U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

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

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

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

86–866 PDF 2014

S. HRG. 113–190 

HOUSING FINANCE REFORM: DEVELOPING A PLAN 

FOR A SMOOTH TRANSITION 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING VARIOUS OPTIONS FOR A TRANSITION TO A NEW HOUSING 

FINANCE SYSTEM THAT ACHIEVES THE ACCESSIBILITY, AFFORDABILITY, AND STABILITY GOALS OF HOUSING FINANCE REFORM 

WHILE MINIMIZING DISRUPTIONS TO BOTH THE PRIMARY AND SECONDARY MORTGAGE MARKETS 

NOVEMBER 22, 2013 

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

( 

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

LAURA SWANSON, Deputy Staff Director 

GLEN SEARS, Deputy Policy Director 

ERIN BARRY FUHER, Professional Staff Member 

MICHELLE MAIWURM, Legislative Assistant 

GREG DEAN, Republican Chief Counsel 

CHAD DAVIS, Republican Professional Staff Member 

MIKE LEE, Republican Professional Staff Member 

MICHAEL BRIGHT, Republican Senior Financial Advisor 

DAWN RATLIFF, Chief Clerk 

TAYLOR REED, Hearing Clerk 

KELLY WISMER, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

FRIDAY, NOVEMBER 22, 2013 

Page 

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

Opening statements, comments, or prepared statements of: 

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

WITNESSES 

James Millstein, Chairman and Chief Executive Officer, Millstein 

and Company ........................................................................................................ 4 

Prepared statement .......................................................................................... 24 

Responses to written questions of: 

Chairman Johnson .................................................................................... 70 

John Bovenzi, Partner, Oliver Wyman .................................................................. 5 

Prepared statement .......................................................................................... 36 

Responses to written questions of: 

Chairman Johnson .................................................................................... 73 

Mark Zandi, Chief Economist and Cofounder, Moody’s Economy.com ................ 7 

Prepared statement .......................................................................................... 41 

Responses to written questions of: 

Chairman Johnson .................................................................................... 74 

David Min, Assistant Professor of Law, University of California, Irvine School 

of Law .................................................................................................................... 8 

Prepared statement .......................................................................................... 59 

Responses to written questions of: 

Chairman Johnson .................................................................................... 77 

(III)

(1) 

HOUSING FINANCE REFORM: DEVELOPING A 

PLAN FOR A SMOOTH TRANSITION 

FRIDAY, NOVEMBER 22, 2013 

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

The Committee met at 10:02 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. The Committee will come to order. Today 

we continue our series of hearings to better inform the Committee’s 

efforts to reform our housing finance system. While we have spent 

time examining what the different components of a new system 

should look like, today we focus on how to develop a credible plan 

that will seamlessly transition us from the current system to the 

new one. 

This is a critical issue, especially as we consider the significance 

of the housing market to the overall economy. If the transition is 

not properly managed, or does not have enough flexibility built in, 

then we are asking for trouble and we could end up with potential 

market disruptions, which would impede economic growth. That is 

the last thing we want. 

There are a number of transition issues worth discussing, starting with how best to wind down Fannie Mae and Freddie Mac 

while we build a stronger system. A key goal is ensuring taxpayers 

are fully repaid as we also consider what well-functioning systems 

and assets could be utilized in a new system. We should seek to 

find options that make the best use of existing resources to avoid 

making the transition needlessly inefficient, costly, and complex. 

We also need to examine the timing and sequence of the transition plan. There should be transparency with respect to the details 

of the transition to provide market participants the certainty they 

need to make long-term plans and decide what roles they may 

want to play. 

While there should be clear goals to make sure we eventually 

reach the desired outcome, we should also consider allowing for 

some overlap so that the new system is well-tested and fully functioning before we turn off the lights on the old system. There is 

simply no need to roll the dice when we are talking about nearly 

20 percent of our economy. 

A few other questions to contemplate: What is the best way to 

verify that risk-sharing structures work and sufficient private capVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
2 

ital is able to provide mortgage credit through good times and bad? 

What kinds of emergency powers are needed to deal with unforeseen events during the transition and minimize market disruptions? If a common securitization platform will help deliver a single 

security, should the platform be fully operational before shutting 

down the old system? And what steps are needed to make sure legacy MBS issued by Fannie and Freddie do not become orphaned? 

Given our witnesses’ expertise in housing finance, as well as 

some of our witnesses’ experiences managing other transitions, I 

look forward to hearing their views on these important questions 

and other issues. With that, I turned to Ranking Member Crapo for 

his opening statement. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you, Mr. Chairman. The issue of how we 

transition into a future system is one of the most important topics 

we will cover in this series of housing finance reform hearings. Numerous challenges will face our regulators and market participants 

as we move toward a new housing finance system. 

These challenges are real and must be addressed. But they must 

also be weighed in the context of the consequences of the status 

quo. The status quo means Government control of nearly all of our 

Nation’s mortgage-backed securities market, stifling financial innovation. The status quo means little, if any, reduction in the $5 trillion of outstanding mortgage debt to which the taxpayer is currently exposed. 

The status quo means continued legal and market uncertainty, 

creating costs that we may be realizing for decades to come. These 

realities prove that inaction carries its own dangers in our housing 

market, as does action that merely gives the appearance of change 

without recognizing the mistakes of the past. 

With that in mind, I look forward to hearing from our witnesses 

regarding issues we need to consider, and recommendations they 

have to most effectively transition to a reformed system. During 

yesterday’s hearing, we heard recommendations on how to best 

equip the future regulator to meet the transitional issues it might 

face in preparing to assume its responsibilities. 

I expect that today’s hearing will give us the opportunity to pair 

the lessons learned yesterday with today’s relevant information, 

particularly as it pertains to how to handle the assets of Fannie 

Mae and Freddie Mac. As we proceed with this discussion, there 

are many questions that must be considered, such as, while Fannie 

and Freddie are unique institutions, what do past experiences suggest are processes to maximize the return on our investment for 

the taxpayer, while also minimizing disruption in our markets? 

How do we allow adequate time to achieve and measure the appropriate benchmarks of the transition while still ensuring accountability in the process? What is the best way of dealing with 

the legacy obligations of Fannie and Freddie to ensure adequate 

protection for both taxpayers and investors? 

While these questions do not represent an exhaustive list, they 

do provide an insight into the complexity that we must address. 

S.1217 seeks to address the questions we will face through a 5-year 

phase-in for the future regulator, FMIC. This phase-in would coinVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
3 

cide with the beginning of a wind down of Fannie and Freddie supervised by the Federal Housing Finance Administration, or FHFA. 

Once the 5-year phase-in is complete and FMIC becomes operational, Fannie and Freddie’s charters would be revoked and they 

would cease writing new business. However, the wind down of the 

companies would continue, and during that time, the obligations of 

Fannie and Freddie would be explicitly guaranteed by the Federal 

Government, offset by a continued revenue stream from the companies. 

Additionally, so long as FMIC did not believe any actions interfered with its duties, FHFA would be free to sell or transfer the 

assets and business lines of Fannie and Freddie to aid in their resolution. One suggested use for some infrastructure of these companies is to aid in the establishment of a small bank mutual company 

prescribed in S.1217. Another destination for this infrastructure is 

likely within the common securitization platform envisioned in the 

bill. 

There has been much discussion of these concepts and other proposals for how Fannie and Freddie’s assets might best be utilized 

in the future housing finance system. This discussion is productive 

and we must consider all perspectives so that we reach an optimal 

solution for consumers and taxpayers. 

However, the consequences of inaction far outweigh the value of 

comprehensive reform. The status quo is not an option. We now 

have momentum of both houses of Congress and the White House 

working toward achieving real reforms. We must build on this momentum. 

I welcome the views of all who seek to aid in this effort and look 

forward to the testimony we will hear today. Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Crapo. Are there any 

other Members who would like to give brief opening statements? I 

would like to remind my colleagues that the record will be open for 

the next 7 days for additional statements and other materials. 

I would like to introduce our witnesses that are here with us 

today. First, Mr. James Millstein is the Chairman and CEO of 

Millstein and Company. Previously Mr. Millstein served as the 

Chief Restructuring Officer at the Treasury Department. 

Next will be Mr. John Bovenzi is a Partner of Oliver Wyman. Mr. 

Bovenzi served over 20 years in high-level positions at the FDIC 

and played a key role with the Resolution Trust Corporation. Next 

is Dr. Mark Zandi, Chief Economist at Moody’s Analytics where he 

directs economic research encompassing macroeconomics, financial 

markets, and public policy. 

And Professor David Min, Assistant Professor of Law at the University of California, Irvine School of Law. Previously Professor 

Min served as a staff attorney at the SEC and as counsel to Senator Schumer, and he helped the lead for American Progress Working Group to develop a housing finance reform proposal. 

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

Mr. Millstein, you may begin your testimony. 

4 

STATEMENT OF JAMES MILLSTEIN, CHAIRMAN AND CHIEF 

EXECUTIVE OFFICER, MILLSTEIN AND COMPANY 

Mr. MILLSTEIN. Chairman Johnson, Ranking Member Crapo, 

Senators Warner and Corker, thanks for inviting me here to testify 

on the transition. 

I have spent the entirety of my 30-year professional career as a 

lawyer, investment banker, and as a public servant in doing corporate restructuring work. During the recent financial crisis, as the 

Chairman mentioned, I was the Chief Restructuring Officer at the 

Treasury Department where my primary responsibility was managing the restructuring and the exit from our substantial investment in AIG. 

I also am an adjunct professor of law at Georgetown where I 

teach a course on the Federal regulation of financial institutions. 

I am here today because embedded in the task of reforming our 

Nation’s housing finance system is a restructuring of the two largest players in that system today, Freddie Mac and Fannie Mae. 

Because they are central to mortgage credit formation in the 

United States, winding them down, as some Members of Congress 

and the Administration have advocated, will have significant and, 

I believe, adverse consequences for mortgage credit availability and 

for the nascent housing and economic recovery. 

Rather than winding them down, I urge you to consider a restructuring alternative that addresses the fundamental causes of 

the companies’ insolvency, eliminates the private gain/public loss 

nature of their current Government charters, generates a significant profit to Treasury for supporting their solvency during the recent crisis, and most importantly, ensures a smooth transition to 

a new housing finance system that better protects taxpayers 

against future losses while providing for the continuing availability 

of mortgage credit to the creditworthy. 

There appears to be a growing consensus in the policy community around the basic architecture of that new housing finance system. A Federal guarantee on qualified mortgage product is required to ensure the widespread availability of a 30-year fixed-rate 

product, and to sustain the deep and liquid mortgage securities 

funding markets that complement balancing lending for the banking industry. 

The Government guarantee should be explicit, structured as reinsurance, priced at arm’s length by an independent agency and 

available to reimburse investor losses only after a thick layer of 

private first-loss capital provided by well-capitalized mortgage insurers or subordinated capital provided by investors has been exhausted. 

The Government reinsurer also needs to be a strong regulator 

with authority over all issuers, guarantors and servicers with 

whom it interacts in the new system. And I commend Senators 

Corker and Warner for having put together a coalition around a 

bill that has all of these elements in it. 

However, the transition contemplated by the bill out of the 

conservatorships to this new system is fraught with danger and 

needs serious rethinking to mitigate three significant risks that 

any credible transition plan must address. 

5 

First, the fragile economic recovery cannot afford the risk of a 

significant disruption in mortgage credit availability. Second, the 

Government must end its ongoing backstop of Fannie Mae and 

Freddie Mac solvency and conservatorship in a way that minimizes 

the likelihood that Treasury will need to cover future losses on the 

$5.5 trillion of liabilities the Treasury now backstops. 

While the substantial fees and net interest margin which the 

companies are currently earning and paying over to Treasury may 

look like an asset to be seized by taxpayers as the quid pro quo for 

the bailout, it could easily turn out to be a substantial liability if 

there were another significant housing downturn. 

Third, there must be a credible path toward the development of 

the substantial layer of private first loss capital on which the functioning of the new system will depend. If you build the new Government reinsurer but the required layer of first-loss capital does 

not come in size or at a pace of your contemplated wind down of 

Fannie and Freddie, the whole system will shut down before it has 

a chance to start. 

In my view, one fundamental choice will determine whether you 

successfully mitigate these risks in the transition. Do you recapitalize and privatize the guarantee businesses within Fannie Mae 

and Freddie Mac using their assets and operations to create a set 

of well-capitalized private market players who can ensure that sufficient first-loss capital is in place to allow the new system to function as contemplated? 

Or do you make the bet that if you build the new reinsurance 

system, players yet to be named with capital yet to be raised will 

generate the sizable amount of first-loss capital required to make 

the new system function on the 5-year timetable that your bill 

would wind Fannie and Freddie down. 

As currently drafted, 1217 chooses the latter course, and for that 

reason, I believe it puts the entire reform project at risk of failure. 

I appreciate the desire to avoid recreating the dangerous duopoly 

that contributed to the financial crisis and, unfortunately, I am 

running out of time, but I have laid out in my written testimony 

five or six steps that are all interrelated to avoid that outcome in 

connection with the privatization of the mortgage guarantee businesses, and I am happy to answer questions in the body of the 

hearing. Thank you very much. 

Chairman JOHNSON. Thank you. Mr. Bovenzi, you may proceed. 

STATEMENT OF JOHN BOVENZI, PARTNER, OLIVER WYMAN 

Mr. BOVENZI. Good morning, Chairman Johnson, Ranking Member Crapo, and Members of the Committee. My name is John 

Bovenzi, a partner at Oliver Wyman, and I want to thank you for 

affording me the opportunity to be here to speak about housing finance reform. 

My perspective draws on 28 years of experience at the FDIC and 

the Resolution Trust Corporation, and I would like to start with 

the RTC’s experience in creating a new Federal agency. First, the 

RTC showed that it is possible to start a new Federal agency and 

be successful in a relatively short period of time. 

However, stakeholders must have patience. The complexities of 

the issues that must be addressed virtually ensure that there will 

6 

be bumps, missteps, and delays along the way. New agencies need 

governance structures, information systems, staff, policies, procedures. The FDIC was able to provide the RTC with a lot of support, 

but it was not nearly enough. 

There was a great deal of frustration with the RTC early on, but 

some perspective is necessary. The RTC managed its way through 

those problems, saved taxpayers money, and finished its work 

early. 

Second, the leadership is critically important. The person in 

charge needs to possess the skills to work effectively with a large 

number of stakeholders and the managerial skills to address the 

many operational issues faced by a new agency. Sometimes there 

is a tendency to focus on high-level policy issues and not give sufficient attention to the critical operational details. 

Third, the employees of the two Government-sponsored enterprises in FHFA are the people who have the experience and the expertise to effectively transfer critical functions to a new agency. 

Their importance should not be undervalued or lost if Congress decides to move in this direction, because they are the ones who will 

ultimately determine success or failure. 

Regarding the lessons that may be learned from the FDIC’s experience, I would like to comment on three areas related to governance, financial strength, and supervision. First, independence in 

the system of checks and balances are two important features of 

the FDIC’s governance structure. The FDIC’s five-person Board of 

Directors and a strong Office of the Inspector General have served 

the agency well as part of an overall system of checks and balances, and those features have been included in the proposed structure for FMIC. 

Second, much has been learned about what is required to maintain a strong deposit insurance fund. The FDIC’s fund became insolvent during the two most recent financial crises. The agency had 

to substantially raise bank insurance premiums during these crisis 

periods when banks could least afford to pay them, and this, among 

other things, exacerbated the credit crunches that existed. 

As a result, Congress granted the FDIC much greater premiumsetting flexibility and the agency now has the authority to set the 

size of the deposit insurance fund high enough to withstand similar 

crisis periods. And FMIC would need sufficient flexibility and authority to manage the size of its fund so it, too, can protect taxpayers during economic downturns. 

Third, the FDIC has a wide range of supervisory and enforcement powers. The proposed bill would grant some, but not all of 

these authorities to the FMIC. It is worth considering whether 

FMIC should be granted broader supervisory and enforcement authority. 

Finally, I would like to make a few comments about the sales 

processes. The FDIC and the RTC experimented with a large variety of sales processes and learned much through trial and error. 

Two key principles emerged. First, virtually all sales were subject 

to inclusive, open, and transparent competitive bidding processes. 

The RTC and the FDIC did not engage in negotiated sales with 

individual buyers, recognizing that open competition would maximize value and reduce the possibilities for fraud or abuse. 

7 

Second, the RTC and the FDIC partnered with the private sector 

in the disposition of many of their assets. Through loss-sharing 

transactions with healthy banks and equity partnerships with private sector investors, the agencies found they could benefit from 

the added value the right management could bring to those assets. 

Thank you and I look forward to your questions. 

Chairman JOHNSON. Thank you. Dr. Zandi, you may proceed. 

STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND 

COFOUNDER, MOODY’S ECONOMY.COM 

Mr. ZANDI. Thank you, Mr. Chairman, Ranking Member Crapo, 

Senators Corker and Warner, thank you for the opportunity to be 

here today. I am an employee of the Moody’s Corporation, but my 

views are my own and not those of the Moody’s Corporation. You 

should also know that I am on the Board of MGIC, the Nation’s 

largest private mortgage insurance company. I am also on the 

Board of TRF, one of the Nation’s largest CDFIs, so it is important 

for you to recognize the context of today’s discussions. 

Most fundamentally, a successful transition from the current 

housing finance system to the future system means that activities 

in the mortgage market cannot be disrupted. Mortgage credit must 

flow smoothly. This is, obviously, very key to the housing market, 

and by extension, the broader economic recovery. It is particularly 

important over the next several years as the economy continues to 

try to recover. 

And because of the size of the U.S. mortgage market, it is key 

to the global financial system, and so it is very important that this 

all works out well; otherwise, we will disrupt a very important part 

of that global financial system. So this is a very important task. 

Now, of course, any discussion of the transition process presupposes an end state for the future housing finance system, and 

I will say S.1217, the Corker-Warner legislation, has, in my view, 

a very good vision of where the system should go, a hybrid system 

with an explicit Government backstop to the system. 

I think under this vision that is in the legislation, the 30-year 

fixed-rate, prepayable mortgage will remain a mainstay of the 

housing market and I think that is very important. It also ensures 

affordable mortgage loans to most middle income Americans 

through most economic times, and that is also very key. 

I would like to suggest a few adjustments to S.1217 to help facilitate the transition process because it is so key, and I should say, 

there are a lot of moving parts here and a lot of things to consider. 

I am just going to consider a few things for you to contemplate. 

The first is, I think there needs to be some flexibility with regard 

to the 5-year deadline. I think a hard and fast deadline in the context of the complexity of this process and the uncertainty involved 

creates some potential for disruption. 

Moreover, you need to consider the economic environment and 

the environment in the financial system as this process unfolds. It 

may very well be the case that the day you want to switch on the 

lights to the new system the economic and financial market environment would not be conducive to that. So I think there needs to 

be some flexibility around this process, and I think the transition 

8 

time line should be based on benchmarks, hitting certain targets, 

and I will mention two things that are very key. 

One is a well-functioning operational common securitization platform. This is vital to any future housing finance system. If that is 

not up and running and working well, then the system will not operate well. So that is very important. 

And I also would argue there needs to be a common security. 

This is becoming an increasing problem in the current—the way 

the system is currently designed, and this would also address some 

issues with regard to legacy MBS issues. So I think this is very, 

very important to consider in terms of transition. 

The other adjustment I would make is that I think the move 

from the current capitalization of the system to the capitalization 

of the system envisaged in the future needs to be phased in over 

time and there needs to be some flexibility around that as well. So 

just based on my calculation, the current system is effectively capitalized to about a 2.5-percent loss rate. Under 1217, we envisaging 

a 10-percent capitalization. 

Moving from 2.5 to 10, even under the best assumptions, and we 

have done a fair amount of calculations here, would add 40 basis 

points to mortgage rates, which in the grand scheme of things may 

not be a whole lot, but it will also be in the context of rising mortgage rates because of what the Federal Reserve Board is doing. So 

I think—and that is the minimum and assuming everything goes 

well in the transition process. 

So I do think that there needs to be some flexibility with regard 

to how those capital levels are phased in. Also in that context, we 

are only talking about one part of the housing finance system. 

There are other parts that need to be calibrated to. You know, 

what is going on with regard to bank capital requirements, what 

is going on in the private level securities market, what are decisions being made by the FHA. So phasing in capital requirements 

are very important. 

There are many other small adjustments I would make, but 

those are the two key things that I would focus on. I think they 

are very doable and at the end of the day, I think we will end up 

with a system that is meaningfully better than the one that we— 

certainly much better than the one we have now. 

Thank you again for the opportunity to speak to you today. 

Chairman JOHNSON. Thank you. Mr. Min, please proceed. 

STATEMENT OF DAVID MIN, ASSISTANT PROFESSOR OF LAW, 

UNIVERSITY OF CALIFORNIA, IRVINE SCHOOL OF LAW 

Mr. MIN. Chairman Johnson, Ranking Member Crapo, Senators 

Corker and Warner, thank you for the opportunity to testify today 

on this incredibly important topic. For the purposes of my testimony, I am going to assume that the system end state that we 

transition into will be some variation of S.1217, the bill proposed 

by Senators Corker and Warner. 

I think that the Corker-Warner bill envisions a so-called hybrid 

system in which the Federal Government provides explicit and 

price reinsurance on mortgage-backed securities created by approved bond issuers in a model based loosely on the Deposit Insurance model, the FDIC. I believe that Corker-Warner provides a 

9 

good framework for long-term housing finance reform, as I discuss 

in my written testimony, but the observations I make today hopefully hold true regardless of whether we go Corker-Warner or in 

some other direction. 

As a threshold matter, I just want to note again, echoing some 

of the other panelists, how massive and complex this proposed 

transition will be. Fannie and Freddie currently account for more 

than $5 trillion in mortgages, and since the crisis, these enterprises 

have been responsible for more than 60 percent of new mortgage 

originations, about $1.7 trillion each year, an amount that is slightly more than 10 percent of GDP. These are the most systemically 

important companies we have ever attempted to resolve. 

Now, the Federal Government has some experience in winding 

down large and systemically important institutions. AIG and GM 

are recent examples that come to mind. But here we are talking 

about winding down two massive and economically vital institutions, while simultaneously transitioning their core functions into 

a newly created set of institutions. I believe there is no precedent 

for this. And if we screw this transition up, we are talking about 

catastrophic damage to a very fragile housing sector and the broader economy. 

So as a threshold matter, I believe the guiding principle for policy makers thinking about transition must be the same that governs doctors, do no harm. Avoiding the disruption in mortgage liquidity must be a paramount concern in structuring the transition 

from the current system to the future one. 

We must also take steps to ensure that sufficient finances be 

available for affordable rental housing. In the aftermath of the financial crisis and housing crisis, policy makers have generally 

sought to deemphasize home ownership and shrink the Federal 

Government’s footprint in housing. If we are successful in these objectives but unsuccessful in redirecting finance to rental housing, 

millions of working class households will pay the price. 

With that in mind, I want to talk about the Corker-Warner transition plan which lays out a few detailed steps. The Corker-Warner 

bill contemplates a transition period of no more than 5 years following its enactment, during which time Fannie and Freddie would 

be phased out and the infrastructure for the new system, including 

the FMIC at the heart of the framework, would be established. 

Upon enactment, Corker-Warner would eliminate the affordable 

housing goals currently in place and begin to gradually reduce the 

loan limits over time, along with their GSE portfolios. Once the 

FMIC is certified as operational, an event that must occur again 

within 5 years of enactment, Fannie and Freddie are to be 

dechartered on their outstanding legacy obligations explicitly guaranteed with full fit and credit of the United States. 

At a high level, I think this plan provides a thoughtful template 

for transition, but leaves certain issues unresolved, several of 

which I identify in my written testimony. Like Dr. Zandi, I have 

a few recommendations I think that could help improve this transition. 

First, I think we should delegate more responsibility to regulators and remove some of the predesignated timetables in place. 

In a number of ways, I think this transition plan in place seeks to 

10 

micromanage the transition process. Specific timeframes are put in 

place for winding down the GSEs, lowering loan limits, and getting 

the FMIC up and running. 

What we have seen, of course, is that, you know, the best laid 

plans do not always work the way we planned. Capital requirements are highly detailed in this plan, but I think that all of these 

things are highly complex and technical issues that are best resolved by regulators looking closely at accumulated data, rather 

than by legislation based on assumptions that may or may not turn 

out to be true. 

Second, I think transition should be phased in over time, echoing 

Dr. Zandi, rather than through the on/off model currently contemplated. As recent events may highlight, unanticipated problems 

can and do arise, particularly with any transition as complex as 

moving trillions of dollars in mortgage origination finance from one 

platform to another. 

We may end up flipping the switch on the new system, only to 

discover that the lights do not turn on. I believe a preferable approach is to adopt a phased-in approach or piecemeal approach to 

transition, turning over small, but increasingly larger parts of the 

mortgage markets to the new infrastructure. 

For example, rather than preparing the CSP, Common 

Securitization Platform, to handle all the mortgage financed by 

GSE securitization, we could start with a dedicated subset, like 15- 

year fixed-rate mortgages or high-cost conforming mortgages. Such 

an approach, I believe, would allow regulators to test the new system in a meaningful way and develop that data that can help them 

perfect the new architecture. I think it would also help build investor liquidity in the MBS which is critically important. 

