably reduce the 

startup costs for new entrants. Similarly, the requirement that all guaranteed MBS 

trade on a common securitization platform would ensure that new entrants have the 

benefits of the full market liquidity. This would avoid a situation in which the securities of a new entrant trade with a considerable liquidity penalty over those of incumbents. The housing finance regulator would likewise be tasked with looking out 

for anti-competitive practices, including such as the past use of volume discounts 

that tended to lock originators into particular channels for securitization. 

The system in S.1217 would require entry by enough firms to ensure competition. 

It is hard to say how many are required, but at least three and preferably five 

seems reasonable as a balance between having enough competition and avoiding 

TBTF concerns, while not dissipating the natural scale economies involved in housing finance. A variety of firms might be expected to enter into the business of 

securitization and guaranty, starting with entities that now take on housing credit 

risks—both investors such as asset managers and private equity funds, and originators such as banks. As noted above, an essential part of housing finance reform is 

to ensure that smaller institutions have access to any secondary Government guarantee without the need to rely on the existing large banks. 

Looking ahead, the Government eventually could ensure the return of nonguaranteed lending by auctioning off a limited amount of insurance capacity for the GovVerDate Nov 24 2008 16:38 Oct 17, 2014 Jkt 046629 PO 00000 Frm 00097 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\10-31 ZDISTILL\103113.TXT JASON
94 

1SIFMA brings together the shared interests of hundreds of securities firms, banks, and asset 

managers. SIFMA’s mission is to support a strong financial industry, investor opportunity, capital formation, job creation, and economic growth, while building trust and confidence in the financial markets. SIFMA, with offices in New York and Washington, DC, is the U.S. regional 

member of the Global Financial Markets Association (GFMA). For more information, visit 

www.sifma.org. 

ernment guaranty. The balance of mortgages would then go into the various forms 

of nonguaranteed lending. Such a system would further help ensure that the risk 

taken on by taxpayers through providing the secondary Government guarantee is 

appropriately priced in an auction setting. 

Conclusion 

A housing finance reform that creates an explicit guarantee is appropriate with 

considerable protection for taxpayers in the form of first-loss private capital, but 

should be seen as an extraordinary ongoing intervention of the Government in the 

market. In allowing for a guarantee, it is vital to avoid having housing finance reform re-create other aspects of the previous system that failed so badly and imposed 

immense costs on taxpayers. This would include ensuring that the retained investment portfolios are not allowed for firms with access to the guarantee, and avoiding 

re-creating the previous housing goals that distorted behavior (though the goals 

were not a primary driving factor behind the collapse of the two GSEs). Any subsidies for affordable housing activities should be done through explicit expenditures 

and not through housing goals or by imposing duties to serve various populations 

on firms participating in the housing finance system. 

A new housing finance system will be beneficial for individual homeowners by 

providing new channels through which borrowers can obtain mortgage funding, 

while providing benefits of greater protection for taxpayers and increased stability 

for the overall economy. An appropriately designed Government guarantee can be 

an element of such a new system. 

PREPARED STATEMENT OF MICHAEL S. CANTER 

SENIOR VICE PRESIDENT AND DIRECTOR OF SECURITIZED ASSETS, ALLIANCEBERNSTEIN, ON BEHALF OF THE SECURITIES INDUSTRY AND FINANCIAL

MARKETS ASSOCIATION

OCTOBER 31, 2013 

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

thank you for the opportunity to testify before you today. My name is Michael 

Canter and I am Senior Vice President and Director of Securitized Assets at 

AllianceBernstein, testifying today on behalf of the Securities Industry and Financial Markets Association (SIFMA). 1 SIFMA and its members look forward to working collaboratively with you all in analyzing how policy choices made will affect the 

ability of secondary mortgage markets to provide liquidity to lenders, and thus the 

availability and cost of credit to support housing finance. 

Among other priorities which I will discuss, SIFMA and its members believe that 

the preservation of the ability of secondary markets to support the 30-year, fixedrate mortgage should be a key priority. The 30-year fixed-rate mortgage is a stable 

and predictable way by which most Americans have historically financed their home 

purchases. While adjustable rate and shorter-term mortgages have benefits of their 

own, the 30-year mortgage provides for an affordable and predictable payment for 

many borrowers. Such 30-year mortgages, however, present significant risks to lenders and investors in that the stream of interest income is locked in over a long period, regardless of where funding costs move. To manage this risk, lenders need access to a liquid, forward market for mortgage loans. Without such a market to manage interest rate risk, lenders would be less willing to originate 30-year fixed-rate 

loans and many would likely not originate them at all. 

Indeed, SIFMA’s primary focus in considering reform of the housing GovernmentSponsored Enterprises (GSEs) is the preservation of a liquid, forward market for the 

trading of mortgage-backed securities (MBS). Today, the ‘‘to-be-announced’’ (TBA) 

markets serve this function. The TBA market serves a critical function in our current system, allowing mortgage originators to sell conforming loans before they are 

originated, enabling them to provide interest rate locks to borrowers well in advance 

of closing while hedging their risk. This allows the borrower the ability to lock in 

a rate well in advance of settlement. Furthermore, the TBA market provides the 

necessary liquidity that enables a national market whereby regional differences do 

not impact credit availability for borrowers in particular locations, as MBS traded 

95 

2We note that such entities should be required to be adequately capitalized and regulated 

to withstand events such as the recent market downturn and avoid the recent experience of rescissions and denied claims. 

in the TBA market tend to be geographically diverse. In addition to the loan origination aspect, the TBA market provides an important benefit to investors such as pension plans, 401(k) plans, mutual funds, State and local Governments, and global investors. Indeed, with over $250 billion of securities traded on an average day, the 

TBA market is the largest and most liquid secondary market for mortgages, and 

second only to the U.S. Treasury securities market in terms of bond market activity. 