Third, convert legacy securities into the new MBS. Make this an 

option. You obviously cannot force investors to do this. Fourth, 

preapprove the new MBS for use in markets like TBA, for use as 

collateral in markets like the Fed discount window lending, repo, 

and derivatives markets. 

And finally, I think that the regulators need to be given more 

tools to prepare for another countercyclical downturn like we have 

today. Obviously, the role that Fannie and Freddie are playing 

today is critically important. I think regulators need more power to 

be able to deal with situations like these. I am out of time, so I 

apologize. 

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. This is a question for Mr. Millstein, Dr. Zandi, 

and Professor Min. Mr. Millstein, what are the most important elements of wind down of Fannie Mae and Freddie Mac? And should 

the charters be repealed prior to the new system being fully tested 

and operational? Should it be a target-based or time line-based approach? 

Mr. MILLSTEIN. I think it should be a target-based, not a time 

line-based approach, and as I said in my opening remarks, I think 

the wind down—I think you have two problems, and the biggest 

problem here is, you have got a new system you are building that 

requires a lot of first-loss capital. You cannot issue a new guarVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
11 

antee unless you have your first-loss capital in place. So there will 

be no guarantees in the absence of that capital being there. 

Today, six out of ten mortgages in America are being provided 

by these two entities you are proposing to wind down. Getting the 

timing of that wind down right with the wind up of your new system, to me, is a very, very—you have made this more complex than 

it needs to be. 

So what I have urged and what the plan I proposed suggests is, 

take the guts of the mortgage guarantee businesses of the two entities, capitalize them so they can play the role of first-loss provider 

in your system, and when they are properly capitalized—because 

today they have no capital other than the backstop from Treasury. 

When they are properly capitalized, turn your system on, because 

now you have got your two—at least two, maybe four if you do it 

with the multifamily businesses as separated from the single family—you have four separate entities who can play the role of firstloss provider. 

In that context, tear up their charters. They are no longer Government-sponsored enterprises. They are just private mortgage insurers competing with MGIC, Dr. Zandi’s company, and every other 

private mortgage insurer for the business of acquiring and pooling 

mortgage loans into conforming MBS, and buying reinsurance from 

the Government. 

Chairman JOHNSON. Dr. Zandi, do you agree? 

Mr. ZANDI. I agree it should be a target-based time line or transition, not a time line-based transition. I mentioned a couple of 

benchmarks and targets that I would focus on, the common 

securitization platform being very important. That is key to allowing for bringing down the barriers of entry to allow more private 

capital to come in. So that needs to be operational, working well, 

and functioning properly before we can transition to the new system. 

I mentioned the common security. I think that is also going to 

be quite important. That helps address also bringing down barriers 

to entry. It allows smaller lenders to participate in the system and 

that is going to be very key to this all working out well. And there 

are others, other key benchmarks. So I think it needs to be targetbased. 

I do think it would be, to answer your question explicitly about 

the charter, I think the approach I would take is to put the two 

institutions into receivership, take their assets, put them into a 

limited life regulated entity. This is a structure that was designed 

as part of the HERA legislation for this purpose. It allows the institutions to operate normally. Liquidity would continue to flow to the 

mortgage market. The market would not be disrupted, but the assets could then be deployed in a way to allow for a greater competition in the mortgage guarantee market. 

The concern I have is that if we just take Fannie Mae and 

Freddie Mac, restructure them and throw them out into the world, 

that the world will be dominated by the entities that follow Fannie 

Mae and Freddie Mac. Nothing will change. It will be a duopoly or 

potentially even a monopoly and I do not think that is appropriate. 

So I think we should take those assets and we should allow 1,000 

flowers to bloom, allow other guarantors to come in, more private 

12 

capital to come in, and they can license those assets in their own 

functions and it would create greater competition and ultimately a 

more resilient, better, stronger market at a lower cost to taxpayers 

and to mortgage borrowers. 

Chairman JOHNSON. Mr. Min. 

Mr. MIN. To answer your questions, I think it should be targetbased. I am a little reluctant to say their charters should be repealed until we know there is enough liquidity in the rest of the 

system. We are in the aftermath, of course, of a 100-year flood. We 

are in a credit downturn. 

It is not clear to me where the sources of private mortgage funding are going to come from right now. As I detail in my written testimony, bank deposits do not appear to be a likely source. Private 

label securitization, which was responsible for so much mortgage financing in the mid-2000s, has scaled back completely. 

So I do not know where this is going to come from. I do not know 

how long it will take. I think we need to achieve those liquidity 

benchmarks. Just to give one anecdote on sort of the target-based 

versus time line, you know, the securitization platform, the common CSP, which Dr. Zandi described, is at the heart of this new 

plan. 

It is necessary either for Corker-Warner or for the PATH Act; 

and yet, if you are following what is going on, it has been a year 

and a half after the FHFA first announced its plans to develop the 

CSP. We have had literally no movement. The last press release 

they issue announced that they had leased some office space. It 

does not appear that they have had a lot development toward that 

goal. 

If that is the sort of timeframe we are looking at, we have to be 

cautious about proceeding ahead based on assumptions that things 

will happen that may take more time. 

Chairman JOHNSON. Mr. Bovenzi, based on your RTC experience, 

to what extent should flexibility be built into the transition process 

to allow a regulator to address potential problems and to avoid 

market disruptions? 

Mr. BOVENZI. Well, like the other speakers, I believe you need to 

build in a great deal of flexibility. Congress can set the basic parameters, but you cannot anticipate everything, and even if Congress could, facts change, markets do not stay the same and there 

will be new issues to address that could not really have been foreseen. 

So I think the RTC experience shows that need for flexibility. 

They tried out some different things that did not work before finding out what did work for them. And it was not a smooth path for 

awhile, but it got to the right place. That flexibility was critical in 

getting there. 

Chairman JOHNSON. Senator Crapo. 

Senator CRAPO. Thank you, Mr. Chairman. Dr. Zandi and Mr. 

Millstein, the two of you have differing perspectives on how to best 

capitalize and establish a reformed market. But it seems to me, as 

I read your testimony, that there is an agreement between you that 

any current revenues of Fannie and Freddie should only be used 

to, either, one, repay the taxpayers or make the taxpayers whole, 

13 

or two, offset the cost of backstopping and capitalizing a new system. 

If I am correct about that, we have already seen this money used 

to offset a temporary tax cut and there are now other proposals out 

there advocating its use for other initiatives. I would like both of 

you to please elaborate on your views. Do I understand your testimony correct? Do you believe we should limit the utilization of 

these assets to either making the taxpayers whole and utilizing the 

necessary assets to capitalize a new system? 

Mr. ZANDI. You have characterized my view accurately. I do not 

believe that it is appropriate to use these resources for other purposes, and I think they should be used to ultimately repay taxpayers. That is an open question, exactly what that means and how 

much that will cost. 

And moreover, I do think it is undesirable to use Fannie Mae 

and Freddie Mac to generate revenues for other Government functions. The best example of that, of course, was the 10 basis point 

increase in the G-fee to help pay for the payroll tax holiday. I view 

that as a mistake, and hopefully we do not go down that same path 

again. 

So I do not think that is the appropriate use of these institutions 

and the profits they are now generating. It should be used to repay 

taxpayers and used to help facilitate whatever future housing finance system we evolve to. 

Senator CRAPO. Thank you. 

Mr. MILLSTEIN. I agree with that. I think the alternative to the 

system we currently have where all of their profits are being swept 

into the Federal Treasury is, in effect, you are taxing the mortgage 

market to pay for other things. And here you are embarked upon 

a great legislative reform effort. These entities are producing $25 

billion to $30 billion a year of cash-flow that can be used to recapitalize a grossly undercapitalized housing finance system. 

It seems to me that as part of your reform effort, you should 

seize those revenues and use them for this public purpose of fixing 

the housing market. 

Senator CRAPO. Thank you. And, Dr. Zandi, I noted in my opening statement that we cannot allow our legitimate concerns about 

unknowns to cause us to forget the equally legitimate concerns 

about the status quo. In your testimony, you laid out several of 

those concerns. Could you further expand on why you believe that 

inaction carries its own dangers? 

Mr. ZANDI. Yeah. I think the current system is a real problem. 

You know, clearly, what we just discussed is an issue. As Fannie 

and Freddie continue to generate profits, the inclination will be to 

use that for other Government purposes, and again, I do not think 

that is appropriate. So that is clearly a risk. 

And also, over time, with those profits getting incorporated into 

the budget and the budget process, that will make it more difficult 

to actually address the reform of Fannie Mae and Freddie Mac. So 

the longer it takes us to do this, the more difficult it will become. 

Moreover, you know, the fact that Fannie Mae and Freddie Mac 

are in this limbo status is creating its own set of issues and problems. You know, increasingly over time, this will become more apparent. I will just give you an example of what I mean. 

14 

Right now, mortgage credit is very tight for potential first-time 

home buyers. The average credit score for someone selling a loan 

or purchasing a loan to Fannie Mae is 760. That means you have 

to be in the top third of the distribution of credit scores. That is 

not consistent with a first-time home buyer. 

One of the reasons for that is because of rep and warranty policies between Fannie, Freddie, and the lenders, and this is not getting resolved, certainly not quickly enough, and one of the reasons 

I would proffer is because of this limbo status. So that is just an 

example of what I mean. There are many others that will become 

more evident going forward. 

And then finally, there is no reason for it. Right? I mean, there 

is plenty of private capital out there. They are all very interested 

in participating in this market. It is clearly obvious in lots of different places and there is no reason why taxpayers should be taking credit risk on mortgage loans. 

Senator CRAPO. Thank you. And, Mr. Bovenzi, you noted many 

valuable lessons learned from a positive nature about the RTC that 

could provide insight into our decision making as we approach 

Fannie Mae and Freddie Mac. Are there any cautionary lessons 

that we should also glean from the history of the RTC? Were there 

actions corrected at the time or merely thought you had gained 

through your benefit of hindsight? 

Mr. BOVENZI. There are probably many cautionary lessons given 

that it was not, you know, a smooth path. I mean, there was a time 

when the RTC was accused of ruining the housing markets in the 

United States, but looking back with some perspective, they are 

now viewed as having been a success in terms of straightening it 

out. 

So I think, you know, there is a danger to everybody having a 

very short-term perspective of what needs to be done versus a 

longer-term perspective. As we are hearing, this is not a simple 

matter either way. You make changes and there will be some disruption; you do not make changes and you have issues as well. 

So I think what I have tried to lay out were things to think 

about if Congress goes down this route that are cautionary to think 

about, like how do we treat the employees in the GSEs who have 

the expertise to help make a smoother transition and issues like 

that from the RTC’s and FDIC’s experience. 

Senator CRAPO. Thank you. 

Chairman JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. First of all, I just 

want to thank you and Ranking Member Crapo for the attention 

you have given this issue. I believe this is our ninth hearing this 

fall, and while there is a lot of other activities going on in the body 

that are showing, perhaps, disruption, I think your leadership of 

this Committee has shown a real focus and attention on this issue, 

and even during these challenging weeks, continuing to advance 

the process forward. I think it is very helpful, one. 

Two, I think this is about our 20th housing finance hearing we 

have had since 2011, and again, I think you and your team have 

built a very solid record here. A couple of comments before I get 

to my question. I think Dr. Zandi has pointed out some of the challenges around 1217 and the legislation we have worked on. 

15 

We do think there needs to be high, solid capital standards. I do 

think that at some point, though, the comparison to the status quo, 

which is right now no private capital risk, this is purely a public 

sector socialized risk, it is really not even an apples-to-apples comparison. Any system, even Mr. Millstein’s system, would have higher costs involved because there would be additional private capital. 

I also wanted to comment to Dr. Min. I think one of the comments you made about the notion that any future market rental 

housing, other kind of first-time home buyer access, perhaps not 

completely eloquently put together, but are market access fund, 

recognizing there is that appropriate role, I think, is something 

that we have taken a pretty good stab at. 

I concur with a lot of the folks on the panel, that we have got 

to get this right in this transition period. The only hesitancy—one 

of the hesitancies I have, if you move simply from a target versus 

time line, those targets always can slide. We have seen that constantly. 

I think Dr. Zandi’s comments about, you know, how quickly 

FHFA is moving toward the common securitization platform is trying to get this judgment right, and I would welcome from all on the 

panel, and really appreciate your testimonies, you know, what are 

those speed bumps, metrics, hurdles, whatever we want to call it, 

along the way so that we do not have this simple moment where 

we flip on the switch. 

There has got to be these points, and I think again, Dr. Zandi— 

well, Professor Min, you have got a number of those, but clearly, 

getting the securitization platform right and the common security 

right is very important. 

I guess what I would hope as well is, Dr. Min, to make sure that 

we do not try to recreate the wheel, you know, a lot of the activity 

going on at FHFA right now, I think, are efforts to make sure that 

we transfer over the assets. 

I want to agree with Mr. Millstein. I think it is really important 

that we keep the people and intellectual capital assets from Fannie 

and Freddie, for a variety of reasons, including the fact that a lot 

of those folks live in Virginia. So I guess what I would ask is, how 

do we make sure—let us take, for example, the question around the 

starting up an issuer. 

Do you, Professor Min or Dr. Zandi, want to make a couple comments on what should be some of those gating things we should 

look at? 

Mr. MIN. I will leave you some time. I think obviously you need 

capital. As I point out in my written testimony, I think that there 

is a lot of capital. It obviously depends on the cost of capital, reverses return analysis that you are well familiar with. But I think 

on top of that, there needs to be some sense that there is going to 

be investor liquidity in this market, and so for that reason alone, 

the CSP and the single security are important. 

I think as Dr. Zandi and I both point out in our testimonies, 

right now there is significant pricing differences between Fannies 

and Freddies. If you simply do not have a single security, those differences in pricing liquidity will be greatly exacerbated as you add 

a third, fourth, or more issuers. 

16 

That is why that particular product is so important. I think at 

the same time, you want to make sure that a lot of the agency investors, the agency liquidity that is there transfers over, because 

I think that itself will be a very important calculation for investors. 

Is there a market key? Will it be there when we startup the operation for that switch? And that is why I have recommended some 

of the steps I have about getting liquidity in place. 

Mr. ZANDI. Senator, so when you say issuer, I take that to be 

issuer guarantor, and that is a matter of some discussion and debate as well, but I am just going to assume that. You know, I do 

think that it will be very important in the transition process that 

the Government is helping to stand up additional guarantors. I 

mean, we have got Fannie and Freddie and the infrastructure is 

there and we can make this work so that they go out into the marketplace and liquidity is sustained and everything is working properly. 

But to really make this a well-functioning system for the future, 

we need to be able to have more than two guarantors out there. 

We need many. It depends on the structure of the market and what 

the scale economies are, but my guess is that the market could reasonably support four or five, six guarantors, and that would be 

competitive market. 

But that is not going to happen, I do not think, on its own. It 

certainly is not going to happen if we just throw Fannie Mae and 

Freddie Mac, whoever we turn them into, out into the marketplace. 

That is just going to shut down the market to competition. 

Even if you do the common securitization platform, even if you 

have a common security that will help bring down various entry, 

even if you stipulate that these new entities are SIFI institutions 

and they have higher capital requirements and raise their cost of 

capital, I still fear that given these legacy relationships they have, 

it will be very difficult to generate a competitive market. 

So it is going to be important, in the transition process, that we 

have a clearly articulated means for standing up, helping stand up 

new guarantors into the marketplace to make this a competitive 

market. And we can talk about how to do that, but that is key to 

this all working out in the end. 

Senator WARNER. Thank you, Mr. Chairman. I just want a final 

quick comment. It is just that I also want to echo and appreciate 

Senator Crapo’s comments about the challenges of the status quo 

and the very real threat. Even though I think the majority of us 

all feel very strongly, we ought to keep the G-fees in this industry, 

there remains that threat. So I appreciate your comments as well. 

Chairman JOHNSON. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. I appreciate you 

having all of these hearings, and Ranking Member Crapo, and 

working with him to make that happen, and all of you for coming 

to them still trying to adjust to having all my rights stripped away 

yesterday by people I have worked with for a long, long time to 

solve issues in a bipartisan way without any discussion. 

But anyway, Mr. Min, I want to tell you, I do appreciate some 

of the concerns you raised about mortgage-backed securities and 

legacy mortgage-backed securities. The notion that you mentioned 

about basically turning them into FMIC-backed mortgage-backed 

17 

securities is exactly what 1217 envisions. So I appreciate the contribution you made to this hearing in stating that, and it is exactly 

what we would like to do. 

Dr. Zandi, I know we have worked together for a long, long time 

to try to figure out a way to move past the system that we have, 

and I know that you know we have had people on the left, on the 

right, in the center. I think you attended a dinner about 15 months 

that had multiple kinds of folks there to try to figure out how we 

begin to look at this system. 

I think there is no question that you agree, as someone who 

spent a lot of time in this world, that we need to move past the 

system we have now where private sector investors do really, really 

well when the market is good, and then the taxpayers do really bad 

when things go wrong. You agree with that, is that correct? 

Mr. ZANDI. Yes, sir, I do. 

Senator CORKER. And I know that we have looked a lot at capital 

and, you know, how much capital is necessary. Today, in a $5 trillion market, which 90 percent of new loans today are coming 

through some Government entity, but under the 1217 bill, there 

would need to be about $500 billion in capital, is that correct, 

under the 1217 arrangements? 

Mr. ZANDI. Yeah, 5 percent of the $5 trillion. 

Senator CORKER. No, 10 percent of that. 

Mr. ZANDI. Excuse me, 10 percent of the $5 trillion. 

Senator CORKER. I know that was a Freudian slip. 

Mr. ZANDI. Yeah, that was Freudian. I am sorry. I am just trying 

to slip down—— 

Senator CORKER. I am not my normal energetic self. I apologize. 

Mr. ZANDI. As you could tell, neither am I. 

Senator CORKER. And I know that you and I looked at a chart 

that actually looked at nonagency capital returns over the last few 

days about $636 billion coming over the next 7 years back into the 

system. So the notion of trying to have about $500 billion, quote, 

quote, quote, is that is what we build back up to, does not seem 

in any way to be farfetched, does it? 

Mr. ZANDI. I think we can do it. I think there is, as we can tell 

from what is going on in the marketplace in recent months, a great 

deal of interest and participating in taking on mortgage credit risk. 

We can see it from the proposals that have come forward in the 

last couple weeks. 

Senator CORKER. Yes. 

Mr. ZANDI. We can see it in my world, in the PMI world that I 

am a board member of MGIC. So there is clearly a great deal of 

interest in private capital coming into this marketplace, yes. 

Senator CORKER. I noticed, over the last couple of weeks, we had 

an offer from a gentleman named Berkowitz from down near Florida to buy actually the credit risk portion of the remnants of 

Fannie and Freddie, and while the offer likely will be rejected because of the amount, in talking with people that are related to that 

type of offer, in many ways, does that not give us hope that there 

are people out there that are willing to invest in the credit risk portion only and it is a matter of just getting the economics right? 

But it does show that there is interest out there for people to 

participate as buying guarantors in a new system. Is that correct? 

18 

Mr. ZANDI. Yeah, that is exactly right. I mean, if you look at the proposal, there are $17 billion of real capital in the proposal, at 

least that is the number he put forward, and by my calculation, 

$17 billion gets you pretty close to what you need to get to that 

10-percent capital in year one of the new system. 

So immediately I saw that, I go, Oh, OK. So there is private capital out there willing to participate in this marketplace and it gets 

you pretty close to where you want to be in year one. So I took a 

great deal of solace in that. And I agree, I would not go with the 

proposed structure that he has, but certainly, you know—— 

Senator CORKER. But my sense is, and I have read some quotes 

since those discussions matured a little bit and developed, it seems 

to me that the offer that he made was very exactly in line with 

1217. In other words, you would have to have 1217 pass to create 

this modular competitive system for that type of offer to even work. 

So it seems to me that what we are already seeing out there is 

hedge funds and private equity and other folks who are willing to 

capitalize this system in such a way as to make it competitive and 

modular. Is that correct? 

Mr. ZANDI. Exactly right. I mean, when I was talking about those 

new guarantors coming into the marketplace, you could envisage 

what he is proposing as, in fact, one of those new guarantors. So 

it fits exactly in with the vision you have that is in 1217. 

Senator CORKER. Mr. Millstein, I know we have had a number 

of meetings in our office. I know that you were in the public sector 

and now are out in the private sector over the last couple of years 

with your firm. I know that when you are in the public sector, you 

learn about just sort of the way Government works and you can 

figure out ways of, you know there is a degree of incompetence and 

people are afraid of change and there are ways of sort of making 

money off of that. 

I know that—I appreciate your testimony today, but I do want 

the Committee to know that unless Mr. Millstein is willing to, 

under oath, say differently, he does benefit personally in the event, 

if we have the fear and inability to move beyond the system that 

we have, in other words, if we were to do what he espoused, he and 

his family would benefit greatly personally. I just think that—— 

Mr. MILLSTEIN. Senator, let me interrupt you just so we do not 

waste any more time on that. I no longer—— 

Senator CORKER. Well, actually—— 

Mr. MILLSTEIN. I no longer—— 

Senator CORKER. ——I am just making a statement—— 

Mr. MILLSTEIN. I know, but I want to make sure you are—— 

Senator CORKER. ——less of a statement of fact and you are willing to—— 

Mr. MILLSTEIN. So I am going to tell you right now, that I do not 

own those securities any longer. I do own a home and I am a smalltime real estate developer, so I have a deep interest in how you do 

this, to make sure you do it right, but I am no longer a stockholder. 

Senator CORKER. So I guess—well, very good. That is good to 

hear. Right. 

Chairman JOHNSON. Professor Min, in addition to single family, 

could you elaborate and what key issues should we consider in 

structuring an orderly transition for multifamily housing reform? 

19 

Mr. MIN. Thank you for that question. I did not have a chance 

to get into in my oral testimony. I think that—so as it is structured 

now, I think that the Corker-Warner plan envisages the market access fund, which is actually made up of several discrete funds receiving or being responsible for the bulk of multifamily. 

In addition to that, I think you all received at least one or two 

proposals, thinking about ways to create multifamily specific guarantor issuers under the new system envisioned by Corker-Warner. 

So I think those would be the two main engines for multifamily, 

and I think that in theory, as I have researched this issue, that 

should actually work. 

But the sort of issues I raised in my testimony, my written testimony, are about getting from Point A to Point B. I think these are 

the segments, particularly in the affordable rental space, that are 

most likely to experience a vacuum as we reduce the footprint of 

the GSEs and try to transition to that Point B where these institutions will be responsible for filling that space. 

So what I propose in my testimony is, is two steps. Basically, let 

us try to get a running start for multifamily housing for institutions that are dedicated for this affordable rental space, including 

starting prefunding the market access fund now, siphoning off a little bit of the G-fee, which is fairly ample at this point, and start 

to prefund that so that it really is in place and operational when 

that transition happens. 

The second step is to go along with the plan proposed by former 

Assistant Secretary Dr. Bostick of trying to create multifamily subsidiaries of Fannie and Freddie and allowing them a head start so 

that they can be operational again as we get into this transition 

period. 

I think the concern is that this is a space that purely private capital has not always gone into and it has been—it is an increasingly 

important part of the system, particularly as I mentioned, as we 

think about pulling back from single family and pulling back the 

Federal Government’s footprint. So those are the steps I would outline. 

Chairman JOHNSON. Senator Crapo, do you have any follow-up? 

Senator CRAPO. Yes, just one last question, Mr. Chairman. And 

I guess I will direct this to Dr. Zandi, but any of the others who 

would like to jump in on it, feel welcome. 

On this question related to the Chairman’s earlier question about 

whether we needed to have a target focus like achieving benchmarks before we actually pull the trigger and move forward with 

the finalization, or whether we needed time lines as Senate Bill 

1217 currently has, and I know Senator Warner got into this. 

I understand the comments that all of you have already made 

about the fact that this is complicated and a rigid time line might 

not be sufficiently flexible to allow us to get it right. That being 

said, I kind of want to focus on the other side of that, and that is, 

if you just continue to try to look at benchmarks, I look at the— 

I am an opponent of quantitative easing, and I look at it the way 

that we are trying to get out of quantitative easing right now with 

benchmark targets that we are not meeting. 

And we just seem to always stay where we are. I know that may 

not be a perfect example, but my point is, how do we ultimately 

20 

have some accountability here in the sense that we get there if we 

start focusing on a benchmark process in order to implement the 

legislation? Dr. Zandi. 

Mr. ZANDI. Yeah, an excellent point and it is a tension that Senator Warner highlighted as well. I think the approach would be to 

have very explicit benchmarks and then to make sure that there 

is clear oversight with regard to how those benchmarks are 

achieved or not achieved and why. 

So if you come up to a certain—it is not that we should not have 

a time line. We should have a time line, but with benchmarks in 

the time line, and as we approach them, then if we are not achieving them, then we need—there should be oversight and there 

should be accountability with regard to why and using that as a 

mechanism for ensuring we get back on the time line. 

But there may be reasons why you might want to delay, because 

there are things that are completely out of our control. I will give 

you just a blue sky example, but it is very possible. You get up to 

the point where you want to turn on the light switch and 2 weeks 

before, there was a financial event in Europe and the financial 

markets are in turmoil. 

Now, do you really want to turn on the light switch at that 

point? The answer is probably not. Nobody would really want to do 

that. So you need to have some flexibility with regard to how you 

do this. 

Senator CRAPO. All right. Thank you. 

Mr. MILLSTEIN. Can I answer that, though? 

Senator CRAPO. Yes. 

Mr. MILLSTEIN. Look, the system that Senators Warner and 

Corker have designed is one that requires a good deal of first-loss 

capital. And we here can speculate on how much there is and when 

it will come and how much appetite there is. But at the end of the 

day, your legislation is depending upon the investment decisions of 

tens of thousands of investment managers, and you cannot command them to show up on cue. 

They are going to have to see the new system design and see it 

operate a little bit before they are going to start coming in droves. 

Today, with all due respect to my colleague, Mr. Zandi, today there 

is $8 billion of capital in the private mortgage insurance business. 

Yes, Mr. Berkowitz has shown up with an offer that says he will 

put $17 billion in, but there is a long way between that offer and 

a closing. A lot of other things have to happen. But the most important lesson, I think, in terms of this benchmark versus time line 

is, you are trying to design a system that will induce people to put 

capital into new mortgage insurers and into new first-loss securities that do not exist today, in a system with a guarantee that does 

not exist today, for a market of new securities that does not exist 

today. 

It is going to take time and you are depending on tens of thousands of individual investment managers to play with you, to shake 

your hand and say, Yes, I will help you build this market. They 

may come on a 5-year timetable, but if they do not, when you flip 

your switch, your system is going to shut mortgage availability 

down, nothing any of you want to do. 

21 

So that is the risk, to me, of having a very hard time line built 

into this, and that is the risk, to me, of taking the assets under 

your control today, that you could recapitalize today, to make sure 

that this system functions. The risk of just saying, ‘‘No,’’ in order 

to preserve the possibility that MGIC will be able to raise $125 billion of capital in order to play my first-loss role, I am going to trash 

the assets that are currently doing this for me in this market. 

That, to me, is crazy, crazy. 

Mr. BOVENZI. If I could make one comment? There may be some 

precedents for finding something in between. I think when the 

FDIC sets up a bridge bank for a failed institution, there is a set 

timeframe for how long the Government should own that bank before it has been sold or restructured. 

But because of the public policy issue of not having nationalized 

banks, if there are reasons why that life of the bridge bank should 

extend, I think the FDIC Board of Directors could, you know, do 

that and have flexibility to have it come forward for, you know, a 

board to say, OK, there are certain reasons why we need to extend 

this beyond. 

So maybe there is some areas where there may be precedents 

where you can try to set some form of timeframe with benchmarks, 

but flexibility to extend if necessary. 

Chairman JOHNSON. Dr. Zandi, do you care to respond? 

Mr. ZANDI. Thank you. I agree that there is a lot of moving parts 

here and there is a lot of uncertainty. A lot of the uncertainty 

revolve around issues of private capital and what cost will the private capital come into the system. And there is a lot of codependencies here. 

I mean, how much capital comes in depends on how much clarity 

you provide and oversight you provide. So there is a lot of reasons 

to be nervous about the process. But let me say that this is very 

doable. It is not like we cannot do this, and we can, and the economics of this are such that there will be investors and there will 

be private capital. It will come in. And this can work out very, very 

gracefully. We just have to be very careful about how we do this 

and articulate it. 

Chairman JOHNSON. Does Senator Warner have any follow-up? 

Senator WARNER. I just really appreciate the conversation back 

and forth here. I saw one of the groups who are interested in this 

issue this week and they were talking about how the housing market has recovered a bit, but there are still challenges. 

And I pressed this particular group, there was like, you know, 

when are you ever going to hit that magic time? I mean, if we could 

predict when that total solidness is there, that may just be an 

unobtainable goal. I would reflect that we are 5 years after the crisis now. Obviously the housing market’s recovery has not been to 

that whole 5 years. 

I would point out that in the wild and wooly final days of DoddFrank, there were efforts to, on the floor of the Senate, to unwind 

the GSEs with no transition on a 2-year basis and completely zero 

them out that got a lot of votes. And, you know, I think we have, 

in a broadly bipartisan way, directionally set a path for reform that 

the Chairman and the Ranking Member are improving upon. 

22 

And if there are moments along the way during this 5-year period where we will have—I am not sure what the right term is— 

a speed bump or indicators, you know, such as the common 

securitization platform that is independent of—I think the appropriate questions Mr. Millstein has raised about private capital 

showing up. 

You have got FHFA trying risk-sharing models now. We have 

had testimony at these hearings about trying to create kind of 

blended securities during the interim that would again give us, I 

think, better indices. And, you know, my point is, you have got to 

start this process, and, you know, waiting for the perfect moment 

leaves also a huge amount of uncertainty over this market that is 

terribly important to our economy. 

And as we have perhaps repeatedly shown, as well intentioned 

as we may be on this panel about not using G-fees or other fees 

for other purposes, locking in a reform basis may be one of the best 

ways to ensure that we do not do that. 

I would also make a comment, as one of the things that I think 

was an area that needed a great deal of improvement in 1217 was 

multifamily. I think there are a lot of Members on this panel from 

both sides who are working on improving that. And, frankly, in 

that area more than ever, the do no harm mantra is important because they did not create the challenges. That part of the business 

did not create the challenges. 

So I guess it is not as much a question other than the fact that 

I think I would at least take your admonitions to heart, but not to 

the point of saying—as an excuse to say we have got to spend another months, years, whatever, studying this issue. I think it is 

time to proceed. 

And again, I am going to close by simply thanking the Chair and 

the Ranking Member because you have brought an attention and 

focus to this that I think has really advanced the debate greatly. 

Mr. ZANDI. Can I make one quick comment just to reinforce 

something the Senator said about timing? You could make a very 

good case that timing is incredibly good right now. Right? I mean, 

the credit environment is excellent. The number of mortgage loans 

that are 30-day delinquent is as low as it has been in the data that 

I have back into the 1980s. 

Sixty-day delinquency, that is 2 months late, is as low as it has 

been, and even 90-day delinquencies are approaching a record low. 

And private capital is very interested in participating now. And 

you also have very low yields and, you know, here is an opportunity to get the yield. 

So I would echo that this is a—you know, there are challenges 

in the environment that we exist and we have a 7-percent unemployment rate and we have got to make sure that this all works 

out well. But I would argue that there is no better time for doing 

this than literally right now. 

Senator WARNER. Right. 

Mr. ZANDI. And then I would say, simply to add, that if Senator 

Crapo, thinking along the continuum, but QE is going to end at 

some point. Interest rates are turning back to kind of more normal 

levels would make it even harder to make this transition. If not 

now, when? 

23 

Chairman JOHNSON. Mr. Millstein, do you have any closing comments? 

Mr. MILLSTEIN. Well, I want to join with Senator Warner in saying that I agree, the most important thing we could do for private 

capital beginning to come back into this market is to pass legislation telling the markets where the Government is going to move 

with regard to Fannie and Freddie and ending of the 

conservatorships. They are at the center of the housing market 

today. 

They are operating with no capital and not seeking a capital return, making the pricing of their guarantees, I think, a discount to 

what private parties would do. And clarifying the future state of 

Fannie and Freddie to the market is critically important for private 

capital formation to return. 

My caution, despite what Senator Corker may have characterized 

my remarks to be, my caution is not about legislating. My caution 

is about having a mechanical line down of the two entities that are 

providing almost all credit formation in the conforming market 

today. 

You have run significant risks, but telling the markets through 

your legislation where you are going and what your objectives are, 

competitive, first-loss, mortgage guarantee industry providing substantial capital in front of a new Government regulator who is 

strong, but guaranteeing qualified product, that is an important 

signal. 

It will allow private capital to start developing plans around your 

new structure. But the one caution I am giving you is, while they 

are doing that, the pace at which they come you cannot command. 

You cannot predict and you cannot write a timetable to be certain 

of, and therefore, you need to take what you have got that is working and transition it to having a role in the new system so that you 

have continuous mortgage credit formation along the way. 

Chairman JOHNSON. Thank you all, our witnesses, for being here 

with us for an unusual hearing. Given the number of Members urging the Committee to move quickly, we anticipated greater attendance. I also want to thank—— 

Senator WARNER. Mr. Chairman, I am proud to be here. 

Chairman JOHNSON. I also want to thank Senator Crapo for his 

thoughtful questions, good partnership and commitment to housing 

finance reform. This hearing is adjourned. 

[Whereupon, at 11:20 a.m., the hearing was adjourned.] 

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

24 

PREPARED STATEMENT OF JAMES MILLSTEIN 

CHAIRMAN AND CHIEF EXECUTIVE OFFICER, MILLSTEIN AND COMPANY

NOVEMBER 22, 2013 

Introduction 

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

you for the opportunity to testify on the development of an effective transition plan 

for the U.S. housing finance system. 

I have spent the entirety of my 30-year professional career—as a lawyer, banker, 

and public servant—in the corporate restructuring business. I have restructured 

companies as diverse as American Airlines, WorldCom, and Charter Communications in the United States, Cadillac Fairview in Canada, United Pan European Communications, EuroDisney, and Marconi in Europe, and Daewoo Corporation in 

Korea. During the recent financial crisis, I served as the Chief Restructuring Officer 

of the U.S. Department of the Treasury. In that role, my primary responsibilities 

were managing, restructuring and designing the exit from the Department’s substantial investments in AIG and Ally Financial. 

I am here today because embedded in the task of reforming our Nation’s housing 

finance system is a restructuring of the two largest players in that system: Freddie 

Mac and Fannie Mae. These companies now operate in conservatorship under the 

control and direction of the Federal Housing Finance Agency. Because they are central to mortgage credit formation in the United States today, ‘‘winding them down’’ 

as some members of Congress and the Administration suggest is certain to have significant and adverse consequences for mortgage credit availability and for the nascent housing and economic recovery. Rather than wind down, I urge you to consider 

a restructuring alternative that addresses the fundamental causes of the companies’ 

insolvency, eliminates the private gain/public loss nature of their current Government sponsorship, generates a significant profit to Treasury for supporting their solvency, and, most importantly, ensures a smooth transition to a new housing finance 

system that better protects taxpayers against future losses while providing for the 

continuing availability of credit to the creditworthy. 

There appears to be a growing consensus in the policy community around the 

basic architecture of that new housing finance system. A Federal guarantee on 

qualified mortgage products is required to ensure the widespread availability of a 

30-year fixed-rate product, and to sustain the deep and liquid mortgage securities 

funding markets that have developed over the past 30 years to complement balance 

sheet lending from the U.S. banking system. The guarantee should be explicit and 

structured as reinsurance, available to reimburse investor losses only after a layer 

of private ‘‘first-loss’’ insurance provided by well-capitalized mortgage insurers or 

subordinated capital provided through structured product markets has been exhausted. The reinsurance should be priced at arm’s length by an independent agency required to use its reinsurance fees to build a reserve fund to protect taxpayers 

against future loss should that reinsurance ever be called. Finally, in contrast to the 

system prevailing before 2008, the Government reinsurer also needs to be a strong 

regulator with authority over all issuers, guarantors and servicers with whom it 

interacts in the new system. In this regard, I commend Senators Corker and Warner 

and the coalition of other members of this panel behind S.1217 for putting out a 

bill with all of these elements in it. 

However, the transition to this new system contemplated by S.1217 is fraught 

with difficulty and needs serious rethinking to mitigate three significant risks that 

any credible transition plan must address. First, our fragile economic recovery cannot afford the risk of a significant disruption in mortgage credit. Borrowing rates 

will need to rise in the new system to reflect the cost of the first-loss capital and 

new reserves required to protect taxpayers on their guarantee. At the same time 

we need to protect against a significant contraction in the availability of housing 

credit that would push us back into recession. Second, the Government must end 

its ongoing backstop of Fannie Mae and Freddie Mac in conservatorship in a way 

that minimizes the likelihood that Treasury will need to cover future losses on their 

$5.5 trillion of liabilities. While the substantial guarantee fees and net interest margin which the companies are currently earning and paying over to Treasury may 

look like an asset to be seized by taxpayers as the quid pro quo for their bailout, 

it could easily turn out to be a substantial liability if there were another significant 

housing downturn. Managing that liability in a responsible way to avoid future taxpayer losses is a critical challenge of the transition. Third, there must be a credible 

path toward the development of the substantial layer of private ‘‘first loss’’ capital 

on which the functioning of the new system will depend. If you build the new Government reinsurer but the required layer of first-loss capital doesn’t come in the size 

25 

1The RFC funded various relief projects during the Depression and authorized loans and investments to support the Government’s efforts during World War II. It also established multiple 

companies to carry out its mission. The RFC was ultimately disbanded in 1957. 

or at the pace of your contemplated wind down of Fannie and Freddie, the whole 

system will shut down before it has a chance to start. The idea that ‘‘if you build 

it, they will come,’’ may work in the movies, but you are playing with the Nation’s 

housing finance system. Hope is not a credible strategy. 

You have to make a fundamental choice in meeting these challenges in the transition: Restructure Fannie and Freddie and use their assets and operations to create 

a well-capitalized set of private market players who can ensure that the new system 

functions as contemplated, or wind them down on the bet that if you build the new 

reinsurance system, new private players with the sizeable capital required to make 

the new system function will come. My concern with both S.1217 and the Protecting 

American Taxpayers and Homeowners Act introduced in the House of Representatives is that each is based on the bet that to-be-named new players with capital yet 

to be raised will show up right on queue as the two institutions at the center of 

the current system are mechanically wound down. As I hope to demonstrate in the 

following testimony, we don’t have to gamble with the future of the housing market. 

There is a better alternative. 

Evolution of the Government’s Role in the Conforming Mortgage Market 

A responsible transition begins with a clear understanding of the status quo and 

how it arose. 

In the late 19th and early 20th centuries, there were various attempts to use bond 

markets to fund housing and commercial real estate. But the lack of adequate securities law and insurance company regulation, the absence of uniform contractual investor protections, poor underwriting, and outright fraud led to repeated funding 

market collapses, subjecting the U.S. economy to painful downturns. The 1870s and 

1880s featured a permutation of covered bonds, where mortgage originators issued 

debt to the public collateralized by pools of the mortgages they had originated. 

While this market functioned for a time and funneled investor dollars into housing 

finance, it eventually collapsed because the originators violated their purported underwriting standards and packed the pools with nonconforming collateral. In the 

1900s, New York title guarantee companies originated mortgages, insured them, 

and sold participation certificates backed by them (an early form of mortgage-backed 

securities). These title insurance companies eventually failed, and the mortgage securities markets they supported collapsed, because of poor underwriting, thin capitalization, and weak State insurance regulation. The 1920s featured the issuance 

of single-property real estate bonds, each governed by a separate set of indenture 

provisions, the proceeds of which were used to finance large construction projects. 

Poor underwriting and weak investor protections led to its eventual collapse. The 

same decade (the roaring 20s) also saw bank and thrift failures at an average rate 

of 600 per year (in a banking system with approximately 10,000 banks and thrifts), 

a crisis by today’s standards and significantly disruptive to home lending and local 

economic activity. The pace of bank and thrift failures peaked 5 years after the 

Crash of 1929 when, in 1933, roughly 4,000 banks and thrifts failed, resulting in 

widespread foreclosure and a severe contraction of housing finance credit. 

In response to the housing and banking crisis of the 1930s, the Federal Government restructured the banking system and significantly expanded its role in housing 

finance. Among other things, the Banking Act of 1933 created and Banking Act of 

1935 expanded the authority of the Federal Deposit Insurance Corporation (FDIC), 

an independent agency of the Government chartered to provide Federal deposit insurance to banks to prevent the bank runs that forced the Roosevelt Administration 

to impose a national 2-month long bank holiday in early 1933. The acts also provided the FDIC with regulatory authority over its member banks, initially funding 

its reserve fund with loans from the Treasury and Federal Reserve. Those loans 

were repaid with interest after member bank insurance fees began to accumulate. 

When faced with widespread bank failures during the recent financial crisis, the 

FDIC’s Deposit Insurance Fund also fell into deficit. However, instead of drawing 

on its line of credit with Treasury to replenish its coffers, the FDIC pulled forward 

insurance assessments and imposed additional fees on its member banks. The DoddFrank Act of 2010 requires the FDIC’s Deposit Insurance Fund to reach 1.35 percent of insured deposits by 2020. 

In the 1930s, Congress also addressed mortgage finance directly. In 1932 it created and capitalized the Reconstruction Finance Corporation (RFC), which made 

loans to, among others, banks and mortgage associations. 1 In 1932, Congress estabVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00029 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
26 

2 As opposed to short-term balloon payment mortgages that were more traditionally available. 

lished the Federal Home Loan Bank System in order to create additional funding 

for home loans originated by savings and loan institutions. Federal Home Loan 

Banks (FHLBanks) make loans to member institutions secured against eligible collateral—typically mortgages—and issue debt to the public to fund such lending activity. The cost of that funding is generally lower than an individual member can 

obtain because the debt is the joint and several obligation of all FHLBanks, which 

operate under Government-sponsored charters. The FHLBanks are capitalized by 

their members, whose borrowing limits are proportionate to their respective capital 

contributions. The FHLBanks are regulated by the Federal Housing Finance Agency 

and have a minimum capital requirement of 4 percent of assets. In exchange for 

their Federal charters and exemption from State taxation, FHLBanks pay an assessment of 10 percent of annual earnings for affordable housing programs. 

These efforts helped stabilize banks and other mortgage providers in the 1930s. 

But many would-be homebuyers in the 1930s remained shut out of the mortgage 

market, and home construction remained muted. The average mortgage required a 

large downpayment, had a maturity of 3 to 5 years, and featured large balloon payments at maturity. Although most loans were renewable at maturity the interest 

rate would reset, subjecting borrowers to the risk of significant interest rate movement over the short life of the mortgage loan, with no ability to hedge that risk. 

The National Housing Act of 1934 established the Federal Housing Administration (FHA) to address this problem and facilitate credit for home construction and 

repairs to a broader swath of borrowers. By offering insurance in exchange for a fee 

and assuming a first layer of risk, the FHA made possible the issuance of fixed-rate, 

long-term mortgage with regular monthly payments. 2 The act authorized the creation of a reserve fund to support claims made on the Government’s insurance: the 

Mutual Mortgage Insurance Fund (MMI Fund). The act also provided initial capital 

for the fund, and it has since been funded through premiums on insured mortgage 

loans. Today the MMI Fund is required to maintain a reserve of 2 percent of insured 

loans based on projected losses over a 30-year horizon. During most of its history, 

a portion of premiums collected in excess of that reserve minimum have been transferred to Treasury. Between 2001 and 2007, for example, the program transferred 

approximately $14 billion to Treasury. Earlier this year, for the first time in FHA’s 

history, it borrowed $1.7 billion from Treasury to bring the MMI Fund reserve up 

to its congressionally mandated minimum level. The FHA single-family mortgage insurance program generally targets first-time and lower-income homebuyers, although during the recent crisis, when other private mortgage insurers failed or became undercapitalized, the FHA significantly expanded its footprint to ensure credit 

availability. 

The same act that created the FHA also authorized the agency to create ‘‘national 

mortgage associations’’ to purchase and sell FHA-insured mortgages. The objective 

was to create additional liquidity for housing credit beyond the then FDIC-guaranteed deposit-based funding available in the banking system or though the discounting of mortgages at the FHLBanks. Similar to the FHLBanks, the national 

mortgage associations would tap capital markets to fund FHA-insured mortgage 

originations. Unlike the FHLBanks, they would not be cooperatives. Instead, it was 

contemplated that they would have a broad base of private equity investors. However, 4 years after passage of the National Housing Act in 1934, no national mortgage association charters were ever taken out by the private sector. As a result, at 

the urging of the Roosevelt Administration, the Government-owned RFC began buying FHA-insured loans and in 1938 formed a subsidiary that became the only chartered national mortgage association: the Federal National Mortgage Association 

(Fannie Mae). 

Fannie provided a secondary mortgage market into which originators could sell 

loans, which freed capital and provided funding so that those originators could recycle the funds and extend additional mortgage credit. In 1954, after 16 years as a 

purely Government entity, the Federal National Mortgage Association Charter Act 

converted Fannie into a mixed-ownership corporation, where the Government held 

preferred stock and private investors held its common stock. In 1968, in order to 

remove its growing balance sheet liabilities from the Federal budget, Congress split 

the company in two, leaving behind the Government National Mortgage Association 

(Ginnie Mae), a Government entity that began guaranteeing passthrough securities 

backed by mortgages insured by FHA, the Department of Veterans Affairs, and 

Farmers Home Administration and fully privatized the ownership of Fannie Mae. 

However, the Government charter remained with the privatized Fannie, and with 

that charter came the obligations to serve the public policy ends of increasing home 

ownership and supporting low- and moderate-income housing. This original policy 

27 

3This was the first in a series of legislative deregulatory initiatives for the financial sector 

over a 30-year period, which culminated in the repeal of the separation of commercial and investment banking that had been provided by the Banking Act of 1933. 

error in the 1968 privatization created a private shareholder-owned company with 

a public mission, allowing Republican and Democrat Administrations alike to pressure Fannie to increase credit availability to serve political ends. It also allowed 

Fannie to use its public mission as political ammunition to fend off challenges from 

banks to its market power and to its relatively lax regulatory oversight. 

In 1970 Congress created the Federal Home Loan Mortgage Corporation (Freddie 

Mac) to compete with Fannie, expand the secondary market for mortgages, and help 

thrifts manage interest rate risk. Freddie had the same charter and implied Government guarantee as Fannie, but it was initially capitalized and owned by the 

FHLBanks. In 1971 Freddie issued its first mortgage backed security (MBS). 

Securitizing mortgages purchased from thrifts defined the company’s business model 

over the next few decades, while Fannie continued primarily to purchase and hold 

mortgage loans in its portfolio funded with balance sheet borrowing from the capital 

markets. Both Government-sponsored enterprises (GSEs) were permitted to purchase non-FHA-insured loans. 

Inflation, interest rate volatility, economic downturns, and the beginning of a 30- 

year wave of bank deregulation in the late 1970s and early 1980s wreaked havoc 

on savings and loan associations, also known as ‘‘thrifts’’, as well as on Fannie. 

Thrifts funded most of the long-term mortgages they held with short-term obligations, largely deposits. Until the 1980s regulators imposed ceilings on the rates of 

interest on savings and time deposits that thrifts could pay. The Depository Institutions Deregulation and Monetary Control Act of 1980 phased out those limits. 3

Meanwhile the then relatively new money market funds began to grow rapidly with 

little regulatory impediment, competing with thrifts for deposits. As a result, the 

rates paid on deposits increased, and the thrifts faced a mismatch between their 

funding costs (deposits) and the earnings on their primary assets. Fannie, as a balance sheet lender, was exposed to similar risks, although it funded itself in the capital markets, largely through long-term debt, rather than with deposits. To try to 

help thrifts mitigate losses from the mismatch between their deposit funding costs 

and the interest rates on their long-term mortgage assets, the Garn-St. Germain Depository Institutions Act of 1982 permitted them to expand into corporate lending, 

an area for which they had little underwriting experience. In relatively short order, 

thrifts experienced significant losses during the recession that occurred during the 

mid-1980s, and the sector virtually collapsed by the late 1980s, simultaneously putting the FHLBanks under pressure. The same act also authorized banks to provide 

adjustable-rate mortgages. 

Regulatory forbearance and a rapid change in its funding profile away from longterm debt toward short-term debt permitted Fannie to weather that particular 

storm, and by the early 1990s it began to shift away from a long-term buy and hold 

strategy to the Freddie securitization model. Meanwhile, in 1989 Congress reorganized and privatized Freddie, and it opened membership in the FHLBanks to commercial banks. The latter action more than offset the losses suffered by the 

FHLBanks during the savings and loan crisis of the late 1980s. As a result of the 

expansion of FHLBank membership to include commercial banks, FHLBank assets 

increased by a factor of six to roughly $1 trillion. 

During the 1980s, as the savings and loan crisis intensified and many thrifts 

failed and withdrew from the mortgage funding markets, the GSEs, FHA, VA, 

Ginnie, and the FHLBanks—filled the void and increased their respective share of 

credit exposure to the residential mortgage market. The figure to the right [below] 

illustrates that between 1982 and the mid-1990s, as the dominant savings and loan 

share of the market shrank, the GSEs and Government agencies went from less 

than 10 percent of the market to roughly 50 percent of it. 

28 

After the collapse of the savings and loan associations in the 1980s, and the concomitant rise of the GSEs and Government agencies in the market, the only other 

significant change in mortgage funding was the creation and growth of the privatelabel mortgage backed security (PLS) market. Like MBS issued by the GSEs, PLS 

facilitated the pass through of funds from security investors to mortgage originators. 