Today’s hearing asks this panel to consider the essential elements of a guarantee 

but to flip that a bit, an essential element of the TBA market is the guarantee itself. 

Homogeneity is what makes the TBA market succeed. In this market, buyers and 

sellers agree on certain terms of a trade, but importantly buyers do not know all 

of the specific characteristics of the security they have purchased until 2 days before 

the trade settles. This is what allows liquid forward trading, and allows originators 

to hedge production pipelines. 

The homogeneity is driven by two main factors: standardization of terms, and the 

absence of credit risk. Terms are currently standardized through the GSE’s lending, 

servicing, documentation, and other guidelines. Credit risk is addressed though the 

implied but near-explicit Government guarantee on the principal and interest payments of the MBS. A structure whereby private capital would take a first position 

loss with a limited Government guarantee supporting losses beyond the first position loss would serve to diminish any credit risk concerns. This allows for what is 

essentially a one-factor analysis of the market—that of prepayment risk or the risk 

that borrowers will refinance or otherwise repay principal before it is due in response to changes in interest rates. It is a so-called ‘‘rates market’’, as opposed to 

a ‘‘credit market’’. The guarantee serves another beneficial function by attracting investors who would otherwise not invest in MBS. 

Possibly the most important benefit of the guarantee is the support that it provides to the market in times of crisis—it allows investors to fund mortgage credit 

creation even at times when other markets become less liquid. This was tested in 

2008, when private-label MBS markets completely shut down, bank portfolios significantly contracted lending standards, and the GSE and FHA markets took on the 

vast majority of credit provision. Without the guarantee, credit would have dried up 

as it did for corporations and other significant borrowers. And what mortgages could 

be sold would have been far, far more expensive. No one disagrees that the role of 

the Government must shrink, but it must also be recognized the critical countercyclical role the guarantee plays. 

Sharing Risk With the Private Sector 

When thinking about the private capital that should stand in front of the guarantee, we believe that the risk that taxpayers are exposed to losses should be very 

remote and that risk should stand behind a number of levels of private capital acting as a shield or buffer. In arranging such a system, the various sources of private 

capital protecting the Government should be recognized: 

• Borrower equity; 

• Equity capital in loan- or pool-level mortgage/bond insurance providers and/or 

providers of corporate guarantees 2 and capital markets-based risk transfer 

transactions; and 

• Well-capitalized insurance reserve funded by fees paid for Government backstop. 

Introducing market-based risk taking into the system will confer an important 

benefit on the system. Global capital markets are often more able to accurately price 

mortgage credit risk than a Government agency or regulator. Capital market participants also price risk on a relative basis, in comparison to other investment options, and this should help temper risks of a race-to-the-bottom. To the extent that 

mortgage risk becomes underpriced, participants should gravitate toward alternatives that provide more attractive returns, tempering the level of underpricing. 

Of course, this pricing of risk will not be perfect, and it will not necessarily in and 

of itself service whatever goals policy makers may set forth. It will, however, provide 

critical signaling to the world as to exactly what level of risk taxpayers are taking 

on as they provide the ultimate guarantee for the new conforming MBS, and should 

promote a more safe and sound system. 

A consideration here is that a mandatory, fixed level of risk sharing could contribute procyclically to fluctuations in mortgage markets and credit availability. We 

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3There is a related, specific inefficiency that should be remedied in housing finance reform 

legislation. The CFTC’s commodity pool regulations would cover risk-sharing transactions executed with credit-linked notes or other derivatives. Characterization of the transaction as a commodity pool, and its sponsors as commodity pool operators, would require the sponsors of the 

transaction to comply with burdensome and not particularly relevant reporting, registration, disclosure, and other requirements which were intended for operators of true commodity pools (i.e., 

those which invest in true commodity interests such as cotton or grain). The original design of 

the GSE’s recent transactions was in the form of credit-linked notes. Because of these still unresolved issues, the transactions were significantly delayed, and were changed to a less efficient 

securities-based structure. Legislation should ensure that these types of risk-sharing transactions are exempted from characterization as commodity pools, and that their sponsors are not 

deemed to be commodity pool operators. 

could support an approach where mandatory levels of risk sharing fluctuate in relation to the demand for mortgage credit risk. If constructed otherwise, the regime 

will tend to exacerbate booms and busts. If there were housing market distress, risk 

would be more expensive to sell, and that would increase the cost of credit. Increases in the cost of credit could exacerbate housing market distress. This is not 

to say that it is inappropriate for mortgage rates to fluctuate due to economic or 

other factors, but rather that it is appropriate for policy makers to have levers to 

ease extreme periods of dislocation before they become systemic problems. Importantly, significant changes in the pricing of this risk will signal to regulators and 

policy makers that something is happening in mortgage markets that may warrant 

further study. One of the most important factors in considering how first-loss capital 

should be introduced into the markets for the new conforming MBS is whether or 

not a particular approach will disrupt the critically important liquidity of the TBA 

market. 

Securities-based structures to take first-loss risk have important advantages and 

disadvantages. Some securities-based proposals involve a requirement that risk be 

shared with capital markets investors concurrently, or near concurrently, in order 

to obtaining a Government guarantee. We note above that the TBA market provides 

important price information to lenders that allows them to hedge risk and provide 

rate locks to borrowers. To the extent that obtaining a Government guarantee is 

conditioned upon the prior sale of a set amount of risk into private markets, advance price information may not be available to the lender because there is no liquid, forward market for mortgage credit risk. This will make it harder or impossible 

for lenders to provide rate locks to borrowers because the cost of the risk sharing 

is a factor in the pricing of the loan. This would likely cause significant problems 

for the liquidity of the TBA market, and could potentially render it inoperable. This 

implies that risk sharing requirements are better structured to not be a strict concurrent mandate with the issuance of a new conforming MBS—risk needs to be 

warehoused somewhere for a period of time. 

The liquidity of the current GSE MBS markets must flow seamlessly into the new 

market; this $4 trillion market cannot be orphaned in the transition to the new system. Abandoning outstanding securities would immediately diminish liquidity and 

value in the market for existing GSE MBS, and would likely damage the confidence 

of current global investors as regards to the merits of investing in the new securities. It would also mean that the market for the new form of conforming MBS would 

start with zero liquidity—it would be very volatile, and would not offer attractive 

pricing to lenders or borrowers. Therefore, the form of the conforming MBS in the 

future needs to be generally compatible with the form of conforming MBS today, or 

at least not so different that the current GSE MBS could not be converted into the 

new form or otherwise made fungible. 

To the extent that capital-markets risk sharing mechanisms involve security 

structuring, such as in a senior/subordinate arrangement, there is a risk that homogeneity will be lost among different structures and this will cause difficulties in promoting a liquid TBA market. It would also be more challenging to ensure these securities would be fungible with existing MBS in a common TBA market. That does 

not mean this structure should be discarded but it is an important factor to keep 

in mind. 

Capital markets transactions similar to Freddie Mac’s STACR or Fannie Mae’s 

CAS series are viewed as the most viable currently used form of risk sharing with 

capital markets. Since these types of transactions do not impact security structure, 

they do not have an impact on the functioning of the TBA market. They are also 

flexible and should be able to accommodate various investor needs and strategies 

for sharing risk with them. 3 However, their performance through a cycle and ease 

of execution in less favorable market environments has not yet been observed. Other 

arrangements that do not alter security structure, such as the pool-level mortgage 

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insurance transaction recently executed by Fannie Mae, also appear to be compatible with TBA. 

There are similar considerations for models that involve private guarantors, especially regarding how many there should be. The range is from zero (i.e., FMIC is 

the guarantor in the system) to one, two, or a multitude of privately owned entities. 

Advantages to a greater number of first-loss credit providers include the ability to 

optimize execution among competing pricing and eligibility criteria, insulation from 

operational failure of any single first-loss credit provider, greater variety and more 

innovation in product offerings and more equal bargaining strength between the 

first-loss credit provider and mortgage originator. 

On the other hand, fewer first-loss credit providers would offer increased product 

standardization, enhanced liquidity for both loans and securities, and lower total 

cost of infrastructure. Due to the extreme correlation of their business models, the 

benefits of risk diversification stemming from larger numbers of first-loss credit providers are likely smaller than they may appear. 

Finally, competition among first-loss credit providers creates a risk of ‘‘race to the 

bottom’’ pricing and guideline offerings. A similar issue also arises in Co-Op structures where members may attempt to gain market share or increase margins by 

making riskier loans and ‘‘free riding’’ by delivering them into the Co-Op’s pricing, 

which is based on aggregate collateral performance. This argues for a focused effort 

to ensure that competition is promoted among guarantors and other parties. Barriers to entry should be limited to the level that is necessary to ensure a stable environment; regulatory standards should be high enough to ensure that incentives to 

‘‘race to the bottom’’ are mitigated. 

Transition Issues 

As many have noted, the transition to whatever new system policy makers create 

is just as important as the new system itself. Put simply, the Government should 

reform, repeal, or avoid policies that repel private capital or generate uncertainty. 

Private market participants demand transparency and certainty in their investments and capital allocations. Many factors and events during and stemming from 

the recent financial crisis have caused private capital to retreat from funding mortgage credit. In particular, the potential for seizures of loans through a municipality’s 

use of eminent domain run the risk of causing private capital to once again flee the 

mortgage markets. Such actions, if they are allowed by policy makers to proceed, 

would damage investor confidence in mortgage markets and drive the cost of mortgage credit higher, and availability therefore lower. Policy makers must recognize 

the national importance of this and ensure that individual municipalities or other 

governmental entities are not able to cause damage and act in opposition to the national interest. Above all, Federal Government programs and entities such as the 

Federal Housing Administration should not be party to such activities. 

The time line for transition must be long enough to facilitate continual liquidity 

and flexible to accommodate unforeseen challenges. The transition will consist of 

changes to the legal and operational framework of the core of mortgage finance. The 

transition begins immediately with the implementation of the legislation, and continues with the development of guarantors and other capital market risk sharing 

and operational standards. Additionally, the expectations of current bondholders 

must be supported through clarification of guarantee for existing securities: Not 

making explicit the implicit guarantee on existing MBS and corporate debt will disrupt the markets for these securities, harm the confidence of investors who are 

needed to participate in the new market, and make impossible a seamless continuation of the liquidity from the current markets to the future markets. 

In conclusion, as this Committee continues down this critical path toward establishing a more sustainable housing finance system, SIFMA and its member firms 

stand ready to assist you and your colleagues in answering the tough questions that 

lay ahead. 

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PREPARED STATEMENT OF DAVID H. STEVENS 

PRESIDENT AND CHIEF EXECUTIVE OFFICER, MORTGAGE BANKERS ASSOCIATION

OCTOBER 31, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Senate Banking 

Committee, thank you for the opportunity to testify on behalf of the Mortgage Bankers Association. My name is David H. Stevens and I am the President and CEO of 

MBA. From 2009 to 2011, I served as Assistant Secretary for Housing and FHA 

Commissioner at the U.S. Department of Housing and Urban Development (HUD). 

I have over 30 years experience in real estate finance. 