However, instead of leaving the credit risk with the Government or one of its Government-sponsored proxies, the PLS market passed credit risk onto private investors. Regulators and rating agencies facilitated the growth of this market by lowering capital charges imposed on banks to hold PLS, especially certain highly rated 

allegedly riskless tranches of them, and by permitting their use as collateral in 

short-term funding markets. While the single-family residential mortgage market 

roughly doubled in size between 2000 and 2007 to over $10 trillion, PLS outstanding 

in that market more than quadrupled, increasing from approximately $400 billion 

to $2.3 trillion. A significant portion of that increase represented PLS composed of 

subprime and Alt-A mortgages, PLS which proved, we now know, to be rife with 

poor underwriting, misrepresentations, and outright fraud. 

Encouraged by legislated charter amendments in 1992 imposing new affordability 

goals, growing competition from issuance in the PLS markets, and private shareholder return expectations, Fannie and Freddie used their Government-subsidized 

balance sheets to purchase riskier assets, including PLS backed by subprime and 

Alt-A mortgages. By contrast, the conforming loans bundled in MBS which the enterprises guaranteed were quite conservatively underwritten and exhibited default 

rates and loss severities modest by comparison to the default rates and loss 

severities exhibited by the PLS which they bought. But weak regulation of the enterprises failed to deter them from what would prove to be a path toward self-destruction. And regulatory arbitrage encouraged banks to purchase large volumes of 

PLS as well, effectively setting them on the same path as Fannie and Freddie. 

House prices began to collapse in 2006. PLS investors fled the market and MBS 

issuance other than what the GSEs supported came to a complete halt by the middle of 2008. In addition, banks cut back sharply on balance sheet lending. The entire 

sector of private mortgage insurers, who had conceptually provided credit enhancement for banks and the enterprises, became insolvent. The thin layers of capital at 

Fannie and Freddie proved woefully inadequate to absorb losses from the risky assets they had acquired in their portfolios. 

And so it was, in the summer of 2008, that the Federal Government found the 

economy spiraling deep into recession with the continuing collapse in home prices 

and mortgage credit formation adding weight to that fall. No one was left to take 

credit risk in mortgages except for Government agencies and the GSEs. And by 

early September, it seemed that the GSEs might be on the brink of failing. 

Treasury intervened. It sought and obtained legislation that created a new regulator, the Federal Housing Finance Authority (FHFA), over the entities with authority to place Fannie and Freddie into a Government supervised conservatorship or 


11221301.eps
29 

4 Accounting rules could require consolidation if the Government owns 80 percent or more of 

a private company. 5Treasury invested $187 trillion in the two companies. Through the end of the third quarter 

of 2013, they had returned $146 billion through dividends on Treasury’s preferred securities. 

In their recent earnings releases, the companies announced that they would send another $39 

billion in dividends by the end of December 2013. That will bring total dividends to $185 billion. 

receivership. Treasury had hoped that the mere existence of that resolution authority would assure markets that the Government would ultimately make good on what 

had been an implicit guarantee of the enterprises’ liabilities, and that Fannie and 

Freddie would be able to fund themselves in private markets without the need for 

formal Federal Government support. 

However, as financial conditions continued to deteriorate, in September 2008 the 

FHFA placed Fannie and Freddie into Federal conservatorships. To ensure that 

they would remain solvent and continue to provide funding to the mortgage markets, Treasury entered into Preferred Stock Purchase Agreements through which it 

committed to inject fresh capital into the companies. Treasury also took a warrant 

on 79.9 percent of each company’s common stock. This investment structure allowed 

Treasury to achieve its goals without taking the liabilities of the enterprises onto 

the Federal balance sheet. 4 This Treasury backstop convinced agency MBS and debt 

investors that they were not at risk of default, and they continued to buy GSE MBS 

and funded debt throughout the crisis. 

Through the mechanism of the Preferred Stock Purchase Agreements, Treasury 

transformed what had previously been an implicit guarantee of two private companies into an explicit guarantee of their balance sheet solvency. Rather than extending the guarantee directly to their liabilities, however, Treasury guaranteed each 

entities’ ability to pay their obligations when due by committing to an open ended 

purchase of sufficient preferred stock to cover the entities’ losses. 

Between the fall of 2008 and the end of 2011, to cover both accounting reserves 

and allowances and real cash credit losses at the enterprises, as well as a mandatory 10-percent dividend on the amount of its outstanding senior preferred stock, 

Treasury provided $187 billion to Fannie and Freddie. However, as the housing 

market stabilized in 2011, the enterprises’ losses abated, and they started to become 

extraordinarily profitable. Prices of securities in their portfolios were rallying, guarantee fees had increased, and large reversals in reserves and allowances seemed 

likely. In August of 2012, Treasury and FHFA amended the terms of the PSPAs, 

changing the fixed 10-percent dividend on the outstanding preferred to a variable 

dividend equal to 100 percent of the enterprises’ earnings in any quarter. As a result, by the end of this year—six quarters after the amendment—Fannie and 

Freddie will have returned to taxpayers almost the entirety of the $187 billion that 

Treasury invested in them. 5


11221302.eps
30 

Nevertheless, more than 5 years after Fannie and Freddie were placed into conservatorship, the PLS market is moribund, balance sheet lending by banks remains 

weak, and those private mortgage insurers that have survived only as a result of 

regulatory forbearance and continuing fee streams related to MBS guaranteed by 

the GSEs. As a result, Fannie and Freddie, together with FHA, VA, and Ginnie, underwrite the credit risk on and facilitate funding for 9 out of every 10 new mortgages written in the United States today. After 5 years of conservatorship, the GSEs 

remain liable for $4.4 trillion securities backed by single-family mortgages—nearly 

half of the outstanding mortgage debt on single-family residences in the United 

States—as well as $1.1 trillion of on-balance-sheet funded debt. But, as a result of 

the August 2012 amendment, and the sweep of all of their earnings to the Treasury 

Department, neither company has any material capital standing between the taxpayers and potential future losses on those $5.5 trillion of liabilities. 

Lessons From Evolution for the Transition 

One of the most important lessons from the evolution of the mortgage markets 

in the United States is that the willingness of private investors to take on mortgage 

credit risk is quite volatile, subject to huge swings in appetite between irrational 

exuberance and fear. After the turn of the century, PLS investors piled into a loosely supervised, poorly underwritten market with securities whose underlying collateral support was both opaque and riddled with fraud and misrepresentation. In this 

respect, the PLS market of the 2000s was not at all unlike the private mortgage 

markets that briefly flowered in the 1870s and 1880s and then again in the 1910s 

and 1920s. They were robust for a time and then floundered on their own excesses. 

Today, institutional investors remain wary of doing business with any of the previous participants in the underwriting chain. And it is safe to assume that it will 

be a long time before investors trust any of the mortgage brokers and bank 

aggregators that managed to survive the crisis, or the ratings agencies that were 

complicit in their flawed offerings. The few PLS deals that have been done in the 

last few years are being done almost entirely by new nonbank finance companies 

against mortgages of high credit quality with huge layers of ‘‘first loss’’ protection 

ahead of the investors. 

The thrift industry has all but disappeared as a source of mortgage funding and 

overall bank portfolio lending is down 20 percent from 2008. Although banks have 

worked through the majority of their troubled residential mortgages, capital requirements have increased, making it more expensive to hold mortgage loans on balance 

sheet. And while deposits at banks have expanded slowly since the crisis, they 

would need to allocate their entire deposit base to fund the existing mortgage market. That means that banks would have to stop all commercial and consumer lending, grinding our economy to a halt, and the fate of the sector would be tied to a 

single asset class. 

Private mortgage insurers have begun to add to their aggregate credit risk and 

capital over the past 2 years. But they still have only half the $17 billion in capital 

they had at their peak—well short of the capital that would be required to adequately support the likely $750 billion to $1 trillion in annual demand for conforming mortgage loans over the next 5 years. 

Another important lesson from history is that change is slow. It took 25 years and 

a major change in the regulatory landscape governing the thrift industry for the 

GSEs and Government agencies to obtain a majority of the credit risk in the U.S. 

mortgage market. Assuming that an objective is to prevent the mortgage credit market from shrinking dramatically, it will likely take an equally long time to shift a 

material amount of that credit risk back into private hands. That is because Fannie 

and Freddie are the central pipes of the current mortgage funding system. Everyone 

participating in the origination, aggregation, securitization, and servicing of mortgage credit risk in America connects to them. They are the only standard setters 

with any market credibility. They own nearly half the credit risk in the mortgage 

market. Banks depend on them to move risk off their balance sheets while capturing 

profits from the spread between the primary and secondary market. Private mortgage insurers depend on credit enhancement requirements that Fannie and Freddie 

impose on conforming mortgages. Rate investors rely on their guarantees to funnel 

investment funds into the housing market. And, without their participation, the socalled To-Be-Announced market would shrink considerably (only Ginnie securities 

would remain), and rate locks for consumers on conforming mortgages would disappear. They have done more mortgage modifications and workouts than any other 

lender in the system. In short, while it could be done, winding Fannie and Freddie 

down will entail a massive restructuring of the entire infrastructure of the mortgage 

funding system. It is not going to be as simple as flipping a light switch or clearing 

a field and building a baseball diamond. 

31 

6 Under the terms of the PSPAs, each company currently has a capital reserve of $3 billion, which is required to decline to $0 in 2018. 

A final takeaway is that the now express Government guarantee of Fannie and 

Freddie’s solvency has left the Government with a rather complicated liability management problem. The credit investor most at risk from a botched transition, in 

which mortgage credit availability contracts, house prices decline and delinquencies 

and defaults spike again, is the Treasury Department. Treasury now effectively 

stands behind those $5.5 trillion in liabilities, with virtually no capital in front of 

it. 6 What now looks like a huge asset could quickly turn into a massive liability 

for taxpayers if a ‘‘wind down’’ throws the mortgage funding markets into disarray. 

A Smooth Transition: Transforming the Government Guarantee and Managing Existing Liabilities 

Given that history and the current state of the housing market, I see one viable 

path to the end state envisioned in S.1217 that does not put the economy or taxpayers at risk: restructure, recapitalize, and privatize the single-family and multifamily guarantee businesses of Fannie and Freddie. Doing so would solve the 

thorniest problem in the transition: ensuring the creation of a durable layer of private capital ahead of the FMIC backstop. 

Note that I am not proposing that you reinstate the precrisis GSE model. On the 

contrary, I suggest that you tear it down. Eliminate the ‘‘national mortgage association’’ charters dating back to 1934 that enabled Fannie and Freddie to operate Government-sponsored hedge funds, using Government-subsidized cost of funds to purchase risky mortgage assets on a highly levered basis. Wind those portfolios down 

to levels necessary to operate a cash window to facilitate the purchase of mortgage 

loans from small banks and credit unions and to manage the workout of troubled 

mortgages that they guarantee. Fully privatize their single-family and multifamily 

businesses separately, and subject them to strong safety and soundness and capital 

adequacy regulation. Create conditions for competition among private sector participants, while establishing a credible resolution regime for all participants, including 

those who may otherwise be deemed too big to fail. Substitute their existing access 

and affordability requirements with FMIC regulatory authority and dedicated Federal vehicles subject to congressional oversight and funded through fees on all securities issued in the conforming market. In short, I propose fixing the problems with 

these businesses and using what remains to bridge to your new system. 

Below I provide a framework for evaluating any transition plan, followed by a 

more detailed explanation of what I propose. Finally, I evaluate the transition plan 

in S.1217. 

Framework for Transition 

Any responsible transition plan for reforming the Government’s role in housing 

finance should satisfy the following 10 criteria: 

1. Avoid a sharp contraction in mortgage credit that would depress house prices 

and risk another recession; 

2. Avoid saddling Treasury with losses from the remaining liabilities at Fannie 

and Freddie to which it is currently exposed; 

3. Establish an adequate and durable layer of private capital ahead of the FMIC 

and taxpayers; 

4. Preserve liquidity between the old and new systems, including through the 

TBA market; 

5. Maintain secondary market access for small and community banks without 

forcing them to go through large U.S. banks; 

6. Prevent concentration of mortgage risk in large U.S. banks; 

7. Facilitate competition among private loss providers on FMIC-reinsured MBS; 

8. Avoid consolidating GSE obligations onto the Federal balance sheet; 

9. Contribute to deficit reduction; and 

10. Respect the rule of law. 

A Realistic Way Forward 

Again, I urge you to use the two companies currently under your control and central to the current mortgage system to transition smoothly to a new, safer system. 

Use them to build capital cushions at each issuer adequate to protect the Govern- ment on the $4.4 trillion in outstanding MBS that the Government has backstopped 

through the conservatorships. To build that capital, FHFA should immediately direct the enterprises to increase their guarantee fees to market levels, reflecting a 

32 

return on capital that other private insurers have to factor into their fees. And 

Treasury should suspend its profit sweep and allow the companies to retain their 

earnings. Building capital to restore the companies’ solvency is one of the express 

mandates of the statute authorizing the creation of the conservatorships, a mandate 

that has been entirely ignored during the past 5 years. 

Meanwhile, begin building reserves at the new Mortgage Insurance Fund to protect the Federal Mortgage Insurance Corporation when the new system is turned 

on. Ten basis points of guarantee fees on the existing GSE MBS books should be 

reallocated to start building the FMIC reserve fund. In exchange, once the FMIC 

is up and running, it could reinsure the outstanding $4.4 trillion of legacy Fannie 

and Freddie MBS. This would relieve Treasury of any further obligation to backstop 

future losses on those securities through the PSPAs. It would also create continuity 

between the securities issued under the old regime and securities issued in the new 

regime, ensuring that securities in the new regime are issued into a deep and liquid 

market based on the same reinsurance. Without this bridge, legacy GSE MBS will 

be orphaned from the new market, and FMIC securities will suffer in pricing during 

the transition. 

The personnel, assets, and operations associated with the single-family and multifamily businesses in each enterprise should be separated. Each separated business 

should be licensed to purchase FMIC reinsurance. And when they attain adequate 

capitalization levels, those businesses should be rechartered under State insurance 

and corporate charter statutes. Equity in each of the separately capitalized businesses should be sold to the highest bidder or in an initial public offering. This separation would promote focused management and reduce consolidated market power 

that could squeeze out competition. The privatized single-family businesses should 

be permitted to maintain portfolios of sufficient size to operate a cash window for 

small banks, credit unions, and other originators, to manage troubled mortgages 

which they have guaranteed, and to conduct basic Treasury operations. 

None of these private companies would have special privileges—no implicit or explicit guarantee of their liabilities that Fannie and Freddie enjoy today as a result 

of their ‘‘national mortgage association’’ charters and the express backstop from 

Treasury of their solvency in conservatorship. They will not have the ability to issue 

Government guaranteed debt to fund expansive on-balance-sheet mortgage portfolio 

investments, which Fannie and Freddie had the ability to do under the Governmentsponsorship model. And each of the separated businesses and new entrants should 

be subject to a resolution regime that could facilitate their failure without wrecking 

mortgage credit formation or the functioning of the mortgage market generally. In 

the case of future failure, shareholders can be wiped out and any mortgage guarantee infrastructure transferred to new ownership. That regime should be modeled 

on the FDIC’s orderly liquidation authority for banks and financial institutions 

deemed systemically important by the FSOC. 

Finally, conduct the ritual slaughter that so many are demanding. The highly 

levered investment portfolios each firm ran before the crisis—in effect, their Government-sponsored hedge funds—should continue to be wound down under Federal supervision. The public charters that allowed private shareholders to benefit on the 

backs of taxpayers should be terminated. Affordability and access requirements that 

have been suspended by the FHFA in conservatorship will end with the termination 

of the charters. Fannie and Freddie should ultimately be placed into receivership 

and liquidated. 

I appreciate the trepidation of recreating two dominant players in the mortgage 

market by releasing parts of Fannie and Freddie back into the wild, however they 

may have been restructured. Therefore, an important element of both the transition 

and the end state is to ensure that there is a competitive marketplace for conforming mortgage credit risk. 

There are at least six concrete, mutually reinforcing steps that the FHFA and 

FMIC can take during the transition to promote a more competitive market structure while ensuring continuity through the recapitalization and privatization of the 

mortgage guarantee businesses: 

1. Common MBS Security: The FMIC could work with private market participants to establish a common To-Be-Announced market for securities eligible for 

FMIC insurance and facilitate options for multilender pools of eligible singlefamily mortgages. A single FMIC security could remove the largest barrier to 

entry for new issuers to compete with Fannie and Freddie. The difference in 

liquidity between Fannie and Freddie securities has given Fannie a more competitive position in the MBS market over Freddie. To combat Fannie’s advantage over Freddie and both companies’ advantages over any new issuer, a common TBA market through which a single FMIC security could be issued would 

33 

defeat the competitive advantages the privatized mortgage guarantee businesses would otherwise have over any new issuer or guarantor. Establishing 

a single security and extending it to legacy GSE MBS could be accomplished 

in 2 to 3 years. 

2. Capital Surcharges: Legislation could require the FMIC to impose heightened 

capital and other heightened prudential requirements on any issuer or bond 

guarantor that establishes a dominant market position. This would be similar 

to the heightened requirements being debated for large banks and other financial institutions designated by the Financial Stability Oversight Council. New 

entrants with lower capital requirements should then be able to offer the same 

first loss protection to taxpayers on better terms while achieving comparable 

return on equity for their investors. S.1217 imposes a hard limit on market 

share, which risks discontinuities and inefficiencies that will translate into unnecessarily higher mortgage pricing. Adverse capital charges rely on economic 

incentives to achieve the same desired outcome, while providing flexibility to 

the regulator to preserve efficiencies in the market. If the consensus is to impose a hard limit on market share, I urge you to base that limit on some empirical analysis of the benefits and costs of the market structure which that 

hard limit will dictate. 

3. Infrastructure Licensing: At least during the transition, the FMIC could coordinate with the FHFA to allow new MBS guarantors to use the issuance infrastructure of the enterprises and/or the common securitization platform in exchange for a fee to help establish and grow their market share. This could 

eliminate or at least mitigate another substantial barrier to entry, and ensure 

that there are existing, viable competitors when the restructured single-family 

and multifamily businesses of Fannie and Freddie are privatized. 

4. Common Securitization Platform: Meanwhile, efforts to establish a common 

securitization platform (CSP) that could serve as a market utility should continue. However, it is important to recognize that the platform will take several 

years to reach its first milestone—bond administration functions—and as currently envisioned even in its final phase it will support only a quarter of the 

aggregation and issuance chain necessary to generate FMIC-reinsured MBS. It 

is more realistic during the transition to expect that the FMIC will rely on a 

combination of issuers (similar to Ginnie Mae) and whatever is available at the 

CSP, which will continue to evolve. The FMIC need not wait on the CSP to 

reach a particular level of maturity to begin offering reinsurance. The FMIC 

should supervise the CSP, but its operations could be managed by private market participants. 

5. Pricing: Raising guarantee fees at the enterprises to take into account a proper 

return on capital charge will also have the collateral benefit of creating a pricing umbrella under which new private investors and insurers can compete. 

6. Equal Access: In all events, the FMIC should offer reinsurance to all new entrant first-loss providers who meet its capital and other eligibility requirements. 

With respect to minimum capital requirements, it would be a mistake to set capital requirements at arbitrarily high levels. Doing so will increase borrowing costs 

with little to no incremental improvement in the safety of the system. It will trap 

capital that could otherwise be used productively in our economy. And it may impair 

returns on MBS guarantee businesses to such a degree that you will deter the investment necessary to capitalize new entrants. It would also be a mistake to set capital standards for first-loss providers or for a subordinated layer of first-loss capital 

in reform legislation that are substantially higher or lower than those required of 

other providers of mortgage credit, such as banks. To do so would create a type of 

regulatory arbitrage between the capital required for mortgages held in whole loan 

form on balance sheet versus mortgages held in MBS form with FMIC reinsurance, 

an arbitrage that was partially responsible for the flight of mortgage credit out of 

the banking system and into the previously undercapitalized GSE system historically. Forcing mortgage credit back into the banking system by having substantially 

higher capital requirements for FMIC first-loss providers is not only inconsistent 

with heightened capital standards coming out of the crisis for banks going forward. 

It would also exacerbate the Too Big To Fail problem with our largest banks if in 

fact better returns on balance sheet mortgage lending leads to accelerated asset 

growth at the largest banks. 

Based on recent experience with the largest mortgage credit shock in any of our 

lifetimes, and consistent with what banking regulators are targeting, a total capital 

requirement between 4 and 5 percent would be adequate to protect the FMIC 

34 

7Since Fannie and Freddie were put into Federal conservatorships, the Congressional Budget 

Office (CBO) has treated them as consolidated entities of the Government that confer a subsidy 

(budget cost) to the market because CBO estimates that the price the companies charge to guarantee mortgages against default is lower than a private entity would charge. Severing the single-family and multifamily businesses’ special relationship with the Government and divesting 

the Government’s financial interests in those businesses subsequently in the market would 

eliminate the guarantee-fee subsidy and generate cash proceeds from sales that CBO could score 

as a substantial negative subsidy (budget benefit) over the budget window. 

against loss. Such a level would be consistent with the 10-percent capital standard 

that S.1217 calls for, assuming a relatively conservative risk-weighting for conforming mortgages. I warn against expanding the set of eligible capital beyond the 

definition accepted by banking regulators. Regarding the capitalization level for the 

MIF, we believe that a reserve balance of 1.5 percent is appropriate and achievable 

within an acceptable timeframe without imposing undue costs on the conforming 

market. This is greater than the 1.35-percent minimum level that the FDIC is targeting for the Deposit Insurance Fund, and behind 4 to 5 percent of first-loss capital, it would have been more than adequate to protect taxpayers against loss during 

the recent crisis. 

Allowing the single-family and multifamily businesses at the heart of today’s conforming market to be recapitalized and privatized rather than liquidated would provide continuity in the transition. Meanwhile, the six tools identified above could be 

used to ensure that a more diversified set of first-loss providers could enter the market and provide a check on the perpetuation of the dangerous duopoly that now 

exist under the conservatorships. In addition, when the new system is switched on 

and the FMIC begins to offer reinsurance on new conforming MBS, there would be 

at least two issuers/guarantors with sufficient capital and capacity to provide small 

banks and credit unions an effective conduit to the secondary market without having to sell their customer relationships to the countries’ largest banks. And those 

two issuer/guarantors would be able to provide a counterweight to the large banks 

in the mortgage market generally. In turn, mortgage risk would not become concentrated in the banking sector. Legacy MBS obligations would follow the privatized 

companies, not be absorbed onto the Federal Government’s balance sheet. Privatization proceeds would flow to the Government and generate over $100 billion in deficit 

reduction. 7

AIG Precedent 

During my recent tenure as the Chief Restructuring Officer at Treasury, I had 

primary responsibility for the oversight of the Government’s capital commitments 

to AIG, which rivaled in size the amount of capital invested to date in Fannie and 

Freddie. After a series of restructurings of that $182 billion commitment, we designed and implemented a recapitalization plan for AIG that involved (i) selling off 

almost half of its insurance businesses to generate sufficient proceeds to repay its 

debt to the Federal Reserve and (ii) exchanging Treasury’s $50 billion of preferred 

stock into 92 percent of the common equity of the company. Treasury then sold the 

common stock into the public markets in a series of secondary offerings in 2011 and 

2012, which fully eliminated Government ownership of AIG. In the end, taxpayers 

made almost $23 billion on an investment that the OMB initially projected would 

result in $50 billion of losses for the Government. 

As with Fannie and Freddie, at the height of the financial crisis regulators determined that the potential failure of AIG could threaten the stability of the financial 

system. Failures in management and regulation were blamed for allowing the company to reach that point. However, once taxpayer capital was committed, Treasury 

and the Federal Reserve Bank of New York went to work figuring out how to fix 

the company and recover the taxpayer support, all while protecting broader financial stability. Approximately $2 trillion of notional derivatives at AIG Financial 

Products were wound down and substantially derisked before the recapitalization 

was consummated in early 2011. Operating businesses were sold as going concerns 

in value-maximizing transactions in order to reduce the company’s complexity, 

shrink its balance sheet and repay its Government support. Financial leverage was 

reduced to responsible levels. Management refocused on AIG’s core property and 

casualty and life insurance businesses, which remain today important cornerstones 

of the global insurance landscape and integral parts of the daily risk management 

realities for countless policyholders. 

The key lesson from this process is that tried and true methods of corporate reorganization within our existing rule of law can be used to move forward with reform. 

Privatizing recapitalized and newly State-chartered mortgage-guarantee businesses 

would enable Treasury to recover its substantial investment in the companies and 

begin moving toward a safer housing finance system driven by market incentives, 

35 

with private capital first in line for losses. Taxpayers deserve both outcomes. Once 

the companies have enough capital to cover their ‘‘first loss’’ insurance exposure, 

Treasury should outline a detailed privatization plan in consultation with various 

stakeholders. The firms could then be released from Government control and Treasury’s ownership stakes in the restructured entities sold to private investors over 

time. 

Maximizing the asset value of what the Government controls today and selling 

it off over time to ensure the new system has at least two well-capitalized first-loss 

providers is a far safer bet in transition than hoping that new capital sources and 

avenues for funding mortgages will arrive in appropriate size to support the market 

according to an arbitrary wind down time line. Moreover, it would provide a clear 

roadmap to the desired end state that all private market participants can plan for 

and invest around. 