I appreciate the opportunity to share with this Committee MBA’s views on how 

to ensure that the multiple objectives of secondary market reform can be best balanced: ensuring liquidity in the secondary market, providing mortgage products that 

borrowers want at a price that is competitive, and protecting taxpayers from risk. 

My testimony today describes how these objectives can be achieved, focusing on the 

interplay between private capital and a necessary Government backstop. 

MBA recognizes that a successful secondary market needs to be more stable and 

competitive for all lenders with greater protections for borrowers and taxpayers. 

This system would utilize familiar and operationally reliable business systems, processes, and personnel from the current GSE model. It is also essential that any new 

system be accessible by lenders of all sizes and business models—as a robust and 

competitive marketplace benefits everyone, including borrowers, taxpayers, and our 

industry. 

We are encouraged by recent legislative activity that has revived the policy debate 

on the future of Fannie Mae and Freddie Mac, including S.1217 offered by Senator 

Mark Warner and Senator Bob Corker. We commend the efforts of the Chairman 

and Ranking Member for working in a thoughtful and transparent manner as you 

seek to reach consensus on legislation to reform the secondary mortgage market and 

create a potential new end state for the housing GSEs. 

Objectives of Secondary Market Reform 

Five years after being placed in conservatorship, Fannie Mae and Freddie Mac 

continue to play a central role in the U.S. mortgage market. MBA believes a successful secondary market needs to produce a more stable and competitive system for 

all lenders. Any transition to an improved system must retain and redeploy key aspects of the GSEs’ existing infrastructures, including certain operational functions, 

systems, people, and business processes. 

In order to prevent disruptions to day-to-day business activities of lenders and to 

ensure a fair, competitive, and efficient mortgage market, any new proposal must 

be carefully phased-in to protect the housing finance system from unnecessary disruptions. 

MBA believes that the secondary market should: 

• Ensure equitable, transparent, and direct access to secondary market programs 

for lenders of all sizes and business models; 

• Preserve key GSE assets—technology, systems, data, and people—by transferring them to any new entities created by GSE reform, or placing them into a 

public utility; 

• Promote liquidity and stability by connecting global capital to the U.S. mortgage 

market; 

• Provide an efficient means of hedging interest rate risk through a robust TBA 

market; 

• Provide for a consistent offering of core products including the 30-year fixedrate prepayable mortgage; 

• Provide certainty in mortgage transactions for qualified borrowers; 

• Rely on a single, highly liquid, Government-guaranteed security that is delivered through a common securitization platform; 

Achieving these objectives will require: 

• An explicit Government guarantee for mortgage securities backed by a well-defined class of high quality home mortgages; 

• Protection for taxpayers through deep credit enhancement that puts private 

capital in a first-loss position, with no institution too big to fail; and 

• Fair and transparent guarantee fees to create an FDIC-like Federal insurance 

fund in the event of catastrophic losses. 

104 

The Government’s role is to provide quality regulation of guarantors and systems 

and to provide a clearly defined, but limited, catastrophic credit backstop to the system. Without this Government backstop, the mortgage market would be smaller and 

mortgage credit would be more expensive, meaning that qualified lower and middle 

class households would have less access to affordable mortgage credit and be less 

able to qualify to achieve sustainable home ownership and the multifamily rental 

market, which predominantly serves those of modest incomes, would be adversely 

impacted. 

The Need for a Government Backstop 

The American mortgage market has long been dominated by 30-year fixed-rate 

fully amortizing loans, with no penalty for refinancing the loan. The advantage for 

borrowers is that it protects them against increases in interest rates while providing 

a long period over which to amortize the loan principal, thus providing more affordable monthly payments than would be available under a shorter amortization schedule. 

The advantages for borrowers, however, are offset by the risks posed to depository 

institutions trying to hold 30-year fixed-rate mortgages in portfolio, given the short 

duration of most bank deposits and other liabilities. When interest rates rise, banks 

may end up earning negative spreads on the mortgages they hold. This funding mismatch can be dangerous for financial institutions. 

For example, the thrift industry debacle of the 1980s largely grew out of the removal of interest rate ceilings on bank and thrift deposits for many years. The resulting spike in the interest rates on the deposits funding long-term fixed-rate mortgages essentially wiped out the capital at many thrifts. Similarly, funding mortgages with long-dated fixed-rate deposits can be a problem if rates fall and borrowers exercise their options to refinance their mortgages at lower rates. The bank 

then faces low or negative interest rate spreads when it reinvests the funds from 

the paid-off mortgages at lower rates. Thus, relying on bank portfolios to fund 30- 

year fixed-rate mortgages places tremendous risk on the existing Government support of the mortgage market through the FDIC. 

Securitization developed as a means of removing this interest rate risk from depository balance sheets, while providing a long-term fixed-rate asset for investors 

that had a better capacity to manage such cash flows. However, securitization relies 

on a steady presence of private investors willing to take on the risks of mortgagebacked securities. We have seen repeatedly over the last 20 years that while investors are generally willing to buy guaranteed MBS, even during a market disruption, 

they are unwilling to take on uncertain credit risk during these times. 

When depositors or security holders become concerned over the health of the assets supporting their investments, they want to liquidate their positions and hold 

on to their cash until the situation settles. In the case of banks, this is a run on 

deposits. For securitization, it is a panic sale of the securities with a large drop in 

price. It is as if bank depositors were forced to sell their deposits to another investor 

at a deep discount rather than attempting to redeem them at par at the bank. Because those who sell first suffer the smallest losses, there is an advantage to sell 

quickly before a panic, thus helping fuel a panic. Even if they do not sell, markto-market accounting rules do not distinguish between normal price drops and those 

caused by panic selling, causing large losses for investors. 

The question is not whether a Government guarantee will limit the potential damage of periodic panics in the securities. The benefit is clear. The real question is how 

to go about limiting the risk to the taxpayers that comes with any sort of Government support. Adequate private capital in a first-loss position, the establishment of 

an insurance fund, and a limited, clearly defined credit box (such as has been accomplished with the QM rule) all would be strong steps in this direction. 

In summary, the U.S. mortgage market is unique in the degree to which 30-year 

fixed-rate mortgages play such a large role in financing home purchases. To date, 

however, that market has been supported by securitization and the implicit and explicit support the taxpayers have given to that market. MBA believes that such a 

guarantee can be put in place in order to reduce the volatility that would exist in 

a purely private market, but that would be implemented in such a way as to limit 

the exposure of the taxpayers. 

Investors Should Be Able To Rely Solely on the Full Faith and Credit Guaranty Behind the Security 

Investors should be ensured that they will receive timely payment of principal 

and interest, and that this backstop reflects the full faith and credit of the U.S. Government. As noted above, the purpose of the backstop on the security is to ensure 

liquidity even during financial market disruptions. Limiting the coverage to less 

105 

than 100 percent would cause investors to question whether the securities would remain liquid in a downturn. 

The Government guaranty should be paid for through premiums that build up a 

Mortgage Insurance Fund (MIF) over time. The MIF only pays in the event that 

a private credit enhancer goes out of business. 

Attachment Points, Capital Requirements, and Risk 

A central question in reordering the secondary market is to define where private 

risk taking ends and where Government support begins. In most proposals, private 

entities (or capital market structures) are assumed to take losses up until the point 

that the entities fail (or the structures are tapped out). The key question then becomes how much capital the entities need to set aside to absorb losses, or alternatively, how thick subordinate tranches within capital market structures need to 

be. 

There are several challenges in answering these questions. First, there is uncertainty regarding precisely how much risk resides within a pool, vintage, or population of mortgages. Mortgage losses are a function of borrower, loan, and property 

characteristics that are measurable at origination. Lenders, investors, rating agencies, and regulators have developed considerable information and analytics which 

can accurately gauge the relative risk of default and loss from mortgages with different characteristics. For example, Standard & Poors in their 2009 ratings criteria 

estimate that holding all other factors equal, loans with a 50 LTV are at less than 

half the risk of default of loans with a 75 LTV, while loans with a 90 LTV are 2.5 

times more likely to default. Loans to borrowers with a credit score of 680 are at 

twice the risk of default of a borrower with a 725. ARM loans have a baseline default rate that is 1.2 times higher. No-doc loans are at six times the risk of full documentation loans. 

However, despite these accurate and precise estimates of relative default risk, it 

is more difficult to get a handle on the level of absolute risk. In a recession, when 

unemployment increases sharply, default rates across all types of loans increase. A 

sudden, sharp increase in interest rates can lead borrowers with adjustable-rate 

mortgages to fall behind on their payments. And as we have clearly witnessed in 

the Great Recession, borrowers who cannot sell their homes because they are underwater, i.e., their property value is less than the balance on their mortgage, are more 

likely to default and go to foreclosure. Home price movements are thus a critical 

factor. Faster rates of home price appreciation such as we saw during the boom can 

dampen default and loss rates across all types of loans, while steep declines in home 

prices may lead to higher loss rates across the board. 

Lenders, investors, and others attempt to address these economic risks by estimating loan performance across a range of different economic environments, testing 

the impact of alternative home price, interest rate, and economic scenarios. These 

experiments result in estimates of performance across a range of outcomes, and can 

provide a credible picture of the potential distribution of losses one might expect 

from a given set of loans. 

It is worth noting that the range of scenarios imagined may necessarily be limited 

by historical experience. In more than 70 years, the U.S. had not experienced an 

economic and housing market downturn that severe since the Great Depression. It 

is extremely difficult to accurately gauge the likelihood of such a tail event recurring. Are the odds 1 in 70? 1 in 200? 1 in 30? The data do not reveal enough information to accurately make that judgment. It is fundamentally an assumption, and 

similar to an engineer constructing a bridge, it is reasonable to err on the side of 

conservatism, but there are costs to being too conservative. 

Typical practice in industry would be to target a rating (e.g., ‘‘AAA’’) which is associated with surviving a certain level of losses while remaining solvent. An alternative approach is to define a stressful economic path, and then show that the entity would survive such a stress. The OFHEO risk-based capital test utilized a stress 

path (roughly a 15-percent decline in national home prices) from the oil-patch recession in the mid-1980s, and then applied that level of losses on a national basis. The 

Corker-Warner bill requires that entities be able to survive a 35-percent decline in 

national home prices. (Note that different home price measures and other factors 

can lead to very different levels of stress, so a larger number may not necessarily 

be consistent with a more severe stress if a more volatile home price index is used.) 

What level of protection is enough? Private credit enhancers should have sufficient capital so that it is extremely rare that the insurance fund is called upon. And 

the insurance fund and associated premiums should be large enough such that Government outlays would almost never be required. 

106 

However, as noted, there is a cost to being too conservative. Requiring capital beyond the actual economic risk drives up costs and would limit access to credit. A 

balance must be achieved. 

Private capital should stand in front of the Government backstop in order to protect taxpayers, but should be at a level to keep credit affordable and accessible to 

middle class homeowners. 

At the loan or at the pool level, substantial private capital should stand in front 

of the Government backstop in order to limit taxpayer exposure. Most discussions 

suggest that private capital should take on the ‘‘predominant’’ credit risk. 

Congress should set broad parameters for the regulator to establish capital requirements/credit enhancement levels that are in line with regulatory capital standards for mortgages held by other institutions. In effect, Congress should establish 

a system where there is no opportunity for regulatory capital arbitrage. 