The Transition Proposed by S.1217 

The transition suggested in S.1217 has elements of the above proposal but ultimately rests on a leap of faith, faith that if we build a new system, new private 

capital will come in sufficient size and speed to allow the new system to meet the 

future demand for mortgage funding currently being channeled through Fannie and 

Freddie. If it does not, the new system will shut down before it ever has a chance 

to get off the ground. As a result, the implementation of the new system contemplated in S.1217 carries significant execution risk, depending on capital yet to 

be raised by players yet to be named. It also puts taxpayers at risk, not only from 

potential shocks resulting from the contemplated break-up of the two largest players 

in today’s mortgage market, but also from the $4.4 trillion of MBS liabilities which 

the bill puts on the Federal Government’s balance sheet. Further, by imposing capital requirements on first-loss providers in the new system higher than those are 

imposed on regulated depositary institutions, S.1217 ignores the lessons of the recent crisis which suggest that capital will flow to that part of the financial system 

where permitted leverage is the greatest and leveraged returns are the highest. 

S.1217 requires that Fannie and Freddie cease doing any new MBS business and 

wind their portfolios down to $0 by the FMIC certification date; that is within 5 

years after the bill’s enactment. This arbitrary deadline risks significant dislocation 

in mortgage credit formation if private capital is not raised in sufficient amounts 

to substitute for Fannie and Freddie on that timetable. 

The bill would consolidate $4.4 trillion of GSE MBS liabilities onto the balance 

sheet of the Federal Government. This poses two problems. It will create discontinuities in the trading markets for those legacy MBS and the new FMIC-reinsured 

MBS, orphaning the existing securities and creating significant liquidity constraints 

on the new FMIC MBS which will negatively affect mortgage pricing during the 

transition. Separately, putting the full faith and credit behind those contingent liabilities could balloon the Federal debt. This would complicate an already difficult 

debate over the sustainability of U.S. debt and austerity measures. 

S.1217 provides that Fannie and Freddie be repurposed in three ways. First, parts 

of their businesses are to be sold to a mutual with small bank members. I am sympathetic to the desire to provide small banks with access to the secondary mortgage 

market away from large banks. Fannie and Freddie do that today. Why create execution risk of trying to recreate Freddie out of spare parts from both companies? 

The bill is also unclear how the mutual would be capitalized, governed, or established to compete on pricing with large banks. Second, the bill takes the multifamily 

businesses ‘‘at no cost’’ and puts them inside the FMIC. Although it may be a 

placeholder for a better plan, in its current form, it is neither legal nor workable. 

Third, the bill would allow certain businesses to be sold as going concerns. But here 

too, it would strip them of assets and purport to sell them without any capital. A 

financial institution without capital is like a widget factory with no assembly line: 

you can sell the building but you are not going to get going-concern value for the 

business that it houses. As a drafting matter, if this is the path you want to pursue, 

S.1217 needs to be redrafted to expressly override HERA’s provisions that obligate 

the conservator or receiver to maximize the sale proceeds of the assets it seeks to 

liquidate. 

More generally, S.1217 requires 10-percent capital at first-loss providers. Assuming the conforming market is $5 trillion in 7 to 10 years after a significant portion 

of the legacy books have rolled over, and assuming that the bill means for that capital to be defined as a percentage of total assets, a 10-percent capital requirement 

means that $500 billion of first-loss capital needs to be raised to backstop the conforming MBS market. That is a gargantuan sum relative to the existing equity capital in the banking and insurance sectors. On top of this, the bill requires another 

2.5 percent, or $125 billion, in the MIF to be raised within 15 years. Again, the bill 

36 

provides no direction of how either such capital level will be reached. But each is 

critical to the functioning of the new system. In short, the bill is based on a leap 

of faith that such a substantial amount of capital will be raised by players yet to 

be named. 

Conclusion 

By highlighting the important role that the mortgage guarantee businesses of 

Fannie and Freddie play in today’s mortgage funding markets, and by taking on the 

politically charged idea that the safest and surest path to raising the significant 

amount of new capital on which the new system depends and ensuring continuity 

in mortgage credit formation during the transition is to recapitalize and privatize 

those businesses, I hope that my testimony today will stimulate a frank conversation about how to handle the transition. I do not envy you the task ahead: To say 

that housing finance reform is the most complicated policy, economic and corporate 

finance challenge I’ve seen in my 30 years in the restructuring business would be 

a gross understatement. 

As I noted previously, you have a fundamental choice in meeting the challenges 

in transition: Fix what you have and use it to move to a better-capitalized system 

of mortgage funding, or destroy what is working today and make a leap of faith that 

new capital will be raised by players to be named. For the sake of the Federal budget, the stability of the mortgage funding markets and the value of the single-most 

important asset for most Americans, I hope that I have persuaded you that the 

choice is clear. 

PREPARED STATEMENT OF JOHN BOVENZI 

PARTNER, OLIVER WYMAN

NOVEMBER 22, 2013 

Introduction 

Good morning Chairman Johnson, Ranking Member Crapo, and Members of the 

Committee. My name is John Bovenzi, and I am a Partner at Oliver Wyman, a business unit of Marsh and McLennan Companies (MMC). I would like to thank you 

for affording me an opportunity to share my perspective on housing finance reform. 

Much of my perspective on housing finance reform draws on my 28 years of experience at the Federal Deposit Insurance Corporation (FDIC) and the Resolution 

Trust Corporation (RTC). I served as Deputy to the Chairman of the FDIC from 

1989 through 1992, the period of time when the FDIC was responsible for establishing and managing the RTC. From 1992 to 1999, I was Director of the FDIC’s 

Division of Resolutions and Receiverships and played a key role in merging the RTC 

into the FDIC. From 1999 to 2009, I served as Deputy to the Chairman and Chief 

Operating Officer at the FDIC. 

I believe there is much of value in the FDIC’s and the RTC’s experience that can 

be helpful to the Committee as it determines the best path forward for housing finance reform. 

Overview of the FDIC and the RTC 

First, let me briefly provide an overview of the two agencies’ missions and responsibilities. 

As you know, the FDIC is an independent agency created by Congress in the 

aftermath of the Great Depression. Its mission is to maintain stability and public 

confidence in our Nation’s financial system, and it has three primary roles through 

which it carries out this mission: (1) by insuring deposits, (2) by examining and supervising financial institutions for safety and soundness and consumer protection, 

and (3) by managing receiverships of failed institutions. 

The RTC was a temporary Federal agency established under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in August of 1989. Its 

mission was to manage the assets and liabilities of Savings & Loan Institutions 

(S&Ls) that had been placed into conservatorship. The agency’s goal was to dispose 

of these assets as quickly as practicable at maximum value in order to reduce taxpayer expense. 

The RTC resolved 747 S&Ls with assets totaling nearly $400B during its 6-year 

existence. While heavily criticized at the time, today, the RTC is widely viewed as 

a success story. The total cost to taxpayers from the failed S&Ls wound down by 

the RTC was about $80B, a far lower number than originally projected. After its 

work was done, the RTC demonstrated that a Government agency can put itself out 

of business effectively and efficiently once its mission has been accomplished. 

37 

How the FDIC’s and the RTC’s Experience Can Be Applied to a New Federal Mortgage Insurance Corporation 

Title 1 of the ‘‘Housing Finance Reform and Taxpayer Protection Act’’ would create a new Federal Mortgage Insurance Corporation (FMIC) to provide insurance 

protection for mortgage-backed securities. In the proposed legislation, the new FMIC 

is modeled to a large extent after the FDIC, so observations on the FDIC’s structure 

and experience may be useful. Also, as a start-up Federal agency, the RTC experience in establishing itself also should be of value. 

Lessons From the RTC’s Experience 

I’ll start with the RTC’s experience in creating a new Federal agency, since I believe that is where we can learn the most. There are three important points I would 

like to make at the outset. 

First, the creation and subsequent experience of the RTC show that a new Federal agency can start up and be successful in a relatively short period of time. However, the RTC experience also shows that the complexity of the political and operational issues that must be addressed requires that stakeholders show some degree 

of patience. There will be bumps, missteps, and delays along the way. 

Second, the leadership of such an organization is critically important. The Director will need to possess both the skills to work effectively with a large number of 

stakeholder groups, as well as the managerial skills to effectively address the many 

operational issues that will be faced by a new agency. 

Third, ultimately the employees of the two Government-sponsored enterprises and 

the Federal Housing Finance Agency (FHFA) will determine whether the start-up 

is a success or a failure. They are the people who have the ability to effectively 

transfer critical functions to a new agency. Their experience and expertise should 

not be undervalued or lost if Congress decides to move in the direction of the proposed legislation. 

Let me elaborate on these three points. 

Regarding the first point, that time and patience will be necessary, when the RTC 

was created, it needed a new governance structure, new information systems, new 

staff, and new policies and procedures. The FDIC was able to provide a great deal 

of support, but not nearly enough. Initially, seven hundred employees were transferred from the FDIC to the RTC. Still, the RTC needed to hire many more employees and contractors. Both the internal hiring and contractor procurement processes 

had to be fair and transparent, with all of the necessary controls, including background checks. This took time, when people outside the agency were more focused 

on seeing immediate results. 

To get off to a faster start, the RTC initially adopted many of the FDIC’s policies 

and procedures, but these proved to be insufficient. The RTC’s mission and duties 

were not the same as the FDIC’s so most of those policies and procedures needed 

to be revised or created from scratch, generally with sufficient time for public comment and revisions based on those comments. Information systems were an even 

greater challenge. The FDIC’s systems were not suited for the RTC’s needs. New 

systems had to be created, only to be populated with poor data from insolvent S&Ls. 

Finally, as a political compromise, the RTC’s governance structure started out with 

two Boards of Directors, one for policy and one for operations. The blurred line between these two sets of responsibilities led to finger pointing and a lack of accountability. 

As a result, the RTC’s start-up went slower than what most observers had hoped 

for and there was a great deal of frustration with the RTC. But some perspective 

is necessary. The RTC successfully managed its way through those problems and 

today is widely viewed as a success story. The agency saved taxpayers money and 

finished its work early. 

Regarding the second point, that the new agency’s leadership will need to possess 

both leadership and management skills, I’ll simply say that while this may be obvious to most people, there is an occasional tendency for the leadership of a Government agency to focus almost exclusively on high level policy issues and not give sufficient attention to operational details. A director need not personally focus on all 

of the operational details involved in the start-up of a Government agency, in fact 

that would be counterproductive. However, that person must have a clear appreciation of the significance of internal operations and ensure there are clear delegations 

of authority and accountability. 

As to the third point, that a new agency’s success or failure will be determined 

by the employees of the GSEs and the FHFA, there are a few issues that Congress 

should consider based on the RTC’s experience. 

Title 3 of the proposed legislation abolishes the Federal Housing Finance Agency 

and transfers its staff, infrastructure, technology and other resources to the FMIC, 

38 

but the bill is silent as to the fate of the employees of Fannie Mae and Freddie Mac. 

If those two enterprises are to be shut down some of their operations will have to 

be transferred to the FMIC or elsewhere, which means some jobs would become 

available in other organizations. But the uncertainty surrounding how many jobs 

will be available, on what terms, and who will get them will create significant complications in ensuring a smooth transition. The experience and the expertise of 

Fannie Mae’s and Freddie Mac’s employees will be needed to have an effective transition, so some thought needs to be given as to how that skill and talent can be preserved. 

As a limited life agency, the RTC’s employees knew that by doing their jobs correctly they might be putting themselves out of a job. The same applied to the FDIC’s 

employees who were responsible for handling the spike in bank closings. Eventually 

the economy would recover and their workload would vanish. 

Certain steps were taken to mitigate the harmful effects on the RTC’s and the 

FDIC’s employees. By law, RTC employees also were FDIC employees, thus they 

had the same rights as FDIC’s employees. This meant that when the two agencies 

were merged together the career civil servants in each agency had equal rights to 

the remaining jobs. Other FDIC and RTC employees who had been hired on a temporary basis were in a more tenuous position. In most cases, they were not likely 

to have their contracts renewed once the workload diminished to the point where 

staff reductions were necessary. 

To the credit of the employees at both agencies, they continued to do their jobs 

effectively even though they did not know if, or for how long, those jobs might last. 

Indeed after the two agencies were merged together, the FDIC had to undergo a 

large and painful downsizing given the substantial reduction in its workload in 

going from the crisis to the postcrisis period. 

Throughout that difficult period, constant and clear communication was critical. 

Employees needed as much information as possible so they could better plan for 

their future. The same would be true here. It will not be possible to provide jobs 

for everyone and some attrition will certainly occur, but should Congress go down 

this path, the employees at the GSEs should know that they will be treated fairly 

and respectfully. 

Lessons From the FDIC’s Experience 

Regarding lessons that may be learned from the FDIC’s experience, I would like 

to make some comments on three broad areas: (1) corporate governance, (2) financial strength, and (3) the supervision of financial-sector participants. 

Corporate Governance 

Independence and a system of checks and balances are two important features of 

the FDIC’s governance structure that have served the agency well over time. These 

features also are part of the proposed structure for the Federal Mortgage Insurance 

Corporation. 

Once certain parameters have been established around an agency’s power and authority, an independent structure allows an agency to carry out its duties in a responsive manner. Because the market is constantly changing, an agency needs the 

ability to continually assess new information and adapt to those changes. 

The FDIC has a five person Board of Directors, each appointed by the President 

and confirmed by the Senate. No more than three Board members may be from the 

same political party. In my view, this structure has served the FDIC well over time 

by providing appropriate checks and balances on important policy decisions. 

The FDIC also has a strong Office of the Inspector General that provides independent reviews of the agency’s operations to prevent waste, fraud and abuse. The 

Inspector General is appointed by the President and reports directly to Congress as 

well as to the FDIC Chairman. This too has served the FDIC well as part of an 

overall system of checks and balances. The creation of an Office of the Inspector 

General is an important safeguard that has been included in the proposed bill. 

Based on my experience it appears that the proposed bill covers the most important aspects of creating a strong governance structure. 

Financial Strength 

Much has been learned over the past 30 years about what is required to maintain 

a deposit insurance fund strong enough to not have to rely on taxpayer support during a financial crisis. During the 1980s and early 1990s nearly 3,000 insured depository institutions became insolvent and were closed. As a result, the Bank Insurance 

Fund became insolvent. While the FDIC did not have to rely on taxpayer support, 

it did have to substantially raise bank deposit insurance premiums during the crisis 

period, when banks could least afford to pay more. This had several adverse effects, 

not the least of which was exacerbating the credit crunch that existed at that time. 

39 

Because of that experience, Congress relaxed some of the controls on the FDIC’s 

ability to manage the size of its deposit insurance fund, but it was not enough. During the 2008 financial crisis the FDIC’s deposit insurance fund again had insufficient funds. The agency did not have to rely on taxpayer support, but once more 

it did have to charge banks substantially higher premiums when banks could least 

afford to pay them. As a result Congress further relaxed the controls on the FDIC’s 

ability to assess high enough premiums over the course of the business cycle. Now 

the agency has the authority it needs to build the deposit insurance fund to high 

enough levels that it can withstand a crisis period. This new authority allows the 

FDIC to charge higher premiums during the healthy part of the economic cycle, so 

it will not be forced to further dampen credit availability during an economic downturn. 

The proposed bill includes targets for the size of the FMIC’s Mortgage Insurance 

Fund. After the first 5 years of its existence the FMIC is expected to have charged 

participating institutions fees sufficient to create a fund that is 1.25 percent of all 

outstanding covered securities. After 10 years the ratio is targeted to be 2.5 percent 

of all outstanding covered securities. It is difficult to know what size fund is needed 

to protect taxpayers against losses. For many years the FDIC’s statutory target 

ratio of the deposit insurance fund to insured deposits was 1.25 percent. Prior to 

the 1980’s the rationale was that while arbitrary, history had shown that the 1.25 

percent target ratio worked. In the aftermath of two financial crises it was clear the 

1.25 percent ratio did not work. Since then the FDIC analyzed what fund size would 

have been necessary to keep the deposit insurance fund from becoming insolvent. 

That review led the agency to raise its target ratio to 2 percent. 

The important point is that the FMIC will need sufficient flexibility and authority 

to manage the size of the Mortgage Insurance Fund based on continuous analysis 

so it can protect taxpayers against losses during economic downturns. 

Supervision of Financial-Sector Participants 

The FDIC sets standards for bank behavior. The agency has the authority to set 

entry standards for groups that seek to obtain bank charters and the authority to 

remove deposit insurance protection for banks that aren’t meeting those standards. 

In between, the FDIC has a wide range of formal and informal enforcement actions 

it can employ to force banks to meet its supervisory standards without removing a 

bank’s deposit insurance coverage. These authorities include issuing formal ceaseand-desist orders, civil money penalties, and agreeing to informal memoranda of understanding. The FDIC also has examination authority to ensure banks are in compliance with FDIC supervisory standards and to determine whether enforcement actions are necessary. Also, to help ensure that supervisory actions are taken in a 

timely manner, the FDIC is subject to Prompt Corrective Action requirements, 

which mandate that certain supervisory actions be taken as bank capital levels drop 

below prescribed levels. In their entirety these powers are an important part of safeguarding the financial system and protecting the deposit insurance fund. 

The proposed bill would grant some, but not all, of these authorities to the FMIC. 

The new agency would have authority to determine entry standards for mortgage 

servicers, issuers, and guarantors. Those standards track the FDIC standards in 

many respects, since they include a review of the financial history of the applicant, 

its capital adequacy, the character of management, and the risk posed to the insurance fund. The bill also empowers the FMIC to issue civil money penalties and revoke its approval if a participating institution does not continue to meet its standards. However, the bill does not grant the FMIC examination authority, nor does 

it allow for a full range of enforcement actions. 

Based on my experience, it would be worth considering whether the FMIC should 

be granted broader supervisory and enforcement authorities beyond controlling 

entry and exit into and out of the program and the ability to issue civil money penalties. The FDIC has rarely used its power to revoke deposit insurance coverage, 

finding it to be a cumbersome process compared to its other enforcement alternatives such informal memoranda of understanding and formal cease-and-desist orders. The FMIC likely would have the same experience. Other more practical enforcement tools may be more effective in helping the FMIC accomplish its objectives. 

Also, consideration should be given to giving the FMIC examination authority. 

While off-site monitoring can be used to help monitor bank behavior, over time the 

FDIC has found there is no substitute for the direct interaction with bank management that occurs during the examination process. 

40 

How the RTC’s Experience Can Be Applied to the Proposed Wind Down of 

Fannie and Freddie 

Title 5 of the ‘‘Housing Finance Reform and Taxpayer Protection Act’’ requires 

that Fannie Mae and Freddie Mac be wound down and phased out of business over 

a 5-year period. The RTC had a similar requirement in its original charter. By statute the agency, which was created in 1989, had to be wound down and merged into 

the FDIC by year-end 1996. It accomplished that objective a year earlier than originally planned. Given those similarities there may be some valuable lessons based 

on the RTC’s experience should Congress determine that it wants to wind down 

Fannie and Freddie’s operations. We already covered issues related to the treatment 

of the GSE’s employees so I won’t repeat those concerns here, rather I’ll talk briefly 

about governance issues and sales processes. 

Corporate Governance 

Many of the same governance principles that apply to the creation of a new agency also apply to the wind down of an existing agency or agencies. Strong oversight 

is critical because taxpayer dollars and important public policy objectives are at 

stake. 

The RTC was governed by a Board of Directors with additional oversight provided 

by Congress, an Office of the Inspector General, and the General Accounting Office 

(GAO), among others. Such checks and balances, while introducing some degree of 

inefficiency, are well worth the costs in order to ensure there are strong oversight, 

effective internal controls, and fair processes. 

Sales Processes 

According to the proposed legislation, Fannie Mae and Freddie Mac should have 

no more than $552.5B in real estate related assets (mortgage loans and mortgagebacked securities) by year-end 2013. The bill requires that these assets be reduced 

by at least 15 percent a year over a 5-year period. Any remaining assets are to be 

put into receivership after that point. This is not significantly different than what 

the RTC was charged with accomplishing. Most of the $400B in assets from the insolvent S&Ls that the RTC was responsible for also were real estate related assets. 

The RTC experimented with a large variety of sales processes for the different 

types of assets it managed. It learned much through trial and error, but a few key 

principles emerged to help guide the agency. 

First, virtually all sales were subject to an inclusive, open and transparent competitive bidding process. The RTC did not engage in negotiated sales with individual 

buyers for pools of assets, despite the desire for such by many potential buyers. The 

agency recognized that open competition would maximize value and that it also reduced the possibilities for fraud or abuse. Given that a number of the insolvent 

S&Ls that were costing taxpayer money had committed fraud and abuse, it was that 

much more important that the Government cleanup be beyond reproach. 

Second, the RTC partnered with the private sector in the disposition of many its 

assets. For pools of assets that required particular expertise, the RTC found it best 

to sell a portion of the pool to private-sector investors with the required expertise 

and retain partial ownership of the assets. Such partnerships allowed the RTC, and 

hence taxpayers, to benefit from the added value the right management could bring 

to those assets as well as from any appreciation in assets value over time due to 

an improving economy. 

Such public/private-sector partnerships in managing and disposing of assets aren’t 

without their challenges. Often both sides have a healthy degree of mistrust for one 

another. The private sector often views the Government as an unreliable and slow 

business partner, while the Government often sees the private sector as overly focused on its financial returns and under appreciative of the types of processes and 

controls that must be put into place whenever taxpayer money is at stake. 

These differences can be overcome by clarifying up front what the expectations 

are for each business partner. The Government needs to understand that financial 

incentives for the private sector maximize value for taxpayers. Private sector asset 

managers need to understand that they have to comply with certain processes and 

oversight that they may view as inefficient and time consuming, but that are necessary to show the public that the overall process is being managed in a way that 

treats people fairly and shows them that their money is not being wasted. 

During the most recent financial crisis the FDIC effectively used public/private 

equity partnerships (and the closely related loss-sharing agreements it entered into 

with the acquirers of insolvent banks) to manage many of the assets it was responsible for as receiver for failed banks. It found that these partnerships greatly enhanced asset values and returns to failed-bank creditors, including the FDIC’s deposit insurance fund. 

41 

Such agreements between the public and private sector, while valuable in certain 

situations, are not necessarily the preferable sales technique in all situations. Some 

assets can be sold outright and still maximize value, in part by eliminating ongoing 

commitments and administrative burdens on the part of the Government. Each 

asset category and situation should be evaluated on its own merits to determine the 

best strategy. 

As the Committee and the Congress deliberate further on this important issue, 

I and my colleagues at Oliver Wyman are ready to collaborate with you to offer our 

experience and expertise on this key public policy matter. 

PREPARED STATEMENT OF MARK ZANDI 

CHIEF ECONOMIST AND COFOUNDER, MOODY’S ECONOMY.COM

NOVEMBER 22, 2013 

Much of the debate over the future of the Nation’s housing finance system has 

focused on the system’s end state—whether housing finance should be privatized, 

retain some form of Government backstop, or even remain effectively nationalized 

as it is today. No matter which goal is chosen, however, reform will not succeed 

without an effective transition. A clearly articulated plan for getting from here to 

there is vital; otherwise policy makers will be appropriately reluctant to move down 

the reform path. 

For the purposes of this testimony, it is assumed that the future housing finance 

system will be a hybrid system, much like that proposed in recent legislation introduced by Senators Corker and Warner, S.1217. That is, private capital will be responsible for losses related to mortgage defaults, but in times of financial crisis, 

when private capital is insufficient to absorb those losses, the Government will step 

in. Mortgage borrowers who benefit from the Government backstop will pay a fee 

to compensate the Government for potential losses. 

While there are advantages and disadvantages to any housing finance system, a 

hybrid system is the most likely to be implemented. Such a system will preserve 

the long-term fixed-rate mortgage as a mainstay of U.S. housing, and it will ensure 

that affordable mortgage loans are available to most middle-income Americans 

through good and bad times. Taxpayers will backstop the system, but it will be designed so that lenders and borrowers bear the ultimate cost. 

A hybrid system will require substantial new private capital. Currently, little private capital is involved in making mortgage loans; the Federal Government acts as 

the Nation’s principal mortgage originator via Fannie Mae, Freddie Mac, and the 

Federal Housing Administration. How much private capital will be needed depends 

on many factors, but assuming the new system’s requirements are consistent with 

those applied to the Nation’s largest banks, as much as $175 billion in today’s dollars might have to be raised. 

For context, this amounts to more than the equity raised in the 10 largest initial 

public offerings in U.S. history combined, including those for the insurer AIG and 

the credit-card giant Visa. Such a large amount will not be easy to raise quickly. 

Any viable transition plan must therefore clearly determine where the private capital will come from and at what cost. 

The transition plan must also spell out the fate of Fannie Mae and Freddie Mac. 

While few wish to return to the old system, which was dominated by these thinly 

capitalized, too-big-to-fail behemoths, the consensus stops there. Some insist that 

Fannie and Freddie be completely dismantled, while others propose using their current profits to recapitalize and ultimately reprivatize them. 