Regardless of who holds mortgage credit risk, regardless of charter type, the capital requirement should be the same. For example, legislation should reference the 

most recent version of the Basel standards when instructing the regulator with respect to proper levels of capital. 

In the old regime, the GSEs were only required to hold 45 bps of capital against 

‘‘off balance sheet’’ exposure to mortgage credit risk. Banks and other depositories 

holding whole mortgage loans had to hold 4-percent capital (50-percent risk weight 

against 8-percent total capital requirement). 

Moreover, the banks had a 20-percent risk weight on GSE MBS, so they could 

hold 1.6-percent capital on MBS. Taken together, the system went from 4-percent 

capital for whole loans on bank books to 2.05-percent capital for loans guaranteed 

by the GSEs but held by banks as MBS. Tragically this was too little to buffer 

against the losses experienced through the downturn. 

Not surprisingly, the GSEs rapidly gained market share under this artificial competitive advantage with respect to required capital. 

Under S.1217, the securitization channel for conforming loans would have a 10- 

percent capital requirement. Banks under Basel III are still at 4 percent (5–6 percent for the very largest banks under the new leverage requirement). With this requirement, mortgages would be expected to flow to the banking system. Another 

worse possibility is that only the highest risk mortgages, which warrant higher capital standards, would be securitized and receive the Government backstop, leading 

the Government-backed segment of the market to be small, high risk, and high cost. 

Lenders originate to best execution. Operationally this means that when they are 

taking an application and pricing a loan, their systems determine which possible investors/programs might be eligible, sort by best all-in price, then assume that the 

loan will be sold through the highest price channel (execution). 

For example, suppose a customer would like a 30-year loan. The bank he is working with could sell the loan to the GSEs, securitize through a private-label issuer, 

or hold the loan on their balance sheet. At the time of application, the lender knows 

the prices associated with each, and assumes that the loan will be sold to the best 

opportunity, and typically would use that quote to provide a rate to the consumer. 

Between application and origination and sale, circumstances may change, and the 

loan may wind up being sold to an alternate execution. 

The relevance here is that relatively small changes in the price of one channel 

can quickly lead to large changes in best execution. A most recent example concerns 

the jumbo market. Before the run up in rates, private-label jumbo securitizations 

were beginning to pick up. After that run up, securitization cannot compete with 

a portfolio execution, so you are seeing jumbo securitizations being canceled or postponed. 

A longer-term trend with respect to jumbos is this: typically, the jumbo-conforming spread on 30-year fixed-rate loans had been roughly 25–50 bps. Though not 

seemingly dramatic, this spread was enough to drive consumer and lender behavior. 

The ARM share of conforming loans was roughly 20 percent. For jumbo loans it was 

roughly 60 percent. The relatively small difference in rates on jumbo vs. conforming 

loans was sufficient to cause jumbo borrowers to choose ARMs. 

If the FMIC channel is relatively expensive compared to other executions, one of 

two outcomes will occur. Either no loans will go through this channel, or only the 

higher risk loans will go through. This adverse selection would increase risk to the 

taxpayer, as the insurance fund and the Government would be left reinsuring a 

much riskier pool of loans. 

How do we know that a capital level similar to what the banks are held to would 

be sufficient to protect taxpayers? There are multiple, sophisticated approaches one 

could take to answering this question, but the simplest, most direct approach is to 

simply require that credit enhancers hold sufficient capital so that they could have 

survived the downturn we just experienced. 

107 

As shown in the chart above, the default rate on the 2007 book of business from 

Fannie Mae is approaching 12 percent. This book contained substantial amounts of 

Alt-A and other high-risk business that would be explicitly excluded by a QM requirement. Loss severity, i.e., losses as a proportion of the unpaid principal balance, 

are running at about one-third. This means that a 12-percent default rate translates 

to a loss rate of roughly 4 percent on this 2007 book. To the extent that tighter underwriting results in lower default rates, loss rates even in future extremely adverse 

scenarios should remain below this recent experience. 

Charging a modest reinsurance premium (on the order of 10–15 bps) should be 

more than sufficient to cover any residual risk over time, particularly if the mortgage credit risk is limited by mandating that only QM loans may be securitized. 

Beyond this simple analysis, researchers (e.g., Moody’s Analytics, Urban Institute, 

et al.) have conducted substantial econometric analysis that shows that capital in 

the range of 4–5 percent would cover losses in all but the most extreme scenarios. 

Proper Regulation and Oversight To Minimize Systemic Risk 

While setting proper capital requirement levels is critical, other aspects of regulation and supervision must receive attention as well. 

MBA strongly recommends that the system be set up so that there is robust competition for business in the secondary market, and so there is a credible threat of 

additional competitors entering the market if existing companies are making outsized profits. Congress and the regulator should work to eliminate barriers to entry. 

Fannie Mae and Freddie Mac had a legislatively granted duopoly. 

In addition to promulgating regulations around capital requirements, the regulator should also have rigorous criteria for approving lenders, servicers, credit 

enhancers, and other participants in the market. The regulator should also be an 

active supervisor, with sufficient timely information to be able to make judgments 

about potential required actions to limit risk to the MIF and to the taxpayer. 

The regulator should monitor concentration risks within the system. If the new 

regime relies upon a small number of entities with highly correlated business models, there is a risk that they could all fail at the same time. Plans for the new system should carefully calibrate capital requirements to mitigate this potential, and 

contemplate how the new regulator could continue lending until new entities could 

be formed following a crisis. The ability for the regulator to temporarily lower capital requirements for reinsurance eligibility during a systemic event is a wise and 

necessary provision. 

If the new regime relies heavily upon capital markets to lay off credit risk, the 

systemic risk potential is that concentrations of risk exposures and leverage could 

build up in hidden ways throughout the system. Unlike with entities that have clear 

and transparent capital requirements, capital market leverage can be hidden and 

can result in multiple, opaque layers of leverage even if transactions appear to be 

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The New System Should Promote Direct Access to the Secondary Market 

for Lenders of All Sizes and Support a Broad Variety of Business Models 

MBA believes that any improved secondary mortgage system should utilize familiar and operationally reliable business systems and processes from the current GSE 

model. It should also include components to ensure access for lenders of all sizes. 

Some examples of what the new model should deliver include the following functions: 

• Cash Window/Whole Loan Execution 

• Multi-Lender Security Execution 

• Single Loan Securitization 

• Servicing Retained Sales 

• Servicing Released Sales 

Single-family lenders should be able to utilize familiar credit enhancement options, such as mortgage insurance, to facilitate secondary market transactions in a 

timely and orderly way. Key functions present in today’s secondary market system 

should be preserved, while allowing new forms of private credit enhancement to develop over time. 

It may well take a combination of approaches to ensure that the system works 

for both smaller and larger lenders. It is imperative that the new system provide 

access on a competitive basis to qualified institutions, as this vibrant competition 

will ultimately benefit borrowers. 

Under the current GSE model, Fannie Mae and Freddie Mac are the issuers. They 

purchase loans from lenders and provide a guarantee (backed by an implicit Government guarantee). 

Under the Ginnie Mae model, lenders are the issuers. Lenders obtain loan-level 

insurance from a Government program (FHA, VA, USDA) and then issue the securities, obtaining a security-level guarantee from Ginnie Mae. 

The GSE model provides for many, typically smaller, lenders to sell whole loans 

to Fannie Mae and Freddie Mac for cash. This provides quick funding, which is a 

valuable benefit for many smaller lenders. 

The Ginnie Mae approach puts greater responsibility and control with the lender. 

However, the operational complexities may prevent some smaller lenders from becoming issuers. As a reference, there are roughly 400 Ginnie Mae issuers, and over 

1,000 direct sellers to Fannie and Freddie. 

The Corker-Warner bill provides both paths, with an ability for lenders to obtain 

private credit enhancement and be the issuer, and a Mutual Securitization Company which can fill the aggregation role for those lenders who do not have the operational capability or desire to be an issuer. Additionally, the bill would allow the 

Federal Home Loan Banks to act as aggregators for smaller lenders. 

MBA believes serious consideration should be given to expanding Federal Home 

Loan Bank membership eligibility to include access for nondepository mortgage 

lenders. In fact, historical evidence shows that such a move is consistent with the 

original intent of the system (see, Snowden, 2013). These lenders are often smaller, 

community-based independent mortgage bankers focused on providing mainstream 

mortgage products to consumers. In exchange for membership in the FHLB system, 

these institutions could be required to hold a limited class of stock with appropriate 

restrictions. Expanding FHLB access to these institutions would enhance market liquidity and ensure a broader range of mortgage options for consumers. 

Getting More Private Capital Back Into the Market Today While the Legislative Process Continues To Refine the Proper End State 

Fannie Mae and Freddie Mac have recently reported substantial profits, leading 

some to ask whether the business models of Fannie Mae and Freddie Mac have regained credibility that was lost during the financial crisis. Record GSE profits do 

not tell the whole story. In their current form, GSE profits are dependent in large 

part on three factors: 

• Guarantee fees, which have more than doubled in recent years. 

• Remarkably low-risk business, a sign of tight credit. 

• Their ability to shift legacy costs back to lenders. 

This current status is not sustainable over the longer term, and MBA believes 

that we should begin moving toward a more sustainable environment. While the legislative process will continue to refine the desired end state, MBA has proposed a 

set of transition steps designed to move in the direction of the developing consensus 

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regarding the shape of the future secondary market. The steps we propose, none of 

which require legislation, create an even greater competitive landscape for all originators beyond where we are today, and provide better value to borrowers. Further, 

they are consistent with the vast majority of end-state proposals. 

• FHFA and the GSEs should move to a common, fungible MBS to improve liquidity in the market. The discount on Freddie Mac’s security represents a loss 

to the taxpayer, as it is being implicitly subsidized by lower guarantee fees resulting in lower dividends to the Treasury. We should act now to remove this 

distortion by moving to a common, fungible security. 

• FHFA should mandate that the GSEs accept deeper credit enhancement on 

pools from lenders in exchange for reduced guarantee fees in order to lower 

costs and increase access to credit for consumers. The PATH Act includes language to this effect, which we would support as a means of bringing additional 

private capital into the market. Importantly, we believe that lenders should 

have ‘‘front-end’’ credit enhancement options in addition to the ‘‘back-end’’ options, as we believe the former have the potential to produce greater cost savings for consumers. 

• Regardless of which end state Congress decides upon, we need to ensure that 

lenders of all sizes have securitization options to directly access the secondary 

market in order to level the playing field. 

• FHFA should impose a well-regulated and fully transparent credit framework 

with clear representation and warranty protections to increase transparency in 

the system and enable lenders to responsibly expand access to credit. 

• FHFA should continue to seek stakeholder input regarding the Common 

Securitization Platform to lay the groundwork for a more efficient market in the 

future. The PATH Act also contains plans for a new market utility that would 

perform many of the roles and functions envisioned for the platform, with the 

exception that the bill would not permit the utility to securitize Governmentbacked loans. While we appreciate the agreement that such a central, operationally focused utility is needed, we do believe that some level of Government backstop is needed for the conventional conforming market. 

Below is an illustrative example of how MBA’s proposal for up-front credit enhancement would work. In today’s market, private capital can be competitive with 

the GSEs in certain segments. If guarantee fees were to increase further, borrowers 

could realize real savings through this approach at the same time that taxpayer exposure to the mortgage market is reduced. 