Dismantling the two institutions would risk disrupting the flow of mortgage credit, which, for all their faults, Fannie and Freddie have continued to provide efficiently through the Great Recession and subsequent recovery. On the other hand, 

recapitalizing and privatizing the institutions could leave them in control of U.S. 

housing finance. It is unclear who could compete with them; without such competition, the future system will eventually resemble the old one. A dominant duopoly 

will allow the entities to overcharge for their services and will become the taxpayers’ 

problem if they blunder again. 

A host of smaller but still critical technical and legal issues must also be resolved 

in the transition to a new system. Moving Fannie and Freddie from their current 

conservatorship status to receivership to new ownership will be complicated. Their 

mortgage securities must be managed by whoever succeeds them at least as efficiently as they are doing. Shifting oversight authority from the Federal Housing Finance Agency, Fannie’s and Freddie’s current regulator, to the overseer of the future 

42 

system will also involve many steps. And ensuring that small lenders have access 

to the Government backstop for the mortgages they originate will not be easy. 

Some initiatives necessary to reshape the housing finance system are already 

under way and should be nurtured. The FHFA is developing a common 

securitization platform, which will be important no matter the system’s final form. 

The platform should support greater transparency, which in turn will promote better credit risk management and lower future mortgage defaults, more liquidity, better access for small lenders and increased competition. 

The FHFA is also requiring Fannie and Freddie to share more risk with private 

investors, including private mortgage insurers and investors. This should provide information and experience necessary for the risk-sharing envisaged under most housing finance reform proposals. 

The transition to the future housing finance system will require legislation and 

take years to implement, but cannot begin unless there is a clearly laid-out road 

to reform. With such a road map, it is plausible that housing finance reform could 

become law soon. It is exciting to think that the new housing finance system could 

conceivably be in place at the start of the next decade. 

A more detailed description of the road to housing reform is provided in the paper 

as an appendix to this testimony, ‘‘The Road to Reform’’, Mark Zandi and Cristian 

deRitis, Moody’s Analytics white paper, September 2013. 

Transition Objectives 

The transition from the current, largely nationalized housing finance system to 

the future hybrid system must protect the economic recovery. Government support 

to the housing finance system cannot be withdrawn too quickly without undermining the housing recovery, which is vital to the broader economic recovery. Mortgage credit conditions are still very tight: Lenders remember the massive losses suffered during the housing crash and are uncertain about a number of regulatory 

issues. Prematurely withdrawing Government support would exacerbate this problem. 

Taxpayers should be made financially whole during the transition. The Government’s support to Fannie and Freddie should be repaid, along with the cost of backstopping the rest of the financial system when Fannie and Freddie failed, and the 

costs associated with setting up a new financial system. Taxpayers should also receive a return on their financial support commensurate with the risks they have 

taken. 

Private capital standing in front of the Government’s guarantee must be adequate 

to absorb mortgage losses resulting from all but the most severe financial crises and 

economic downturns. This is necessary to protect the Government against losses and 

avoid future bailouts. A substantial amount of private capital, from varied sources, 

will be needed by the future housing finance system. 

The transition to the new housing finance system must reduce the system’s reliance on large and complex financial institutions such as Fannie Mae and Freddie 

Mac. The housing finance system’s design must ensure that institutions in the system can fail without catastrophic economic consequences. 

Access to affordable owner-occupied and rental housing must be maintained 

through the transition. This has become even more important in the wake of the 

Great Depression and the significant destruction of homeowners’ equity in the Great 

Recession, ongoing financial pressure on low-income households, and changing demographics. 

Legacy Fannie and Freddie Securities 

Investors in legacy Fannie and Freddie MBS and debt securities must be protected. The Federal Government now guarantees existing MBS and bond obligations 

of Fannie and Freddie through agreements between the Treasury Department and 

the two firms. This must continue through the transition period. Not doing so would 

undermine investors’ faith in the U.S., raising borrowing costs and exacerbating the 

Nation’s fiscal problems. This is a legacy of the old system, and while the new system should avoid re-creating this obligation, we cannot retroactively change expectations without damaging the Nation’s credibility in global credit markets. 

S.1217 addresses this issue by providing an explicit guarantee on the ‘‘payments 

of all amounts which may be required to be paid under any obligation’’ of the Government-sponsored enterprises. Legacy GSE MBS would thus be backed by the Government’s full faith and credit, much like a GNMA MBS. This support applies to 

mortgage-backed securities that have been issued by Fannie and Freddie in the 

years leading up to the ‘‘certification date,’’ when the GSEs stop issuing MBS. 

Legacy GSE MBS must be made fungible with Government-backed MBS in the 

new housing finance system. In S.1217 this would be MBS backed by a Government 

43 

regulator—call it the Federal Mortgage Insurance Corp. One possibility is to establish a resecuritization process whereby investors in legacy MBS are able to, but not 

required to, convert them into FMIC MBS. These new MBS would be deliverable 

into the new to-be-announced market, and would simply require a new CUSIP number and a matching-up of payment delays. 

Investors should be able to exchange legacy GSE MBS for the new FMIC MBS 

indefinitely and without cost. When the existing stock of legacy securities outstanding becomes small enough so that the costs of maintaining the exchange program exceed its benefits, some type of ‘‘clean up’’ call may be appropriate. 

Common Security 

Smoothing the transition to these new securities would be the development of a 

common Government-guaranteed security prior to the full implementation of the 

new housing finance system. This would improve liquidity in the TBA market and 

result in lower mortgage rates. A common security would also lower entry barriers 

to the guarantor market, as no guarantor would have an advantage because of the 

liquidity of the securities they back. 

This is a problem in the current housing finance system, as Freddie Mac securities are much less liquid than Fannie Mae securities. Fannie and Freddie split the 

MBS market 60–40, but on a typical day the trading volume of Fannie MBS is 10 

times greater than that of Freddie MBS. To compensate, Freddie is forced to charge 

a lower guarantee fee than Fannie. In the second quarter of 2013, Fannie’s average 

G-fee was 57 basis points, compared with Freddie’s 51 basis points. 

There are some modest differences between the securities—Freddie pays investors 

more quickly than Fannie and its securities prepay a bit more quickly—but the key 

difference is their liquidity. This liquidity difference makes the mortgage market 

less efficient and less competitive, and leads to higher costs for mortgage borrowers 

and taxpayers. 

A potential near-term fix to this problem would be to make Fannie and Freddie 

securities fungible, creating a common TBA security. That would require a change 

to the good-delivery guidelines for TBA, to allow the delivery of either Fannie or 

Freddie securities into the same contract. The securities themselves would not 

change; their separate TBA markets would simply be merged. Both securities would 

still be separately identifiable and tradable, only the TBA trades would be merged. 

Not only would this interim step improve liquidity, it would demonstrate investor 

interest in a truly common security that would be an important feature of the future 

hybrid housing finance system. 

The Future of Fannie and Freddie 

A critical question in the transition to a future housing finance system is what 

to do with Fannie Mae and Freddie Mac. For all that is wrong with the current system, Fannie and Freddie are doing an effective job buying conforming mortgages, 

bundling them into MBS with a Government guarantee, and selling them to global 

investors. The mortgage market is not working as well as it should, but it is working. Whatever is done with Fannie and Freddie must not disrupt this flow of mortgage credit, for the sake of the housing and economic recoveries. 

Arguably the most straightforward approach, with the least amount of near-term 

risk, would be to recapitalize and reprivatize Fannie and Freddie. Both are currently profitable, as a result of improving mortgage credit conditions and their higher guarantee fees. The two agencies’ profits are flowing to the U.S. Treasury, rapidly 

repaying the $188 billion Fannie and Freddie received from taxpayers in order to 

stay in business. The GSEs are on track to repay the Treasury’s investment by the 

end of this year. 

After that, their profits could be used to build the capital necessary for them to 

become private guarantors in the future finance system. Once appropriately capitalized, they would be reprivatized, with the Government selling them to private investors to maximize the return to taxpayers. 

There is a considerable downside to this approach, however: The future housing 

finance system could again be dominated by Fannie and Freddie or their successors. 

The system could encourage competition, for example, by establishing a new common securitization platform run as a Government utility that produces a single Government-backed security. The reincarnated Fannie and Freddie would also likely be 

classified as systemically important financial institutions, or SIFIs, and thus face 

stiffer capital and liquidity requirements. This would raise their cost of capital visa-vis newer entrants, further supporting competition. 

But the two giant firms would still have considerable advantages of size and scale, 

important legacy relationships, and entrenched software and systems. Most likely 

this approach would create a hybrid system dominated by a duopoly, firms with sigVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00047 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
44 

nificant power over the mortgage and housing markets that would be much too big 

to fail. The arrangement would be uncomfortably similar to the dysfunctional system that prevailed prior to the Great Recession. 

An alternative approach would be to simply put Fannie and Freddie into receivership and liquidate their assets. Guarantors in the hybrid system would be largely 

new entities, begun by those purchasing Fannie’s and Freddie’s assets. There is significant risk in this approach, as there would be no assurance that the new guarantors would be able to continue the institutions’ activities, at least not in a timely 

way. The chance of a disruption in the flow of mortgage credit would be uncomfortably high. 

A better approach would be for the Government to put Fannie and Freddie into 

receivership, and to strip them of their key assets. They would then be rechartered 

as new private guarantors, able to license back these assets from the Government 

receiver. Their operations would not be disrupted, ensuring that the mortgage market functioned smoothly through the transition. But to level the competitive playing 

field, any other new guarantors could also license the same key assets from the receiver. This would facilitate easy entry into the guarantor market and thus encourage competition. 

The current Senior Preferred Stock Purchase Agreement between the U.S. Treasury and Fannie and Freddie would need to be restructured to permit the redemption 

of the Treasury’s senior preferred shares and the cancelation of its warrant in the 

firms. The restructured SPSPA would determine the appropriate compensation taxpayers require from Fannie and Freddie for their financial support. 

Fannie and Freddie would be put into receivership, and their operating assets and 

liabilities moved into limited life regulated entities, or LLREs, allowing them to 

maintain their operations independent of the resolution process. This is similar to 

the procedure envisaged in Dodd-Frank for failing SIFIs. The assets of the LLREs 

would then be sold or licensed back to Fannie’s and Freddie’s successor firms, which 

would be chartered as independent guarantors, and to the new competitor guarantors. 

Fannie’s and Freddie’s $4.5 trillion legacy guaranty book would not be included 

in the assets transferred from the Government receiver to the LLREs. More private 

capital would be needed to support the legacy books than could be raised in a reasonable period, ensuring that the new housing finance system would never get 

going. The receiver would engage the new guarantors to manage the loans in the 

legacy books, providing a steady source of revenue. 

Sources of Private Capital 

A substantial amount of private capital will thus be necessary to support the future housing finance system. Over time, some will come through the guarantors’ retained earnings. This will not help in the early years, but under conservative assumptions, retained earnings could eventually provide as much as one-third of the 

guarantors’ capital requirements. 

The equity market is another potential source for early capital. Some financial institutions have held big initial public offerings in the recent past: AIG, Visa, and 

Bank of America each raised close to $20 billion in equity. The guarantors in the 

future housing finance system should see returns on equity similar to those of the 

money-center banks and life insurers, or about 10 percent. This would be consistent 

with a valuation of 100 percent of tangible book value and a price-earnings multiple 

of 10. The guarantors’ return on equity would be less than the 15-percent ROE that 

private mortgage insurers have historically received, although this appears to have 

declined to near 13 percent in the current low interest-rate environment. It is encouraging that many private mortgage insurers have been able to raise significant 

equity capital in recent months. 

But it is hard to see the equity market producing all the remaining capital needed 

by the guarantors. Equity investors will be rightly nervous about the new system, 

and will question the guarantors’ earnings prospects in a highly regulated and mature market. The guarantors’ earnings may also be relatively volatile, fluctuating 

with the housing and business cycles, and their market share will shift against the 

nonguaranteed part of the mortgage finance system. And of course there is the 

reputational risk associated with playing a pivotal role in the provision of mortgage 

credit. 

Equity investors in the new guarantors would likely include those currently taking equity stakes in private mortgage insurers. Shareholders in the Nation’s largest 

PMI companies include mutual funds such as Fidelity and the Vanguard Group, 

pension funds such as TIAA–CREF, asset management firms such as Goldman 

Sachs Asset Management and State Street Global Advisors, hedge funds such as 

Paulson & Co. and Citadel, and diversified financial institutions such as BlackRock. 

45 

A wide range of global reinsurers are also providing capital relief to the PMI companies and would likely be interested in taking stakes in the new guarantors. 

Yet, even if the guarantors can raise the amount of equity envisaged from public 

markets, a capital shortfall will remain. This would be temporarily filled by the Nation’s large mortgage originators through a seller-financing arrangement. In the hybrid system assumed here, originators would not be permitted to own guarantors, 

but there would be an exception while the system is being established. In that period, originators would be required to temporarily take equity in the guarantors in 

partial payment for the Government-guaranteed mortgages they sell. The equity received by the originators as payment would be valued at 100 percent of tangible 

book value. 

The success of requiring large originators to temporarily hold equity in the guarantors hinges on several factors. Most importantly, the originators, which include 

the Nation’s largest banks, would need to have excess capital. Capital ratios in the 

banking system are at a record high and rising: According to the Federal Deposit 

Insurance Corp., the Tier 1 capital ratio for all banks is above 9 percent and climbing. Banks are also making record profits, and although their recent profitability is 

temporarily supported by improving credit quality and the resulting release of loan 

loss reserves, they should have plenty of excess capital given their long-term earnings power and more limited growth opportunities postregulatory reform. 

While bank originators may object to this arrangement, they also have a strong 

incentive to ensure that guarantors in the new hybrid system are well-capitalized. 

Originators will prefer a well-functioning housing finance system, with a Government backstop and a TBA market, to alternatives that require them to hold many 

more mortgages on their balance sheets. However, since the banks’ investments in 

the guarantors would have pedestrian returns, and since a 100-percent riskweighting would be capital-intensive, bank originators would be expected to sell 

their stakes in the guarantors as soon as their capital is no longer needed. There 

would also be a reasonable divesture period, in case they are unexpectedly slow to 

sell their shares. 

Critical to this arrangement’s success is that even with their equity stakes, the 

large bank originators should have no control over the guarantors. Otherwise, small 

lenders would be appropriately nervous about their ability to compete. Large originators would receive nonvoting or B-shares as payment from the guarantors. This 

is similar to the arrangement Visa set up with its bank members when it designed 

its IPO. Once the B-shares were sold to nonoriginator investors, they would become 

voting A-shares. 

Common Securitization Platform 

A well-functioning common securitization platform is an important requirement 

for a successful transition to a new housing finance system. All non-Ginnie Mae, 

Government-guaranteed securities should use a common securitization platform. Although not required, nonguaranteed securities could use the same platform. 

The common securitization platform would produce a more liquid market, facilitate loan modifications in future downturns, and give issuers operating flexibility 

at a low cost. It would also allow for a robust TBA market. Such a platform is also 

important for lowering barriers of entry into the future mortgage guarantor market, 

allowing for more competition and reducing too-big-to fail risks. 

The securitization facility would leverage current efforts by the FHFA to develop 

a single platform for Fannie Mae and Freddie Mac securities. For a fee, the 

securitization facility would provide a range of services, including mortgage loan 

note tracking, master servicing, data collection and validation to improve transparency and integrity, and bond administration. 

Mortgage loans included in securities that use the common securitization facility 

would be covered by a uniform pooling and servicing agreement and uniform servicing standards that encourage prudent underwriting and align investor and borrower interests. This would encourage the adoption of similar standards for other 

mortgages. 

The common securitization platform would permit multiple originators to sell 

mortgages into single securities with access to the Government guarantee. In return, the originators would receive pro rata shares of the security. Pooling requirements would be largely the same as for typical single-originator securities, and they 

would be good for delivery into the TBA market. Originators could thus easily convert securities to cash before the securities were created, an especially important 

feature for smaller originators. 

46 

Transition Contingencies 

It is important to recognize the possibility that the transition process may not go 

as smoothly as planned. The transition involves complex changes to the legal and 

operational framework at the center of housing finance. It also involves the development of new guarantors and securities and new oversight responsibilities over a 

wide range of institutions and activities. Given all these moving parts, it is plausible 

to think that things will not come together as quickly as hoped. 

As such, any legislation to reform the housing finance reform system should allow 

for some flexibility in the timing of the transition process. In S.1217 the transition 

process must be completed within 5 years. There should be some flexibility in this 

deadline, as the FMIC needs the ability to speed or slow the process if it jeopardizes 

the housing market and capital markets more broadly. Suppose, for example, that 

there is a major financial crisis in year five of the transition. The FMIC should thus 

have the authority to reduce or even eliminate the private capital first-loss requirement in cases of significant financial market disruption. It is thus also critical that 

the GSEs be able to continue their business operations until the new system is fully 

operational. 

Conclusions 

Since the Government took over Fannie Mae and Freddie Mac during the financial collapse 5 years ago, effectively nationalizing the Nation’s housing finance system, nothing meaningful has changed. The Government still makes nearly nine of 

every 10 U.S. mortgage loans. This is bad for both taxpayers and homebuyers. 

Taxpayers are on the hook for potential losses on the hundreds of billions of dollars in mortgages that Fannie and Freddie insure each year. This is not necessary: 

Private investors are willing to take on much of this risk and, with some safeguards, 

are capable of doing it. 

The longer Fannie and Freddie stay in Government hands, the more lawmakers 

will be tempted to use them for purposes unrelated to housing. This has already 

happened. Last year’s payroll tax holiday was partially paid for by raising the premiums Fannie and Freddie charge homebuyers for providing insurance. Mortgage 

borrowers will be paying extra as a result over the next decade. 

The housing market’s revival has allowed Fannie and Freddie to again turn large 

profits, amounting to tens of billions of dollars each year. Policy makers may begin 

to rely on these profits to fund Government spending, making it especially hard to 

let Fannie and Freddie go. 

Policy makers may also eventually be tempted to make Fannie and Freddie lend 

to people who really cannot afford mortgages. This is partly how the two institutions 

got into financial trouble during the housing bubble—they took on more risk than 

they should have to meet their housing-affordability goals. Helping disadvantaged 

households become homeowners is laudable, but experience shows that politically 

driven help can be abused. 

The bigger problem now is the limbo status of Fannie and Freddie, which fosters 

indecision at the two institutions and by their regulator, the FHFA. Lenders who 

do business with Fannie and Freddie are unsure of the rules, and are thus extra 

cautious, keeping credit overly tight for potential homebuyers. This is evident in the 

average credit scores of borrowers through Fannie and Freddie, which today are in 

the top third of all of credit scores. 

Lawmakers recognize the current situation’s dangers and have introduced legislation to reform the Nation’s housing finance system. Yet these legislative efforts lack 

a clear plan for getting from the current housing finance system to the future one. 

The transition cannot be bungled: The Nation’s economic recovery depends on housing, which in turn depends on the flow of mortgage credit. The $10 trillion U.S. 

mortgage market is also critically important to the entire global financial system. 

Yet while the transition will be complicated and rife with risk, it is eminently doable. 

The Federal Government has unwound much of its extraordinary intervention in 

the economy prompted by the Great Recession. Fiscal stimulus has been replaced 

by fiscal austerity. The Trouble Asset Relief Program bailout fund will soon be history. The Federal Reserve is planning to begin normalizing monetary policy. That 

leaves Fannie and Freddie and the Nation’s housing finance system as the largest 

piece of unfinished business. It is time to finish it. 

47 


11221303.eps
48 


11221304.eps
49 


11221305.eps
50 


11221306.eps
51 


11221307.eps
52 


11221308.eps
53 


11221309.eps
54 


11221310.eps
55 


11221311.eps
56 


11221312.eps
57 


11221313.eps
58 


11221314.eps
59 

1 Housing Finance Reform and Taxpayer Protection Act of 2013, S.1217, 113th Cong. (2013) 

(hereinafter ‘‘Corker-Warner’’ or the ‘‘Corker-Warner bill’’). 2See, e.g., David Min, ‘‘How Government Guarantees in Housing Finance Promote Stability’’, 

50 HARV. J. LEG. 437 (2013); David Min, et al., ‘‘The Future of U.S. Housing Finance: Five 

Points of View’’, 17 J. STRUCTURED FIN. 36 (2011). Before Agency securitization evolved to 

dominate U.S. mortgage markets, federally insured depository institutions were the primary 

source of residential mortgage funding. In both types of financing, the Federal Government 

holds the catastrophic tail risk. Since the 1940s, this Government backing has existed for the 

vast majority of U.S. home loans, typically more than 70 percent. Id. 3 According to their Form 10-K filings, at the end of 2012, Fannie held $3.064 trillion in mortgage related assets, and Freddie held $2.005 trillion. 4Following the conservatorship of Fannie and Freddie, many have ceased calling these firms 

‘‘Government-sponsored,’’ since they are effectively seen as part of the Federal Government. 

Technically, however the conservatorship was structured in a way that kept the enterprises private and lacking an explicit Government guarantee, so the term ‘‘Government-sponsored enterprise’’ or ‘‘GSE’’ is still accurate. 

PREPARED STATEMENT OF DAVID MIN 

ASSISTANT PROFESSOR OF LAW, UNIVERSITY OF CALIFORNIA, IRVINE SCHOOL OF LAW

NOVEMBER 22, 2013 

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

name is David Min and I am an Assistant Professor at the University of California, 

Irvine School of Law, where I teach and research in the area of banking and capital 

markets regulation. Before coming into academia, I spent over a decade working in 

financial markets law and policy, both in private practice and in the Federal Government. Most recently, I served as the Associate Director for Financial Markets 

Policy for the Center for American Progress, where I was responsible for managing 

the activities of the Mortgage Finance Working Group organized by CAP. I am here, 

however, in my individual capacity, and not as a representative of either CAP or 

the Mortgage Finance Working Group. 

For the purposes of my testimony, I will assume that the system of housing finance that we transition into will be some variation of S.1217, the bill proposed by 

Senators Bob Corker (R-TN) and Mark Warner (D-VA). 1 The Corker-Warner bill envisions a so-called ‘‘hybrid’’ system, in which the Federal Government provides explicit and priced reinsurance on mortgage-backed securities insured by approved 

bond guarantors, in a model based loosely on the deposit insurance model of the 

Federal Deposit Insurance Corporation. As I have noted elsewhere, the Federal Government has provided, in one way or another, a catastrophic backstop on most residential mortgage funding since the New Deal’s banking and housing reforms, and 

this role has been inextricably linked to a number of key policy objectives, including 

financial stability, broad and constant liquidity, and the wide availability of the 30- 

year fixed-rate mortgage that has become the hallmark of U.S. housing finance. 2

The transition being contemplated would be the largest such undertaking in history, and one that, to the best of my knowledge, has no close precedents. Fannie 

and Freddie currently hold slightly more than $5 trillion in mortgage-related assets. 3 Since the sudden and steep decline in private mortgage finance that occurred 

in 2008, the two enterprises have been responsible for more than 60 percent of the 

new mortgage originations, about $1.7 trillion each year, an amount equivalent to 

slightly more than 10 percent of our Nation’s annual gross domestic product. The 

Federal Government has some experience in resolving failed institutions—recently, 

the Government’s interactions with AIG and General Motors come to mind, and before that, we had the experience of the Resolution Trust Company in resolving hundreds of failed thrifts. But I can think of no instance in which we have tried to simultaneously resolve large failed institutions and transition their core economic 

functions into a newly created set of institutions, certainly not on the scale imagined 

by Corker-Warner. 

The experience of the past decade has shown us that the current housing finance 

model, which relies predominantly on the mortgage-backed securities issued by the 

Government-sponsored enterprises (GSEs) 4 Fannie Mae and Freddie Mac, well 

serves a number of critically important policy goals, including offering a broadly 

available and affordable 30-year fixed-rate mortgage product, meeting the credit 

needs of underserved populations and product types such as rural areas and multifamily housing, and providing countercyclical liquidity when other sources of housing finance have dried up. Unfortunately, this experience also illustrates a number 

of serious flaws with the GSE model. Because these enterprises were publicly 

backed, with private shareholders, they continuously sought to maximize profits by 

increasing their risk-taking, creating a ‘‘heads I win, tails you lose’’ dynamic between their shareholders and taxpayers. Moreover, protections against taxpayer exVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00063 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
60 

5 Corker-Warner §§501–506. 6 Corker-Warner §506. 7 Corker-Warner §504. 8 Corker-Warner §505. 9 Corker-Warner §501. 10 Corker-Warner §501. 11See, Edward J. DeMarco, Acting Director, Federal Housing Finance Agency, ‘‘The 

Conservatorships of Fannie Mae and Freddie Mac’’, remarks before the National Association of 

Federal Credit Unions Congressional Caucus, Washington, DC (Sept. 13, 2012). 

posure were clearly insufficient in this framework. In my view, the Corker-Warner 

bill is a good starting point for thinking about how to keep the parts of the current 

system that worked, while eliminating the parts that proved problematic. 