• Up-front Gfee reflects loan-level price adjustments (LLPAs). 

• MI premium is standard 25-percent coverage. Pricing is by credit tier. 


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1 2011 American Housing Survey. 

2 Joint Center for Housing Studies Tabulations of 2009 American Housing Survey, U.S. Census Bureau. 

• Proposed deeper coverage (45 percent on 90 LTV) accounts for vast majority of 

the risk. 

• 10 bps covers catastrophic risk assuming MI is sufficiently capitalized. 

• 10 bps for payroll tax. 

• Specific Gfee is most sensitive to level of MI capitalization and required returns 

for GSEs. 

• Savings to borrowers are significant. Would extend to borrowers at lower credit 

tiers as well. 

Process 

• Each approved MI would file a standard pool policy with FHFA/Fannie and 

Freddie and the insurance regulators so that everyone was clear on the structure—the simpler, the better. 

• Any approved lender could deliver deep CE pools to the GSEs for a Gfee discount. 

• Menu approach—lenders would have the option to deliver loans and pay the full 

Gfee, or arrange for deeper CE through an MI or by retaining recourse, and pay 

a much reduced Gfee. 

• MIs would compete for the business on total price, but also on mix of business, 

e.g., LTV and credit score. Allows for differences in views on credit. 

Multifamily Finance Key Principles for Multifamily Housing Finance Reform 

Our views on the multifamily housing finance market run parallel and are consistent with our views on the single-family residential market. 

More than one in three American households rent their home, and more than 16 

million 1 of those households live in multifamily rental housing, a development with 

five or more units. Renters include workers who want to live near their jobs, young 

professionals, empty-nesters, retirees on a fixed income, families with children, students, and households who value the convenience and mobility that renting offers. 

Notably, the vast majority of multifamily rental housing provides homes for households earning modest incomes, with 93 percent of multifamily rental apartments 

having rents affordable to households earning at or below the area median income. 2

Recognizing the unique attributes of the multifamily market as a key component 

of the broader housing finance system, we believe that policy makers should pursue 

the following principles in shaping the Government’s role in the multifamily housing 

finance system. 

First, our Nation’s housing policies should reflect the importance of multifamily 

rental housing, the range of capital sources that support this market, and the need 

for liquidity and stability in all market cycles. The number of renter households in 

multifamily housing is expected to grow from the current estimate that exceeds 16 

million. A broad range of capital sources support the multifamily finance market, 

including private capital sources. The roles of the GSEs and FHA in financing multifamily mortgages have been substantial, but other market participants—including 

life insurance companies, banks, and other lenders—have maintained a strong presence as well. With respect to the GSEs’ multifamily activities, credit performance 


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has been strong during the recent market downturn and, with Government support, 

the GSEs have served a countercyclical role that provided liquidity when private 

capital sources largely exited the market. 

Second, private capital should be the primary source of financing for multifamily 

housing with a limited, Government-backed insurance program ensuring that the 

market has access to liquidity in all cycles. The risk insurance program would provide support at the mortgage-backed security, rather than at the entity, level. The 

role of private capital is vital in several respects: (1) the deployment of private capital through market participants that have historically supported multifamily finance, such as portfolio lenders and CMBS investors; (2) the private capital that is 

already embedded within existing market executions (e.g., DUS, K-Deals) through 

risk-sharing structures; and (3) the investment of private capital in entities that 

would be permitted to issue Government-backed securities. We believe that a focused role for the Federal Government through a Government-backed risk insurance 

fund, with a Federal catastrophic backstop, would ensure continuous liquidity and 

stability in all market cycles. Eligible mortgage-backed securities would have a Government wrap. The insurance fund, paid for through risk-based premiums, could be 

modeled after FDIC programs and would support such mortgage-backed securities, 

not at the level of the issuer, as is the case today. 

Third, entities eligible to issue Government-backed securities should be funded by 

private capital, be focused on securitization, serve the workforce rental market, and 

be regulated in a manner that protects taxpayers and ensures robust competition 

among capital sources. A strong Government regulator with market expertise would 

provide oversight regarding the issuing entities, including their safety and soundness, risk-based capital requirements, and products offered. The entities, which 

would not be limited to potential successor entities to the GSEs, also would assume 

a significant risk position by providing an entity-level buffer, placing private capital 

at risk ahead of any Government backstop. Risk-based premiums would be deposited into a Federal insurance fund, to be drawn upon only if and when the entity 

becomes insolvent. The pricing of the premiums would be structured in a manner 

that allows robust competition. Importantly, the issuing entities would need to attract private capital and maintain financial viability. We believe, however, that they 

should be mono-line institutions limited to secondary mortgage market activities 

and the housing finance sector, with a focus on workforce and affordable rental 

housing. 

Fourth, stewardship of existing GSE assets and resources on behalf of taxpayers 

should be a core consideration for any action—during the current period of conservatorship, any transition period, and in the future state of multifamily finance. 

The talent and expertise at the GSEs, their existing books of business, their market 

executions, and any profits generated by their multifamily businesses are valuable 

to U.S. taxpayers and should be deployed in a manner that supports the future state 

of multifamily housing finance. Preserving and dedicating such resources would support an orderly transition to a new mortgage finance system and optimize potential 

returns to taxpayers. Fundamentally, the ‘‘do no harm’’ principle should govern, particularly in light of the stability and successes of the multifamily market overall. 

We wish to underscore that as policy makers deliberate the future of the Government’s role in multifamily housing finance, it is vital they ensure that capital continues to be available to support this essential source of housing. 

In conclusion, I appreciate this opportunity to again present testimony before this 

Committee, and look forward to answering any questions you may have.