This same balance needs to be reflected in how we think about transitioning to 

the future housing finance system outlined in Corker-Warner. Thus, while safety 

and soundness and taxpayer protection are obviously important policy goal, I believe 

the most important priority in structuring the transition should be to ensure that 

there continues to be sufficient liquidity across all market segments. Given the complexity and size of the GSEs’ current operations, this is a tremendously complex and 

multilayered task. Moreover, the stakes could not be higher, as major hiccups would 

have devastating effects on an already-stagnant economy and financial system. 

This is particularly true for financing affordable multifamily housing, which is a 

primary source of rental housing in this country. In the aftermath of the housing 

crisis, policy makers have generally sought to reduce the emphasis on home ownership and shrink the Federal Government’s role in housing finance, which is reflected 

in Corker-Warner. But achieving these objectives will naturally mean that affordable rental housing will be much more important, both from a social and economic 

perspective. Thus, one of the most important elements of the transition will be ensuring that we maintain sufficient liquidity for rental housing, such as multifamily 

housing. 

The guiding principle for legislators and regulators who are structuring our housing finance transition must first and foremost be, ‘‘Do no harm.’’ Avoiding the disruption of mortgage liquidity, either systemwide or in individual market segments, 

should be a paramount concern during this period. A failure to adhere to this principle would be catastrophic for the housing markets and the broader economy. 

Assessing the Corker-Warner Transition Plan 

The Corker-Warner bill contemplates a transition period of no more than 5 years 

following its enactment, during which time Fannie and Freddie would be phased out 

and the infrastructure for the new system, including the Federal Mortgage Insurance Corporation (FMIC) at the heart of this framework, is established. 5 Upon enactment, Corker-Warner would eliminate the affordable housing goals currently in 

place for Fannie and Freddie, 6 and begin to gradually reduce the high cost area 

loan limits, which currently stand at 150 percent of the conforming loan limit (now 

set at $417,000) to 115 percent of the conforming loan limit within 5 years. 7 The 

mortgage assets held in Fannie and Freddie’s investment portfolios would be reduced by 15 percent each year until the FMIC is certified as being operational; at 

the end of that year, their remaining assets would be used to wind down the enterprises and help cover the costs of any remaining legacy guarantees. 8

Upon FMIC certification, an event which must occur within 5 years of enactment, 

the charters for Fannie and Freddie are repealed and these firms barred from conducting any new business. 9 At this time, outstanding ‘‘legacy’’ debt obligations 

(bonds and mortgage-backed securities) issued by the GSEs would be explicitly guaranteed with the full faith and credit of the United States. 10

At a high level, Corker-Warner provides a thoughtful template for long-term mortgage finance reform. But transitioning to the new system that Corker-Warner creates will be a long and difficult process. The Corker-Warner bill provides some 

broad guidance and mandates on the question of transition, but many issues remain 

unresolved and need to be addressed before we move on. I discuss some of these 

below. 

Developing a Common Securitization Architecture 

Central to the Corker-Warner framework is the development of a new infrastructure for issuing securities with a common Government guarantee. Currently, Fannie 

and Freddie each have their own securitization architectures, but creating a common securitization platform (CSP) is a prerequisite to opening the new system up 

to a multitude of issuers. 11 Creating the CSP is also important for creating a single 

security, which many see as a precondition for a successful transition towards the 

61 

12See, American Securitization Forum, ‘‘Discussion of a Proposed Single Agency Security’’ 1- 

2, ASF White Paper Series, July 2, 2012. 13 Id. at 3. 14See, generally, James Vickery and Joshua Wright, ‘‘TBA Trading and Liquidity in the Agency MBS Market’’, Federal Reserve Bank of NY Economic Policy Review, May 2013. 15See, e.g., id.; Mortgage Bankers Association, ‘‘Ensuring Liquidity Through a Common, Fungible GSE Security’’, in Key Steps on the Road to GSE Reform, Sept. 11, 2013; American 

Securitization Forum, ‘‘Discussion of a Proposed Single Agency Security’’, supra n. 12; Richard 

Johns, Executive Director, ‘‘Structured Finance Industry Group, Essential Elements of Housing 

Finance Reform’’, Testimony Before the U.S. Senate Committee on Banking, Housing, and 

Urban Affairs (Sept. 12, 2013). 16See, ‘‘Bank of America Merrill Lynch Completes Transaction Data Repository’’, Press Release, Sept. 16, 2013, available at http://newsroom.bankofamerica.com/press-releases/commercial-and-middle-market-banking/bank-america-merrill-lynch-completes-transaction. 17See, Federal Housing Finance Agency, ‘‘A Progress Report on the Common Securitization 

Infrastructure’’ (Apr. 30, 2013), available at http://www.fhfa.gov/webfiles/25144/ 

WhitePaperProgressReport43013.pdf. The idea for creating a common securitization platform 

was first announced in February 2012 by FHFA, which followed up with a detailed proposal 

that was released to the public in October 2012. 18See, Federal Housing Finance Agency, ‘‘FHFA Announces Significant Steps in Organization 

of Joint Venture To Establish Common Securitization Platform’’, News Release (Oct. 7, 2013). 

new system, because of the differences in liquidity and pricing that are likely to develop in a system that has more than two issuers. 

Even in the current environment, with two virtually identical issuers enjoying the 

same Government guarantee, investors clearly prefer Fannie obligations over 

Freddie obligations, and as a result, Fannies trade in deeper and more liquid markets and enjoy better pricing. 12 As of June 2012, the spread between 30-year 4.5- 

percent Fannie MBS and Freddie MBS was about 48 cents. 13 These spreads are certain to widen with the entry of additional issuers, unless a common security is created. Thus, moving towards a single security seems to be an important part of any 

transition towards the new system. A single security should also improve liquidity 

in the important ‘‘To Be Announced’’ (TBA) market, the forward market that is responsible for more than 90 percent of the trading volume in agency MBS (and which 

allows borrowers to ‘‘lock in’’ their rates). 14

In theory, establishing a CSP and single security should not be overly difficult. 

After all, Ginnie Mae securities have a large number of issuers and a shared Government guarantee, and they effectively trade as a single security. Several white papers have been written describing best practices in creating a single security, and 

they generally share the same recommendations. 15 We need a common platform, 

such as the CSP, and standardization of terms and contracts, including loan delivery and pooling requirements, remittance requirements, underwriting guidelines, 

servicing standards, and disclosure policies. 

But in reality, moving towards a common platform and single security may be 

quite difficult. The technical challenges alone are likely to be very challenging. 

Fannie and Freddie each created and perfected their securitization infrastructures 

over many years. Integrating these systems together into an open securitization 

platform that can be utilized by any approved issuer will be a painstaking task. But 

as recent history teaches us, developing a complex technology infrastructure can be 

much more difficult than originally anticipated. It took Wells Fargo 3 years to integrate its data systems with those of Wachovia, following its acquisition of the Charlotte-based bank holding company. Bank of America did not finish integrating its 

data systems with those of Merrill Lynch until September of this year, nearly 5 

years after Merrill was acquired. 16

Indeed, it is worth noting that the Federal Housing Finance Agency’s progress towards creating the CSP is proceeding exceedingly slowly. At this point, more than 

18 months after the common securitization platform was first publicly announced 

by the FHFA, 17 the only public announced progress towards creating this CSP has 

been the filing of a certificate of formation for a limited liability company and the 

signing of a lease for office space. 18 The slow pace of CSP development does not 

bode well for the relatively aggressive time line envisioned by Corker-Warner, which 

calls for the FMIC to be certified as operational within 5 years. 

Achieving Liquidity for the New MBS 

Another important transition issue that must be considered is how to best scale 

up liquidity for the new securities guaranteed by the FMIC in the Corker-Warner 

framework. Corker-Warner essentially envisions an on/off progression, in which the 

GSEs are shut down at the same time that the FMIC opens for business. Once the 

FMIC is certified as operational, the GSEs lose their charters and are barred from 

conducting any new business. The concern with this approach, of course, is that 

62 

19 Jim Millstein, Chairman and Chief Executive Officer, Millstein and Co., ‘‘A Blueprint for 

Finance Reform in America’’, Remarks before the Woodrow Wilson International Center for 

Scholars, May 22, 2012. 20 Adam J. Levitin, Professor of Law, Georgetown University Law Center, ‘‘Housing Finance 

Reform: Fundamentals of a Functioning Private-Label Mortgage Backed Securities Market’’, 

Testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs (Oct. 1, 

2013). 21See, Ethan Handelman, Vice President for Policy and Advocacy, National Housing Conference, ‘‘Housing Finance Reform: Essential Elements To Provide Affordable Options for Housing’’, Testimony Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs 

(Nov. 7, 2013). As Mr. Handelman outlines, one key reason why the GSEs play such a dominant 

role in affordable multifamily is that, unlike purely private sources of mortgage capital (such 

as insurance funds or pension funds), they offer long-term products, which are critical for many 

of the specific needs of developing and maintaining affordable multifamily deals. 

when this handoff occurs, there is a lack of demand for the new securities, due to 

any number of factors (such as a reluctance by investors to be early adopters). If 

that were to occur, the sudden drop in liquidity could be quite problematic for the 

housing markets. 

Responsibly Reducing High Cost Area Loan Limits 

Corker-Warner calls for scaling back the size of the Federal Government’s footprint, with so-called ‘‘high cost’’ loan limits being, at least in the transition phase, 

the primary focus of this reduction. But it is not clear how much private nonguaranteed liquidity is currently available to fill the vacuum that will be created. Some 

have suggested that depository institutions should play a greater role in financing 

home loans, reprising the role they once played in originating and holding mortgages to term (as opposed to simply originating mortgages with the intent to sell 

these to secondary market actors, which has increasingly displaced originate-to-hold 

lending). But the fact is that bank deposits are simply not a large enough source 

of funding at this time to replace much of the activity that Fannie and Freddie currently do. As Figure 1 illustrates, the total amount of U.S. bank deposits is barely 

sufficient to meet U.S. housing finance needs. Moreover, as my fellow witness Jim 

Millstein has noted, we have been experiencing a net decline in real estate loans 

held by commercial banks, suggesting that traditional bank balance sheets are an 

unlikely source of increased housing finance in the near future. 19

Similarly, it is improbable that private-label securitization, which accounted for 

so much volume during the housing boom years of 2002–07, will be able to replace 

much of the vacuum left by a reduced Government footprint in the near future. 

Since 2008, private-label securitization of mortgages has essentially been nonexistent. Figure 2 lists the underwriting characteristics for all of the private-label 

mortgage securitization deals that have taken place since the 2008 financial crisis. 

The credit characteristics are extremely high, and the volume is still very low. As 

Georgetown Law professor Adam Levitin has described, the PLS market is currently 

a ‘‘market for lemons’’ and is likely to stay that way for some time, until investors 

regain confidence in the integrity of the highly informationally asymmetric PLS 

process. 20 At the same time, the implementation of the ‘‘Qualified Mortgage’’ (QM) 

standard, which provides safe harbor for mortgage originators, and the ‘‘Qualified 

Residential Mortgage’’ (QRM) standard, which provides an exemption from the risk 

retention requirements of Dodd-Frank, are likely to have some impact on the availability of private, nonguaranteed mortgage finance, but it is too early to tell what 

this impact might be. 

In the near term, aggressively lowering loan limits may lead to a gap in the availability of mortgages in high-cost areas, which could adversely affect the housing 

markets in those regions. 

Ensuring the Continued Flow of Mortgage Finance for Underserved Market Segments 

Historically, the GSEs have played an important role in providing mortgage credit 

to underserved market segments, such as rural housing and housing for lower-income households. They have played a particularly important role in providing financing for affordable multifamily rental housing, with roughly two-thirds of the 

multifamily units they finance being affordable to households earning less than 80 

percent of area median income. 21 GSE financing for affordable multifamily rental 

housing has come from both their guarantee activities and purchases for their investment portfolios, and has been motivated at least in part by their affordable 

housing goals. The GSEs’ footprint in multifamily housing finance has generally 

been much more variable than their single family market share, shrinking down to 

about 25 percent of the market when market conditions are good and increasing to 

63 

22See, Shekar Narasimhan, Managing Partner, Beekman Advisors, Inc., ‘‘Housing Finance 

Reform: Essential Elements of the Multifamily Housing Finance System’’, Testimony before the 

U.S. Senate Committee on Banking, Housing, and Urban Affairs (Oct. 9, 2013). 23This includes the National Housing Trust Fund and Capital Magnet Fund that were established but not implemented under the Housing and Economic Recovery Act of 2008, as well as 

other funds meant to provide targeted credit support meant to facilitate securitization of niche 

products. See, Corker-Warner, §§401-403; Ellen Seidman, Phillip Swagel, Sarah Wartell, and 

Mark Zandi, ‘‘A Pragmatic Plan for Housing Finance Reform’’, June 19, 2013, available at 

http://www.urban.org/uploadedpdf/412845-Housing-Finance-Reform.pdf. 24Mark Zandi, Chief Economist and Cofounder, Moody’s Analytics, ‘‘Essential Elements of 

Housing Finance Reform’’, Testimony before the U.S. Senate Committee on Banking, Housing, 

and Urban Affairs (Sept. 12, 2013). 25 Corker-Warner §601. 26Mark Zandi and Cristian deRitis, ‘‘Evaluating Corker-Warner’’, Moody’s Analytics Report 

(Sept. 2013). 27Mark Zandi and Cristian deRitis, ‘‘The Road to Reform’’ 5-7, Moody’s Analytics Report 

(Sept. 2013). 28While it is generally thought that equity investors prefer higher leverage, so as to maximize 

their potential returns, there is some evidence that lower leverage (such as created by higher 

capital requirements) leads to higher returns over time. See, generally, Malcolm Baker and Jeffrey Wergler, ‘‘Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation and 

the Low Risk Anomaly’’, NBER Working Paper No. 19018 (2013). 29 Corker-Warner §202. 

fill the vacuum when market conditions deteriorate (70 percent at the height of the 

crisis). 22

Corker-Warner calls for an aggressive reduction in the GSE portfolios over a period of 5 years, and for the elimination of the affordable housing goals. Replacing 

these mechanisms would be a separate set of entities that have been collectively described as the ‘‘Market Access Fund,’’ which would be funded by a small levy, between 5 to 10 basis points of outstanding mortgage guarantees. 23 The Market Access Fund would, as my fellow witness Mark Zandi has described, attempt to provide both direct subsidies and explicit credit enhancement to foster greater access 

to securitization in underserved market segments, particularly in affordable multifamily housing. 24 The existing multifamily guarantee business would be transferred 

to the FMIC, as Corker-Warner currently stands, 25 although as Dr. Zandi has 

noted, this is likely a placeholder, as it is difficult to imagine a regulator running 

a business. 26

One concern with the proposed transition is that it may wind down key aspects 

of the current system that have provided financing for these underserved segments—the investment portfolios and the affordable housing goals—without having 

fully established the Market Access Fund. Given economic and demographic trends, 

we have already seen a sharp increase in the demand for affordable rental housing. 

As policy makers seek to deemphasize home ownership and reduce the Federal Government’s footprint in single-family housing finance, we should expect to see this 

demand increase. Thus, it is imperative that we avoid leaving vacuums in the availability of mortgage credit, which would be devastating for renters, rural homeowners, lower income families, and many others who are vulnerable and struggling 

to make ends meet during a period of economic stagnation. 

Attracting Sufficient and Appropriately Priced Capital Into the New System 

Another important concern is bringing in sufficient capital to fund the new private MBS issuers that are central to the hybrid system envisioned by Corker-Warner. While some have raised concerns about the availability of private capital willing to serve as equity in this new system, 27 I am optimistic that there is a large 

pool of capital to draw upon, and I think that last week’s proposal from Fairholme 

Capital Management gives us some evidence of that. The question, of course, is on 

what terms this capital is available. 

The core economics of this business are strong, as Figure 3 indicates. Since their 

conservatorship, the GSEs have been steadily improving their performance, as the 

impaired loans guaranteed during the 2003 to 2007 period are written off and the 

new books of business from 2008 and onward grow to become a larger proportion 

of their balance sheets. That being said, there are a number of variables that will 

affect how much capital is available and on what terms. These include capital requirements, 28 expected market size and share (which is affected by, among other 

things, loan limits and barriers to entry), and the pricing of the Government guarantee. 

Corker-Warner requires that private capital representing no less than 10 percent 

of the guaranteed MBS be placed in a first loss position, 29 although as former 

Treasury official Phillip Swagel has noted, Corker-Warner contemplates that this 

64 

30Phillip Swagel, ‘‘Housing Finance Reform: Essential Elements of a Government Guarantee 

for Mortgage-Backed Securities’’, Testimony before the U.S. Senate Committee on Banking, 

Housing, and Urban Affairs (Oct. 31, 2013). 31Laurie S. Goodman and Jun Zhu, ‘‘The GSE Reform Debate: How Much Capital Is 

Enough?’’, Urban Institute, Oct. 24, 2013. 32There are two other layers of protection against taxpayer loss that Corker-Warner increases. Private mortgage insurance currently covers a little less than 15 percent of mortgages 

securitized by the GSEs and takes a first loss position between 6 percent and 35 percent. See, 

Fannie Mae 2013 Third Quarter Credit Supplement; Freddie Mac October 2013 Investor Presentation. Under Corker-Warner, PMI is left in place, covering loans with an LTV over 80, but its 

coverage amounts are increased. Corker-Warner §2. Homeowner equity is also likely to be increased, by virtue of the 5-percent downpayment requirement created in Corker-Warner. CorkerWarner §2. Fannie Mae’s current average loan-to-value ratio on all single-family loans they have 

guaranteed is 67.1 percent. See, Fannie Mae 2013 Third Quarter Credit Supplement. Freddie 

Mac’s average loan-to-value ratio on its single-family conventional guaranty book of business is 

73 percent. See, Freddie Mac October 2013 Investor Presentation. 33See, Office of Federal Housing Enterprise Oversight, ‘‘Mortgage Market Note: Fannie Mae 

and Freddie Mac Capital’’, July 17, 2008. Fannie and Freddie were also subject to risk-based 

capital requirements, based on a 10-year stress test model. Id. The two enterprises were actually 

subject to surplus capital requirements due to alleged accounting improprieties and other issues, 

from 2004 until the time of their conservatorship. See, Federal Housing Finance Agency, ‘‘Capital Prior to Conservatorship’’, available at http://www.fhfa.gov/Default.aspx?Page=146. Following their conservatorship, FHFA has suspended capital classifications and announcements. 

See, Federal Housing Finance Agency, ‘‘Capital Under Conservatorship’’, available at http:// 

www.fhfa.gov/Default.aspx?Page=78. 34See, David Min, ‘‘How Government Guarantees in Housing Finance Promote Stability’’, 

supra n. 2. 

private capital may be tranched, which would lower its costs. 30 Some have argued 

that this capital level is too high, and will thus lead to both a dearth of private capital and a sharp increase in mortgage rates. For example, Laurie Goodman and Jun 

Zhu conduct an empirical analysis and conclude that 4–5 percent capital would have 

covered all of the GSEs’ losses coming out of the 2007–08 mortgage crisis. 31 Taking 

into account the proposed Mortgage Insurance Fund, which is required to reach a 

reserve level of 2.5 percent of outstanding principal balance within 10 years (1.25 

percent within 5 years), Corker-Warner effectively contemplates a 12.5-percent buffer against taxpayer loss, 32 on top of any improvements to mortgage loss rates that 

may accrue as a result of QM and QRM. This compares to the current system, in 

which Fannie and Freddie had minimum capital requirements of 2.5 percent of assets plus 0.45 percent of adjusted off-balance sheet obligations (including guaranteed mortgage-backed securities). 33

Maintaining Sources of Countercyclical Liquidity 

A longer-term transition goal should be to preserve sources of countercyclical liquidity. The unfortunate fact about private bank capital is that it is highly 

procyclical, chasing profits during credit booms and becoming overly risk averse during credit contractions. As a result, the Government is typically the only game in 

town when it comes to countercyclical liquidity. We need only look to our current 

mortgage markets to see this phenomenon on display. Since the credit contraction 

began in 2007, Agency securitization has been responsible for virtually all housing 

finance, accounting for over 90 percent of residential mortgage originations. Without 

this countercyclical liquidity, it is certain that the housing bust would have been 

far worse, with extremely negative effects on the broader economy. Before this most 

recent housing crisis, the last great housing crisis we had occurred in the 1930s, 

when we did not have in place any sources of countercyclical liquidity. The result 

was a 50 percent national delinquency rate and a 10-percent foreclosure rate. 34

Of course, in winding down Fannie and Freddie, Corker-Warner eliminates the 

two largest sources of countercyclical mortgage liquidity. Corker-Warner recognizes 

the need for such a function, however, and thus, in the presence of ‘‘unusual and 

exigent’’ circumstances, allows for the issuance of securities that do not have 10-percent private capital in a first loss position. In the event that we have another mortgage crisis, this exigency clause may not be sufficient to meet the liquidity needs 

of the market. Based on observations of the current experience, in which Fannie and 

Freddie have been responsible for roughly two-thirds of all mortgage originations, 

it may be the case that greater emergency powers are appropriate. 

Recommendations for Transition 

Given the issues with the transition contemplated by Corker-Warner, what should 

we do next? I lay out some recommendations below. 

65 

35 Compelling investors to convert their securities could raise contractual and other issues, 

and thus is likely to raise more problems than it solves. However, if there were cost-effective 

ways to encourage these investors to convert, those might be worth considering as well. 

Delegate More Responsibility to Regulators and Remove Arbitrary Timetables 

In a number of different ways, Corker-Warner looks to micromanage the transition process. The GSEs are given specific time lines for lowering their loan limits 

and winding down their portfolios, and the FMIC is provided with very specific capital requirements as well as a specific schedule for implementing the CSP and ending the activities of the GSEs. But as the above analysis demonstrates, these are 

highly technical issues that would benefit greatly from dedicated expertise and data. 

Is 10 percent the right level of capital? Will winding down the GSE portfolios by 

15 percent a year have an adverse effect on the housing markets (particularly underserved and vulnerable areas)? Will private sources of mortgage finance come into 

the market if the GSEs lower their loan limits each year? What if we shut down 

the GSEs, the CSP opens for business and liquidity is lacking? All of these are questions that are best answered by regulators making decisions based on data analysis, 

rather than by legislation making choices based on assumptions that may or may 

not turn out to be correct. 

Regulators should be given greater discretion and encouraged to respond to developments on the ground, with broad principles guiding their actions rather than detailed and specific rules. Timetables should not be dictated ex ante, but rather 

should be developed in response to data-driven analysis. It may be useful to compare the roles of the FHFA and FMIC with those of Federal banking regulators, 

who enjoy very broad discretion and expansive powers to promulgate and enforce 

regulations based on their regulatory goals. Given the complexity of the transition 

we are anticipating, giving regulators more flexibility in their actions and timetable 

would seem a prudent and more effective course of action. 

Thus, I believe that Corker-Warner should not attempt to create specific capital 

requirements, or create specific timetables, but should instead substitute high level 

regulatory targets and mandates, while leaving the specifics to the regulators. 

Greater flexibility and delegation to regulators are preferable for managing a transition of this scale and scope. 

Phase in the Transition in Parts, Not All at Once 

The current transition plan contemplated by Corker-Warner effectively calls for 

flipping on a switch (certification of the FMIC), at which point the GSEs will turn 

off and the FMIC and CSP will turn on. But as recent events may highlight, unanticipated problems may arise, particularly with any transition as complex as moving 

a trillion dollars in mortgage origination financing over from one platform to another. Flipping the switch may lead us to discover that the lights are not working, 

or only working in parts of the building. 

Rather, I believe a preferable approach would be to adopt a piecemeal approach 

to transition, turning over small (but increasingly greater) parts of the mortgage 

markets to the new infrastructure. For example, rather than preparing the CSP architecture to handle the mortgages financed by GSE securitization all at once, we 

could first start with a dedicated subset of mortgages, such as 15-year fixed-rate 

mortgages, or ‘‘high cost’’ conforming mortgages. Such an approach would have a 

myriad of benefits. First, it would allow regulators to test the new system in a 

meaningful way, and develop data that can help them perfect the new infrastructure. Second, it would help build investor liquidity in the new MBS being produced. 

Instead of requiring investors to all become early adopters, a piecemeal approach 

to transition would build volume over time in specific product segments. Third, to 

the extent that there were problems with liquidity in the transition, such an approach would leave in place the GSEs to pick up any slack that might be needed. 

Under this approach, transition could proceed based on meeting specified liquidity 

benchmarks, and not on a preordained timeframe. Such an approach might actually 

proceed more quickly than the transition called for by Corker-Warner, since this 

would allow for earlier partial certifications of FMIC, rather than the all-or-nothing 

approach currently specified in the legislation. This would also wind down the GSEs 

in an orderly fashion by removing increasingly larger parts of their business and 

transferring them to the new system. 

Convert Legacy Securities Into New FMIC-Backed MBS 

One way to build liquidity in the new system is to offer all holders of legacy securities the option of converting their securities into the new, explicitly guaranteed 

MBS created under the new housing finance regime. 35 Assuming transition was 

66 

36See, generally, Vickery and Wright, ‘‘TBA Trading and Liquidity in the Agency MBS Market’’, supra n. 14. 37 Raphael Bostic, Shekar Narasimhan, and Mark Willis, ‘‘Multifamily Finance Reform’’, June 

24, 2013, available at http://www.beekmanadvisors.com/presentations/ 

Multifamily%20Finance%20ReformlMoving%20to%20a%20Solution-2013-06-24- 

DRAFT%20FOR%20DISCUSSION.pdf. 

phased in as described in the previous section, each class of securities could be converted at the time that an equivalent product was offered by the FMIC. This approach would build immediate volume into the new architecture, which would improve liquidity and lower prices. 

Preapprove the New MBS for Use in TBA Market and as Collateral 

Another relatively simple step that could improve liquidity for the new security 

is to ensure, ahead of time, that it will be accepted for delivery into the TBA market. As I discussed previously, the TBA market is an enormous futures market that 

is responsible for over 90 percent of the trading in Agency MBS, and thus is a critical source of liquidity. On their face, these new securities should have no problem 

fitting into the TBA market, as they are Government-backed (an important de facto 

requirement for TBA trading) and seem to possess all of the other predicate characteristics. 36 As part of the transition process, regulators should open up discussions 

with the Securities Industry and Financial Markets Association (SIFMA), which sets 

standards for the TBA market, and take any steps necessary to ensure that the new 

MBS are accepted for TBA trading. 

Similarly, regulators should seek to preapprove the new MBS as collateral in the 

various markets and transactions in which Agency MBS is accepted as collateral, 

such as the Fed’s discount window lending, the OTC derivatives market (standards 

set by the International Swaps and Derivatives Association), and repo markets 

(standards set by SIFMA). Given that the new MBS carry an explicit Government 

guarantee (typically the most important requirement), this should not be a difficult 

task, but simply setting expectations ahead of time may have a large beneficial impact on liquidity. 

Give a Running Start to Institutions Focused on Underserved Markets 

As I described earlier, the transition process may have particular issues in maintaining liquidity in underserved market segments. As the GSEs are unwound, it 

may be the case that the new infrastructure is not yet set up well enough to fill 

the void. To help alleviate this problem, it makes sense to give a head start to the 

new institutions tasked with serving these markets. 

Thus, it may make sense to start funding the Market Access Fund immediately, 

taking these funds out of the G-fee that is currently being levied by the GSEs. Since 

2008, Fannie and Freddie have financed roughly $2.5 trillion in new mortgage originations, and they are charging 50 basis points on these. Taking even a small 

amount out of this could go a long way in getting the MAF up and running, so that 

it is able to take on a greater share of the underserved market once transition is 

underway. 

Similarly, it would be useful to immediately fund and activate MBS guarantors 

with a specific focus on affordable housing finance, with an eye towards immediately 

becoming part of the new Corker-Warner architecture. Some of you may be familiar 

with the plan put forth by Raphael Bostic, Shekar Narasimhan, and Mark Willis, 

which proposes the immediate spin-off of the multifamily securitization assets and 

business of Fannie and Freddie into a new joint subsidiary. 37 This new multifamily 

entity would, for a fee, piggyback off of the guarantees of Fannie and Freddie, until 

such time as the GSEs were eliminated and the FMIC was operational. At that 

point, the new multifamily entity would convert into an issuer in the new CorkerWarner system. 

Whether or not the Bostic/Narasimhan/Willis plan is adopted, it provides an interesting template for thinking about how to serve affordable housing finance needs. 

As this plan illustrates, it is critical to get things up and running immediately, to 

give these entities a running start and thus help to ensure that liquidity in these 

underserved markets will not be lacking when transition occurs. 

Providing Expanded Emergency Powers to FMIC To Deal With Housing Crises 

Finally, we should think about the importance of tools that can allow our housing 

finance system to respond to emergency situations. In addition to the current provisions articulated in Corker-Warner, which allow for FMIC to guarantee MBS that 

don’t meet the 10-percent private capital requirement, other powers should be provided, which allow FMIC to effectively provide countercyclical liquidity in the event 

of another crisis, like the one we are currently emerging from. At a bare minimum, 

67 

this should include the ability to raise loan limits and lower its insurance fees. Policy makers may want to consider the feasibility of emergency powers that would 

allow for expanded eligibility for FMIC guarantees, or the ability to (temporarily) 

directly invest in mortgage assets. 

Conclusion 

The topic of transitioning into the new housing finance system of the future is 

a critically important but highly complex one. The Corker-Warner transition plan 

provides us with a good starting point to start thinking about some of these difficult 

issues, and I appreciate the opportunity to discuss this topic with you today. Thank 

you again for holding this hearing, and for the opportunity to testify. I look forward 

to your questions. 

68 


11221315.eps
69 


11221316.eps
70 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM JAMES MILLSTEIN 

Q.1. Should a new system be designed to issue a single security regardless of how many guarantors or issuers there may be? If so, 

how should the issuance of a single security be structured during 

transition? How should the issuance of new guaranteed MBS be introduced while ensuring that legacy GSE securities do not become 

orphaned? 

A.1. Yes, the new system should provide for a single conforming 

To-Be-Announced (TBA) eligible pass-through single-family mortgage-backed security (MBS) reinsured by the Federal Government 

through the Federal Mortgage Insurance Corporation (FMIC), regardless of the number of guarantors or issuers. Such a ‘‘single security’’ is necessary to avoid liquidity advantages any one issuer or 

guarantor could obtain, which would likely, over time, pose an insurmountable barrier to entry to competitors for the majority of investor demand for conforming MBS. 

The first step toward a single security during transition could be 

to issue a common GSE MBS. The Federal Housing Finance Agency (FHFA) could work with the Securities Industry and Financial 

Markets Association to amend the good-delivery guidelines to provide that such a security would be TBA eligible. The Securities and 

Exchange Commission may need to grant an additional exemption 

from Regulation AB to ensure that is the case. The enterprises 

would also need to standardize requirements and processes to be 

able to issue a common GSE security. We believe that all of this 

could be accomplished within 2 years if the enterprises are given 

a clear directive. 

Note that depending on the rate at which the FMIC is stood up, 

the enterprises could, during conservatorship, instead seek to issue 

a single FMIC MBS. Elements of a Common Securitization Platform (CSP) could be used for such issuance, but it would not be 

necessary to wait for such a platform to be developed. In the interim, Fannie Mae and Freddie Mac could alter their requirements 

and processes to do it, similar to issuers participating in the Ginnie 

Mae II program, which provides for a common security. 

To avoid orphaning the market for legacy GSE securities, creating liquidity premia for new issuance, and turning away current 

investors, the FMIC could reinsure legacy GSE securities in exchange for a fee to appropriately compensate it for the risk of doing 

so. Alternatives, such as an exchange of old securities for new securities, carry significantly higher execution risk and would be difficult if not impossible to coordinate given the widespread investor 

base. 

Although the single security would account for most of the new 

conforming market, the FMIC should also work with participants 

in the new conforming market to facilitate issuance of alternative 

securities to satisfy different investment demands. For example, 

the Government-sponsored enterprises (GSEs) accounted for over 

$200 billion of issuance of collateralized mortgage obligations 

(CMOs) in 2012. That represented approximately 20 percent of 

total agency issuance and a significant portion of funding for U.S. 

residential mortgages. The FMIC should attempt to retain this volume of demand by allowing multiple structured forms of conVerDate Nov 24 2008 10:27 Oct 20, 2014 Jkt 046629 PO 00000 Frm 00074 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\11-22 ZDISTILLER\112213.TXT JASON
71 

forming MBS to issue. And the FMIC could prevent the liquidity 

barriers among issuers of alternative forms of conforming MBS by 

employing multiple issuer pools, similar to the Ginnie Mae II securities backed by fixed-rate and adjustable-rate mortgages. 

Q.2. Please discuss whether or not licensing of Fannie Mae and 

Freddie Mac’s assets can be an important tool in managing their 

wind down in a manner that maximizes value and minimizes disruption to the housing finance market. Are there other authorities 

that could be helpful to a regulator in managing their wind down? 

A.2. Developing an issuance infrastructure to compete with Fannie 

Mae and Freddie Mac is another barrier to entry for private competitors. Building such an infrastructure from scratch will require 

substantial time and expense for any new entrant. While a Common Securitization Platform might eventually provide new entrants with a utility for securitization and bond administration 

functions, and while the FMIC might also promulgate national 

standards for origination and servicing, the build-out of a network 

of mortgage originators and the systems for sourcing and screening 

their loans to be underwritten or qualified to be included in a guaranteed pool of loans for eventual securitization in a FMIC reinsured mortgage-backed security are critical functions in the MBS 

issuance chain that are not, to my knowledge, currently contemplated to be included in the CSP. 

To allow bond guarantors to compete on equal footing with the 

GSEs in the interim, Fannie Mae and Freddie Mac could be directed to license or offer necessary elements of their issuance infrastructure for a fee that would reflect run-rate operating expenses 

for a private competitor. In a sense, these elements of GSE infrastructure would serve as a market utility. And they could do so before the CSP is launched. As more issuance functions are performed by the CSP and private competitors develop their own networks and systems, they would rely less on the legacy GSEs. 

During the transition to the new system while the old GSE 

model is wound down, there are indeed additional authorities that 

would help a regulator to maximize value and minimize disruption 

to the housing finance market. Most importantly, the mortgage 

guarantee businesses of Fannie Mae and Freddie Mac need to be 

recapitalized and ultimately privatized to ensure that there is adequate private capital to support desired levels of conforming 

issuance through the transition and in the end state, and to protect 

taxpayers against loss on the legacy book of GSE MBS before that 

book is reinsured by the FMIC (as described above in Answer 1). 

The FHFA, in conjunction with the FMIC and Treasury, need the 

authority and directive to accomplish this, which would have the 

added benefit of maximizing the value of the legacy GSE estates 

for their largest owner: taxpayers. A regulator needs discretion to 

increase fees charged by the GSEs to guarantee MBS depending on 

the risk of providing that guarantee, market conditions, the relative costs of private competitors, and the need to recapitalize the 

mortgage guarantee businesses of Fannie Mae and Freddie Mac. A 

regulator also needs discretion to change conforming loan limits depending on market conditions. Further, a regulator should have the 

authority to supervise and establish requirements for participants 

72 

in the conforming MBS chain, including capital requirements for 

entities assuming credit risk or providing credit enhancement on 

individual mortgages or pools, and fees and processes for servicing 

those mortgages. Finally, a regulator should have the authority to 

direct the legacy GSEs to experiment with risk-sharing structures, 

infrastructure leasing and other avenues to facilitate private competition in conforming mortgage credit. 

Q.3. Should a common securitization platform be fully operational 

before the old system is shut down? Are there other goals that 

should be achieved before the old system is shut down to help 

make the transition as effective and smooth as possible? 

A.3. It is not necessary to wait to launch the new system until a 

CSP is fully operational. As I explain in my responses to the first 

and second questions, while a CSP is being established, the legacy 

GSEs could facilitate the issuance of a single security and could be 

directed to license issuance infrastructure to private competitors. 

Both steps could accelerate the entry of new guarantors into the 

market and thereby allow the FMIC to offer secondary-loss insurance on conforming MBS relatively quickly. 

Moreover, it is unclear what it would mean for the CSP to be 

fully operational. To my knowledge, plans for the CSP are still 

being developed, and the most likely first phase would provide for 

a portion of the securitization and bond administration functions 

currently performed by the GSEs to be performed by the CSP. That 

first phase will take several years. And beyond that initial phase, 

I am skeptical that a CSP will ever perform all of the additional 

elements in the issuance chain, as I explain in my response to the 

second question. To my knowledge, no one is contemplating that 

the CSP would purchase loans for cash from originators and warehouse them on its balance sheet until they can be securitized. 

There are important goals that should be achieved before the legacy GSE model is shut down. The mortgage guarantee businesses 

of Fannie Mae and Freddie Mac should be recapitalized and ultimately privatized to ensure that there is adequate private capital 

to support desired levels of conforming issuance through the transition and in the end state, and to provide an adequate capital cushion in front of the FMIC’s reinsurance so as to protect taxpayers 

against loss on that reinsurance. A single conforming TBA-eligible 

pass-through single-family mortgage-backed security should be established. The FMIC should be established and its Mortgage Insurance Fund should be capitalized from fees paid by the GSEs for the 

reinsurance of their legacy MBS. The new regulator should also 

have the resources necessary to supervise participants in the conforming MBS chain in order to prevent market disruption and to 

protect taxpayers against potential losses on the FMIC’s insurance. 

Standards for originating and servicing conforming mortgages 

should be established. 

However, the FMIC should not establish standards for 

securitized conforming mortgages in a vacuum. It should work 

closely with borrower, lender, servicer, and investor groups to develop standards that are not only theoretically sound but also 

workable and sensible in practice. To that end, the newly formed 

CSP is attempting to establish an industry advisory group that 

73 

would be similar to the Treasury Borrowing Advisory Committee. 

Such a group would increase the likelihood that the CSP can be 

useful across the mortgage market. The FMIC should establish 

similar advisory committees to facilitate meaningful vehicles for 

private-sector input for the new system before the legacy GSE 

model is shut down. 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM JOHN BOVENZI 

Q.1. In an earlier Housing Finance Reform hearing the Committee 

held on regulatory issues, witnesses called for the new housing finance regulator to have more supervisory and enforcement authorities than simply approval and denial of participation. Do you agree 

that is something we should consider adding? If so, why is it important to equip a regulator with explicit supervisory and enforcement 

authorities? 

A.1. Based on my experience at the FDIC, I believe it is worth considering whether the FMIC should be granted broader supervisory 

and enforcement authorities beyond controlling entry and exit into 

and out of the program and the ability to issue civil money penalties. Those three authorities are important, but in most instances 

appropriate behavior can be maintained by less extreme enforcement measures than by forcing an institution’s exit from the program. The FDIC has found its authority to issue informal memoranda of understanding and formal cease-and-desist orders to be 

quite effective in that regard. Moreover, the FDIC has rarely used 

its power to revoke deposit insurance coverage, finding it to be a 

cumbersome process compared to these other enforcement alternatives. 

The FDIC also has examination authority to ensure banks are in 

compliance with FDIC supervisory standards and to determine 

whether enforcement actions are necessary. Consideration also 

should be given to giving the FMIC examination authority. While 

off-site monitoring can be used to help monitor an institution’s behavior, over time the FDIC has found there is no substitute for the 

direct interaction with bank management that occurs during the 

examination process. 

Finally, to help ensure that supervisory actions are taken in a 

timely manner, the FDIC is subject to Prompt Corrective Action requirements, which mandate that certain supervisory actions be 

taken as bank capital levels drop below prescribed levels. In their 

entirety these powers are an important part of safeguarding the financial system and protecting the FDIC’s deposit insurance fund. 

Q.2. What should we consider when it comes to employee retention 

and related issues in the transition? 

A.2. Based on my experience at the FDIC and RTC I believe it is 

critical to provide open and clear communication to employees as 

to their job status. As a limited life agency, the RTC’s employees 

knew that by doing their jobs correctly they might be putting themselves out of a job. The same applied to the FDIC’s employees who 

were responsible for handling the spike in bank closings. Eventually the economy would recover and their workload would vanish. 

74 

But they were the ones who had the experience and the expertise 

to determine whether their agencies would succeed or fail. The 

same is true here. Ultimately the employees of the two Government-sponsored enterprises and the Federal Housing Finance 

Agency (FHFA) will determine whether a new start-up agency succeeds or fails. 

Uncertainty surrounding how many jobs will be available, on 

what terms, and who will get them will create significant complications in ensuring a smooth transition. There may not be answers 

to all of these questions, but employees can understand that as 

long as they are kept informed in a timely manner and believe they 

will be treated fairly, even if there aren’t enough jobs for everyone 

at the end of the transition. 

Q.3. Please discuss whether or not licensing of Fannie Mae and 

Freddie Mac’s assets can be an important tool in managing their 

wind down in a manner that maximizes value and minimizes disruption to the housing finance market. Are there other authorities 

that could be helpful to a regulator in managing their wind down? 

A.3. Licensing certain of Fannie Mae’s and Freddie Mac’s key assets could be helpful in certain situations in order to preserve value 

and minimize disruption. This would allow the Government to obtain additional revenue by selling licenses to a number of privatesector firms. For other assets where licensing isn’t appropriate, it 

would be important to ensure that they are sold through open and 

competitive processes rather than through negotiated sales. It may 

also be valuable to form partnerships with private-sector participants for the management and sale of certain assets. Such partnerships have served the FDIC well in maximizing value from its 

failed-bank receiverships. 

Q.4. Should a common securitization platform be fully operational 

before the old system is shut down? Are there other goals that 

should be achieved before the old system is shut down to help 

make the transition as effective and smooth as possible? 

A.4. As a general matter, to ensure a smooth transition, it is important not to shut down one system before its replacement is operational. This may mean some extra costs in the short run, but stability to the system is too important to risk otherwise. Thus, some 

patience and flexibility in approach is required as transitions as 

complicated as a moving to a new housing finance system generally 

don’t move as fast as one hopes or initially anticipates. 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM MARK ZANDI 

Q.1. Acting Director DeMarco indicated that FHFA is planning further increases to guarantee fees. Do you believe further increases 

are justified in light of current market conditions? 

A.1. No, I don’t believe further GSE G-fee increases are appropriate at this time. The housing recovery has been hurt by the 

close to 100 basis point increase in fixed mortgage rates over the 

past year. The housing recovery is vital to the broader economic recovery, job growth and lower unemployment. With the Federal Reserve tapering its bond-buying program, long-term interest rates 

75 

are likely to rise further in coming months. In this context, increasing G-fees and thus mortgage rates would not be productive at this 

time. 

While it is desirable for the GSEs to reduce their footprint in the 

mortgage market and allow more private lending to occur, private 

lending remains constrained. The private residential mortgage 

backed securities market is moribund due to a range of factors, including a lack of regulatory clarity over such things as the QRM 

rule, and will be unlikely to provide sufficient credit, at least not 

for much of 2014. 

The current G-fees charged by the GSEs is consistent with an approximately 2.5-percent capitalization (this estimate is based on a 

number of assumptions). While this is an insufficient level of capitalization for the housing finance system in the long-run, it is sufficient for the very immediate future. 

Q.2. Should a new system be designed to issue a single security regardless of how many guarantors or issuers there may be? If so, 

how should the issuance of a single security be structured during 

transition? How should the issuance of new guaranteed MBS be introduced while ensuring that legacy GSE securities do not become 

orphaned? 

A.2. Yes, the future housing finance system should be designed to 

issue a common Government-guaranteed security. This would improve liquidity in the TBA market and result in lower mortgage 

rates. A common security would also lower entry barriers into the 

guarantor market, as no guarantor would have an advantage because of the liquidity of the securities they back. 

This is a problem in the current housing finance system, as 

Freddie Mac securities are much less liquid than Fannie Mae securities. Fannie and Freddie split the MBS market 60–40, but on a 

typical day the trading volume of Fannie MBS is 10 times greater 

than that of Freddie MBS. To compensate, Freddie is forced to 

charge a lower G-fee than Fannie. There are some modest differences in the securities—Freddie pays investors more quickly 

than Fannie and its securities prepay a bit more quickly—but the 

key difference is their liquidity. This liquidity difference makes the 

mortgage market less efficient and less competitive, and leads to 

higher costs for mortgage borrowers and taxpayers. 

A potential fix to this problem in the transition would be to make 

Fannie and Freddie securities fungible, creating a common TBA security. That would require a change to the good-delivery guidelines 

for TBA, to allow the delivery of either Fannie or Freddie securities 

into the same contract. The securities themselves would not 

change; their separate TBA markets would simply be merged. Both 

securities would still be separately identifiable and tradable, only 

the TBA trades would be merged. Not only would this interim step 

improve liquidity, it would demonstrate investor interest in a truly 

common security that would be an important feature of the future 

hybrid housing finance system. 

The future housing finance system should not orphan the cur- rently close to $5 trillion in legacy MBS that are already guaranteed by the GSEs and effectively backed by taxpayers. Any reform 

process should make clear that the United States will stand behind 

76 

these legacy obligations. In effect, legacy GSE MBS would become 

like Ginnie Mae MBS, with a full faith and credit wrap guarantee 

on the entire security. 

Legacy MBS should also be made fungible with the new Government-backed MBS. This would require a restructuring process 

whereby holders of these legacy MBS can convert them into the 

new MBS, deliverable into the new TBA market. While there would 

be some technical issues, including requiring a new CUSIP number 

and a matching-up of payments delays, they could be easily addressed. 

Q.3. Should a common securitization platform be fully operational 

before the old system is shut down? Are there other goals that 

should be achieved before the old system is shut down to help 

make the transition as effective and smooth as possible? 

A.3. Yes, a common securitization platform should be fully operational before the old system is shutdown. The CSP would produce 

a more liquid market, facilitate loan modifications in future 

downturns, and give issuers operating flexibility at a low cost. It 

would also allow for a robust TBA market. 

The CSP would leverage current efforts by the FHFA to develop 

a single platform for Fannie Mae and Freddie Mac securities. For 

a fee, the securitization facility would provide a range of services, 

including mortgage loan note tracking, master servicing, data collection and validation to improve transparency and integrity, and 

bond administration. 

Mortgage loans included in securities that use the CSP (including all mortgages that benefit from the Government guarantee plus 

some nonguaranteed loans) could be covered by a uniform pooling 

and servicing agreement and uniform servicing standards that encourage prudent underwriting and align investor and borrower interests. This would encourage the adoption of similar standards for 

other mortgages. 

The CSP would permit multiple originators to sell mortgages into 

single securities with access to the Government guarantee. In return, the originators would receive pro rata shares of the security. 

Pooling requirements would be largely the same as for typical single-originator securities, and they would be good for delivery into 

the TBA market. Originators could thus easily convert securities to 

cash before the securities were created, an especially important feature for smaller originators. 

Other goals that should be achieved before the old system is shut 

down include the issuance of a common Government-guaranteed 

security (see response to Question 2), and well-developed risk-sharing by the GSEs. Enticing private capital back into the housing finance system is part of the transition to any future housing finance 

system. It is thus encouraging that the FHFA has mandated 

Fannie and Freddie to begin that process through risk-sharing with 

capital market investors and private mortgage insurers. The goals 

so far are modest and should be steadily expanded. What is learned 

from these efforts will be instrumental to ensuring there is enough 

private capital to support the future housing finance system. 

77 

RESPONSES TO WRITTEN QUESTIONS OF 

CHAIRMAN JOHNSON FROM DAVID MIN 

Q.1. In the written testimony you provided you state, ‘‘Regulators 

should be given greater discretion and encouraged to respond to developments on the ground . . . .’’ How can a regulator set capital 

requirements in a manner that protects taxpayers while keeping in 

mind broader market dynamics, including access to credit? 

A.1. As I state in my written testimony, determining the specific 

level of capital necessary to protect taxpayers from losses is a 

largely empirical question that ought to be studied in great detail. 

A number of factors are still unknown, including, importantly, how 

much investment capital will come into the new system contemplated by Corker-Warner and at what price. With that being 

said, I would offer the following principles in thinking about how 

to balance the different policy objectives of reducing taxpayer risk 

and keeping access to credit broadly and consistently available. 

First, capital requirements for the new MBS issuers should generally be harmonized with those for other financial institutions, in 

order to prevent capital arbitrage. 

Second, consistent with many of the proposals put forth in Basel 

III and by U.S. banking regulators, it is appropriate to think about 

countercyclical capital measures, such as contingent capital or 

countercyclical capital buffers. Regulators may also consider following the lead of the Federal Reserve and conducting stress tests 

to ensure that banks are sufficiently capitalized during credit expansions. On the flip side, during credit downturns, it is necessary 

to ensure sufficient liquidity, either through relaxing countercyclical capital requirements or other activities. 

Finally, in thinking about the ‘‘right’’ level of capital that the 

new MBS issuers should hold, it may be worth considering the 

highly disparate performances of different mortgage products. 

While bank capital requirements currently do not differentiate between different types of home loans, or different types of MBS, the 

starkly different delinquency rates between say 30-year fixed-rate 

mortgages originated for Agency securitization and 5-year adjustable-rate mortgages originated for private-label securitization suggest that such a differentiation may be quite appropriate. Such an 

approach would be somewhat consistent with the treatment of 

home loans under Basel III’s new standardized approach, and with 

the Qualified Residential Mortgage exemption to risk retention 

under Dodd-Frank. 

Q.2. Should a common securitization platform be fully operational 

before the old system is shut down? Are there other goals that 

should be achieved before the old system is shut down to help 

make the transition as effective and smooth as possible? 

A.2. As I stated in my written testimony, I believe the overriding 

policy goal of any transition should be to do no harm. Thus, it is 

imperative that the new common securitization platform (CSP) be 

fully operational before we shut down the old system. But any such 

endeavor will inevitably have unexpected developments. Therefore, 

testing out the new system is clearly necessary before the old system is shut down, to avoid jeopardizing the mortgage markets and 

the broader economy. This reasoning is why I strongly advocate a 

78 

piecemeal approach to transition. The new system should start 

with small dedicated pieces of the business currently held by 

Fannie and Freddie, such as 15-year fixed-rate mortgages or high 

cost conforming mortgages, before moving on to absorb larger 

chunks of the conforming market. Such an approach would allow 

regulators to work out the kinks in the new system before shutting 

down the old one.